Glossary

This mode of financing can be used by the modern banks and financial institutions especially to finance the agricultural sector. In Salam, the seller undertakes to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot. The price is in cash but the supply of purchased goods is deferred.

Purpose of use:
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. When Allah declared Riba haram, the farmers could not take usurious loans. Therefore Holy Prophet 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 for them that they sell the goods in advance so that after receiving their cash price, they can easily undertake the aforesaid business. Salam is beneficial to the seller because he received the price in advance and it was beneficial to the buyer also because normally the price in Salam is lower than the price in spot sales.

The permissibility of Salam is an exception to the general rule that prohibits forward sale and therefore it is subject to strict conditions, which are as follows:

Conditions of Salam:

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 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.

2. 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.

3. Salam cannot be effected on a particular commodity or on a product of a particular field or farm eg. 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.

4. All details in respect to 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 effected in respect of things, which must be delivered at spot.

8. The commodity for Salam contract should remain in the market right from the day of contract up to the date of delivery or at least till the date of delivery.

9. The time of delivery should be at least fifteen days or one month from the date of agreement. Price in Salam is generally lower than the price in spot sale. The period should be long enough to affect 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 in order to ensure that the seller delivers.

12. The seller at the time of delivery delivers commodities and not money to the buyer who would have to establish a special cell for dealing in commodities.

Benefits:

There are two ways of benefiting from the contract of Salam:

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.

Parallel Salam

1. In an arrangement of parallel Salam there must be two different and independent contracts; one where the bank is a buyer and 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 1000 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' did not deliver wheat on 31 December, 'A' is duty bound to deliver 1000 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. Even if the purchaser in the second contract is a separate legal entity, but owned by the seller in the first contract; it would not tantamount to a valid parallel Salam agreement. For example, 'A' has purchased 1000 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'.