Salam and Istisnaa'
Essentials of Islamic Banking and Finance
IRSHAD AHMAD AIJAZ
[email protected]
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 1
Salam
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 2
Scope of presentation








Introduction;
Definition of Salam;
Conditions of Salam;
Comparison with Murabahah;
Parallel Salam;
Parallel Salam: important points;
Application; and
Risks and its mitigations.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 3
Introduction

Basic principle for validity of a sale in Shari'ah is that:
– The commodity must be existing;
 Non-existing
goods are not eligible for sale;
– The seller must have ownership of the commodity;
 Short
sale (selling of what is not owned by seller) is not allowed;
– The commodity must be in the physical or constructive possession
of the seller;
 Selling


of what is not possessed by seller is not allowed;
All sale transactions should conform to these rules;
There are only two exceptions to these principles in Shari'ah
and they are:
– Bai’ Salam ; and
– Bai’ Istisna';
– Both these are sales of special nature and are exceptions to the
general rules of sale.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 4
Introduction


Salam is a type of Sale in which:
– “the seller undertakes to supply some specific goods to the buyer
at a future date, against an agreed price which is fully paid in
advance and the delivery of the sold commodity is deferred;
So there are three distinguishing features of Salam:
– The subject matter (commodity to be purchased/sold) is delivered
in future;
– The price is paid full in advance;
– The goods for sale will be specific;
– Another name of Salam is “Salaf”, meaning of both are same;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 5
Explanation of Salam







Before prohibition of interest, farmers in Madinah
Munawwarah used to obtain interest-based loans for their
agricultural and routine life needs;
After prohibition of interest, the farmers faced hardship;
Similarly trade caravans of Arabs used to get interest based
loans for purchasing the commodities for trade;
After prohibition of interest, the traders have also faced
difficulties;
To solve this problem of Ummat, Holy Prophet ( ‫ ) ﷺ‬allowed
Bai' Salam;
The purpose of this permission was to ease the financial
needs of small farmers and traders;
Salam transactions has been allowed by the Holy Prophet ( ‫ﷺ‬
) with some conditions;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 6
Explanation of Salam





By the permissibility of Salam it becomes beneficial for both
buyer and seller;
It is beneficial to the seller because he receives the price in
advance and it is beneficial to the buyer because the advance
Salam price is usually lower than the spot price;
Since Salam is an exception to the general rules of sale and it
is allowed before existence of goods, the element of Ghare is
obvious here;
To minimize the element of Gharar certain conditions have
been laid down by Shari'ah;
The element of Gharar for this special type of sale has been
lowered down by imposing some conditions;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 7
Conditions of Salam

Conditions for validity of Salam are:
► The Salam price must be paid in full at the time of effecting sale;
Because, in the absence of full payment it will be selling debt
(commodity whose delivery is deferred) against debt (price
deferred) which is prohibited;
– Also this is against the basic wisdom behind permissibility of Salam
which is fulfilling the instant needs of the farmers and traders;
– If the price is not paid in advance this purpose can not be achieved;
–
►
Salam can be effected only in those commodities that can be
exactly specified in quantity and quality;
It means only those goods can be sold under Salam transaction
which fall under the category of ‘Dhawatul-Amthal’ ( ‫;) ﻝﺎﺜﻣﻷﺍذوات‬
– The term ‘Dhawatul-Amthal’ refers to such commodities, the units
of which are homogeneous in characteristics;
– It means the commodities which are traded by counting, measuring
or weighing according to usage and customs of trade;
– For example wheat, rice, cotton and barley;
–
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 8
Conditions of Salam
►
Conditions for validity of Salam (contd.):
On the other hand, Salam is not allowed in heterogeneous ( ‫ﻢﻴﻘﻟﺍت ﺍذو‬
) goods;
– Heterogeneous goods are those goods the units of which are
different among each other in characteristics. Meaning thereby
each piece is different, in size, weight and value;
–

►
For example animals and precious stones are not possible to precisely
defined beforehand.
Subject matter of Salam should be of common nature;
Therefore Salam cannot be effected on a particular commodity of a
particular field or farm;
– The reason is that it is not necessary that the farm or the tree
would be able to produce the required commodity or fruit;
– Alternatively, one can define a particular type of the commodity for
which Salam is being done.
–

For example Rice Irri or Basmati etc. etc.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 9
Conditions of Salam
►
►
Conditions for validity of Salam (contd.):
Both the quality and quantity of the goods should be very clearly
agreed upon;
–
–
►
The exact date and place of delivery must be specified in the
contract;
–
–
►
All the possible details in this respect must be expressly mentioned;
For example if the commodity is quantified in weight in the market,
its weight must be determined and if it is quantified through
measures, its exact measure should be known. Therefore, if
something is sold by measuring it cannot be sold by weighing in a
Salam transaction;
The date may be in range form (e.g. from 10 to 15 on July);
The place should be specified as per custom;
Salam cannot be effected in respect of things which must be
delivered on spot;
–
Gold with silver or wheat with barley are example of it. According
to Shari'ah delivery of these goods should
be be simultaneous;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 10
Conditions of Salam
►
►
►
►
Conditions for validity of Salam (contd.):
The commodity which is the subject of Salam contract is normally
available in the markets at the time of delivery;
– Salam of Mangoes in January is invalid Salam;
– Delivery of goods to buyer is mandatory;
The seller should hand over commodities to buyer at the time of
delivery. He can not give money back to the buyer on the basis of setoff;
– Buyer can not contractually bind the seller to buy-back the sold
commodity. This will be a case of implicit interest (Heelah);
Similarly the seller can not contractually bind the buyer to sell-back
the sold commodity to seller, because it would be conditional sale;

►
However, after the delivery, both may enter in a transaction of sale with
mutual consent, independently from Salam sale.
The buyer shall not sell or transfer ownership of the goods before
taking possession (actual or constructive) of these goods;
– This would be case of short-selling;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 11
Comparison with Murabahah
Salam


In Salam Price is paid at
Spot;
In Salam delivery of subject
is deferred.
Murabahah


In Murabahah Price is
deferred;
The delivery of subject
matter is at spot.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 12
PARALLEL SALAM
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 13
Parallel Salam





Parallel Salam is not a kind of Salam;
It is an arrangement by buyer to sell the commodity he
purchased from some one;
The buyer can not sell the commodity before he takes the
possession from seller in a Salam contract as we discussed
earlier;
But the buyer may sell the commodity he bought it on Salm
to another person on Salam basis;
This arrangement is called 'Parallel Salam';
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 14
Parallel Salam
►
Lets assume Mr. 'Ahmed' enters into a Salam Contract with Mr.
'Basheer' to purchase one thousand bales of cotton at a price
100,000/= per bale to be delivered on 20 August;
–
–
–
►
In this contract (“Salam A”):
Mr. 'Ahmed' is a Purchaser/Buyer; and
Mr. 'Basheer' is a Seller;
Mr. 'Ahmed' can enter into another Salam with Mr. 'Khalid' to
sell the same cotton at a price of 105,000/= per bale on a 21
August;
–
–
–
In this contract (“Salam B”):
Mr. 'A' is a Seller; and
Mr. 'Khalid' is a Purchaser.
Mr Basheer
Salam 1
Contract on 25 June
Delivery on 20 August
A parallel Salam transaction
Mr Ahmed
Salam 2
Contract on 05 July
Delivery on 23 August
Mr Khalid
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 15
Parallel Salam: important points
 Parallel Salam is allowed with a third party only;
 The seller in the first contract cannot be made purchaser in
the parallel contract of Salam;
 It will be a buy-back arrangement, which is not permissible;
 If the purchaser in the second contract is a separate legal
entity, then it is necessary that it should not be a subsidary
or sister concern of the seller company in the first contract;
 The arrangement will not be allowed because in practical
sense it will be a 'buy-back' arrangement.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 16
Istisnaa
'
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 17
Scope of presentation
 Introduction of Istisnaa';
 Definition;
 Explanation of Istisnaa', its rules and requirements;
 Comparison with other modes;
 Parallel Istisnaa';
 Application of Istisnaa';
 Risks analysis and mitigations;
 Q & A.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 18
Introduction
 As we discussed earlier two types of sales are exceptions
from general rules for sale;
 Istisnaa' is the second exception where sale of a subject
matter which is not there at the time of transaction, has been
allowed;
 In fact permissibility of Istisnaa' is very logical and
understandable;
 In routine life any person may need a thing which requires
manufacturing;
 The manufacturer is not ready to manufacture before
commitment from a buyer to buy;
 Keeping this need in view Islam has permitted Istisnaa'
transaction;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 19
Definition
 Istisnaa' is 'an order from purchaser (buyer) to a
manufacturer (seller) to produce a specific good for him
(buyer) against mutually agreed price and period for
manufacturing and delivery';
− So the main feature is manufacturing of the sold good;
− Istisnaa' is only possible in goods which require manufacturing;
 There is flexibility in payment of price;
 It is may be paid according to any schedule by mutual
consent (In advance, in tranches or at the time of delivery of
the goods);
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 20
Features of Istisnaa'
 Essential requirements for Istisnaa':
− Goods / commodities should require manufacturing;
► Manufacturing
means:
● Any type of work that change the material significantly;
■
Like work of carpenter;
● Value addition in which material changes its values;
■
Like powdering of liquid milk;
− Manufacturer (seller) must use his own material;
► If
the material is provided by the buyer then this will be case of
Services Ijarah and not of Istisnaa';
− The commodity must be known and specified in terms of kind,
type, quality and quantity;
► Ambiguity
in these elements lead to Gharar;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 21
Features of Istisnaa'
 Essential requirements for Istisnaa' (contd):
− Nature of price in Istisnaa':
► As
other kind of sales, price of goods sold under Istisnaa' could be
anything i. e. money, commodity and usufruct (Manafi');
− Price of the goods in Istisnaa':
► Price
in Istisnaa' should be preferably fixed;
► Price in Istisnaa' may be tied up with the time of delivery;
► For example the buyer may fix 'X' price for delivery in 10 days and
'Y' price (reduced price) if the manufacturer delays delivery from
the agreed time schedule;
► The reason for this flexibility is resemblance of Istisnaa' with
Ijarah;
− Payment of Price of Istisnaa':
► The
price can be paid immediately (spot); or
► Can be paid at delivery (deferred); or
► Could be paid in installments. The installments
may be tied up
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 22
Features of Istisnaa'
 Essential requirements for Istisnaa':
− Goods / commodities should require manufacturing;
► Manufacturing
means:
● Any type of work that change the material significantly;
■
Like work of carpenter;
● Value addition in which material changes its values;
■
Like powdering of liquid milk;
− Manufacturer (seller) must use his own material;
► If
the material is provided by the buyer then this will be case of
Services Ijarah and not of Istisnaa';
− The commodity must be known and specified in terms of kind,
type, quality and quantity;
► Ambiguity
in these elements lead to Gharar;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 23
Istisnaa' – Comparison
(Istisnaa' and Salam)

Istisnaa'
−
−
−
−
The subject matter of an
Istisnaa' contract is always
something which requires
manufacturing;
Price may be paid under any
agreed schedule;
Contract may be canceled
unilaterally before the
manufacturer starts work;

Salam
−
−
−
−
Subject of Salam could be
anything which can satisfy Salam
conditions laid down by Shari'ah.
Price must be paid in full in
advance;
Salam contract, once effected,
cannot be canceled unilaterally;
Determining the time of delivery
is an essential part in Salam;
May change with the consent of
the contractors;
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 24
Istisnaa' – Comparison (Istisnaa' and
Ijarah)

Istisnaa'
−
−
In Istinsa' manufacturer agrees to
produce the required goods using
his own material.
Therefore, the material in
Istisnaa' should be provided by
the manufacturer himself.

Ijarah
−
−
In Ijarah the manufacturer
utilizes his labour and skills.
Therefore, if the raw material is
provided by the customer and
manufacturer uses his labor and
skills only, the transaction would
be of Ijarah and not istisnaa'.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 25
PARALLEL ISTISNAA'
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 26
Parallel Istisnaa'
 Parallel Istisnaa':
− Like Salam parallel Istisnaa' is not a kind of Istisnaa';
− It is parallel arrangement for an other Istisnaa' transaction that
follows first Istisnaa';
− The second transaction is also an Istisnaa' transaction in all
manners and conditions;
− This arrangement of two transaction has been introduced to
reduce the risk of buyer (Bank) for holding the
commodities/goods.
− In a Parallel Istisnaa' contract, the buyer enters into a Parallel
Istisnaa' contract in which he is a seller to a another buyer;
− Applying to banking, in one of these two transactions, the Bank
is the buyer and in the second it is the seller.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 27
Parallel Istisnaa'
 Conditions for parallel Istisnaa':
− Each of the two contracts must be independent of the other;
− They cannot be tied up in a manner that the rights and
obligations of one contract are dependent on the rights and
obligations of the parallel contract;
− Similar to Parallel Salam, Parallel Istisna is allowed with a third
party only;
− Therefore, Parallel Istisnaa' to the same party (seller in first
Istisnaa') is not allowed.
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 28
Questions
Essentials of Islamic Finance – IU Gulshan Campus, Slide # 29