Istisna & Salam

“ Concept of Istisna and

Shariáh Basis
”
 Istisna - Definition

Literally the word Istisna is derived from root word sana’ that means to
manufacture or to construct something.

It is a contract of sale of specified items to be manufactured (or constructed), with

an obligation on the part of the manufacturer (or contractor) to deliver them to
the Customer upon completion.

Payment of Istisna price may be:

▪ At spot
▪ In installments
▪ At the time of delivery of goods
 Istisna - Introduction

▪ An Istisna contract is permitted only for raw materials that can be transformed from
their natural state by a manufacturing or construction process involving labour.
▪ It is not permissible that the subject matter of an Istisna contract be an existing and
identified capital asset. For example, it is invalid to sell a designated car or factory on
Istisna Basis. This is because Istisna is a sale of items identified through specification
and not be designation.
 Istisna - Introduction

▪ The time of delivery of goods does not necessarily have to be fixed in Istisna however,
a maximum time may be agreed upon between the parties.
▪ The delivery of the subject matter may take place through constructive possession. At
this point, the liability of the manufacturer in respect of the subject matter comes to
an end and the liability of the ultimate purchaser begins.
 Istisna - Introduction

▪ Unlike Murabaha where only raw material can be financed, Istisna can be easily
utilized to facilitate payment of overheads etc. in addition to the purchase of raw
material.
▪ It is also to be noted that amount paid out as Istisna price to the manufacturer can be
used by the manufacturer anywhere he deems fit. It doesn’t have to be utilized
exclusively for the production process.
 Istisna Vs. Conventional Financing

Sr. No. Conventional Financing Istisna Financing

1 Qard Based Sale Transaction
2 Compensation in Form of Interest Compensation in Form of Sale Price of
Goods
3 Bank does not assumes ownership Ownership risk is borne by bank
risk
4 Charges Penalty for delay payment No late payment penalty can be charged as
as income of bank income of bank
Diagrammatic Representation
Disbursement of Istisna
2 Price to Customer
3
Delivery of assets to Bank

Offer to sell manufactured

1 Goods by way of Istisna
CUSTOMER/
4 MANUFACTURER
Bank appoints Customer to
sale the goods.

ULTIMATE
5 Sales Proceeds BUYER
Product Development, Training and Business Shariáh - IBSD, Askari Bank Ltd.
“ Istisna
Documentation
”
 Istisna Documentation

There are a number of documents involved in an Istisna transaction. The most essential of these
documents are:
1. Master Istisna Agreement
a) Written Offer – Appendix A
b) Goods Receiving Note – Appendix B
2. Agency Agreement
a) Notice to Sell – Schedule 1
b) Agency fee – Schedule 2
c) Confirmation of Sale of Goods – Schedule 3
3. Corporate Guarantee
a) List of Credible buyers – Schedule 1
 Istisna Documentation

1. Master Istisna Agreement – MIA (Agreement to Istisna)

▪ It is a memorandum of Understanding (MoU) between the client and the Bank
whereby the client agrees to manufacture goods from time to time for the Bank as
per the terms and conditions of this MoU.
▪ This is an over all facility agreement under which various Istisna may be executed
from time to time.
▪ This needs to be signed once at the time the facility is sanctioned.
 Istisna Documentation

a) Written Offer (Appendix ‘A’)

▪ This document is executed each time the customer requires Istisna for manufacturing
of goods.
▪ Through this document customer shows his willingness to manufacture goods for
Bank.
▪ Customer agrees exact specification of goods, Price of the goods, Quantity of goods,
maximum Delivery period and Delivery Point.
 Istisna Documentation

b) Goods Receiving Note (Appendix ‘B’)

▪ This document is the most important part of the Istisna process. Through this
document the customer transfers ownership of the goods to the bank.
▪ An important point to be kept in mind is that the goods must be in existence and in
their original form at the time of signing of Goods Receiving Note (execution of sale).
 Istisna Documentation

2. Agency Agreement
▪ Through this agreement the Bank appoints customer its agent to sell the Istisna goods
of the Bank to credible buyers. It is to be noted that under this agreement the agent is
liable to take every possible measures to put its utmost effort to sell the Istisna goods
in the market.
▪ This agreement needs to be signed once between the client and the Bank to cover the
specified agency period.
 Istisna Documentation

a) Notice to Sell – (Schedule 1)

▪ Through Notice, the bank appoints customer as its agent to sell the Istisna goods to
credible buyers.
▪ Bank must issue Notice to the customer right after the Istisna goods are delivered to
the bank by the customer (acting as manufacturer).
▪ The Agent shall sell on behalf of the Principal the Goods referred to in such Notice for
the sum of the Sale Price as set forth in the Notice and shall ensure that following the
sale of the Sale Goods, it pays the Sale Price to the Principal in accordance with the
instructions specified in the Notice.
 Istisna Documentation

b) Agency Fee & Incentive Fee – (Schedule 2)

• Through Notice bank appoints customer as its agent on compensation. Bank advice
fixed Agency fee and Schedule for Incentive Fee.
• Through the Increase/Decrease in Incentive Fee, bank recovers its Profit over the
Istisna transaction calculated on daily basis.
 Istisna Documentation

c) Confirmation of sale – (Schedule 3)

▪ Through this document the Agent will confirm the Bank that it has sold the goods on
behalf of the Bank.
▪ At this stage bank will book Financing against the disbursed amount.
 Istisna Documentation

3. Corporate Guarantee:
▪ The Customer may be asked to provide a separate/ independent ‘Corporate
Guarantee’ to guarantee the payment obligations of the potential buyers of the
goods.
▪ As per Shariah rulings, this independent Corporate Guarantee will be given after
identification of the Creditworthy Buyer and not before that. (i.e. The Guarantee
cannot be given for an unknown buyer.)
 Recap of Istisna Documentation

Master
Istisna Agency Corporate
Agreement Agreement 1) Notice Guarantee
1) Written Offer
1) List of Credible
2) Agency Fee Buyers
2) Goods
Receiving Note
3) Confirmation of
sale
“
Bai’ Salam
”
 Salam - Definition

Salam transaction is the purchase of a commodity for deferred delivery in exchange for
immediate payment.
 Concept of Salam

• It is a type of sale in which the price, known as the Salam capital, is paid at the
time of contracting while the known as the Salam capital, is paid at the time of
contracting while the delivery of the item to be sold, known as al-Muslam Fihi (the
subject-matter of a Salam contract), is deferred.
• Seller undertakes 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.
“
Purpose of Use
”
 Salam - Purpose

• For Islamic banks this product is an ideal for Agriculture financing but can also be
used to finance the working capital needs to the business customer.
• To meet the need of small farmers who need money to grow their crops and to feed
their family up to the time of harvest.
• To meet the needs to liquidity problem.
• To meet the need of traders for import and export business.
“
Conditions of Salam
”
 Salam – Conditions

• The capital of Salam should be made known to the two parties in a manner that
removes all uncertainty and eliminates the possibility of dispute.

• In principle, the capital of Salam should be in the form of cash. In this case, the
currency of payment, the amount and the manner of payment shall be clearly defined.
 Salam – Conditions

• 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.
• In the absence of full payment, it will be tantamount to sale of a debt against a debt
which is expressly prohibited by the Holy Prophet.
• Moreover 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.
 Salam – Conditions

• 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.
• 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.
 Salam – Conditions

• All details in respect to quality of goods sold must be expressly specified leaving no
ambiguity which may lead to a dispute.
• 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 only meaning what is normally
weighed cannot be quantified and vice versa.
 Salam – Conditions

• The exact date and place of delivery must be specified in the contract.
• Salam cannot be effected in respect of things, which must be delivered at spot.
• The commodity for Salam contract should remain in the market right from day of
contract up to the date of delivery or at least at the date of delivery.
 Salam – Conditions

• Actual delivery should take place and netting of the difference is not allowed.
• Since price in Salam is generally lower than the price in spot sale; the difference in the
two prices may be a valid profit for the Bank.
• A security in form of a guarantee, mortgage or hypothecation may be required for a
Salam in order to ensure that the seller delivers.
“ Difference b/w Salam
& Istisna
”
 Salam Vs. Istisna

Sr. No Salam Financing Istisna Financing

1 The sold goods can be anything thing The sold goods must be something that
whose descriptive condition can be need to be manufactured.
fulfilled.
2 The full price is paid in advance. The full or part price may be paid in
advance or deferred or in instalments.
3 The time of delivery is essential. The time of delivery is not essential an
essential part of the contract.
4 The contract once effected cannot be The contract can be cancelled unilaterally
cancelled unilaterally. before the manufacturing work starts.
“
Benefits of Salam
”
 Salam – Benefits

• Seller/Customer will get the full amount in advance.

• Buyer/Bank will get the commodity lower than market rate.
• Sale of non existing item subject to certain conditions.
• Unlike Murabaha, seller can use the sale proceeds to meet his over head expenses
such as paying of salaries, rentals, administrative cost.