SALAM

DEFINITION

Bai salam: 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.

Imagine you want to buy something from a seller, but you don't want it right away; you want it in the
future, say next month. So, you pay the full price for it now, but you'll get the thing later. It's like pre-
ordering a video game or a book. You pay upfront, and they deliver it to you when it's ready. In this case,
you pay in cash, but you wait for the item to be delivered later on. That's what this arrangement means.

PURPOSE

Bai Salam transaction in Islamic finance is for financing farmers and small traders, functions as a vital
financial tool for micro banks and financial institutions in supporting small industries.

1. Supporting Small Farmers: Many small farmers often struggle to afford the expenses of planting and
growing their crops until harvest time when they can sell them. Salam can help by providing them
with the money they need upfront to buy seeds, fertilizer, and other essentials. This way, they can
focus on growing their crops without worrying about immediate financial burdens. Once they
harvest and sell their crops, they can use the proceeds to repay the Salam agreement.

Example of Salam in Agriculture Financing

Consider a farmer who requires capital to purchase seeds, fertilizers, and other essentials for an
upcoming planting season. However, the farmer lacks immediate resources but can deliver 100 tons of
wheat after six months.

Contract Initiation: The farmer and the bank enter into a bai salam. The bank commits to paying
$100,000 upfront to the farmer for 100 tons of wheat to be delivered at the end of the harvest season.

The bank provides the farmer with the entire $100,000 at the inception of the contract, enabling him to
procure the necessary agricultural inputs. The farmer uses the funds to buy seeds, fertilizers, and other
essentials. The principle of mutual agreement allows the farmer to decide how best to utilize this
capital. On maturity of the contract and completion of the harvest, the farmer delivers 100 tons of
wheat to the bank, adhering to the Salam delivery principle.

Thus, the bank provides the farmer with essential capital for agricultural operations while adhering to
Islamic banking ethics. Subsequently, the bank can either sell the wheat in the market or engage in a
parallel Salam contract to ensure the wheat reaches its final consumers.

2. Assisting Traders in Import-Export Business: Importers and exporters often need funds to purchase
goods for trade, but they might not have immediate cash available. Salam allows them to pay
upfront for the goods they need to import or export. For example, an importer might use Salam to
pay a supplier in advance for goods that will be shipped later. This helps traders secure the goods
they need for their business operations without having to wait for the actual delivery or sale of the
goods
CONDITIONS OF SALAM:
 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.
 Only those goods can be sold through a Salam contract in which the quantity and quality can be
exactly specified.
eg. 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 contracts cannot be based on specific commodities or products from a particular field or
farm.
For instance, you can't enter into a Salam agreement for the supply of wheat from a specific
field or the fruit from a particular tree. The reason behind this restriction is the uncertainty
involved. There's a possibility that the crop may get destroyed before it's delivered, and because
of this uncertainty, the delivery of such specific items remains uncertain. Therefore, Salam
contracts typically involve more general terms, such as a certain quantity of wheat rather than
wheat from a specific field, to minimize this risk of uncertainty.
 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.
 The exact date and place of delivery must be specified in the contract.
 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.
 A security in form of a guarantee, mortgage may be required for a Salam in order to ensure that
the seller delivers.
 In the agreement the unit price and total price of the goods will be fixed and mentioned

PARRALLEL SALAM
Once the Salam agreement has been executed with one party, the buyer or seller initiates another
Salam contract with a third party. Parallel Salam contract is allowed with third party only. They must be
two different and independent contracts, and these two contracts cannot be tied up.
In a parallel Salam arrangement, there are two separate contracts involved, one where the bank acts as
the buyer and another where it acts as the seller. Let's break it down:

1. Buyer Contract: In one contract, the bank acts as the buyer. This means the bank agrees to pay
upfront for a certain commodity or product to be delivered at a future date. This contract is
independent and standalone.

2. Seller Contract: In the other contract, the bank acts as the seller. Here, the bank agrees to
deliver the same quantity of the same commodity or product at a future date in exchange for
payment received upfront. Again, this contract is independent and standalone.
The key point is that these two contracts are separate and not tied to each other. The performance of
one contract should not be contingent upon the performance of the other. For example, if the bank fails
to deliver the goods as a seller, it should not affect its obligation to pay as a buyer, and vice versa. This
separation helps to ensure that each party fulfills its obligations independently and reduces the risk of
one party defaulting affecting the other contract.

SALAM AS A MODE OF FINANCE

steps:

1. Bank pays the full price against a commodity which will be delivered in future.
2. A distinct party undertakes to purchase the commodity of same quantity and quality without
referring to the first contract.
3. Like wise Bank can make a parallel salam contract matching the terms of first salam contract
without referring to it.
4. Bank gets the delivery of the commodity and passes on
 to the other buyer in parallel salam OR
 enters in to a sale agreement with the promiser OR
 makes the seller of the first salam its agent to sell the commodity

ISTISNA’

Istisna' is a type of sale transaction where the commodity being sold doesn't exist yet at the time of the
agreement. Instead, it's an order placed by the purchaser for the production or manufacturing of a
specific commodity.

 Made to order
 According to specifications
 Once the item is produced, it is delivered to the purchaser, who then pays for it according to the
terms agreed upon in the Istisna' contract.

DIFF BTW SALAM & ISTISNA’

ISTISNA’ SALAM
 The subject on which transaction of  Subject can be anything.
Istisna’ is based, is always a thing which
needs to be manufactured.

 Price must be fixed, but need not to be  Price has to be paid in full in advance
paid in advance

 Time of Delivery does not have to be  Time of delivery is an essential part of

fixed the sale
  The contract can be cancelled before the  The contract cannot be cancelled
manufacturer starts working. unilaterally.

Istisna' can be used as a mode of financing in various scenarios, including:

1. House Financing: Istisna' can be utilized for house financing, particularly in construction
projects. In this case, the buyer (often the homeowner or a real estate developer) enters into an
Istisna' contract with a builder or contractor. The builder agrees to construct a house or a
building according to the buyer's specifications. The buyer pays the price of the construction in
installments, and once the construction is complete, the property is delivered to the buyer.

2. Build-Operate-Transfer (BOT) Arrangement: Istisna' can be incorporated into BOT

arrangements, especially in infrastructure projects like highways, bridges, or public facilities.
Under a BOT agreement, a private entity (often a consortium or a private company) enters into
an Istisna' contract with a construction company to build and operate a public infrastructure
project. The construction company constructs the infrastructure and private entity operates it
for a specified period to recoup its investment. After the agreed-upon period, ownership of the
infrastructure is transferred to the government or the public authority.

3. Government Projects: Istisna' can also be employed in government projects, particularly for the
construction of public infrastructure or facilities. In this case, the government or a public
authority enters into an Istisna' contract with a construction company or a contractor to build
schools, hospitals, roads, or other public amenities. The construction is financed through Istisna'
contracts, and the completed projects are handed over to the government upon completion.