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SALAM

SALAM
Introduction
The basic conditions for a validity of a sale in Shriah are
three:
(1)The purchased commodity must be existing,
(2)The seller should have acquired the ownership of
that commodity,
(3)The commodity must be in the physical or
constructive possession of the seller,
There are only two exceptions to this principle in
Shariah: (1)Salam
(2)Istisna
• Definition &Concept
• Seller agrees to supply specific goods
to the buyer at a future date in exchange
of an advanced price fully paid at spot.
• Price is in cash but the supply of goods
is deferred.
Background of Salam
• Before prohibition of interest farmers used to get interest
based loans for growing crops and harvesting. After
prohibition of interest, they were allowed to do Salam
transactions. This helped them to get money in advance for
their needs.

• During the days of our prophet (S.W.) the caravans used to get
interest based loans for purchasing the commodities. After
prohibition of interest, they were allowed to do Salam.
Purpose of Salam
• To meet the needs of small farmers who need money to grow
their crops and to feed their family up to the time of harvest.
• To meet the need of working capital
• To meet the needs of liquidity problem.
• To meet the need of traders for import and export business.
Benefits

Salam is beneficial to the


seller,because he receives the price
in advance,and it is beneficial to the
buyer also,because normally,the
price in salam used to be lower then
the price in spot sales.
Conditions of Salam

(1) It is necessary for the validity of Salam that the buyer pays the
price in full to the seller at the time of effecting the sale,
because the basic wisdom for allowing Salam is to fulfill the
instant need of the seller. If its not paid in full, the basic
purpose will not be achieved.

(2) Only those goods can be sold through a Salam contract in


which the quantity and quality can be exactly specified
e.g.precious stones cannot be sold on the basis of Salam
because each stone differ in quality, size, weight and their
exact specification is not possible.

(3) All details in respect to quality of goods sold must be expressly


specified leaving no ambiguity which may lead to a dispute.
(4)It is necessary that the quantity of the commodity is agreed upon in
absolute terms. It should be measured or weighed in its usual
measure.

(5) Salam cannot be effected on a particular commodity or on a product


of a particular field or farm e.g.. supply of wheat of a particular field
or the fruit of a particular tree since there is a possibility that the crop
is destroyed before delivery and given such possibility, the delivery
remains uncertain.

(6)The exact date and place of delivery must be specified in the contract.
(7) Salam cannot be effected in respect of things, which must
be delivered at spot. e.g Salam b/w wheat and barley.
(8)The commodity of Salam contract should remain in the
market right from day of contract up to the date of delivery .
(9) there should be actual delivery of commodity.
(10) Salam is not possible for rare products.
Difference b/w Salam & Murabaha
Salam Murabaha

• In Salam, purchased • In Murabaha


goods are deffered, purchased goods
price is paid on spot. are delivered at spot,
price may be either
on spot or differed.
• In Salam price has
to be paid in full in • In Murabaha price
advance. may be on spot or
differed.
Difference b/w Salam & Murabaha
Salam Murabaha

• Salam is not executed in • Murabaha can be


the particular commodity executed in particular
but commodity is commodity.
specified by
specifications.
Delivery of Salam goods

• Before delivery, goods will remain at the risk of seller.


• After delivery, risk will be transferred to the purchaser.
• Possession of goods can be physical or constructive.
• Transferring of risk and authority of use and
utilization/consumption are the basic ingredients of constructive
possession.
Khiyar (option)
• After taking delivery, the purchaser
has the “option of defect” (Khiyar-
e-Aib). Not “option of seeing”
(Khiyar-e-ruyat)
Options available for purchaser after taking delivery

1. Parallel Salam
After the execution of Salam agreement with one party,seller
executes another salam agreement with third party,

Conditions for Parallel Salam:


(a) there must be two different and independent contracts, these
two contracts cannot be tied up and performance of one should not
be contingent on the other.

(b) Parallel Salam is allowed with third party only.


Parallel Salam Diagram
1st Salam Seller 2nd Salam Purchaser

Parallel
Salam
Salam
Sale

Delivery of Delivery of
Commodity Commodity

Islamic Bank Islamic Bank


Purchaser Seller
2. Agency agreement

• If the bank has no expertise to sell the commodities received under


Salam contract, then the bank can appoint the customer as its agent
to sell the commodity in the market/third party, subject to Salam
agreement and Agency agreement are separate from each other.

• A price must be determined in agency agreement on which the


agent will sell the commodity but if the price is increased, the
benefit can be given to the agent.
3. Selling in the market

• If the bank has expertise in the relevant commodity, it


can sell the commodity in the market/third party, Or
hold the commodity to fetch a better market price to
maximize its profit .
4. Promise to purchase

• Before maturity the bank can give promise


to sale the commodity to third party, after
taking delivery, bank will sell the same
commodity to the promissee,
• This promise should be unilateral.
5. Salam combining with Murabaha
• Bank can sell the Salam commodity to the seller of Salam on
Murabaha subject to following terms:
(a) Salam agreement and Murabaha agreement should be independent, not
contingent and with free will of the parties.
(b) Murabaha will be executed after taking the possession of Salam goods.
(c) Bank shall assume the risk of loss b/w taking delivery and execution of
Murabaha.
(d) Bank cannot take undertaking from seller of Salam that he will purchase the
Salam commodity from Bank on Murabaha basis.
Revoking the Salam contract

• After execution of Salam


agreement, it cannot be revoked
unilaterally without mutual
consent of both parties.
• Penalty for non performance
• Seller can undertake in the Salam agreement that in case of
late delivery of Salam goods, he shall pay to the charity
account maintained by the bank a sum calculated on the basis
of….% per annum for each day of default,bank will spend
this amount in charity purpose on behalf of the client.
• This undertaking is infact a sort of self-imposed penalty to
keep oneself away from default.
Security
A security in the form of a guarantee, mortgage or
hypothecation may be required for a Salam in order
to ensure that the seller shall deliver the commodity
on the agreed date. In the case of default in
delivery,the guarantor may be asked to deliver the
same commodity and if there is a mortgage, the
buyer can sell the mortgaged property and the sale
proceeds can be used either to realize the required
commodity by purchasing it from the market or to
recover the price advanced by him.
Scope and potential of Salam

• The Salam sale has the flexibility to cover the needs


of various sectors of people such as farmers,
industrialists, contractors, exporters or traders. It can
be used to meet the capital requirements as well as to
meet the cost of operations.

• Salam sale is suitable to finance the agricultural


operations
– Where the Bank transact the farmer to fulfill the promise to
deliver the commodity.
– Salam can fulfill all the requirement of farmer i-e liquidity,
Purchase of inputs, fertilizers, render the transportation etc.
• Salam sale is also used to finance the commercial
and industrial activities, especially in phases prior
to production and export of commodities and that
is purchasing it on Salam and marketing them for
lucrative prices.

• The bank can financing craftsman and small


producers to improve productivity.
Istisna
Introduction
Istisna’ is sale transaction where commodity
is transacted before it comes into existence.
Definition
It is an order to producer to manufacture a
specific commodity for the purchaser.
Istisna’: Legitimacy
• The Prophet (PBUH) required that a pulpit
(platform) be built for preaching [Bukhari
2/908]
• The Prophet (PBUH) required that a finger
ring be manufactured for Him [Bukhari 5/220
and Muslim 3/1655]
Conditions of Istisna
(1)The subject of Istisna is always a thing which needs
manufacturing
(2)Manufacturer use his own material
(3)Quality and Quantity should be agreed in absolute term
(4)Purchase price should be fixed with mutual consent
(5)The manufacturer uses his own material to manufacture
a good to differentiate from Ijarah
Price of Istisna
• Price of istisna may be in the form of money,commodity and
usufruct.
• Price of Istisna may be spot and differed therefore Istisna is
applicable where Salam is not applicable.
• Price of Istisna is can be paid in installments.
• The installments may be tied up with different stages of
projects.

Option
When the required goods have been manufactured by the
manufacturer purchaser can exercise his option of defect,but
he cant use his option of seeing,
Revoking of Istisna

• The contract of Istisna can be cancelled


unilaterally before the manufacturer starts
working.
• After starting the work, Istisna cannot be cancelled
unilaterally.
Difference between Istisna’ & Salam
ISTISNA SALAM
• The subject of istisna is • The subject can be any
always a thing which thing.
needs manufacturing.
• The price in istisna does • The price has to be paid
not necessarily need to be in full in advance.
paid in full in advance.
Difference between Istisna’ & Salam
SALAM
ISTISNA • Time of delivery is an
• Time of Delivery does essential part of the sale
not have to be fixed • The contract cannot be
cancelled unilaterally.
• The contract can be
cancelled before the
manufacturer starts
working.
Difference between Istisna’ & Ijarah
IJARAH
ISTISNA The material is provided by
• The manufacturer the customer and the
either uses his own manufacturer uses only
material his labor and skill.
Security

A security in form of a guarantee, mortgage or


hypothecation may be required for Istisna in order to ensure
that the manufacturer shall deliver the commodity on the
agreed date,
in the case of default in delivery,the guarantor may be
asked to deliver the same commodity,and if there is a
mortgage,the buyer can sell the mortgaged property and the
sale proceed can be used either to realize the required
commodity by purchasing it from the market,or to recover
the price advanced by him.
Time of Delivery

It is not necessary in Istisna that the time of delivery is


fixed. However, The purchaser my fix a maximum time for
delivery after the appointed time,he will not be bound to
accept the goods and pay the price.
In order to ensure that the goods will be delivered within
the specified period, some modern agreement of this nature
contain a penalty clause to the effect that in case the
manufacturer delays the delivery after the appointed time,
the price shall be reduced by a specified amount per day.
Delivery of Manufacturing goods

• Before delivery, goods will remain at the risk of seller.


• After delivery, risk will be transferred to the purchaser.
• Possession of goods can be physical or constructive.
• Transferring of risk and authority of use and
utilization/consumption are the basic ingredients of constructive
possession.
• If manufactured goods are delivered before agreed date, purchaser
can refuse to accept the goods.
Parallel Istisna and its applications

After the execution of Istisna agreement with one party, buyer


or seller executes another Istisna agreement with third party,

Conditions for Parallel Istisna :

(a) there must be two different and independent contracts, these two contracts
cannot be tied up and performance of one should not be contingent on the
other.

(b) Parallel Istisna is allowed with third party only.


Parallel Salam Diagram – Example I
1st Istisna Manufacturer 2nd Istisna Purchaser

Parallel
Istisna Istisna
Sale

Delivery of
Commodity Delivery of
Commodity

Islamic Bank Islamic Bank


Purchaser Seller
2 Istisna Sale Contract 1 June 06

3 Istisna Price Payment 1 June 06, 1 Jul 06, 1 Aug 06

Manufacturer/ Bank
Delivery of
Builder Purchaser/

Pays 15 May + 15 Aug – 31 Dec 06


Commodity 4
[ISTISNA’] Seller
1 Aug 06

Istisna’ Contract
Parallel Istisna’

15 May 06
6 1

Example II 5

Delivery of
Commodity Customer
1 Aug 06 or [ISTISNA’]
15 Aug 06
Potential of Istisna

The client can get finance for raw material, working


capital and other overhead expenses
by the execution of Istisna agreement.

House financing, import and export products can be


easily designed on Istisna basis.
Istisna as Mode of Financing

• House Financing
• Project Financing
• BOT Arrangement
• Export Pre Shipment