Recommendations on Providing Financing in Accordance with Islamic Principles of Banking and Agricultural Development Financing

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Date of creation: 2023-01-13

Approved

by the Resolution of the Supervisory Committee of the National Bank of the Kyrgyz Republic No. 16/6 dated May 8, 2019

RECOMMENDATIONS

on providing financing in accordance with Islamic principles of banking and agricultural development financing

(amendments and additions approved by the Resolution of the Supervisory Committee of the National Bank of the Kyrgyz Republic dated 30.12.2022 No. 43/2)

CHAPTER 1. General Provisions

1. These Recommendations define the minimum list of contracts under Islamic principles of banking and financing concluded by banks and other financial and credit organizations (hereinafter – FCO) for agricultural financing, as well as the types and procedures of financing depending on agricultural objectives.

2. These Recommendations outline the main features of operations corresponding to Islamic principles of banking and financing used for financing the agricultural sector. Operations are described in more detail in the Regulation "On Operations Performed in Accordance with Islamic Principles of Banking and Financing".

CHAPTER 2. Classification of Financing Types in Accordance with Islamic Principles of Banking and Financing for Agricultural Purposes

§1. Financing Based on Trade Operations

3. Types of financing based on trade operations imply financing through the implementation of commodity trade. When implementing this type of financing, the FCO acts as a seller and supplies goods upon the client's request after purchasing the necessary goods in 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 merely as a lender of funds. The FCO must ensure its participation in trade operations and exchange of goods through procedures such as:

• actual exchange of goods;
• disposal of goods;
• ownership of goods;
• establishing the price and subject of sale in a specific manner.

4. The main types of financing based on trade operations are:

• Murabaha;
• Salam;
• Istisna.

5. The mechanism for implementing financing based on trade operations is carried out by adhering to Islamic principles of banking and financing. In order to properly conduct transactions based on trade operations, the following basic concepts and their explanations are presented below:

a) Agency Agreement.

Due to lack of experience in trade operations, as well as the specific needs of each individual client and other similar reasons, the FCO may not be ready to acquire the necessary goods in the open market; therefore, in accordance with Islamic principles of banking and financing, the FCO may use the services of a third party acting as the FCO's agent, or the FCO may assign this task to its employee who has sufficient experience in this field. The client may also act as the FCO's agent provided that the conditions established in the Regulation "On Operations Performed in Accordance with Islamic Principles of Banking and Financing" are met. All risks and benefits associated with the task assigned to the agent are borne by the FCO.

b) Physical Inspection and Ownership.

Physical inspection of the goods is necessary so that the buyer knows what he intends to purchase, and the seller knows what he intends to sell. It is very important that the taking of possession of the subject of the contract is actually carried out, as possession of the subject of the contract is an important part of financing based on trade operations. Physical inspection of the subject of the contract must be performed for each operation, however, the Shariah Council of the FCO may make a different decision on the procedure and frequency of inspection of the subject of the contract to achieve the goal of Islamic principles of banking and financing.

c) Direct Payment.

Direct payment means that the cost of goods purchased on behalf of clients is paid directly to the supplier, and the FCO receives any legal confirmation (act of acceptance and transfer, waybills, etc.) from the supplier confirming the actual sale. If direct payment from the FCO to the supplier is impossible for valid reasons, the FCO may make payment to the supplier through an agent. However, the proper use of funds and timely submission of documentary evidence of the purchase of goods by the agent is ensured by the FCO.

d) Timely Execution of Acceptance and Transfer of Goods.

To execute a Murabaha contract, the FCO may acquire the necessary goods through an agent, who may be the client himself. In such cases, if the goods are consumed/used by the client before the execution of the act of acceptance and transfer of goods between the client and the FCO, the Murabaha contract becomes invalid. Therefore, the FCO must ensure the proper execution of the acceptance and transfer of goods.

§2. Financing Based on Leasing

6. In accordance with financing based on leasing, the FCO acquires an asset and transfers it to the client on lease terms. Ijara/Ijara Muntahia Bit Tamlik is the only method of financing based on leasing.

§3. Financing Based on Equity Participation

7. Financing based on equity participation

–

is financing based on profit and loss sharing. In accordance with financing based on equity participation, the FCO provides financial resources for carrying out business activities and has the right to share in the profits and losses of this activity in accordance with previously agreed conditions.

Main types of financing based on equity participation:

• Shariika/Musharaka;
• Diminishing Musharaka;
• Mudaraba.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

CHAPTER 3. Classification of Financing Types for Working and Fixed Capital

8. Financing to meet short-term or daily operational expenses of farmers is classified as working capital financing. For farmers, the main purpose of working capital financing is the purchase of seeds, fertilizers, pesticides, labor costs, water, electricity, etc. Below is a table of recommended types of working capital financing in accordance with Islamic principles of banking and financing.

Table 1. Recommended Types of Working Capital Financing in Accordance with Islamic Principles of Banking and Financing

No. p/p

Objective

Types of Financing Contracts

Financing the purchase of raw materials and materials for:

1)

crop production: purchase of seeds, fertilizers, insecticides, pesticides, herbicides, manual sprayers, etc.

2) poultry farming: acquisition of feed, birds/day-old chicks, feed raw materials, vaccination, vitamins and other medicines for agricultural birds, sawdust, wood, coal, water filter cartridges, bird feeding dishes, etc.

3) dairy cattle farming: purchase and planting of animal feed and feed for animals, meat grinders, feed mills and feed or milk containers; purchase of vaccination, vitamins and other preparations for animals, animal feeding dishes, calf feeders, bracelets, ropes/iron chains, etc.

4) fish farming: purchase of fuel, ration and ice, packaging/processing/cleaning means necessary for fish export. Consumables for salting and drying. Purchase of insulated boxes, plastic boxes for fish and plastic baskets.

• Murabaha contract;
• Salam contract.

In accordance with the Murabaha contract, the FCO purchases raw materials/materials in the market and sells them to the client/farmer on a "cost + profit" basis. Direct purchase and sale is recommended, i.e., the FCO buys them in the open market and sells to the client/farmer. This can be done by agreement with material suppliers. In case of difficulties with direct purchase and sale, the FCO may appoint any other person or the client/farmer themselves as an agent to purchase the necessary raw materials/materials.

In the case of financing under a Salam contract for the purpose of crop production, the FCO may also use this type of financing as a purchaser of raw materials/materials.

Expenses for operation of machinery, equipment, inventory, etc. Needs for working capital to pay for labor, water, utilities, etc.

Salam Contract

Since these are current expenses, the FCO needs to implement direct financing, so one of the possible types of financing is financing under a Salam contract. In accordance with the Salam contract, the FCO purchases materials that will be supplied in the future, provided that the cost of the material is paid at the time of concluding the contract, which can be used by the client/farmer to meet their financing needs.

9. Financing to meet medium-term and long-term financial needs of farmers is classified as fixed capital financing. Issuance of fixed capital financing is carried out for the purpose of financing the purchase of necessary machinery, equipment, etc., as well as financing the construction of sheds, farms, fish farms, etc. Below is a table providing the financing objective and recommended types of fixed capital financing in accordance with Islamic principles.

Table 2. Recommended Types of Fixed Capital Financing in Accordance with Islamic Principles

No. p/p

Financing Objective

Types of Financing

Financing of agricultural mechanization

Purchase of agricultural machinery, equipment, such as trailers and threshers, motor cultivators, motor and boom sprayers, plows, cultivators, drilling devices/seeder, rotary cultivators, earth-moving machinery, cotton pickers, mechanical saws for box production, wheat straw and dry feed pressing machines, chisel-cultivators, potato planters, sugar cane planters, rice planters, self-propelled harvesters for wheat and rice harvest, etc.

• Murabaha contract;
• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Diminishing Musharaka contract.

Financing may be provided under a Murabaha contract for small/small-scale equipment or for short-term financing, as well as under Ijara/Diminishing Musharaka contracts for large equipment or long-term financing).

Under the Murabaha contract, the FCO purchases the necessary equipment in the market and sells it to the client/farmer on a "cost + profit" basis.

Under the Ijara contract, the FCO acquires the necessary property and leases it to the client/farmer.

Under the Diminishing Musharaka contract, the FCO and the client/farmer participate in the purchase of property proportionally to their invested funds. The client/farmer contributes a certain percentage of the total cost, and the rest is paid by the FCO. Then the FCO leases its share to the client/farmer. Both parties share risks according to their shares in the property.

Transport Financing

Acquisition of tractors, refrigerated trucks, cooling tanks for farms, small pickups, mini-trucks, refrigeration units, etc.

• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Diminishing Musharaka contract;
• Murabaha contract.

The FCO acquires the necessary transport vehicle and leases it to the client/farmer. The FCO bears the risks associated with the leased transport vehicle during the term of the Ijara contract, provided the tenant does not commit any wrongful acts or negligence regarding the leased property.

Under the Diminishing Musharaka contract, the FCO and the client/farmer participate in the purchase of movable property proportionally to their invested funds. The client/farmer contributes a certain percentage of the total cost, and the rest is paid by the FCO. Then the FCO leases its share to the client/farmer. Both parties share risks according to their shares in the movable property.

Under the Murabaha contract, the FCO acquires the necessary equipment in the market and sells it to the client/farmer on a "cost + profit" basis.

Livestock Financing

Financing the acquisition of dairy cows, replacement of existing cows, purchase of young cattle, sheep and goats for fattening for meat, cooling tanks for milk storage, refrigeration units and containers for milk transport, warehouses for frozen meat and refrigerated containers, transport vehicles for product distribution, such as trucks, refrigerated trucks, etc.

Construction of sheds, acquisition of water tanks, water pumps, borehole wells and generators, fences and enclosures, slaughterhouses (abattoirs), etc.

• Murabaha contract;
• Diminishing Musharaka contract;
• Istisna contract.

Financing may be provided under a Murabaha contract for small/small-scale equipment or for short-term financing, as well as under Ijara/Diminishing Musharaka contracts for large equipment or long-term financing).

Under the Murabaha contract, the FCO purchases the necessary equipment in the market and sells it to the client/farmer on a "cost + profit" basis.

Financing of installation of borehole wells/turbines, spraying/drip irrigation systems, water resource management, solar installations, pumps for irrigation systems, etc.

• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Murabaha contract;
• Diminishing Musharaka contract.

The above contracts may be used depending on the nature of the client/farmer's financial needs.

Financing of construction/laying of water pipelines, expenses for leveling/development of land, etc.

• Salam contract;
• Istisna contract.

To cover current expenses, the Salam contract is most suitable for providing financing, under which the FCO will acquire products that will be supplied in the future, provided that the cost of the products is paid at the time of concluding the contract. The amount received by the client/farmer as payment for their products/materials can be used by the client/farmer to meet their financing needs.

The FCO can also finance the construction/laying of water pipelines under an Istisna contract.

Financing of forestry development and expansion.

• Diminishing Musharaka contract;
• Murabaha contract.

The Musharaka contract is suitable if the client requires financing for the purpose of purchasing land for forestry development.

Under the Diminishing Musharaka contract, the FCO and the client/farmer participate in the purchase of property proportionally to their invested funds. The client/farmer contributes a certain percentage of the total cost, and the rest is paid by the FCO. Then the FCO leases its share to the client/farmer. Both parties share risks according to their shares in the property.

The Murabaha contract can be used to finance the purchase of plants for growing forests and other resources.

Poultry Financing.

Financing the construction of broiler, breeding and feed farms, poultry houses, automatic drinkers/tube feeders, generators, fans, refrigeration units for egg storage, purchase of machinery/equipment for poultry farm/incubator station/feed mill, transport vans – van for transporting eggs and poultry, transport vehicles for product distribution, such as trucks, freezers, automated slaughterhouses and feather removal machines, etc.

• Diminishing Musharaka contract;
• Murabaha contract;
• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Istisna contract.

Fishery Financing

Financing the purchase of motor boats/fishing trawlers. Purchase of marine engines (outboard and inboard), replacement of engines and spare parts, construction of fisherman's refrigerators using insulation material/sheets for walls/roof, purchase of other deck equipment such as winch, rope, booms, manual net control device, navigation lights, communication equipment, radar, life jackets, lifeboats, anchors, compasses, echo sounders (fish finders), life buoys, insulation materials, purchase of nets - trawl nets/purse seine nets/mesh nets, purchase of refrigeration/freezing units, fish storage warehouse (finished goods warehouse).

Fish/shrimp hatcheries, purchase of mobile isolators, pickups/transport vehicles, etc.

• Diminishing Musharaka contract;
• Murabaha contract;
• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Istisna contract.

Dairy Industry Financing.

Purchase of equipment/installations for primary milk processing, cheese production equipment, etc.

• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Diminishing Musharaka contract;
  -
  Murabaha contract;
  -
  Istisna contract.

Financing of greenhouse installation.

• Ijara/
  Ijara Muntahia Bit Tamlik contract;
• Diminishing Musharaka contract;
  -
  Murabaha contract;
• Istisna contract.

Financing of construction of goods warehouses and cold storage.

Financing of construction and improvement of livestock laboratories.

Financing of installation of equipment for processing fruits and vegetables.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

CHAPTER 4. Types of Contracts and Financing Procedures in Accordance with Islamic Principles of Banking and Financing

10. Murabaha.

The Murabaha contract is a contract providing for the installment sale of goods purchased by the FCO on behalf of the client, or owned by the FCO at the time of the client's request.

An essential condition of the Murabaha transaction is the mandatory indication and separation in the sale price of the markup amount.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

11. Procedure for executing a Murabaha transaction:

1) Signing of a General Agreement for Murabaha financing between the client and the FCO.

2) If necessary, appointment of an agent to purchase goods on behalf of the FCO by concluding an agency services agreement.

3) The client submits an application to the FCO for the purchase of goods.

4) The FCO directly or through an agent acquires the goods and becomes their owner.

5) In case the purchase of goods is carried out through an agent, the agent must necessarily inform the FCO that he (the agent) bought the goods on his (the FCO's) behalf.

6) Where possible, the FCO must conduct a physical inspection of the goods.

7) The FCO and the client conclude a Murabaha contract.

8) Ownership of the goods, including risks associated with the goods, is transferred from the FCO to the client.

9) The client pays the cost in accordance with the agreed payment schedule.

12. Salam.

Under a Salam contract, one party (the seller) undertakes to deliver goods to the other party (the buyer) by a specified future date, and the buyer undertakes to pay for these goods at the time of concluding the Salam contract.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

Financing under a Salam contract may be provided to clients/farmers who need working capital (working capital financing).

In accordance with the Salam contract, the buyer (FCO) has the opportunity to buy a certain commodity at a relatively low cost. On the other hand, the seller (client/farmer) receives an advance payment for goods/products that are not yet in the possession of the client/farmer or have not yet been produced.

13. Procedure for executing a Salam transaction:

1) A Salam contract agreement is drawn up between the client/farmer, acting as the seller of the goods, and the FCO as the buyer of these goods.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

2) The agreement describes the full 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 client/farmer, which will be delivered in the future.

4) The client/farmer, after receiving the advance sum, may use it for their own needs.

5) On the delivery date, the client/farmer supplies the goods in accordance with the agreement.

14. Istisna.

The Istisna contract is a contract under the terms of which one party (the contractor) undertakes to perform a certain work on the order of the other party (the customer) and hand over the result to the customer within a specified time, and the customer undertakes to accept the work result and pay the previously agreed cost.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

Payment of cost and delivery may be made in the future.

The Istisna contract can be used to finance the construction of farm buildings, manufacturing of equipment/machinery and other assets used in agriculture.

Payment of cost is made by mutual agreement of the parties.

15. Procedure for executing an Istisna transaction:

1) An Istisna contract is drawn up between the FCO and the client/farmer, where the FCO acts as the seller/manufacturer of the goods, and the client/farmer acts as the buyer/customer of these goods.

2) The agreement describes the full specification of the goods, cost of the manufactured goods, date and place of delivery.

3) The client pays the cost of the goods according to the payment schedule.

4) On the delivery date, the FCO supplies the goods in accordance with the agreement.

16. Ijara and Ijara Muntahia Bit Tamlik.

The Ijara contract is a contract according to which the lessor provides the lessee with the use (lease) of property for an agreed period for a certain fee, which the lessor acquires ownership of on behalf of the client, or is owned by the lessor at the time of the lessee's request, or property for which the lessor acquires the right of use on behalf of the lessee.

Also, the Ijara contract may imply financing of services, according to which, on behalf of the lessee, the lessor acquires the right to receive services with subsequent provision of this right to the lessee for an agreed period for a certain fee.

The Ijara Muntahia Bit Tamlik contract is a contract (including the conditions of the Ijara contract), according to which the client undertakes to purchase the leased property in accordance with the contract conditions.

(In the edition of the Resolution of the Supervisory Committee No. 43/2 dated 30.12.2022)

Ijara/Ijara Muntahia Bit Tamlik contracts are the most suitable type of financing for long-term financing with the possibility of changing rent, according to the conditions of Chapter 2.4 of the Regulation "On Operations Performed in Accordance with Islamic Principles of Banking and Financing".

In the agro-industrial sector, the Ijara instrument can be used for financing almost all types of needs for agricultural equipment or for the construction of facilities, etc.

17. Procedure for executing transactions under Ijara and Ijara Muntahia Bit Tamlik contracts:

1) Signing of a client commitment, according to which the client undertakes to take a certain asset on lease from the FCO after it is provided for use by the client.

2) If necessary, the FCO and the client may conclude an agency agreement, according to which the client will acquire the asset on behalf of the FCO.

3) After purchasing a specific asset, the FCO and the client draw up an Ijara contract, in which rent payments and term are agreed upon.

4) The FCO, after signing the agreement, provides the client with the asset for use.

5) According to the Ijara Muntahia Bit Tamlik transaction, upon expiration of the lease term, the FCO and the client conclude a separate sales contract, through which the leased asset will be sold to the client at an agreed cost.

18. Shariika/Musharaka.

The Shariika/Musharaka contract is a partnership contract between two or more parties, through which each partner contributes a certain amount of money or, with the consent of all partners - material assets, which gives each partner the right to conduct business using the company's assets on the conditions of profit distribution according to the Shariika/Musharaka contract, and losses are borne by each partner in accordance with their contribution to the general

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