TABLE OF CONTENTS

1.0 INTRODUCTION ............................................................................................................... 1

1.1 THE ORIGINS OF SALAM IN AGRICULTURE IN MALAYSIA. .............................. 1

1.2 MODUS OPERANDI OF SALAM (PARALLEL SALAM FINANCING) ................... 3

1.3 ECONOMIC EFFECTS OF THE SALAM MODE SALE ............................................. 3

2.0 RISK OF TRADITIONAL SALAM IN AGRICULTURE.................................................. 4

2.1 MARKET RISKS ASSOCIATED WITH THE SALAM SALE MODEL ...................... 5

2.1.1 Price Risk .................................................................................................................. 5

2.1.2 Quality Risk .............................................................................................................. 5

2.1.3 Asset-Holding Risk ................................................................................................... 5

2.1.4 Asset Replacement Risk............................................................................................ 5

2.2 THE DISADVANTAGES/ ISSUE OF ENGAGING IN THE SALE OF CLASSIC

SALAM OPERATION .......................................................................................................... 6

3.0 NEW PRODUCT DEVELOPER......................................................................................... 7

3.1 SALAM FINANCING: BANK PERTANIAN MODEL ................................................. 8

4.0 CONCLUSION .................................................................................................................. 10

REFERENCES ........................................................................ Error! Bookmark not defined.

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1.0 INTRODUCTION

1.1 THE ORIGINS OF SALAM IN AGRICULTURE IN MALAYSIA.

Economics is a branch of knowledge that focuses on the study of how individuals,

businesses, and society make decisions about the allocation of limited resources in the
production, exchange, and consumption of products and services (Schimmelpfennig and
Norton, 2003). Agricultural economics is the field of study that focuses on the efficient
allocation, equitable distribution, and effective exploitation of resources involved in farming,
as well as the resulting agricultural products. Agricultural economics is a significant factor in
the economics of development since a consistent level of excess agricultural production serves
as a source of technological and commercial advancement (Johnson, 2023). Typically, when a
significant portion of a nation's populace relies on agriculture as their main source of income,
the average earnings tend to be quite low. Engaging in agriculture does not necessarily indicate
that a country is impoverished; rather, it is more accurate to state that due to a country's poverty,
most of its population must depend on agriculture for their livelihood.

While Malaysia has always been an agricultural nation, the importance of food
production has only recently gained significant attention. Historically, the dominant
agricultural products have been rubber, padi, and, in more recent times, oil palm and cocoa.
The livestock business was predominantly non-existent. Consequently, the country has
primarily relied on importing its main food products. Malaysia's import value in the year 2000
is predicted to be RM 11.0 billion (Arkib Portal Rasmi Kementerian Kewangan Malaysia, n.d.).
The government offered a range of incentives to encourage large plantation businesses to
expand their involvement in food production in the 2000 budget. However, no plantation
company used the incentives due to the private sector's prevailing lack of faith in the
profitability of investments in the food industry. Major corporations should explore
opportunities in the agriculture sector, as it holds significant potential for integrated farming
on a big scale, with the adoption of advanced technology. The dynamic economic landscape
has introduced fresh prospects. Enhanced communication leads to larger manufacturing units,
which benefit from increased economies of scale by enabling the transportation of goods to
distant markets.

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 The country's previous agricultural policies failed to address the concerns of food
production, as these policies prioritized the interests of rubber, oil palm, cocoa, and other
lucrative cash crops. The reassessment of the National Agriculture Policy (NAP) received
increased emphasis. Since 1984, there have been two Non-Aggression Pacts (NAPs). Despite
facing competition from other economic sectors, agriculture continues to grow and maintains
its significance in the national economy. The value-added of the industry rose from RM 11.9
billion in 1985 to 16.2 billion in 1995, despite a decrease in its percentage contribution to the
national GDP. This trend is anticipated to continue, reaching 7.1% in 2010 from 13.5% in 1995.
In a similar vein, the employment rate has experienced a fall both in absolute and relative terms,
however it still accounts for 18.0% of the whole national workforce in 1995 (compared to
31.3% in 1985). Undoubtedly, the objective is to broaden and generate a greater quantity of
food in order to reduce the country's reliance on foreign imports.
The Agricultural Bank of Malaysia, also known as Bank Pertanian Malaysia (BPM),
was founded by the enactment of Parliament Act No. 9/1969 with the aim of minimizing food
imports. The primary goal of establishing the Bank was to facilitate agricultural development
by providing loans and collecting deposits, with a special focus on the agricultural sector. BPM
is a government-owned entity that operates as a statutory organization. As mandated by the
Act, BPM is obligated to provide annual reports on its actions to the Malaysian Parliament and
the Ministry of Agriculture. The loan programs aim to enhance and update the agriculture sector
by offering financing facilities along with project and financial management services. The
government allocates an annual subsidy to BPM to cover the expenses associated with
providing loans to the intended beneficiaries, namely farmers. The provision of credit to the
target demographic aligns with the Government's objective of eliminating poverty among
farmers and fishermen and restructuring society. Revitalizing the agriculture sector in Malaysia
is crucial, and one effective way to achieve this is by introducing salam as a source of finance.
This would help strengthen the food production business in the country. Salam will serve as a
supplementary enhancement to the current facilities.

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1.2 MODUS OPERANDI OF SALAM (PARALLEL SALAM FINANCING)

Salam is an Islamic financial contract that involves paying in advance for products or
commodities, typically agricultural, with the delivery taking place on a specified future date.
This type of interaction is advantageous for small agricultural firms who require funds for
operational purposes. Salam offers multiple advantages for small enterprises, including the
supply of Shariah-compliant working capital, usefulness for short-term financing, and benefits
for the agricultural industry.

Figure 1: modus operandi of salam

1.3 ECONOMIC EFFECTS OF THE SALAM MODE SALE

Initially, I observe that the salam mode has emerged to effectively govern and interact
with the members of the Islamic society, while ensuring adherence to the sectarian framework
and alignment with the legitimate objectives. For a Muslim individual who now lacks a product
available for sale, this situation diminishes their ability to make purchases and limits their
freedom to choose. It limits his options to only dealing with a single source or a few specific
suppliers, which has an impact on the pricing, quantities, and types of purchases. This also
decreases his ability to make plans for future output.

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2.0 RISK OF TRADITIONAL SALAM IN AGRICULTURE

Regarding the Salam Classical style contract, the customer faces certain risks, including
as the possibility of not receiving the purchased item on time or not receiving it at all. There is
also a danger of the item not being delivered from its original source, or not being delivered as
agreed upon. Furthermore, the potential for jeopardizing peace is not solely determined by
variables within the supplier's jurisdiction, but also by external events outside its influence,
such as natural disasters, climate conditions, and other reasons. Based on a comprehensive
survey of farmers and producers, it has been observed that the traditional model, with its
various applications and practices, exposes significant financing and liquidity risks when using
advanced financing or cash purchase methods. These risks undermine the true purpose of
finance and investment.
Islamic banks must exercise meticulous caution in Salam transactions. They encounter
many hazards. Counterparty risk is a prevalent risk in Salam-based financing, where the client
has the potential to default on their payment obligations after receiving the advance payment.
Commodity price risk refers to the possibility that the price of products obtained may be lower
than the initially projected price, which is a risk linked with Salam. Another factor to consider
is Quality Risk, which refers to the possibility of receiving items that do not meet the intended
standards or are unacceptable to potential buyers, resulting in a low return on investment or
loss. The bank may also have challenges in selling the products within the expected timeframe,
which might lead to the loss of assets for the unsold goods and tie up money until they are sold.
This risk, known as Asset-Holding Risk, could result in additional fees for storage and Takaful.
Furthermore, if the Islamic bank needs to acquire products through parallel Salam from the
market and the third party fails to provide the designated items as agreed in the parallel contract,
the bank is exposed to the risk of having to replace the asset. Ultimately, if the original seller
of Salam fails to deliver the goods as anticipated, it is deemed to be a fiduciary risk. (An
Analytical Framework for Regulation and Supervision Of, n.d.)

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2.1 MARKET RISKS ASSOCIATED WITH THE SALAM SALE MODEL

Market risk refers to the potential for financial investments to experience losses due to
unfavorable market fluctuations. Market risk encompasses several factors such as swings in
share prices, commodity prices, interest rates, and foreign exchange rates. Market risk is a
fundamental risk that all banks must disclose and allocate capital for, in addition to credit risk
and operational risk. Value-at-risk is the conventional approach used to assess market risk.
(Market Risk Definition - Risk.net, n.d.)

2.1.1 Price Risk

The inclusion of the Islamic financial institution in a peace agreement. The company's
ownership of the commodity at the contract's expiration and its intention to sell it in the absence
of a corresponding contract. When a commodity is received directly, it entails the risk of price
variations (market risk). Holding onto the commodity with the expectation of selling it at a
higher price exposes it to potential changes in future commodity prices. A parallel peace
agreement effectively mitigates this danger and safeguards the institution from incorporating
its debt into commodities debt, all while ensuring that the enterprise's primary source of activity
remains monetary.
2.1.2 Quality Risk
The potential hazards associated with quality aim to minimize the return on investment
in Salam sale. This happens when the assets provided under the contract are either lower in
quantity or do not meet the buyer's requirements.
2.1.3 Asset-Holding Risk
The dangers in the Salam sale contract stem from the inability to quickly sell the
promised asset, which leads to tied-up capital and other expenses such as storage and insurance
charges.
2.1.4 Asset Replacement Risk
The potential risk of substituting the asset in place of the Salam contract, if
acknowledged, is demonstrated when the financial institution acquires the asset through a
parallel Salam contract. If the third party fails to deliver the asset on schedule, the institution
will need to acquire the asset from the market and transfer it to the buyer as originally agreed
in the Salam contract.

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2.2 THE DISADVANTAGES/ ISSUE OF ENGAGING IN THE SALE OF CLASSIC
SALAM OPERATION

The only issue in Salam is that they are able to receive specific goods from their clients,
but they do not accept monetary payments. Prior to the actual delivery of the commodities, it
is not permissible for them to engage in the sale of those commodities. This is due to the fact
that the Salam contract has significant risks, namely market risk and credit risk. This financial
institution provides upfront cash, while the seller arranges for delivery at a later date. The many
categories of risks encompass credit, operational, and market risks, which also involve the
volatility of commodity prices and the risk of mark-up. The challenges faced by financial
institutions in terms of liquidity can be demonstrated by the provision of Salam contracts.

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3.0 NEW PRODUCT DEVELOPER

There is a significant need for investment capital and the provision of sustainable
financial services for rural areas and agriculture in order to meet the global demands for growth
and food security. Agricultural financing plays a crucial role in facilitating the expansion of the
agricultural industry. Ensuring food security, creating jobs, and promoting economic growth
are crucial. To achieve this, it is necessary to explore new avenues in agricultural finance,
specifically through the implementation of Salam sale of production. This innovative approach
will contribute to sustainable agricultural economic development and foster international
innovation in the field.

This innovative approach involves using an accreditation model to fund agricultural

activities, hence promoting increased production rates in several crucial regions. The project's
key objectives are to depend on the provision of fundamental producers and tangible production
inputs to bolster and enhance agricultural production in all its facets. This project revolves
around the pivotal role played by global financial institutions, utilizing cutting-edge technology
to provide necessary resources and capital loans. It aims to address the ineffectiveness of
traditional financial institutions throughout history. The new product relies on providing
producers with tangible production inputs rather than monetary loans, serving to enhance
production rather than merely facilitating it.

Moreover, the previous approach has led to numerous concerns for societies, including
a rise in inflation rates and a surge in unemployment rates. Additionally, it has resulted in an
increase in default rates and challenges in meeting financial obligations promptly. Financial
institutions and input suppliers are similarly affected by covariant risks, as they may encounter
a high number of loan defaults and unpaid payments.

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3.1 SALAM FINANCING: BANK PERTANIAN MODEL

The function of PadiBeras Nasional Berhad (BERNAS) as the buyer of rice from Bank
Pertanian Malaysia (BPM). Bank Pertanian Malaysia demonstrates a clear inclination towards
risk-aversion or even risk-avoidance when it comes to salam funding. While the Bank intends
to expand its range of Islamic goods, its primary focus remains on generating profits and
ensuring safety. For instance, the execution of the first salam is contingent upon the
confirmation of the second salam, which may be unattainable due to the unwillingness of the
third party to assume the price risk. The salam contract, however unique and interesting, lacks
sufficient appeal to inspire confidence. Contrary to a loan, salam carries a higher level of risk.
Production may be disrupted by the fluctuation in prices and the impact of climate change. The
potential danger faced by BPM can be catastrophic if funding is extended to encompass all
categories of agricultural commodities, including rice, palm oil, rubber, fruits, and food
production.

To decrease risks connected to salam finance, BPM has agreed to experiment on one
project with BERNAS. Here, Bank Pertanian has engage BERNAS, a government-owned rice
wholesaler as the third party buyer. BERNAS took over Lembaga Padi and Beras Negara’s
position as the custodian of Malaysian rice when the latter was privatized on January 12 1996.
Apart from its principal responsibility to lead and regulate the growth of the national paddy
and rice sector, the privatized BERNAS continued to assume the numerous social and
economic tasks previously handled by its predecessor. This include the management and
disbursement of subsidies to paddy farmers on behalf of the Malaysian government,
management of Bumiputra (indigenous Malay) Rice Miller scheme, undertaking the purchase
of paddy from farmers at a guaranteed minimum price (RM560 per metric ton) and acting as a
buyer of last resort. Upon privatization, BERNAS was also granted the unique right to import
rice into Malaysia for a duration of 15 years. BERNAS was listed on the Kuala Lumpur Stock
Exchange (KLSE) main board in August 1997. BERNAS has also foray into other commercial
activity such as logistics, packaging, farming, engineering, realty and building. The Group is
now aiming towards being an international business ready to compete with world class
competitors post-Asean Free Trade Area deployments.

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 BERNAS will not enter into any salam arrangement with BPM. As a ready market,
BERNAS will purchase rice from any farmer at the controlled price. In this approach, BPM
will discover it relatively easier to dispose the items following delivery. Rice is a restricted item
with a price-ceiling of RM560 per metric ton. In other words, the price of rice cannot decrease
below RM560. In this method, BPM do not have to worry about lowering prices upon getting
delivery. Government regulations on rice production and distribution has removed the price-
risk associated to the salam facility. In this approach, the application of salam financing in rice-
farming has an optimistic outlook.

Typically, farmers have the liberty to vend their crop to alternative distributors.
However, once they get into a salam contract with BPM, they are prohibited from selling the
rice to any other wholesalers. Hence, we can anticipate that their choice to participate in salam
with BPM is motivated by religious beliefs, namely, to circumvent riba. BPM may consider
procuring rice at a price somewhat higher than RM560 to incentivize farmers to utilize the
salam facility. However, the final decision will be contingent upon the price proposed by
BERNAS to BPM. Furthermore, BERNAS will benefit from this arrangement as it ensures a
steady rice supply at comparatively lower pricing. This statement is accurate since farmers can
sell their agricultural products to autonomous rice traders at a more favorable price. However,
the salam contract will enhance BERNAS' market dominance as any new salam contract
established between farmers and BPM ensures a reliable rice supply to BERNAS. By adopting
this approach, the salam facility can serve as an effective marketing tool for BERNAS, resulting
in many advantages.

In order to incentivize BPM to provide additional salam funding, it would be necessary

to present BPM with an appealing price. Otherwise, the salam product will not yield a
beneficial outcome for BPM.

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4.0 CONCLUSION

Additionally, considering all of this, the Salam agreement has been authorized to fulfill
the contractors' aspirations, in pursuit of economic benefits. It lacks comprehension of the
rationale of enacting a contract of approval, despite it being a form of collaboration and
attachment. Salam is a form of charitable contract as it addresses the seller's requirement, not
in terms of poverty or scarcity, but with the aim of facilitating transactions, managing funds,
and obtaining things at a reduced price.

This new product aims to provide relevant models of Islamic Banking specifically
tailored for the agro sector. It utilizes innovation and can be of significant value for the strategic
decision-making process of Islamic Financial Institutions. In the future, Bai-Salam might be
seen as a trade-based instrument in Islamic agricultural finance. It allows farmers who cannot
afford to purchase inputs with cash to make advance complete payments.

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