Islamic Agricultural Business Financing

 

 

To date, agricultural business financing—especially for smallholder farmers—has generally come from the farmers' own pockets. In terms of investment, more than 90 percent of agricultural business investment is funded by the farmers themselves; they are the ones who provide the capital and the ones who worry about whether the investment will yield a return or end in failure.

Commercial banks have largely refrained from this sector, citing high risks and the lack of collateral provided by farmers. On the other hand, I often encounter farmers who refuse to take on debt due to the prohibition of interest (riba). This is a key reason why government agricultural financing programs have met with limited success.

However, as businesses grow, it becomes difficult to forgo financing support, such as bank loans. Conceptually, agricultural financing encompasses a broad scope, including the source of funds, management, and—in the case of loans—repayment terms, among other aspects.

Fortunately, Indonesia has long been developing Sharia-compliant financing that aligns with Islamic principles and operates without interest. This framework is based on Law No. 21 of 2008 concerning Sharia Banking; however, the Law contains no specific regulations—or even a specific entry—for the agricultural sector. Consequently, financing schemes for agricultural and non-agricultural sectors are treated identically.

A Sharia Bank is a bank that conducts its business operations based on Sharia principles; these are categorized into Sharia Commercial Banks (BUS) and Sharia Rural Banks (BPRS). Financing is defined as the provision of funds or equivalent claims through five types of transactions:

a.   Profit-sharing transactions in the form of mudharabah and musyarakah,

b.   Leasing transactions in the form of ijarah or lease-to-own arrangements in the form of ijarah muntahiya bittamlik,

c.   Sale and purchase transactions in the form of murabahah receivables, salam, and istishna’,

d.  Lending transactions in the form of qardh (benevolent loan) receivables, and

e.   Service leasing transactions in the form of ijarah for multi-service transactions.

In conducting business activities based on Sharia principles, Islamic banks apply the concepts of economic democracy and prudence. For agricultural activities, several financing contracts are available for selection:

First, profit-sharing

Profit-sharing may utilize mudharabah or musyarakah contracts. In the context of fund mobilization, mudharabah refers to a cooperation agreement between a first party (malik, shahibul mal, or Customer)—acting as the fund owner—and a second party (‘amil, mudharib, or Islamic Bank)—acting as the fund manager—wherein business profits are shared according to the agreement stipulated in the contract.

Meanwhile, musyarakah is a cooperation agreement between two or more parties for a specific business venture, where each party contributes a portion of the funds; profits are shared according to the agreement, while losses are borne in proportion to each party's capital contribution.

Two, buying and selling

This takes three forms: murabahah, salam, or istishna contracts. A murabahah contract involves financing an item by disclosing its purchase price to the buyer, who then pays a higher price that includes an agreed-upon profit margin. Meanwhile, a salam contract involves placing an order and making payment in advance, subject to specific agreed-upon conditions.

In an istishna contract, the transaction involves ordering the manufacture of a specific item based on criteria and requirements agreed upon by the ordering party or buyer (mustashni’) and the seller or manufacturer (shani’). This method is free from fixed interest rates and offers a sense of security, as the customer receives goods rather than cash, and there is no interest burden established upfront.

Three, lending and borrowing

A qardh contract involves lending funds to a customer, with the stipulation that the customer must repay the received funds by an agreed-upon time.

Four, leasing and rental

This applies to the leasing or renting of movable or immovable assets to customers. It encompasses ijarah (standard leasing/rental) and ijarah muntahiya bittamlik (lease-to-own). An ijarah contract involves providing funds to transfer the right of use or the benefit of an asset or service through a lease transaction, without transferring ownership of the asset itself. This differs from ijarah muntahiya bittamlik, where the ownership of the asset is eventually transferred to the lessee.

Five, debt transfer

A hawalah contract involves the transfer of debt from the original debtor to another party who becomes liable for assuming or paying the debt.

Sharia Financing Alternatives for Agriculture and Livestock Businesses

The development of Sharia-compliant agriculture and livestock businesses has not yet expanded rapidly—particularly for farmers with limited land who fall into the low-income category, a demographic that commercial banks have historically been reluctant to serve.

A "Sharia Plasma" scheme has been developed to address this. This initiative involves a collaborative system linking the agro-industry, Sharia banking, farming and livestock-rearing communities, and Zakat and Waqf institutions. Zakat and Waqf institutions contribute by providing waqf (endowment) land assets for integrated agricultural and livestock operations, thereby ensuring communities have access to land that is economically viable. The contractual agreement may utilize qardh (a benevolent loan)—specifically, the provision of land to be managed over a period of several years—a model previously implemented by organizations such as Dompet Dhuafa and Rumah Zakat.

Entrepreneurs acting as off-takers for the community's agricultural and livestock produce may utilize the salam contract, wherein the entrepreneur specifies the required product standards through a written agreement with the producers.

Meanwhile, banks can enter into Musharakah (partnership) contracts with entrepreneurs or utilize Mudharabah (profit-sharing) contracts based on either profit sharing or net revenue sharing.

The significant potential of the Qard al-Hasan scheme

Financing based on the Qard al-Hasan model has been widely extended to micro-entrepreneurs. Various studies on the implementation of Qard al-Hasan financing indicate positive outcomes for the community.

Research into the effectiveness of Qard al-Hasan financing provided by Baitul Mal wat Tamwil (BMT) in Central Java yielded positive results. Similarly, an economic empowerment initiative by the organization Dompet Dhuafa in West Java found that Qard al-Hasan financing enhanced the organization's economic empowerment efforts.

Another instance involves the application of Qard al-Hasan financing through a Gapoktan (Joint Farmer Group) in Cianjur. The Gapoktan facilitates financing for its member farmers using this model. Initially, the managed fund stood at IDR 70 million; after four years, it grew to over IDR 170 million. The number of recipient farmers rose from an initial 87 to 209.

This demonstrates that Qard al-Hasan financing is well-suited to providing capital support to farmers, particularly small-scale farmers classified as dhuafa (the needy). Eligibility is restricted to farmers holding a maximum of 0.25 hectares of land, and the funds are sourced from zakat (obligatory alms), infaq (voluntary spending), and sadaqah (charity). The Qard al-Hasan system requires no collateral or complex procedures; while administrative fees are legally permissible, the system generally avoids them, making this method highly appropriate for small-scale farmers.

What is Sharia financing? Sharia financing refers to the activity of providing financial assistance to business operators based on Sharia principles. Because it adheres to Sharia principles, the funds provided do not take the form of a conventional loan. This is because a loan arrangement must not entail any additional charges or benefits. The basis for prohibiting such additions or benefits derived from a loan is the Hadith of the Prophet (PBUH), which states: "Every loan that yields a benefit is riba (usury)."

On this basis, Sharia financing is generally structured as a sale-and-purchase transaction. Under this scheme, the financing provider assists in purchasing the goods required by the farmer or agricultural entrepreneur at an agreed-upon price, plus a profit margin.

Productive financing is intended to meet production capacity needs—specifically for business expansion—whether in production, trade, or investment. This type of financing falls into two categories:

•        Working capital financing: financing to meet production needs in order to improve financial standing and increase output volume (quantitatively) and quality (qualitatively) for trade purposes and to enhance the "place utility" of the goods produced.

•        Investment financing: financing to meet needs such as capital goods, aimed at upgrading related facilities.

Sharia financing mechanisms allow for the provision of collateral or guarantees. According to Article 1, Point 26 of the Sharia Banking Law, collateral is defined as an additional guarantee—consisting of either movable or immovable assets—handed over by the collateral owner to a Sharia bank or a Sharia Business Unit (UUS) to secure the repayment of obligations by the customer receiving the financing. Collateral may take the form of securities or risk guarantees provided by the debtor to secure the repayment of financing in the event that the debtor is unable to settle the credit as agreed.

Wallahu ‘alam. And God knows best.