By Jaafar S. Abdulkadir
Kenya’s agricultural sector is increasingly gaining a greater footing as a driver of economic expansion, heightening the need for financiers to rethink their strategies. As the sector grows, Islamic Finance providers have continued to deepen their investments to support the sector. Through Salam financing, institutions plying in Islamic finance are becoming critical in driving the growth of the agricultural sector, curving a strong niche that is redefining the engagements between the two industries — financial sector and agribusiness.
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Under Islamic Finance, Salam is an innovative financing contract considered appropriate for the production of primary commodities, especially in the agricultural sector, where the farmers have dire needs for funds to purchase seeds, fertilisers, farm implements as well as meeting their other domestic needs, as well as paying school fees and medical expenses. The structure allows the seller of the specified goods in terms of quality and quantity to undertake to deliver the same at an agreed future date against the upfront payment of the full price.
Normally Sharia does not approve of any forward sales but Salam transactions, under certain conditions, are permissible. The validity of Salam transactions depend upon the seller paying the full payment for the specified quality and quantity of goods to be delivered at a specified future date and place of delivery.
The main objective behind the legitimacy of the Salam sale is to relieve people of their hardships in undertaking trading and financing activities.
The Salam price is generally lower than the price of a spot sale. The bank, when executing a Salam contract with a farmer, can also have a parallel Salam contract with another party buying the goods after delivery. Since the parallel Salam period is shorter and the price the end purchaser pays is higher, the bank stands to benefit. The end buyer of the parallel Salam facility makes a unilateral promise to the bank to purchase, at pre-set prices, the specified commodity.
The first Salam contract and the parallel contract must be independent and should reflect that the bank is a buyer in the former and a seller in the latter. The two contracts must be tied together, making the performance of one contingent upon the other.
Commodities that cannot be described by type, quality and quantity cannot be subject of sale under this contract. Such contract is not permitted where the commodity involved in the sale is money or any form of currency.
How it works
The wheat farmer in Narok can approach a bank to finance him to engage in the production of 50 tonnes of wheat of a specified quality at a negotiated price and at an agreed date and place of delivery. The bank pays the agreed price on the spot awaiting the delivery of the wheat. The bank can simultaneously enter into an independent Salam contract to sell 50 tonnes of the specified quality to a third party (a miller, for instance) at a higher price at an agreed date and place of delivery after the actual delivery by the farmer who is the bank’s client.
It is important to note that should the farmer fail to deliver the wheat as agreed or delivers substandard wheat, the bank can seek whatever recourse it has against him but cannot rid itself of the liability to deliver to the miller. The farmer or the seller is under obligation to deliver as per the terms agreed.
Salam sales can help promote agricultural productivity by reducing the risk arising out of uncertainties of market prices of farm produce, especially during harvest seasons. It limits the exploitations of the poor farmers by speculative middlemen and brokers who often cash on the miseries of farmers during harvest seasons.
It can also help manage liquidity issues for the farmers and improve livelihoods for them and their families by affording them secure cash payments against future harvests.
The Salam sales also helps check against the temptation of traders venturing into speculative activities, and instead engage in earning income from real economic activities by meeting the obligations of making advance payments for future deliveries.
An institutionalised, Salam based financing can spur agricultural productivity, improve food security, create employment opportunities, reduce poverty and enhance income levels for the rural folk. All that is needed is the development of necessary infrastructure and institutions to help generate quality data that could assist in decision-making and risk management for the banks, traders and the farming community. Information asymmetries in this exchange market can be managed better through proper regulations designed to enhance efficiency.
Salam may sound like a regular forward contract that usually represent agreements between sellers and buyers for future deliveries of specified commodity with a settlement date agreed but no payment made in advance, but Salam sale is not permissible without the full payment of the price at the time of executing the contract.
Shariah scholars hold the opinion that a Salam contract remains an obligation that is akin to debt until the delivery date when the debt obligation is fulfilled.
Writer is head of Islamic Banking at KCB Group, and chair of the Islamic Finance sub-committee at Kenya Bankers Association