In today’s world, the ever-growing globalization has contributed to the economic development of countries around the world, which unfortunately also leads to income inequality. More than half of the global income is concentrated in the hands of the top 10% of the world’s population.
This opens up the scope of developing financial instruments that can address such challenges. Currently, agriculture-related Islamic financing has been gaining popularity in agriculture-rich countries such as Indonesia, Pakistan and Bangladesh.
In recent years, several Islamic microfinance experiments have been conducted in Muslim-majority nations. By concentrating on the agricultural and livestock sectors, these poverty-alleviation initiatives aim to reduce poverty in rural areas, combat food insecurity and generate livelihoods.
Islamic microfinance institutions have employed a variety of Islamic microfinance methods and instruments in their efforts to serve farming communities both financially and non-financially. Through a survey done in Indonesia’s Java Island, it was found that the Islamic profit-sharing financial model helped farmers to expand their cultivation more sustainably.
As Islamic financial schemes prevent the use of interest and debt-based instruments, this system encourages risk-sharing, promotes entrepreneurship, discourages speculative behavior and emphasizes the significance of contracts. The factors of entrepreneurship and risk-sharing can be an effective tool for development in the agricultural sector, which is characterized by various kinds of fluctuation, especially in terms of crop yield and commodity price.
Review of 2022
As of 2022, unfortunately, only 4% of the global Islamic banks’ financing is channeled to the agricultural sector, compared with 27% for households and 26% for the wholesale and retail trade sectors. In relation to ensuring the food supply, the percentage of a Salam contract is at a negligible level in Islamic banks, reaching merely 4.1%.
In contrast, the markup facilities of Murabahah and commodity Murabahah or Tawaruq are dominantly utilized at 47.4% and 25.7% respectively. As a result, although Islamic financing in agriculture has been growing lately, it has yet to promote just socioeconomic development in the agricultural sector.
Preview of 2023
Through its contribution in the agricultural sector, Islamic financing provides a large opportunity to reduce food shortage, and thus, food insecurity. Food insecurity has become a significant problem following the COVID-19 pandemic and the conflict between Russia and Ukraine. The Global Report Food Crisis 2022 shows that it is the OIC countries that are the most food-insecure regions.
Therefore, these regions could largely benefit from an expansion in agricultural cultivation resulting from the implementation of Islamic financing, especially the Islamic financing method of Salam which specifically aims to ensure food security.
Among the main issues with the agricultural sector in Muslim-majority nations is the absence of a safety net for farmers. This discourages potentially skilled labor from entering the industry. In order to mitigate the risks of crop failure resulting from crises such as climate change, an insurance scheme is required. This is where the use of blended Islamic finance can contribute the most.
As per the deputy head of an Islamic boarding school, Ali Chamani Al Anshory, Islamic finance should best combine Waqf and Salam financing to ensure the most efficient operation of the agricultural sector. The Waqf fund would insure the agricultural project, financed by the Islamic bank employing a Salam contract. As the project is insured by the Waqf fund, the bank has a lower risk, and hence, can offer the product at a competitive rate.
In addition, Islamic microfinance institutions frequently take a ‘project’ approach and offer assistance in a variety of non-financial areas, such as technology, procurement, production, marketing, business development and capacity-building, thereby guiding the project toward success. However, going ahead, the microfinance institutions may have to limit their outreach significantly in order to tackle the challenges faced by the farming communities.
While in the case of credit-based finance, the size of financing per beneficiary is very small, perhaps in the range of US$100, the same is very high in the case of project-based approaches that seek to finance the entire value chain. Such partnership-based agri-finance may necessitate significant upstream investments, thereby classifying them as social impact investments rather than microfinance.
One unexplored possibility in Islamic finance is the establishment of Waqf or endowments to take care of the upstream investments that create permanent or long-lasting facilities for use by farmers. Such investments need not be funded with bank finance. In that case, the quantum of financing per beneficiary will significantly go down and the outreach of Islamic microfinance institutions may be significantly increased.
Conclusion
Overall, with the global Islamic finance market expected to reach a valuation of US$3.02 billion by 2027, we can predict that the scope of Islamic financing in agriculture will also see significant growth, paving the way for greater financial inclusion across the world.
Md Mahmudur Rahman is CEO and co-founder at WeGro. He can be contacted at [email protected].