In Salam, the seller undertakes to supply specific goods to the buyer at a future date in exchange for an advanced price fully paid at the spot. The payment is at the spot but the supply of purchased goods is deferred.
Purpose of use:
- This mode of financing can be used by modern banks and financial institutions especially to finance the agricultural sector.
- To meet the needs and requirements of small farmers who need financing to grow their crops and to feed their families until the time of harvest. When Allah’s messenger declared Riba as haram, the farmers could not take usurious loans. Therefore, the Holy Prophet ﷺ allowed them to sell their agricultural products in advance.
- To meet the need of traders for import and export business. Under Salam, it is allowed to sell the goods in advance so that after receiving cash price, they can easily undertake the aforesaid business. Salam is beneficial to the seller as he receives the price in advance and it is beneficial to the buyer also as normally the price in Salam is lower than the price in a spot safe.
The permissibility of Salam is an exception to the general rule that prohibits forward sale therefore it is subject to strict conditions, which are as follows:
Conditions for Salam
The conditions for Bai Salam are as follows:
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. In the absence of full payment, it will be tantamount to the sale of a debt against a debt, which is expressly prohibited by the Holy Prophet ﷺ. Moreover, the basic wisdom for allowing Salam is to fulfill the “instant need” of the seller. If the full price is not paid in advance, the basic purpose of Salam 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 differs in quality, size, weight and their exact specification is not possible.
3) Salam cannot be effected on a particular commodity or for 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 may get destroyed before delivery and given such possibility, the delivery remains uncertain.
4) All devils with respect to the quality of goods sold must be expressly specified leaving no ambiguity, which may lead to a dispute.
5) 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.
6) The exact date and place of delivery must be specified in the contract.
7) Salam cannot be affected in respect of items, which must be delivered at the spot. For example, if gold is purchased in exchange for silver, it is necessary that the delivery of both commodities be simultaneous, thus gold or silver cannot become the subject matter of Salam if the price is paid in the form of gold/silver.
8) The commodity for the Salam contract should be available in the market at the time of delivery. This view is as per the rulings of Shaafi, Maliki, and Hanbali schools of thought.
9) The time of delivery should be at least fifteen (15) days to one month from the date of the agreement. Price in Salamis generally lower than the price in spot sale. The Salam period should be long enough to affect the prices. But Hanafi Fiqh did not specify any minimum period for the validity of Salam. It is all right to have an earlier date of delivery if the seller consents to it.
10) 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.
11) A security in the form of a guarantee, mortgage or hypothecation may be required for a Salam to ensure that the seller delivers.
12) The seller at the time of delivery must deliver commodities and not money to the buyer who would have to establish a special cell for dealing in commodities.
There are two ways of using Salam for the purpose of financing:
- After purchasing a commodity by way of Salam, the financial institution can sell it through a parallel contract of Salam for the same date of delivery. The period of Salam in the second parallel contract is shorter and the price is higher than the first contract. The difference between the two prices shall be the profit earned by the institution. The shorter the period of Salam, the higher the price and the greater the profit. In this way, institutions can manage their short term financing portfolios.
- The institution can obtain a promise to purchase from a third party. This promise should be unilateral from the expected buyer. The buyer does not have to pay the price in advance. When the institution receives the commodity, it can sell it at a pre-determined price to a third party according to the terms of the promise.
Conditions of the Parallel Salam
In an arrangement of parallel Salam, there must be two different and independent contracts;
i) one, where the bank is a buyer.
ii) the other in which it is a seller.
The two contracts cannot be tied up and performance of one should not be contingent on the other. For example, if ’A’ has purchased from ‘B’ 1000 bags of wheat by way of Salam to be delivered on 31 December, ’A’ can contract a parallel Salam with ‘C’ to deliver to him 1,000 bags of wheat on 31 December. But while contracting Parallel Salam with ’C’, the delivery of wheat to ‘C’ cannot be conditioned with taking delivery from ’B’. Therefore, even if ’B’ does not deliver wheat on 31 December, ‘A‘ is duty bound to deliver 1,000 bags of wheat to ’C’. He can seek whatever recourse he has against ’B’, but he cannot rid himself from his liability to deliver wheat to ’C’.
Similarly, if ’B’ has delivered defective goods, which do not conform to the agreed specifications, ’A’ is still obligated to deliver the goods to ’C’ according to the specifications agreed with him.
2. A Salam arrangement cannot be used as a buy back facility where the seller in the first contract is also the purchaser in the second contract. Even if the purchaser in the second contract is a separate Iegal entity but owned by the seller in the first contract; it would not be tantamount to a valid parallel Salam agreement.
For example, ’A’ has purchased 1,000 bags of wheat by way of Salam from ’B’ – a joint stock company. ‘B’ has a subsidiary ’C’, which is a separate legal entity but is fully owned by ’B’. ’A’ cannot contract the parallel Salam with ’C’. However, if ‘C’ is not wholly owned by ‘B’, ’A’ can contract parallel Salam with it, even if some share-holders are common between ’B’ and ’C’.
Risk Mitigation in Salam
Some of the risks that are present in Salam financing for banks are as follows:
|1||Delivery Risk||Delay in delivery of goods from the customer||Wait untiI the goods are available|
Bank can canceI the contract and recover the Salam price
Bank can agree on replacement of goods provided that the market value of the replaced goods does not exceed the market value of the original goods that were subject matter of Salam.
|2||Quality Risk||The Customer delivers defected|
|The Bank has the right to reject the delivery or bank can accept the delivery at discounted price|
|3||Price Risk||Market price of the subject matter decreases after Bank enters into Salam agreement.||Parallel Salam or promise to purchase from a third party will mitigate the risk.|
|4||Storage Risk||The goods once delievered by Customer wilI be at Bank’s risk before the same are sold to the ultimate purchaser.||Obtain Takaful coverage for Salam goods|
Minimize the time duration between acceptance of delivery under Salam and delivery to the ultimate purchaser.
Written by: Dr. Muhammad Imran Usmani
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