Islamic Approaches of Microfinancing

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banks 268 financial 257 finance 242 agricultural 232 agriculture 185 credit 132 islamic 122 commercial 111 loans 102 sudan 99 government 94 institutions 91 risk 86 development 75 salam 74 farmers 65 rural 63 lending 62 policy 56 deposits 52

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islamic development bank islamic research and training institute on the experience of islamic agricultural finance in sudan challenges and sustainability adam b
box jeddah kingdom of saudi arabia tel fax email aelhiraika isdb

C islamic development bank islamic research and training institute king fahd national library cataloging in publication data elhiraika adam b on the experience of islamic agricultural finance in sudan challenges and sustainability
isbn the views expressed in this paper are not necessarily those of the islamic research and training institute or of the islamic development bank

the role of salam in promoting islamic agricultural finance in sudana a a a a a a a a a a a a a a a a a
conclusion and recommendations referencesa a a a a a a a a a a a a a a a a a a a appendix data format and questionnairea a a a a a a vii

mustafa and mister badreldin abdelmageed of the bank of sudan for their efficient assistance and facilitation of data collection
i wish to express my sincere gratitude to him and to other participants at irti staff seminar for their constructive remarks

in the light of international rural finance experiences the experience of sampled financial institutions prevailing institutional constraints and incentives and the nature of islamic modes of finance the study draws policy recommendations for promoting agricultural finance in sudan in terms of establishing autonomous market oriented and decentralized rural finance institutions that can serve agriculture as well as other sectors
the present study deals with the important question of how to develop the agricultural financial market and to promote wider outreach and financial self sustainability among agricultural financial institutions in sudan where all these institutions operate according to shariah principles

i hope that the publication of this paper will contribute to a better understanding among researchers policy makers and other stakeholders of the problems of islamic financial institutions and instruments in relation to agricultural finance in member countries
i also hope that the paper will stimulate further research in this important area

this policy shift coincided with the full adoption of islamic modes of finance in the entire financial system in and led to remarkable increases in formal agricultural loans from just about of total bank credit in the s to about in
in addition to supplying raw material to other sectors such as manufacturing agriculture also plays a major role in government efforts to ensure food security

the next section reviews the literature on agricultural finance covering the need for farm credit the reasons for both limited formal agricultural finance and observed widespread failure of directed agricultural finance progra miss we then examine the argument for an alternative market based financial service to agriculture with special attention to the lessons learned from recent successful rural finance experiences in some developing countries
in this survey we aimed to gather information on such items as the size number and maturity of various bank assets nature of sources of funds various costs and rates of return and institutional structures and policies relating to bank operations and management

yaron et al that financial services matter for the rural producers while the existing sources of finance formal and informal are not sufficient to accelerate income growth entrepreneurship in agriculture is constrained by lack of access to a wider range of financial services the availability of which will be welfare improving from a social perspective and that there is now a better understanding of the basic requirements of providing farm credit
in addition to channeling external resources to agriculture financial intermediaries can facilitate the transfer of savings within agriculture assist in appropriate risk and liquidity management and better use of financial surpluses and other assets and provide an array of valuable noncredit services

the concept of credit needs has been strongly criticized because it ignores risk and alternative ways to achieve development objectives von pischke and raises a number of conceptual and practical proble miss first focusing on credit needs overstates the role of credit and underestimates alternative sources of finance including informal and farmers own savings
improved farmers access to credit therefore requires not just credit policies that force banks to lend to agriculture but also improved opportunities for economic growth institutional development as well as financial innovations that are tailored to the needs of farmers von pischke

in summary worldwide experiences corroborate that the institutional design and objectives of public agricultural credit programs agencies creates a poor credit culture manifested by a dependency on subsidies low recovery rates inadequately diversified portfolios mis targeting of credit and rent seeking behavior on the part of credit officials and influential farmers
as gonzalez vega and graham point out ultimately specialized development banks lack institutional and financial viability as often reflected in their inability to expand declining lending capacity inability to mobilize resources increased dependence on government subsidies and high rates of default

the new direction builds on the successes of several microfinance institutions and suggests that the successful provision of agricultural credit requires a market perspective that encourages the design of financial products that suit farmers preferences and capacity to repay stresses the significance of mobilizing savings and enhancing financial independence rhyne and otero

these include lack of required expertise and the business culture needed to establish sustainable credit services limited range of financial products inability to expand and to mobilize savings because of legal restrictions and absence of formal regulation and supervision system
they operate like a special category of banks and under separate regulation and supervision mechanis miss whether cucs operate as formal or informal micro lenders they tend to have better ability than banks to screen appraise and monitor borrowers because of social group pressure and superior information on borrowers gurgand et al

therefore instead of trying to drag traditional banks into microcredit it may be preferable to create new and fully specialized banks that are committed to the expansion and sustainability of microfinance
but the ability of banks to engage in microcredit may still be constrained by lack of expertise in microfinance and the temptation of sticking to the traditional banking functions

ultimately government intervention should be limited to removal of the causes of market failure by such means as temporary and transparent grants or subsidies for generation of information and institutional development and capacity building and by providing seed capital and refinancing facilities for term lending
in muzara financing one or more individuals enter into a contract to invest in an agricultural enterprise or operation whereas musaqah is a musharaka agreement involving orchards trees or crops in which one party provides

from shariah viewpoint the validity of the murabaha contract hinges on the condition that the bank must own the asset financed before the transfer of the ownership right to the client who placed a promise to buy and not a purchase contract
because of fluctuations in agricultural price and the cost of storing crops crop price represents a major source of risk for lenders on top of counterpart risk that includes failure to supply the goods agreed upon on time completely or partially

on the other hand if the client is given the option not to accept the goods at the time of delivery the bank faces additional risks since the bank would have already paid for the goods supplied by subcontractors

they concluded that because of the sharing of risk and outcome of joint efforts of the capital owners and the entrepreneurs the recovery rates are quite high
first credit risk is highest in pls modes musharaka and mudaraba in general and lowest in murabaha followed by ijara and istisna respectively

outreach may be measured by a hybrid index of indicators including number of clients and bank branches the value of loan portfolio and its annual growth the percentage of female clients the average loan size distribution of bank services transaction costs flexibility and suitability of services and so on

this includes analysis of the risk return and recovery aspects of the islamic agricultural financial instruments in sudan in addition to the size and maturity of formal finance to rain fed and irrigated agriculture legal and institutional constraints inadequate information collaterala
supply side constraints such as meager bank capital and other resources liquidity lack of expertise and so on and strategies for dealing with these problems are also covered

the specialized banks represent an interesting mix comprising the agricultural bank of sudan the largest and fully state owned bank the farmers bank and the animal resources bank that are dominated by private capital and the savings and social development bank which is a government owned bank that specializes in agricultural as well as other types of development financing

economic environment and policies and the role of agriculture in sudan in this section we discuss the main features of the general economic environment including the structure of aggregate output the nature of agriculture and the key economic developments and policy issues affecting the performance of agriculture and or the agricultural financial market for the period under review

first irrigated agriculture which accounts for about of the total cultivated area in the country and uses modern technology and inputs to produce a variety of crops including wheat cotton groundnuts sorghum and vegetables
on the other side table also signifies the domination of the domestic credit market by the government with a private sector share that never exceeded during the period

structure of the agricultural financial market and the role of commercial banks this section begins with an overview of the institutional structure of the agricultural financial market in sudan the changing role of commercial banks and the main islamic instruments of agricultural finance
because of monopoly power tadamn bank khartoum bank al gareb islamic bank elnielen group bank sudanese islamic bank and the islamic cooperative development bank

in and in the context of the nesp the government directed commercial banks to assume the responsibility for agricultural finance both by lending to farmers directly and indirectly through a commercial banks consortium
this type of financing is acceptable from shariah perspective except that it often entails an unfair share for the provider of labor who is normally a landless rural poor and that some contracts do not allow for loss risk sharing

in addition to the above institutions the ministry of finance has always been involved in the agricultural financial market through provision of funds for capitalization of specialized state banks re lending through both specialized and commercial banks and lines of credit to both banks and agricultural corporations responsible for financing such as the sudan cotton corporation
figure structure of the formal agricultural credit market in sudan formal agricultural credit market banks non banks bos commercial specialized mof other cbc direct lending abs fb arb notes bos bank of sudan mof ministry of finance cbc commercial banks consortium abs agricultural bank of sudan fb farmers bank arb animal resources bank

credit on the one hand and inability of the mof to honor its promises on the other the bos always accumulated huge amounts of bad debts in the s and s
according to this arbitrary criterion and by comparing estimated production cost and actual credit provided self finance and informal finance contributed of total agricultural finance in

the commercial banks consortium the commercial banks consortium cbc was set up by the bos in when commercial banks were compelled to contribute to a central agricultural finance fund
in effect the agricultural financial market is presently as dependent on the state as it used to be in the s prior to the liberalization attempts

on the other hand the cbc lending rates are not competitive and were negative in real terms throughout and scheme administrations frequently fail to collect and repay loans in time or in full due to low productivity of agriculture and other factors
thus the average or unit cost revenue of a bank is obtained by dividing its total cost total revenue by its total output

in general the decline in credit is attributable to a host of factors including under capitalization of most banks too high credit risk in sectors other than trade relatively high a namely murabaha cost of borrowing high lending cost associated with such modes as salam lack of credit lines from abroad and high yields on government and central bank musharaka certificates kireyev

these sources include charges on depositors transfers of money and letters of credit sale of foreign currencies purchase and sale of government and central bank certificates and direct equity due to elimination of interest rates in sudan and the fact that subsidized institutions statecontrolled specialized banks are virtually completely dependent on subsidies it was not possible to calculate the subsidy dependence index
real total assets sd bn real total deposits sd bn real savings and investment deposits sd bn real total finance loan deposit ratio source data collected from respective banks notes outstanding finance loans no information on loan flows

within rain fed agriculture formal loans are confined largely to mechanized far miss there is no information on loan maturity but as can be gauged from the share of mudaraba and musharaka agreements medium and long term loans to agriculture account for less than of total financing by commercial banks

the agricultural bank of sudan the abs is the largest and oldest specialized bank in the country established by the government in to supply funds accept deposits and provide various modern farm inputs including improved seeds fertilizers insecticides as well as extension and marketing services

more specifically and aside from the weak macroeconomic environment that prevailed during most of the period under review the abs failed to perform because of its lack of profit orientation state intervention manipulation of funds by influential groups and lack of adequate incentives for both personnel and clients

the main objectives of the bank are provision of agricultural finance in specific and rural finance in general supply of inputs mobilization of savings from rural and urban areas through easy banking and competitive rewards and participation in the establishment of various development and social projects in industry agriculture and other sectors

one of the major reasons for the limited role of the fb in agricultural finance is that instead of being deeply rooted in the interest of and managed by farmers the founders of the bank preferred to run it like any other commercial bank with much of its activities based in the capital
the bank has to compete for deposits with other commercial banks and to do so successfully it has to generate competitive returns by employing its funds in commercial and other activities

the animal resources bank the animal resources bank arb was launched in as a specialized financial institution affiliated to the ministry of livestock resources with the objective of assisting in the modernization of the livestock sector through the provision of various credit and noncredit services
table resource mobilization and allocation by the arb number of branches number of branches in capital real capital sd bn

advances by the ssdb were well distributed among various economic sectors and in the s period the bank provided funds for agriculture industry and housing far in excess of the funds jointly provided by the then three state owned specialized banks including the abs the estate bank and the industrial bank
it was characterized by its huge number of customers which increased from thousand in to thousand in and thousand in with savings and investment accounts representing more than two third of total accounts

in addition to diversification of sources and uses of funds the success of the ssdb in the s was attributed to its character as a fully autonomous development oriented institution as opposed to state controlled banks on the one hand and commercial banks on the other
the ssdb clearly lacks financial selfsustainability yet directed of its agricultural loans in to rain fed agriculture in fulfillment of its welfare mission under the auspices of the ministry of social affairs

table resource mobilization and allocation by the ssdb number of branches number of branches in capital real capital sd mn
source data collected from ssdb notes outstanding loans no information on loan flows information on number of depositors and borrowers was not available

the experience of the ssdb in the s provides a robust further example of the inefficiency of direct government intervention in the rural financial market
figures and display a remarkable contrast between commercial banks and state controlled specialized banks as regards volume of lending to agriculture and overall net returns respectively

the factors affecting the performance of agricultural financial institutions as mentioned earlier the sample includes an interesting mix of commercial banks and specialized banks and that two of the latter banks are public with one abs specializing entirely on agriculture and the other ssdb engaged in both agricultural and non agricultural finance
being less committed to target clients and in the absence of external support private banks that attempt to specialize in agriculture fb and arb can only achieve financial viability by operating like commercial banks providing limited access to agricultural borrowers

table ranking of factors affecting the supply of agricultural finance and the main types of risk and mechanisms for its management salient factors affecting the main types of risk in mechanisms for dealing with supply of agricultural finance agricultural finance risks of agricultural finance

with the acceptance rate of real estate and fixed assets are the most acceptable forms of collateral to all banks followed by mortgages in possessions and letters of guarantee and group guarantees normally provided by farmers unions
many bankers argue that delinquency is common among borrowers some of whom consider access to loans from government banks as a right and demand high flexibility in repayment ter miss in particular salam repayment problems have been aggravated in recent years following the introduction of a beneficence clause called band al ihsan

for of bankers the cost of legal procedures is the most significant legal problem followed by delays in court action cost of liquidating collaterals and the fact that some contracts are not covered by the law
all commercial banks and specialized banks with commercial orientation select borrowers according to the financial feasibility of their projects but established customers are usually preferred to new ones with government directives playing the least effect on the selection of individual borrowers

despite differences across banks analysis of the operational structure of sampled banks reveals an adequate understanding of the risks and challenges faced by islamic banks gained through more than years of experience with islamic finance under various policy regimes
this obviously indicates the lack of incentives for hard work and innovative behavior among staff that would just resign for doing their routine work as expected or instructed by their supervisors

to justify substantial public sector investment in the development of the agricultural financial market the institutions involved must have vested interest in the growth of output and employment in the rural sector
organization of farmers and other small producers through production and services cooperative societies rather than politicized unions that help them to economize on many common inputs such as irrigation mechanized harvesting and so on

the general risks associated with the use of islamic instruments in agriculture comprise absence of compensation for delayed repayment by borrowers whether they are genuine or delinquent loss of capital in cases of investment failure high exposure to price risk high evaluation monitoring and follow up cost costly and lengthy legal procedures lack of adequate guarantees for small borrowers and frequent weather changes and other natural calamities

the role of salam in promoting islamic agricultural finance in sudan in connection with the above discussion on islamic financial instruments and due to its function in propagating islamic agricultural finance in sudan this subsection gives special highlights on the experience of salam and the reasons
absence of need for monitoring and does not have to honor his supervision

however for the reasons stressed below the application of salam declined considerably in irrigated agriculture since the beginning of the financial reform and liberalization program in but increased in rain fed agriculture where the government still obliges specialized banks to provide finance
salam involves upfront cash payments that can be freely utilized by the seller and the cost of salam finance is uncertain as it depends on the difference between contract price and the prevailing price at the time of delivery

figure the use of salam in agricultural finance in sudan of agricultural finance of total finance percent all commercial sampled abs arb ssdb banks commercial banks the prominence of the salam mode also stems from the fact that it is almost the only islamic financial instrument for farmers to obtain the right amount of official cash finance which they can use to cover various needs in the agricultural season

conclusion and recommendations the objective of this study is to examine the key challenges and opportunities for the development of a sound agricultural financial market in sudan in the context of recent macroeconomic and financial liberalization and the full adoption of islamic modes of finance that started in
for example islamic banks can use mudaraba and murabaha modes to finance the fixed and working capital needs of micro entrepreneurs and small farmers who cannot provide sufficient collateral to qualify for finance by conventional institutions

after formulating a phased plan for the development of this market government and donor support should focus on the institutional development in the medium term and later on promoting healthy competition through regulation and supervision in the rural financial market
direct state intervention in the activities of agricultural financial institutions frustrates the development of efficient operational structures distorts incentives allows manipulation of bank lending by influential groups and ultimately nurtures a culture of credit rights that discourages timely repayment

alternatively where fully fledged banks are not feasible or less efficient small farmers and enterprises should be organized along professional or geographical lines to form savings and credit institutions possibly in the form of credit unions and cooperatives societies cucs that serve local farm and non farm credit needs

because of the important specific risks relating to the nature of agriculture on the one hand and the nature of islamic modes of finance on the other farm credit insurance or insurance of the goods financed as explained previously may be critical in stimulating formal agricultural finance
as a general note modernization of livestock and crop production and better marketing plus improved physical infrastructure will boost rural income and incentives to increase production

variable investment in agriculture salam istisna muzaraa leasing ijara muqawala mudaraba diminshing musharaka musharaka murabaha lilalamir bealshraa murabaha real estate other investment in agriculture specify total investment in agriculture number amount total finance to irrigated schemes total finance to rain fed agriculture investment in other sectors e
number amount off balance items premises and fixed assets equipment total assets current account deposits number amount

from central bank share capital retained earnings income statement income from investment in agriculture income from investment in other sectors income from grants concessionary loans a a income from other sources tax concessions total revenue staff expenses total wages and salaries depreciation premises and office expenses total cost other information total distributed profit to depositors provisions for losses bad investment loans write off investment loans number of full time managerial staff number of full time general staff number of bank branches number of bank branches in capital
saving investment deposits number amount total deposits grants e

variable investment in rain fed agriculture salam istisna muzaraa leasing ijara muqawala mudaraba diminshing musharaka musharaka murabaha lilalamir bealshraa murabaha other investment in rain fed agriculture specify total investment in rain fed agriculture number amount
table financing of rain fed agriculture no

for each of the modes of agricultural finance listed below please indicate the key advantages and disadvantages of those employed by your bank
lack of resources from savings grants and so on high cost and relatively low profitability of agricultural investment inadequate training of employees credit policies

how do you deal with farmers who refuse to repay although they can afford to do so confiscate collateral court action arbitration other specify
when do you classify a loan as a bad one after months of non repayment after months of non repayment after

staff incentives are determined according to a flat salary structure and promotion system profit related bonus incentive and promotion system other criteria specify

publications a c published in international refereed journals including the journal of development studies development policy review the middle east business and economic review the journal of agricultural economics canadian journal of development studies savings development iium journal of economics and management eastern africa social science research review and the journal of administrative sciences ksu
conferences seminars attended and contributed research papers in several local regional and international conferences seminars on economic policy issues and finance

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DOCUMENT WORD ANALYSIS

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AlHuda Material\islamic micro

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islam finance fund mfis institute developed agricultural financial bankable oper credit rate client econometric mfi loan program beneficiarie imfi sustain

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Number of Pages

84

Published Date

2005-03-08 14:07:15

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Islamic Approaches of Microfinancing

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