Chapter 14

SALAM

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 payment is at spot but the supply of purchased
goods is deferred.

Purpose of use:

• This mode of financing can be used by the modern banks

and financial institutions especially to finance the agricultural
sector.

• To meet the needs and requirments 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 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
spot sale.

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:
 162 Meezan Bank’s Guide to Islamic Banking

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 affecting 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 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 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.
 Chapter # 14: Salam 163

7) Salam cannot be affected in respect of items, which must be

delivered at spot. For example, if gold is purchased in exchange
of 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 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 agreement. Price in Salam is
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 in order 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.

Benefits
There are two ways of using Salam for the purpose of financing:
 164 Meezan Bank’s Guide to Islamic Banking

1) 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.

2. 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 Parallel Salam

1. In an arrangement of parallel Salam, there must be two

different and independent contracts;

i) one, where the bank is a buyer and

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' 1,000 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
 Chapter # 14: Salam 165

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 legal 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'.
 166 Meezan Bank’s Guide to Islamic Banking

Risk Mitigation in Salam

Some of the risks that are present in Salam Financing for Banks
are as follows:

RISKS DETAILS MITIGANTS

Delay in delivery of i) Wait until the goods are

goods from the available.
customer. ii) Bank can cancel the contract
and recover the Salam Price
1. Delivery Risk iii) 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
subj ect matter o f Salam .

The Customer The Bank has the right to reject

2. Quality Risk delivers defected the delivery or bank can accept
/inferior goods. the delivery at discounted price.

Market price of the Parralel Salam or promise to

subject matter purchase from a third party will
3. Price Risk decreases after Bank mitigate the risk.
enters into Salam
agreement.

The goods once i) Obtain Takaful coverage for

delivered by Customer Salam goods
4. Storage Risk will be at Bank’s risk ii) Minimize the time duration
before the same are between acceptance of delivery
sold to the ultimate under Salam and delivery to the
purchaser. ultimate purchaser.