SALAM

• The Seller undertakes to supply specific

goods to buyer at a future date in
exchange of an advanced price fully paid
at spot.
• The payment is at spot but the supply of
purchased goods is deferred
 Purpose Of Use
• Can be used for agricultural financing.
• To fulfill needs of small farmers regarding cash for
buying inputs for the crop .
• To meet the needs of traders for import and
export business.
• Salam is beneficial to the seller as he receives
price in advance. And for the buyer it is beneficial
as normally the price in Salam is lower than the
price in spot sale.
 Salam -Introduction

• Basic principles for validity of sale in Shariah is that

a) Commodity should be existing, non existing goods
are not eligible for sale.
b) Seller must have ownership of commodity.
c) The commodity must be in physical or constructive
possession of the seller, selling of what is not
possessed by the seller is not allowed
However Bai Salam and Bai Istisna are sales of special
nature and are exceptions to general rules of sale
 Salam Background
• Before prohibition of interest , farmers in
Madinah use to obtain interest based loans for
their agricultural and routine life needs.
• After prohibition of interest they faced
hardship.
• Holy Prophet (PBUH) allowed salam with
certain conditions.
 Salam Background
• The basic purpose of the permission of Salam
was to ease the financial needs of small
farmers , who needed money for their
agricultural and personal needs till the time of
harvest.
• Since after prohibition of interest they could
not borrow money on interest , they were
allowed to sell their agri. Products in advance
before existence of these goods/commodities.
 Salam Conditions
To eliminate element of Gharar certain conditions
have been laid down to minimize the element of
Gharar:
1. The Salam price must be paid full in advance at
the time of effecting sale. Because in absence of
payment of full price, it will be like selling debt
against debt, which is prohibited. Also basic
purpose of salam is to fulfill instant need of
seller, and if price not pad fully in advance the
purpose is defeated.
 Salam Conditions
2.
• Salam can be effected only for those commodities
that can be exactly specified in quantity or quality.
• It means only those goods can be sold under Salam
transaction that fall under category of Dhawat Ul
Amthal i.e. such commodities the units of which are
homogeneous in characteristics.
• It means the commodities which are traded by
counting ,measuring or weighing according to usage
and customs of trade e.g. wheat ,rice, cotton ,barley
 Salam Conditions
3.
• Salam is not allowed in heterogeneous goods.
• These are those goods ,the units of which are
different among each other in characteristics.
Meaning that each piece is different in size ,
weight , value .
• For example animals and precious stones are
not possible to be precisely defined beforehand
 Salam Conditions
4.
• Subject matter of Salam should be of common
nature .Therefore Salam cannot be effected on a
particular commodity of a particular field or farm.
• If the seller undertakes to supply the wheat of particular
farm or fruit of a particular tree , then it will be an invalid
Salam. The reason behind it is , that it isn’t necessary
that the farm or tree would be able to produce the
required commodity or fruit. Alternatively one can define
a particular type of the commodity for which salam is
being done e.g. Rice irri or basmati etc.
 Salam Conditions
5.
• Both the quality and quantity of goods should be
clearly agreed upon. All possible details should be
expressly mentioned .
• If commodity is quantified in weight in the market ,its
weight must be determined and if it is quantified
through measures its exact measures should be
known.
 Salam Conditions
6.
• The exact date and place of delivery must be specified in
contract. The date may be in range as well i.e. from 10th
to 15th oct. The place should be specifies as per custom.
• Salam cannot be effected in respect of things which must
be delivered on spot .
• It is necessary that the commodity which is the subject
of Salam contract is normally available in markets at the
time of delivery. Salam of Mangoes in January is invalid,
Salam of strawberry in December is invalid etc.
 Salam Conditions
7.
• Delivery of goods to buyer is mandatory. The seller
should hand over the commodities to buyer at the time
of delivery. Seller cannot give money back to the byer on
basis of set off.
• Buyer cannot contractually bind the seller to buy back
the sold commodity.. This will be a case of implicit
interest (Hellah) and vice versa.
• However after the delivery they both may enter in a
transaction of sale with mutual consent , independently
from Salam sale
 Salam Conditions
8.
• The buyer shall not sell or transfer ownership of
goods before taking possession (actual or
constructive) of these goods.
9.
• A security in form of gurantee, mortgage or
hypothecation may be asked for surety of delivery.
However it will be limited up to the price paid in
advance by the buyer
 Salam Conditions
10.
• The time of delivery should be at least 15 days or 1
month from date of agreement. Price in Salam is
generally lower than price in spot sale.
• 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.
 BENEFITS
There are 2 ways of using Salam for purpose of financing:
1. After purchasing commodity by way of Salam , bank
can sell it through parallel contract of Salam. The
period of Salam in second contract will be shorter and
price is higher than the first contract.
2. The bank can obtain a promise to purchase from a 3rd
party. This promise should be unilateral from the
buyer. Buyer does not have to pay price in advance.
When goods are received it can sell at a pre
determined price to 3rd party as per terms of promise.
 Parallel Salam
• It is not kind of a salam.
• It is an arrangement by buyer to sell the
commodity he purchased from someone.
• The buyer cannot sell the commodity before
he takes possession from seller in a Salam
contract.
• But buyer may sell the commodity he bought
on Salam to another person on Salam basis
 Parallel Salam
• Lets assume Ahmed enters into a Salam
contract with Bashir to purchase 1000 bales of
cotton at a price of Rs. 100,000/ bale to be
delivered on 20th August. In this contract
(Salam A) Ahmed is buyer and Bashir is seller.
• Ahmed can enter into another Salam with
Khalid to sell the same cotton at price of
105,000/ bale. In this contract (Salam B)
Ahmed is seller and Khalid is buyer.
 Parallel Salam
• This arrangement is known as Parallel Salam.
• It can be effectively used if Salam is used by an
intermediary.
• In a Parallel Salam arrangement bank enters into 2 different
and separate contracts. In one bank becomes buyer and in
second Bank is seller.
• Each one of these contracts must be independent of the
other. They cannot be tied up in a manner that the rights
and obligations of 1 contract are dependent on the rights
and obligations of parallel contract. Each should have its
own enforcement and should not be contingent on the other
 Parallel Salam
• Lets assume that on 31 Dec. Ahmed has purchased 1000 bales of
cotton from Basheer through a Salam contract . It is decided that
cotton would be delivered on 31st January.
• Ahmed then enters into a contract of Parallel Salam with Khalid
to sell same 1000 bales of cotton to him
• Delivery is to be made on 31st January.
• But while contracting Parallel Salam with Khalid the delivery of
cotton cannot be dependent on delivery of cotton by Basheer. If
Basheer fails to deliver , Ahmed is responsible to deliver the
required bails to Khalid.
• Ahmad may start legal action against Basheer but he will still be
responsible for delivery of cotton to Khalid .
 Parallel Salam
• IMP. POINTS
• Parallel Salam is allowed with 3rd party only
• The seller in first contract cannot be made purchaser
in the parallel contract of Salam.It will be buy back
arrangement and this is not allowed
• If the purchaser in second contract is a separate legal
entity , then it is necessary that it should not be a
subsidiary or sister concern of the seller company .
• This will not be allowed because n practical sense it
will be a buy back arrangement .
 Salam-Application
• Salam is a useful product that can be used for many
banking activities.
• Islamic bank can use it for Agricultural finance and
working capital finance as well.
• Salam is somewhat risky transaction. Business wise it
may become a problem for bank if it takes delivery of
goods.
• Islamic banks usually combine 2 or more products to
make Salam viable business wise.
 Salam-Application-Option 1
1. Unilateral promise to buy Salam goods from 3rd parties.
• If parallel contract of Salam is not feasible , bank can
obtain a promise to purchase from 3rd party ( expected
buyer)
• The promise should be unilateral from expected buyer
• Being merely a promise , and not actual sale the buyer will
not have to pay price in advance.
• Therefore a higher price may be fixed
• As soon as the goods are received by the bank, it will be
sold to 3rd party at the pre agreed price , according to
terms of promise.
 Salam-Application-Option 2
2. Appointment of seller as an agent of a ban for
selling to 3rd party:
• The bank may also appoint the seller as its
agent to the sell the goods to a 3rd party.
• In this scenario if the seller fails to sell the
goods to 3rd party bank will have to bear the
loss.
• The agent cannot be made responsible for his
failure in selling the goods.
 Salam-Application-Option 3
3.Combination of Agency for Salam and Murabaha:
• Salam can also be used in agency agreement to
facilitate a Murabaha transaction.
• Leather industry needs hides to Manufacture leather.
• The structure of this product will have to tailor made
to suit both the bank and customer
 Salam-Case 1 Working Capital Financing

• A sugar Mill has a financing requirement of Rs. 20M

for a period of 90 days.
• Client approaches bank for required financing.
• Salam finance agreement is executed between both .
• Islamic Bank purchases 1m kg of sugar for rs 20M
from client. The calculation behind the quality of
sugar purchased is as follows
- Sugar Purchase rate= Rs 20/Kg
- Quantity Purchased = 1M Kg
 Salam-Case 1 Working Capital Financing
• As per Salam arrangement Rs. 20 M will be immediately paid
by bank to client, whereas 1 M kg of sugar will be delivered
to Bank by client on a specified future date.
• Let us assume disbursement of Rs 20.0M was made on
March 10. 2016, with a tenure of 3 months , i.e. maturity
date will be June 9 2016.
• As per Salam arrangement , client agrees to deliver the sugar
to Islamic Bank on June 9 2016(90 days after disbursement).
• Upon preparation of consignment banks appointed
Mucaddum will take charge of sugar. Technically Salam is
over
 Salam-Case 1 Working Capital Financing
• Option A –Appointment of client as agent.
- On 09/06/2016 Bank signs agency agreement with
client .
- Through this agreement client is appointed agent to sell
sugar to a 3rd party at the rate of Rs. 20.70/kg.
- Price arrived at keeping in view profit rate of 14% for 3
months period.
- Client appointed as agent to sell sugar mainly because
Bank does not have expertise to sell the sugar.
- After sale of sugar , agent deposits sale proceeds with
bank through DD/Payorder/Chque/Cash
 Salam-Case 1 Working Capital Financing
• Option B – Direct Sale to 3rd Party:
a. On 09/06/2016 Bank sells the delivered goods to a 3 rd
party ( sugar dealer/beverages plant/confectionery).
b. To mitigate the risk of fluctuating prices , Bank may
beforehand obtain a MOU /promise to purchase from
3rd party This MOU / Promise should be unilateral from
the 3rd party. 3rd party will not have to pay price in
advance.
c. A higher price may be agreed to mitigate the risk of
fluctuating prices. After delivery from 1 st party goods
will be sold to the promisor as per MOU/Promise.
 Salam-Case 1 Working Capital Financing
• Option C Parallel Salam
a. After execution of Salam arrangement with
client , bank may execute another Salam
agreement from 3rd party.
b. In parallel salam arrangement , bank will sell
the sugar to 3rd party on Salam basis .
 Salam-Case 2 Agricultural Financing
• Let us assume a farmer needs financing of 1m for a
period of 6 months.
• Salam Finance agreement will be executed whereby bank
purchases for example 40,000 kgs of Basmati rice for Rs
1.0M assuming price of Rs 25/Kg from the farmer.
• As per Salam arrangement Rs 1.0 M will be disbursed to
farmer immediately, whereas rice will be delivered by
farmer to Bank on a specified future date (Most probably
180th day). Mucaddum will take charge of goods.
• Bank again has 3 options.
 Salam Risks and Mitigants
1. Commodity Price Risk:
• Under Salam arrangement the commodities
purchased are to be delivered on future date , there
is a risk that on the delivery date, the price of
commodity is lower then the expected price
• We can mitigate this by understanding the
commodity risk , stable-price commodities should be
selected for Salam.
• Obtain MOU/Promise to Purchase from 3rd party.
 Salam Risks and Mitigants
2. Pre- Mature Adjustment risk
• Due to rising sugar prices in in 2007 , SBP instructed all sugar
mills to settle their outstanding loans(availed against security
of sugar stocks)by July 31 2006
• So if salam facility of 100 M was extended to sugar mill by the
bank and delivery date of September 2006 , Bank cannot
compel the client for early delivery of sugar.
• Maturity of price or sold sugar ,cannot be changed
unilaterally.
• If bank is forced to terminate Salam transaction prematurely ,
the Bank can only recover principal amount. Conventional
bank can however recover interest for number of days .
 Salam Risks and Mitigants
3. Risk of Default in Delivery
• Since the price of commodities has already been
advanced to the client , he may default after
accepting the payment. The client may declare on
the delivery date that he will not be able to deliver
the commodity .
• As a mitigant bank can liquidate the security and
the sale proceeds can be used either to realize the
required commodity by purchasing it from market,
or to recover the Principal amount.
 Salam Risks and Mitigants
4. Risk of delay in delivery
• As per Salam arrangement , it was agreed that
client will deliver the goods on 1/11/2016 ,
however he delivers the commodity on
15/11/2016,
• As a mitigant bank can charge charity, but loss
to bank will occur.
 Salam Risks and Mitigants
5. Fault in Delivery/Quality Risk:
• The client has delivered the commodity to the
ban with lower quality of commodity or there
is a fault in commodity.
• The Bank has right to reject on the basis of
“Option of Defect”- Khiyar E Aib
 Salam Risks and Mitigants
6. Holding Risk
• Client delivers commodity on 1/11/2016. If Bank
holds the commodity and sells the same on
15/11/2016to the 3rd party , it will have to bear the
holding cost as well as the risk of any danger to
commodity for these 15 days.
• As a mitigating factor bank can make an
arrangement beforehand under which t will sell the
commodity immediately to a 3rd party as soon as
delivered from client.