International Conference on Innovative Agricultural Financing

Promoting Agriculture Financing through

Islamic BanksChallenges & Opportunities

28 – 29 April 2015

Akram KhalidVice Chairman, SC FPCCI

Demand & Supply of Agriculture Credit

Perceived Demand Over 985 billion Rupees Increasing @ 14.6 percent annually

Disbursements – InstitutionalPublic Sector Banks = 5Private sector = 22* (Islamic* = 5)Foreign = 7Specialized = 4Microfinance = 10

389 billion Rupees (30-JUN-2014)Increasing @ 8.6 percent annually

Outreach 2.1 million borrowers against 8.3 million farm households

Agriculture Credit in total lending 5.7 percent

Disbursements - Non InstitutionalAarthi / middleman

61 percent approx

Basic Comparison – Bank vs Aarthi

• Institutional lending : 39 percent• Aarthi & Middleman : 61 percent

Interest / Mark-up• Institutional lending: Up to 30 percent• Aarthi / Middleman: Up to 80 percent• Security / Documentation:• Institutional lending: All legal documentation

+ collaterals• Aarthi / Middleman: PDCs in rare cases

Basic Comparison – Bank vs AarthiAgriculture credit appetite: Rs. 985 billion

DESCRIPTION INSTITUTIONAL NON-INSTITUTIONAL

Lending 39 percent 61 percent

Cost to farmer Up to 30 percent Up to 80 percent

Security Complete documentation plus collaterals

Negligible documentation. No security. In rare cases PDCs are required

Processing time 3 to 10 days Immediate (mostly)

Default Percentage is negligible compared to banks. But Aarthis normally do not initiate legal proceedings for recovery

Minimum Farm Size 12.5 Acre 1 acre

What makes Aarthis Successful?Aarthis charge exorbitantly high rates of interest yet farmers prefer

to borrow from Aarthis instead of institutions. Why?• Aarthi is an integral part of the rural society; he is available to the

farmer 24 hours just like a family member• Aarthi takes immediate decision when a farmer approaches him• While Aarthi’s decisions are motivated by profit, the comfort level

of farmer makes him indispensible• Aarthi is his own boss so he can bend his rules according to

circumstances• Aarthi normally does not require documentation, nor any

security. For new farmers, he might obtain post-dated cheques• Aarthi extends support to farmer not only in farming but also in

routine daily life requirements. He extends support on occasions of marriage, funeras, eid; even in buying clothing

How Aarthi Operate?• Aarthi operates from the commodity market; banks do not

• Aarthi is integral part of the wholesale markets system; banks are not

• Distributors find it convenient to supply inputs on credit to the farmer at his farm; banks cannot get involved in such deals

• Aarthi is involved in functions such as picking of crop (large farmers), storage, transportation, auction process, rate determination; banks have no role in these processes

• Aarthi and farmer might know each other for generations; banks do not have such a connection

• If there is a default, Aarthi would not let him die. He will extend more support to help him repay the loan

Punjab Government’s Initiative

Bill passed in the Punjab Assembly Prohibition of Private SectorMoney Lending Act 2007”

Now private money lending has become a non-bailable offence with 10 years of imprisonment and Rs. 500,000 fine

Some bankers are of the view that it will affect the Aarthis business

But it is yet to be seen. If it does, it will adversely affect the farming community as well

Islamic Banking

Concept: (1) Welfare & (2) Share in Profit & Loss• Risk averse in financing transactions • LIBOR & KIBOR are used as benchmark for product

pricing• Murabaha is a major lending product• Ijarah is a hybrid model of the operating & finance

lease• Mudarabah & Musharika are considered by majority

of ulema to be real financing modes• Bai Salam is said to be an approved form of Islamic

financing for agriculture community

Islamic Financing ProductBai Salam / Bai Salaf means “to give in custody”. It is said to

be an approved form of Islamic financing for agriculture community

• This product is said to be in line with the specific guidelines of the Holy Prophet

• It is a sale transaction • Seller undertakes to supply some specific goods to the

buyer at a future date • Advance price fully paid on spot • It is not Loan but a forward sale contract• Seller and buyer can agree on any price at their free will• Price in Salam can be lower than the spot sale price

Conclusion/Recommendations• Agriculture sector is vital for Pakistan’s economy. Its growth

will ensure:– National Food security– Provision of raw material for our major industry (textile). Half of our

foreign exchange is coming from textile exports• Agriculture sector needs innovation and modernization for

growth & development• Innovation and modernization need investment and financing • Despite progress, our agriculture has not been able to become

competitive in the international markets and attractive for investors & financial institutions

Conclusion / Recopmmendations

• We need out of box solutions to create win-win situation for farmers, investors and banks

• Herewith are two proposals:

1. We need to move towards corporatization with a touch of cooperative model

2. We need to establish NBFIs to work on the pattern of Aarthis

Corporatization

• Small farmer is living hand to mouth for centuries• Rural youth is not willing to continue with the profession• Banks do not find it attractive to finance to the farmers

especially the smaller farmers• Private sector investment can help establishing

cooperative models, modern farming techniques and value addition

• Banks will be comfortable to lend to the corporate entities

• Government should develop legal framework for protection of farmers’ rights

Establishing NBFIs

• Establishing NBFIs should have the potential to compete with Aarthis

• SBP should make regulations for NBFIs to work on the pattern of Aarthis

• NBFIs should be allowed to seek deposits from public and loans from banks

• Any Aarthi or a group of Aarthis who can fulfill the regulatory requirement may be allowed NBFI license

Thank you

ECONOMICS OF COST BENEFIT ANALYSIS OF BAI SALAM TO FARMER AND MICRO FINANCE BANK

Example of Wheat has been taken as it is cultivated over largest area i.e., approx. 9 Million hectares (1 hectare = 2.485 acres) Crop ProductionInput Cost @ Rs. 15000 / AcreGross Expenditure on cultivation of 12.5 Acres = Rs. 187,500Gross Production (12.5 acres@1400 Kgs per acre) = 17500 Kgs. Wheat Support Price of Govt. for 2013 is Rs.1250 per 40 kgsTherefore Gross value of production of 17500 Kgs. = Rs.546,875 The above calculations show that a farmer investing inputs of Rs.187,500/= in his land will be able to get agri produce worth Rs.546,875/= after a period of 7 months.

• Therefore a Bai Salam Bank will negotiate the price of Rs.546,875/= worth of agri produce keeping in view the profit margin it wants to retain on the investment. Suppose the Salam Bank contracts to purchase the produce for Rs.450,000/=, then it will be a WIN WIN situation for both the Bank as well as the Farmer - the Bank getting a phenomenal profit of around 36% on its investment and the farmer getting a net income of Rs.450,000/= as compared to Rs.337,500/= in case of Loan from Aarthi (Benefit of Rs.112,500/=)as detailed below:

• Under the Aarthi system the farmer will get a loan of Rs.187,500 for farm input and has to pay back Rs.375,000/= PLUS 4% commission of Rs.21,875 on farm produce (4% of Rs.546,875). Therefore the farmer will be left with meager income of Rs. 337,500/= (Rs.546875+187500-375000-21875).