UNNExT Workshops on Trade Facilitation

Almaty, Kazakhstan 4-6 May 2015

UNNExT Workshop on Paperless Trade Facilitation for Small and

Medium-Sized Entreprises

30 April 2015

Introduction to Islamic Finance

for Agriculture and SMEs

Dr Abdelkader ChachiSenior Training Specialist & Economist Researcher

Islamic Research and Training Institute, Islamic Development Bank, Jeddah, KSA

Presented at the Workshop organised by UNNExT onTrade Facilitatio : Paperless Trade Facilitation for

Small and Medium-Sized Enterprises in Central Asia

Held in Almaty, Kazakhstan, 4-6 May 2015

30 April 2015 2

1. Importance of Agricultural Sector

2. Problems faced by Agricultural Sector

3. Importance of SMEs

4. Finance Needs for SMEs

5. Introduction to Islamic Finance

6. Islamic Finance for Agriculture and for SMEs

7. Conclusion

Outline of the Presentation

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◊ Agriculture is probably the first economic activity performed by human beings, if we

add to it hunting, fishing and cattle breeding.

◊ Agriculture remained for centuries the most important economic activity in the entire

world.

◊ Agriculture is still a major source of livelihood throughout the world, especially for

the majority of poor people living in rural areas in developing countries.

◊ Agriculture sector contributes about 40% of worldwide employment and 100% of

food production.

◊ Despite the discovery of industry, trade and other services that became rival to

agriculture, agriculture was and still is the primary source of food security for the

world s populatio s.

Importance of Agricultural Sector

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◊ Increasing agricultural production is required in all countries, especially in

developing countries to feed the increasing populations.

◊ Investment in agricultural sector is critical for driving global economic growth.

◊ A key challenge for the majority of farmers all over the world is access to finance.

◊ Lack of access to finance is a key impediment to farmers in improving the

efficiency of their productions and adopting better technologies.

◊ Therefore, funding it is a necessity in to support economic growth, sustain

economic development, and ensure food security, youth employment, increase

food supply and reduce inflation, etc..

Importance of Agricultural Sector

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1. The small size of the cultivated areas in some countries

2. The urban expansion in the countryside.

3. The exodus from the countryside towards the cities.

4. The small size of properties.

5. The fluctuation of agricultural production (depending on rain from year to year) and

prices.

6. The desertification (where agricultural land became non-productive).

7. The lack of financial support for agricultural projects.

8. The failure of financial authorities and laws to meet the demand for Islamic finance

9. The lack of encouragement to engage in agriculture.

Problems Facing Agricultural Sector

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◊ Small and medium-sized businesses account for more than 90% of private sector

companies and provide more than 60% of private sector jobs.

◊ However, these businesses are all too often overlooked and grossly underestimated by

policy makers, bankers and other financers.

◊ Often the hardest part of starting a business is raising the money to get going. The

entrepreneur might have a great idea and clear idea of how to turn it into a successful

business. However, if sufficient finance cannot be raised, it is unlikely that the business

will get off the ground.

◊ The economic importance of small and medium businesses has grown dramatically in

developed countries since 1980s

Importance of SMEs

Sabine Vinck Importance Of SMEs Is Grossly U deresti ated http://www.forbes.com/sites/lbsbusinessstrategyreview/2014/12/12/importance-of-smes-is-grossly-underestimated/2/

Lim Riley (2012) "Sources of finance for startups and SMEs http://www.tutor2u.net/business/finance/finance_sources_smes.htm

30 April 2015 7

◊ Much attention has been paid to small firms worldwide due to their potential for generating jobs

and economic growth.

◊ Small and medium enterprises (SMEs) are increasingly seen as playing an important role in

the economies of many countries. Thus, governments throughout the world focus on the

development of the SME sector to promote economic growth.

◊ For example the UK now has more than one million small businesses than it had in 1979. As a

result, it is now accepted government policy that the small firm sector is the main vehicle for

recovery from recession and the main provider of jobs.

◊ Similarly in the US, the economy passed a milestone of great importance in 1979 by the shift

from industrial manufacturing economy composed of large firms to an entrepreneurial economy

driven by information and innovative technology (Wetzel, 1996).

Importance of SMEs

Sabine Vinck Importance Of SMEs Is Grossly U deresti ated http://www.forbes.com/sites/lbsbusinessstrategyreview/2014/12/12/importance-of-smes-is-grossly-underestimated/2/

Lim Riley (2012) "Sources of finance for startups and SMEs http://www.tutor2u.net/business/finance/finance_sources_smes.htm

30 April 2015 8

◊ Access to finance

◊ All businesses require financial resources in order to start trading and to fund growth.

◊ Lack of access or availability can be a constraint on business growth.

◊ Whether business owners can access adequate and appropriate finance to grow is a

particular concern for policymakers.

◊ New SMEs can e fi a ed fro fou ders ow wealth a d/or by accessing external sources

of finance, whether fro i for al sour es su h as fa ily a d frie ds, or fro for al , market-based sources such as banks, venture capitalists and private equity firms.

◊ Once businesses are trading, further development can be financed using retained profits.

Finance Needs of SMEs

http://www.forbes.com/sites/skollworldforum/2013/08/26/financing-agricultural-growth-in-africa/

30 April 2015 9

◊ The preservation of wealth is one of the 5 main Objectives of Islamic “hari ah (Maqasid Al-

“hari ah). These are the preservation of:

Deen (religion)

Nafs (life)

Aql (mind)

Nasl (progeny)

Mal (wealth)

◊ Anything that affects any of these objectives positively is welcomed in Islam and anything

that affects any of them negatively is not acceptable.

Introduction to Islamic Finance

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◊ The Islamic “hari ah is made up of two components. These are:

Ibadat (Worship Rites)

Mu a alat) (Transactions)

◊ Any innovation in Ibadat is not acceptable.

◊ Every Mu a alat (transaction) is acceptable in Islam as long as it does not involve one or

more of the prohibited ones such as Riba (usury & interest), Gharar (deception), Qimar

(gambling), Ihtikar (monopoly), Iktinaz (hoardding), Mujazafah (speculation), etc..

◊ Therefore, the Muslims could have their own Financial or banking System that complies with

the rules of the Islamic “hari ah, as long as they avoid the prohibited transactions.

Introduction to Islamic Finance (cont.)

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◊ Permission of all transactions that do not involve any prohibition.

◊ Prohibition of Riba (Interest/Usury) is perhaps the most eminent.

◊ Prohibition of contracts involving Gharar (excessive risk, deception and uncertainty).

◊ Prohibition of Qimar (gambling), Iktinaz (hoarding), Ihtikar (monopoly), Israf (extravagance),

Fasad (corruption), Mujazafah (speculation), Ghish (deception) Tadlees (fraud) Kathib (lying),

Sariqah (stealing), etc..

◊ Prohibition of dealings involving Khamr (intoxicants), Khinzir (Pork), and all unethical

dealings such as prostitution, stealing, etc..

◊ Selling what is not owned or possessed.

◊ Selling Fruits before they are ripe.

◊ Selling debts.

Introduction to Islamic Finance (cont.)

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As Sami Suweilem put it the Islamic Financial

System is based on two fundamental pillars:

For-Profit Domain or Business Sector

Non-Profit Domain or Charitable Sector

For Islamic Finance to be successful it must

take a balanced approach and implement the

2 pillars at the same time.

Introduction to Islamic Finance (cont.)

Like a bird, an economy needs the two sectors to fly

Sami Suweilem (2011) "Introduction to Islamic Finance", power point presentation

delivered to the Staff of the World Bank through video-conferencing

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◊ Islamic Modes of Finance for Agricultural Sector

◊ Islamic banks and other Islamic financial institutions may apply the following Islamic

contracts to specifically finance agriculture:

1. Muzara ah Contract (between an owner of a land and a farmer who is ready to work in it.

They share the yields as agreed 50-50% or 40-60%, for example)

2. Mugharasah Contract (a landowner gives a farmer a land to plant fruit trees to be partners

in the land and trees when they bear fruits)

3. Musaqah Contract (Use someone in watering fruit trees of an existing orchard and share

the yields as agreed 50-50% or 40-60%, for example)

4. Salam Contract (the financier advances money to a farmer in order to receive a certain

amount of a measured quantity and described quality of a crop)

Introduction to Islamic Finance (cont.)

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◊ Islamic Modes of Finance for Business Sector

◊ Islamic banks and other Islamic financial institutions may apply the following

Islamic contracts to finance agriculture, SMEs or any business either directly if

the country's laws allow it, or through subsidiaries:

1. Musharakah (Partnership/joint venture). A contract in which two or more

investors pool their funds for a project and share its profits and losses

2. Mudarabah contract under which the Mudarib (entrepreneur) manages the

funds of Rabb al-Mal (investor) for a percentage on any profits made.

Financial losses to be born by Rabb al-Mal.

Introduction to Islamic Finance (cont.)

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◊ Islamic Modes of Finance for Business Sector (cont.)

3. Murabahah (Markup sale) a contract of sale in which payment is made some

time after delivery of the goods transacted with a pre-agreed higher price

4. Bay Mu ajjal sale on deferred payment: allows the buyer to pay for the

goods over a series of instalments.

5. Ijarah (Leasing) hire of an asset for an agreed rental for a fixed period.

6. Ijarah waqtina (Hire Purchase) same as Ijarah, but that at the end of the

contract the asset leased becomes the property of the lessee.

Introduction to Islamic Finance (cont.)

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◊ Islamic Modes of Finance for Business Sector (cont.)

7. Jo alah: A Commission or a reward for doing a specific job or rendering a

specific service.

8. Istisna commissioned manufacture made-to-order in which the manufacturer

designs and makes the product in accordance with the buyer's wishes.

9. Tawarruq: Buying a commodity on deferred payment then selling it for cash to

a different buyer than the original seller.

10. Sukuk: Certificates of investments in a project for a specific period with a

promise of a share in the proceed of the investment.

Introduction to Islamic Finance (cont.)

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◊ Islamic Modes of Finance for Charitable Sector1. Nafaqah: obligatory spending for designated relatives: parents, family and close

relatives.

2. Zakah (compulsory charity) 2.5% of savings given annually to the poor and needy. One

of the 5 pillars of Islam.

3. Sadaqah (voluntary charity) very much recommended by Islam in addition to help the

poor and destitutes.

4. Awqaf (endowments) perpetual charity.

5. Takafol (Mutual or cooperative solidarity or insurance). Participants pool their funds as

a provision against any losses to life, limb, or property that one of them may suffer.

6. Qard Hassan: interest-free loan.

Introduction to Islamic Finance (cont.)

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◊ Islamic Finance is offers a number of alternative modes of finance that can suit

any business, whether in agriculture, for SMEs or any other business.

◊ Contrary to conventional finance which lend finance on interest, that the client

has to pay or face bankruptcy, The client of Islamic finance has a number of

choices to select from.

◊ In most of the Islamic contracts of finance, the client loss is limited to his share

in the capital of the project or to his reward in the contract and he does not

need to guarantee the capital and interest to the financier.

Conclusion

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◊ Islamic Finance is ethical

◊ Islamic Finance is fair

◊ Islamic Finance is balanced

◊ Islamic Finance is more stable

◊ Islamic finance provides more choice of financial products

◊ Islamic finance deals in real economy

◊ Islamic finance prohibits all forms of exploitative means such as gambling, fraud,

speculation, monopoly, etc..

◊ Islamic finance is spreading all over the world including Non-Muslim Countries

Conclusion

2030 April 2015

شكرا جزياThank You very much

Merci Beaucoup

Muchas Gracias

Email: achachi@isdb.org

Tel. +966-12-646 6229

Fax. +966-12-637 8927

Website: irti.org