Approved by
Resolution No. 16/6 of the
Supervisory Committee of the National Bank
of the Kyrgyz Republic
as of May 8, 2019
RECOMMENDATIONS
for the Provision of Financing in Accordance with the Principles of Islamic Banking and Finance for Agricultural Development
CHAPTER 1. General Provisions
1. These Recommendations define the minimum list of contracts under the Principles of Islamic Banking and Finance signed by banks and other financial and credit organizations (hereinafter - FCO) for financing agriculture, as well as types and procedures of financing depending on agricultural purposes.
2. These Recommendations outline the main features of transactions under the Principles of Islamic Banking and Finance used to finance the agricultural sector. The transactions are described in more detail in the Regulation “On Transactions Carried Out in accordance with the Principles of Islamic Banking and Finance.”
CHAPTER 2. Classification of Financing Products in accordance with the Principles of Islamic Banking and Finance for Agricultural Purposes
§1. Trade-Based Transactions
3. Trade-based financing products refer to financing through merchandise trade. When implementing this financing product, the FCO acts as a seller and delivers goods at the request of a customer after purchasing the necessary goods on the open market/from a specific seller/supplier, either directly or through an agent. The FCO must ensure that its actions reflect the real role of the FCO as a seller of goods and not just a creditor of funds. The FCO should ensure its participation in trade transactions and exchange of goods by such procedures as:
- Actual exchange of goods;
- Disposal of goods;
- Ownership of goods;
- Setting the price and the subject of sale in a certain way.
4. The main types of trade-based financing products are:
- Murabahah;
- Salam;
- Istisna'
5. The mechanism for implementing trade-based financing is carried out by adhering to the Principles of Islamic Banking and Finance. In order to carry out trade-based transactions properly, some basic concepts and their explanations are given below:
a) Agency agreement.
Due to the lack of experience in trade transactions, as well as the specific needs of each individual customer and other similar reasons, the FCO may not be ready to purchase the necessary goods on the open market, therefore, the FCO may use the services of a third party acting as an agent of the FCO, or the FCO can assign this task to its employee who has sufficient experience in this area in accordance with the Principles of Islamic Banking and Finance. The customer himself can also act as an agent of the FCO, subject to the conditions established in the Regulation “On Transactions Carried Out in accordance with the Principles of Islamic Banking and Finance.” The FCO bears all risks and benefits associated with the task assigned to the agent.
b) Physical examination and possession.
Physical examination of the goods is necessary so that the buyer knows what he is going to purchase and the seller knows what he is going to sell. It is very important that the taking possession of the subject matter is actually carried out, as the possession of the subject matter is an important part of trade-based financing. A physical examination of the subject matter must be performed in relation to each transaction, however, the Shariah Council of the FCO may decide otherwise on the procedure and frequency of examination of the subject matter in order to achieve the goal of the Principles of Islamic Banking and Finance.
c) Direct payment.
Direct payment means that the cost of goods purchased at the request of customers is paid directly to the supplier, and the FCO receives any legal confirmation (Certificate of Transfer and Acceptance, invoices, etc.) from the supplier, which confirms the actual sale. If the direct payment of the FCO to the supplier is not possible for valid reasons, then the FCO can make the payment to the supplier through the agent. However, the proper use of funds and the timely submission of documentary evidence of the purchase of goods by the agent is ensured by the FCO.
d) Timely acceptance and transfer of goods.
For the implementation of the Murabahah contract, the FCO can purchase the necessary goods through an agent, which can be the customer himself. In such cases, if the goods are consumed/used by the customer before the execution of the Certificate of Transfer and Acceptance of the goods between the customer and the FCO, the Murabahah contract becomes invalid. Therefore, the FCO must ensure the acceptance and transfer of goods in the proper manner.
§2. Lease-Based Financing
6. Under lease financing, the FCO acquires the asset and transfers it to the customer on a lease basis. Ijarah/Ijarah Muntahia Bittamlik is the only lease-based financing product.
§3. Equity-Based Financing
7. Equity-based financing is the financing based on participation in profits or losses. In accordance with the equity-based financing, the FCO provides funds for the implementation of entrepreneurial activities and has the right to share the profits and losses in this activity in accordance with previously agreed terms.
The main equity-based financing products:
- Sharikah;
- Musharakah;
- Mudarabah.
CHAPTER 3. Classification of Financing Products for Floating and Fixed Assets
8. Financing to meet the short-term or day-to-day costs of farmers' activities is classified as floating assets’ financing. For farmers, the main purpose of floating assets’ financing is the purchase of seeds, fertilizers, pesticides, labor costs, water, electricity, etc. Below is a table of the recommended financing products of floating assets in accordance with the Principles of Islamic Banking and Finance.
Table 1. Recommended Financing Products of Floating Assets In Accordance With the Principles of Islamic Banking and Finance
|
Ser. No. |
Purpose |
Types of financing contracts |
|
1 |
Financing the purchase of raw materials and supplies for: 1) crop production: purchase of seeds, fertilizers, insecticides, pesticides, herbicides, hand sprayers and others. 2) poultry farming: the purchase of feed, birds/day-old chicks, feed raw materials, vaccinations, vitamins and other medicines for poultry, sawdust, wood, coal, water filter cartridges, utensils for feeding poultry, etc. 3) dairy farming: purchase and planting of zoo and animal feed, meat grinders, feed machines and feed or milk containers; purchase of vaccinations, vitamins and other preparations for animals, utensils for feeding animals, feeders for calves, bracelets, ropes/iron chains, etc. 4) fish farming: purchase of fuel, ration and ice, packaging/processing/cleaning products required for the export of fish. Consumables for salting and drying. Purchase of insulated boxes, plastic fish crates and plastic baskets. |
- Murabahah contract; - Salam contract. In accordance with the Murabahah contract, the FCO buys raw materials on the market and sells them to a customer/farmer on a cost + profit basis. Direct purchase and sale is recommended, i.e. the FCO buys them on the open market and sells to the customer/farmer. This can be done by agreement with material suppliers. In case of difficulties with direct purchase and sale, the FCO can appoint any other person or the customer/farmer himself as an agent to purchase the necessary raw materials. In the case of financing under the Salam contract for the production of crops, the FCO can also use this financing product as a buyer of raw materials. |
|
2 |
The costs of operating machinery, equipment, inventory and others. Needs in the floating assets for wages, water, utility bills, etc. |
Salam contract - Since this is an ongoing cost, the FCO needs to carry out direct financing, therefore one of the possible financing products is under the Salam contract. In accordance with the Salam contract, the FCO purchases materials that will be supplied in the future, subject to payment of the cost of the material at the time of signing the contract, which can be used by the customer/farmer to meet his financing needs. |
9. Financing to meet the medium and long term financial needs of farmers is classified as fixed assets’ financing. The fixed assets’ financing is carried out for the purpose of financing the purchase of the necessary machinery, equipment, etc., as well as financing the construction of sheds, farms, fish farms and others. Below is a table that shows the purpose of financing and the recommended financing products of fixed assets in accordance with the Islamic principles.
Table 2. Recommended Financing Products of Fixed Assets In Accordance With the Islamic Principles
|
Ser. No. |
Purpose |
Types of financing contracts |
|
1 |
Financing agricultural mechanization. The purchase of agricultural machinery, equipment such as trailers and threshers, motorized cultivators, power and boom sprayers, plows, cultivators, drills/seeders, rotary cultivators, earthmoving machinery, cotton pickers, power crate saws, pressing machines for wheat straw and dry feed, chisel cultivators, potato planters, sugarcane planters, rice planters, self-propelled wheat and rice harvesters, etc. |
- Murabahah contract; - Ijarah/Ijarah Muntahia Bittamlik contract; - the Musharakah contract. Financing can be provided under the Murabahah contract for small equipment or for short-term financing, and Ijarah/Musharakah for large equipment or long-term financing). Under the Murabahah contract, the FCO purchases the necessary equipment on the market and sells it to a customer/farmer on a cost + profit basis. Under the Ijarah contract, the FCO acquires the necessary property and rents it out to the customer/farmer. Under the Musharakah agreement, the FCO and the customer/farmer participate in the purchase of property in proportion to their invested funds. The customer/farmer contributes a certain percentage of the total cost and the rest is paid by the FCO. The FCO then leases its share to the customer/farmer. Both parties share the risks in accordance with their shares in the property. |
|
2 |
Transport financing. The purchase of tractors, refrigeration units, farm cooling tanks, small pickup trucks, mini-trucks, refrigeration units, etc. |
- Ijarah/Ijarah Muntahia Bittamlik contract; - Musharakah contract; - Murabahah contract. The FCO purchases the necessary vehicle and rents it out to the customer/farmer. The FCO bears the risks associated with the rented vehicle during the term of the Ijarah contract, if the lessee does not commit any illegal actions or negligence in relation to the rented property. Under the Musharakah contract, the FCO and the customer/farmer participate in the purchase of movable property in proportion to their invested funds. The customer/farmer contributes a certain percentage of the total cost and the rest is paid by the FCO. The FCO then leases its share to the customer/farmer. Both parties share risks in accordance with their interests in movable property. Under the Murabahah contract, the FCO purchases the necessary equipment on the market and sells it to a customer/farmer on a cost + profit basis. |
|
3 |
Animal husbandry financing. Financing for the purchase of dairy cows, replacement of existing cows, purchase of young cows, sheep and goats for fattening in order to produce meat, cooling tanks for storing milk, refrigeration units and containers for transporting milk, warehouses for frozen meat and refrigerated containers, vehicles for delivery of products such as trucks, refrigerated vans, etc. Construction of sheds, purchase of water tanks, water pumps, pipe wells and generators, fences and enclosures, slaughterhouses, etc. |
- Murabahah contract; - Musharakah contract; - Istisna' contract. Financing can be provided under a Murabahah contract for small equipment or for short-term financing, as well as Ijarah/Musharakah contract for large equipment or long-term financing). Under the Murabahah contract, the FCO purchases the necessary equipment on the market and sells it to a customer/farmer on a cost + profit basis. |
|
4 |
Financing the installation of pipe wells/turbines, spraying/drip irrigation system, water management, solar installations, pumps for the irrigation system, etc. |
- Ijarah/Ijarah Muntahia Bittamlik contract; - Murabahah contract; - Musharakah contract. The above transactions can be used depending on the nature of the customer’s/farmer’s financial needs. |
|
5 |
Financing the construction/laying of water pipes, land leveling/ development costs, etc. |
- Salam contract; - Istisna’ contract. In order to cover operating costs, the Salam contract is the most suitable for providing financing, according to which the FCO will purchase products that will be supplied in the future, subject to paying the cost of the products at the time of signing the contract. The amount received by the customer/farmer as payment for his products/materials can be used by the customer/farmer to meet his financing needs. The FCO can also finance the construction/laying of water pipelines under the Istisna’ contract. |
|
6 |
Financing the development and expansion of forestry. |
- Musharakah contract; - Murabahah contract. The Musharakah contract is suitable if the customer requires financing in order to purchase land for forestry development. Under the Musharakah contract, the FCO and the customer/farmer participate in the purchase of property in proportion to their invested funds. The customer/farmer contributes a certain percentage of the total cost and the rest is paid by the FCO. The FCO then leases its share to the customer/farmer. Both parties share the risks in accordance with their shares in the property. The Murabahah contract can be used to finance the purchase of plants for growing forests and other resources. |
|
7 |
Financing the poultry industry. Financing the construction of broiler, breeding and feed farms, poultry houses, automatic drinkers/tube feeders, generators, fans, refrigerated egg storage units, purchase of machinery/equipment for a poultry farm/ hatchery/feed mill, transport vans - van for transporting eggs and poultry, transport means for the distribution of products, such as trucks, freezers, automated slaughterhouses and feather pickers, etc. |
- Musharakah contract; - Murabahah contract; - Ijarah/Ijarah Muntahia Bittamlik contract; - Istisna’ contract. |
|
8 |
Fishery financing. Financing the purchase of motor boats/fish trawlers. Purchase of marine engines (outboard and inboard), replacement of engines and spare parts, construction of refrigerators by fishermen using insulation material/sheets for walls/roof, purchase of other deck equipment such as winch, rope, rostrum, manual network control device, navigation lights, communication equipment, radar, life jackets, lifeboats, anchors, direction finders (compasses), echo sounders (fish finders), life buoys, insulation materials, net purchase - net/pursed/lattice-like trawlers, purchase of refrigeration/freezers, fish storage (finished goods warehouse). Fish/shrimp hatcheries, purchase of mobile isolators, pickups/vehicles, etc. |
- Musharaka hcontract; - Murabahah contract; - Ijarah/Ijarah Muntahia Bittamlik contract; - Istisna’ contract. |
|
9 |
Dairy industry financing. Purchase of equipment/installations for the primary processing of milk, equipment for the production of cheese, etc. |
- Ijarah/Ijarah Muntahia Bittamlik contract; - Musharakah contract; - Murabahah contract; - Istisna’ contract. |
|
10 |
Financing the installation of greenhouses. |
- Ijarah/Ijarah Muntahia Bittamlik contract; - Musharakah contract; - Murabahah contract; - Istisna’ contract. |
|
11 |
Financing the construction of a warehouse for goods and refrigerated warehouses. |
|
|
12 |
Financing the construction and improvement of livestock laboratories. |
|
|
13 |
Financing the installation of equipment for processing fruits and vegetables. |
CHAPTER 4. Types of Contracts and Financing Procedures In Accordance With the Principles of Islamic Banking and Finance
10. Murabahah.
A Murabahah contract is a transaction that provides for the instalment sale of goods purchased by the FCO at the request of the customer, or owned by the FCO at the time of the customer’s request.
An essential condition of the transaction under the Murabahah contract is the mandatory indication and allocation of the amount of the margin in the selling price.
11. Procedure for a transaction under the Murabahah contract:
1) Signing the General Agreement for the Murabahah financing between the customer and the FCO.
2) If necessary, the appointment of an agent for the purchase of goods on behalf of the FCO by signing an agreement on agency services.
3) The customer submits an application for the purchase of goods to the FCO.
4) The FCO purchases goods directly or through an agent and becomes its owner.
5) If the purchase of goods is carried out through an agent, then the agent must inform the FCO that he (the agent) purchased the goods on his (FCO) behalf.
6) If possible, the FCO should conduct a physical examination of the goods.
7) The FCO and the customer sign the Murabahah contract.
8) The ownership of the goods, including the risks associated with the goods, is transferred from the FCO to the customer.
9) The customer pays the cost in accordance with the agreed payment schedule.
12. Salam.
Salam contract is a transaction for the purchase of goods on a deferred delivery basis, subject to payment of the cost of the goods at the time of signing the contract.
Financing under the Salam contract can be provided to customers/farmers who need floating assets (floating assets’ financing).
In accordance with the Salam contract, the buyer (FCO) has the opportunity to purchase a certain product at a relatively low cost. On the other hand, the seller (customer/farmer) receives an advance payment for those goods/products that are not yet available from the customer/farmer or have not yet been produced.
13. Procedure for carrying out the transaction under the Salam contract:
1) A contract under the Salam transaction is drawn up between the customer/farmer, acting as the seller of the goods, and the FCO as the buyer of these goods.
2) The contract describes the complete specification of the goods, cost, date and place of delivery of the goods.
3) The FCO pays the full cost of the goods to the customer/farmer, which will be delivered in the future.
4) The customer/farmer, after receiving the advance amount, can use it for his needs.
5) On the date of delivery, the customer/farmer delivers the goods in accordance with the contract.
14. Istisna’.
An Istisna’ contract is a transaction under which the property, manufactured by the manufacturer or built by the construction contractor on the basis of the order (project), will be transferred to the customer after the completion of the work at a pre-agreed price.
Payment of cost and delivery can be made in the future.
The Istisna’ contract can be used to finance the construction of outbuildings, the manufacture of equipment/machinery and other assets that are used in agriculture.
Payment of the cost is carried out by mutual agreement of the parties.
15. Procedure for carrying out the transaction under the Istisna’ contract:
1) The Istisna’ contract is drawn up between the FCO and the customer/farmer, where the FCO acts as the seller/manufacturer of the goods, and the customer/farmer as the buyer/ordering party of this product.
2) The contract describes the complete specification of the goods, the cost of the manufactured goods, the date and place of delivery.
3) The customer pays the cost of the goods according to the payment schedule.
4) On the date of delivery, the FCO delivers the goods in accordance with the contract.
16. Ijarah and Ijarah Muntahia Bittamlik.
An Ijarah contract is a transaction for the special acquisition of movable or immovable property by the FCO at the request of the customer, and its provision to the customer in property lease for temporary possession and use for an agreed period on a paid basis.
An Ijarah Muntahia Bittamlik contract is a transaction that includes an Ijarah contract, whereby the customer undertakes to buy back the leased property (asset), either at the end or in stages during the Ijarah period in accordance with the contract.
Ijarah/Ijarah Muntahia Bittamlik contracts are the most suitable type of financing for long-term financing with the possibility of changing the rent according to the terms of Chapter 2.4 of the Regulation “On Transactions Carried Out In Accordance With the Principles of Islamic Banking and Finance.”
In the agro-industrial sector, the Ijarah instrument can be used to finance almost all kinds of needs for agricultural equipment or for the construction of facilities, etc.
17. Procedure carrying out the transactions under the Ijarah and Ijarah Muntahia Bittamlik contracts:
1) Signing the customer’s commitment, according to which the customer undertakes to lease a certain asset from the FCO after providing it to the customer for use.
2) If necessary, the FCO and the customer can enter into an agency agreement, according to which the customer will purchase the asset on behalf of the FCO.
3) After the purchase of a specific asset, the FCO and the customer draw up an Ijarah contract, in which the lease payments and the term are agreed.
4) The FCO, after signing the contract, provides the customer with an asset for use.
5) According to the transaction under the Ijarah Muntahia Bittamlik contract, the FCO and the customer sign a separate sales and purchase contract at the end of the lease term, through which the leased asset will be sold to the customer at an agreed price.
18. Sharikah.
A Sharikah contract is a partnership contract between the FCO and one or more parties, in accordance with which each partner contributes a certain amount of money, or, with the consent of all partners, tangible assets, and in which coordinated management of the case is carried out using joint assets on a profit distribution basis according to the contract, and each partner incurs losses in accordance with his contribution to the total capital.
The Sharikah contract can be used to finance needs in floating assets (short-term financing) and for project financing (long-term financing).
19. The procedure for carrying out the transaction under the Sharikah contract:
1) One or several entrepreneurs apply to the FCO to obtain the necessary financing for the project.
2) The FCO, along with other partners, provides full or partial financing; a Sharikah contract is signed.
3) All partners, including the FCO, have the right to participate in project management.
4) Profits are distributed according to an agreed profit distribution ratio/formula, which does not have to match their capital ratio.
5) The losses, however, should be allocated in accordance with the capital invested by each partner.
6) At the end of the period specified by the parties, the principal amount of capital with profit must be distributed between the partners.
20. Musharakah.
A Musharakah contract is a form of partnership based on a Sharikah agreement, in which one of the partners gradually buys out the share of the other partner(-s) in the amount determined by the contract until the ownership of this share is fully transferred to him.
21. The procedure for carrying out the transaction under the Musharaka contract:
1) The parties draw up a Musharakah contract, according to which they participate in the purchase of property in proportion to their invested funds.
2) One party contributes a certain percentage of the total value of the property, and the rest is paid by the other party.
3) After purchasing the property, one party leases its share to the other party.
4) The party leasing its share gradually sells its share to the other party until the ownership of the property passes completely to him.
5) The risks associated with the property are divided between the parties in accordance with their shares in the property.
22. Mudarabah.
A Mudarabah contract is a contract on the basis of which one party - the investor - provides capital (funds), and the other party (Mudarib) accepts this capital and manages it in order to obtain profits, which are proportionally distributed between the parties in accordance with the terms of the contract. A debt owed by a Mudarib or another party to an investor cannot be used as equity in a Mudarabah transaction.
23. The procedure for carrying out the transaction under the Mudarabah contract:
1) The parties draw up a Mudarabah contract, according to which the FCO provides capital, and the other party (Mudarib) will manage the capital for a certain period.
2) Profits should be distributed by agreement of the parties.
3) Mudarib manages the provided capital on agreed terms.
4) At the end of the term of the contract, the Mudarib returns the principal amount and a pre-agreed share of the profits to the FCO.
5) In the event that losses are incurred during the execution of the contract, the FCO incurs losses in the amount of the provided amount of capital, and in this case the Mudarib does not receive remuneration for his work. This rule of distributing losses applies if the losses have arisen through no fault of the Mudarib.
6) The FCO is not responsible for losses in excess of the capital that it provided.
24. Proper implementation of agricultural finance in accordance with the Principles of Islamic Banking and Finance requires appropriate knowledge to apply them, as well as the procedures outlined in these Recommendations.
