Agriculture sector is a risky business that exposed to the failure due to the uncertainty of commodity price, inefficient management or etc. If the farmers or firms facing such a failure in their agriculture business, they could not afford to pay back the loan, besides all the financial risk are burdensome on the borrowers (farmers or firms) alone. There is no concept of sharing loss in conventional system.
Then, here the banking and financial system need to find the financing alternatives that is appropriate to the agriculture sector.One of the financing methods that have growing potential is through Islamic financing principle that is in line with Muslim’s need and also complies with Shariah principle. In Islamic system, loss is shared when the borrowers suffer loss in business. Besides that, the terms of contract are transparency and clear. Despite its importance, limited attempt has been made to study the application of Islamic instrument in agriculture financing.
This may be due to domination of existing conventional concept that applies since the preliminary development of banking and financial system in Malaysia.Problems occur when Islamic bank giving more priority to provide financing to the commercial, finance and service sector, compared to the agricultural sector, and at the same time these sector is the main contributor to the economy and social development. Previous studies also revealed that, agriculture sector are risky and exposed to failure due to various factors. Moreover, most of the farmers do not have strong business proposal that cause the financial institutions reluctant to lend money.
Islamic countries such as Pakistan, Saudi Arabia and Indonesia have conducted many research works on Islamic financing for agriculture sector.The State Bank of Pakistan also prepared guidelines on Islamic financing for agriculture to facilitate the bank to develop their own Shariah compliant products. Even though Malaysia is an Islamic country and already practices Islamic banking system, the study conducted on Islamic Banking for agriculture financing is still limited and need to be improved. As the government aim to increase the national income generated from the agriculture sector, there are high demand for agricultural loans from the armers and firms. For this purpose, Islamic mode of financing is one of the preferred ways for the farmers and firms to obtain business financing.
However, conventional financing system that currently apply relies on the concept that contras from Shariah compliant. One of the most prominent features of conventional loan is interest for a large part of its borrowing and lending activities. While in Islamic financing, interest is prohibited because it leads to greater inequalities in generating income and wealth.Therefore, this study will contribute to the understanding of Islamic modes of financing especially in agriculture sector. Bay Al Salam contract can be used as an alternative financial instrument in agriculture sector.
The contract is defined as a contract of sale of goods, where the price is paid in advance and the goods are delivered in the future. The findings of this study will benefited to the pool of knowledge in agriculture finance from Islamic perspective and encouraged the financial institutions (banks and financial intermediaries) to promote and apply the Islamic products via their financing system.