Salam Contract

Salam in Islamic Banking:

Salam Contract or generally known as Salam in Islamic Banking is a sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot. The Salam contract creates a moral obligation on the Salam seller to deliver the goods,. The Salam contract cannot be cancelled once signed. Salam in Islamic banking may be considered as a kind of debt, because the object of the Salam is the liability of the seller, up to the agreed future date, to deliver the object for which advanced payment of the price has already been made.

There is consensus among Muslim jurists on the permissibility of Salam contract, notwithstanding the general principle of the Shari´ah that does not permit the sale of a commodity which is not in the possession of the seller, because the object of the contract is that the goods are a recompense for the price paid in advance, just as price is recompense paid for getting the goods in advance. The transaction is considered Salam if the buyer has paid the purchase price to the seller in full at the time of sale. The idea of Salam is to provide a mechanism that ensures that the seller has the liquidity they expected from entering into the transaction in the first place. Muslim jurists are unanimous that full payment of the purchase price is key for Salam contract to exist. However, Salam contract cannot take place in money or currencies as these are subject to rules relating to bai al-sarf, wherein exchange has to be simultaneous.

Overview of Salam Contract:

The basic conditions for a validity of a sale in Shariah are three:

  • The purchased commodity must be existing
  • The seller should have acquired the ownership of that commodity,
  • The commodity must be in the physical or constructive possession of the seller,

There are only two exceptions to this principle in Shariah:

  • Salam.
  • Istisna.

Definition and Concept of Salam in Islamic Banking:

  • Seller agrees to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot.
  • Price is in cash but the supply of goods is deferred.

Background of Salam Contract:

  • 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.A.W.) the caravans used to get interest based loans for purchasing the commodities. After prohibition of interest, they were allowed to do Salam contract.

salam contract

Purpose of Salam Islamic Finance:

  • Salam contract is usually used 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 contract, 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 in Islamic banking 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 Islamic finance is lower than the price in spot sales. The permissibility of Salam contract is an exception to the general rule that prohibits forward sale and therefore it is subject to strict conditions, which are as follows:
Benefits of Salam Contract:

There are two ways of benefiting from the Salam contract:

  • After purchasing a commodity by way of Salam in Islamic banking, 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 contract, 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 in Salam Contract:
  • It is necessary for the validity of Salam contract 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 bas wisdom for allowing Salam contract is to fulfill the instant need of the seller. If it’s not paid in full, the basic purpose will not be achieved.
  • 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 in Islamic banking, because each stone differ in quality, size, weight and their exact specification is not possible.
  • Salam contract cannot be affected on a particular commodity or 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.
  • 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 only, meaning what is normally weighed cannot be quantified and vice versa.
  • The exact date and place of delivery must be specified in the contract.
  • Salam in Islamic banking cannot be effected in respect of things, which must he delivered at spot.
  • 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.
  • The time of delivery should be at least fifteen days or one month from the date of agreement. Price in Salam contract 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 contract. It is all right to have an earlier date of delivery if the seller consents to it.
  • Since price in Salam contract is generally lower than the price in spot sale; the difference in the two prices may be a valid profit for the Bank.
  • A security in the form of a guarantee, mortgage or hypothecation may be required for a Salam contract, in order to ensure that the seller delivers.
  • 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.
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.

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