Salam as asset side mode of Islamic finance

a) b) c) d) e) f) Introduction to Salam Meaning of Salam Conditions of salam Salam as a mode of financing Some rules of parallel salam Difference b/w Istisna and 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 1. Seller agrees to supply specific goods to the buyer at 2. a future date in exchange of an advanced price fully paid 3. at spot. 4. 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.

BENEFIT OF SALAM

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, 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.

CONDITIONS OF SALAM

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.

CONDITIONS OF SALAM

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.

CONDITIONS OF SALAM

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. e.g.. Salam b/w wheat and barley.
The commodity of 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. There should be actual delivery of commodity.

DIFFERENCE B/W SALAM & MURABAHA Salam

Murabaha

In Salam, purchased goods are deferred, price is paid on spot.

In Murabaha purchased goods are delivered at spot, price may be either on spot or deferred.
In Murabaha price may be on spot or deferred.

In Salam price has to be paid in full in advance.

DIFFERENCE B/W SALAM & MURABAHA

Salam
Murabaha

Salam is not executed in the particular commodity but commodity is specified by specifications. Salam cannot be effected in respect of things, which must be delivered at spot. e.g. Salam b/w wheat and barley.

Murabaha can be executed in particular commodity.

Murabaha can be executed in those things.

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-eAib). Not option of seeing (Khiyar-eruyat)

OPTIONS AVAILABLE FOR PURCHASER AFTER TAKING DELIVERY

Parallel Salam
(a) After the execution of Salam agreement with one party, buyer, or (b) 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) It is allowed with third party only.

1st salam seller

2nd Salam Purchaser

Salam Sale

Parallel Salam

Delivery of Commodit y

Delivery of Commodit y

Islamic Bank Purchaser

Islamic Bank Seller

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. 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.

AGENCY AGREEMENT

If the price is decreased the loss will be suffered by the bank. Commission / Brokerage may be given to the agent against his service. In case he fails to sell out goods on time, he will not be eligible for the commission. The agent should provide the evidence of selling the commodity to a third party.

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.

PROMISE TO PURCHASE

Before maturity bank can take promise to purchase from a third party, after taking delivery, bank will sell the same commodity to the promissee, and he will be bound to purchase the same according to his undertaking. This promise should be unilateral.

SALAM COMBINING WITH MURABAHA

Bank can sell the Salam commodity to the seller of Salam on Murabaha subject to following terms: 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. This practice should be avoided because fulfilling the above mentioned term is so difficult.
(a)

PENALTY FOR LATE DELIVERY

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 infect a sort of Yameen/Nazar which is a 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. Bank cannot recover the principle and profit from sell proceeds of security.

Salam is not possible in same currencies. However Salam is possible in different currencies subject to Salam will be executed on the Spot Rate.