The word Salam is derived from the Arabic words ??? and ??? . The word ??? means “to purchase and sell” and the word ??? means “to advance”. So Bai Salam means advance purchase and sale.
It is a contract in which a buyer pays full price in advance in exchange for goods to be delivered at specified time in future.
BENEFITS OF SALAM:
– It provides Islamically accepted financing alternatives and helps to not get involved in Riba.
– The seller gets in advance the money he needs.
– The purchaser gets goods at a discounted price because usually salam price is lower than the market price. This way the purchaser is secured from fluctuation of price.
CONDITIONS FOR SALAM:
It is necessary for the validity of Salam that:
– Buyer must pay the price in full at the time of contract.
– The subject of sale must be determined with all its specifications. For example: quality, quantity etc. Things which differ in quality in every other piece cannot be sold on Salam basis.
– The exact date and time of delivery must be agreed upon by both parties at the time of contract.
– The good sold must be available in the market throughout the period of Salam.
– The time of delivery should be from15 days to a month.
SALAM AS A MODE OF FINANCING:
Salam is used for financing by the banks in the following ways:
1) Salam is used as a mode of financing by modern banks and financial institutions, especially to finance the agriculture sector. The bank pays advance cash to the farmers in exchange for delivery of the crop at a future date. This helps farmers move away from taking loans that charge them with a heavy interest and through salam they get money in advance for their needs without having to pay a large sum of interest.
2) The financial institution after purchasing a commodity from a supplier by way of Salam, sells it to a buyer through a parallel contract of Salam for the same date of delivery. So the bank sets a higher price and shorter period of delivery in the second salam contract because the shorter the period, the higher the price and this difference between the two salam prices serves as profit for the bank.
CONDITION OF PARALLEL SALAM:
– In parallel salam, bank must enter two different contracts: bank being the buyer in one and seller in the other.
– The two contracts must be independent of each other. For example: A purchases goods from B by way of Salam to be delivered at a specified date and then comes in parallel salam contract with C to deliver goods at the same date. But the delivery of goods to C cannot be affected by any delay in delivery from B. This means that even if B fails to deliver the goods to A at the promised time, A will still be obligated to deliver the goods to C on the specified time agreed with him.
– Parallel salam is allowed with third party only. This means the seller in the first contract cannot be the buyer in the second contract. For example: A has purchased a product from B but it can sell it to C ONLY if C is a separate legal entity and not owned by B in any way.
RISKS INVOLVED IN SALAM:
Some of the risks that are present in Salam Financing are as follows:
a) Counter Party Risk: The client or seller might default after taking full payment in advance.
b) Commodity Price Risk: At the time of delivery, the market price can be lower than the price that was originally expected. In this case, the bank will be at loss.
c) Quality Risk: Seller delivers good of low quality.
d) Asset Holding Risk: The goods once delivered by the supplier will be at Bank’s risk and the bank might incur extra expenses on their storage until the same are sold to the ultimate buyer. Furthermore, if the bank is not able to market the goods on time, the quality of goods might also deteriorate.
e) Delivery Risk: Supplier delays the delivery of goods.
Islamic banks therefore takes following measures for the mitigation of above risks:
a) Take security from the seller either pledge or guarantee.
b) Parallel Salam or promise to purchase from a third party will mitigate the risk.
c) Bank rejects the delivery or accept the delivery at a discounted price.
d) Minimize the time duration between receiving goods from the seller to delivering the goods to the ultimate buyer.
e) Insert penalty clause in the contract as deterred against late delivery.
Istisna is derived from the word Sana’a which means “manufacturing or constructing something”. It is a contractual agreement with a manufacturer to produce goods with specified description using his own material with his own efforts at an agreed price payable in advance or by installments.
BENEFITS OF ISTISNA:
– It provides flexibility to the customer where payment can be made in installments linked to project completion, at delivery or after project completion.
– The time of delivery does not have to be fixed.
CONDITIONS OF ISTISNA:
– The contract must clearly define specifications and dimensions of the product that has to be manufactured.
– Istisna is used for products that can be manufactured. It cannot be used to purchase corn, wheat or any natural product.
– The time and place of delivery must be specified in the contract to avoid any confusion that might lead to any dispute at the time of delivery.
– The manufacturer must construct the goods with his own material.
– Before the manufacturing work commences, the contract can be cancelled by one party without the consent of the others. But once the manufacturing has begun, the contract cannot be cancelled unilaterally.
ISTISNA AS A MODE OF FINANCING:
Banks use istinsa as a mode of finance in the following ways:
1) House Financing: The bank promises to construct a house for a customer on a specified future date and bills the customer a price that includes the cost of the house plus the bank profit margin. The customer pays the agreed price either on a deffered arrangement or on different completion stages of the work. The bank subcontracts the construction work to another contractor who then delivers the constructed house at a future date earlier than that the bank promised to deliver to the customer.
2) Working Capital Requirement: Bank orders the customer to manufacture specified goods and pays the istisna price to the customer in lump sum or in installments. The bank receives the goods from the manufacturer once they are completed and then sells the goods in the market, either directly or through some agent, to recover its cost price and earn some profit over it.
3) Financing of plant: If a client wants to install a plant in a factory, and the plant needs to be manufactured too, the bank as the financier takes the responsibility to prepare the plant through istisna contract according to the same procedure as in house financing.
4) BOT arrangements: Buy, operate and transfer agreements are also made on the basis of istisna. When a government wants to build a highway, it can enter into a contract of istisna with the builder. In such a case, the istinsa price is the right given to the builder to operate the highway and collect tolls for a specified period.
RISKS INVOLVED IN BAI ISTISNA:
Some of the risks that are involved in istisna financing of the banks are as follows:
a) Delivery Risk: Late delivery by the subcontractor in case of parallel istisna.
b) Quality risk: Bank gets delivery of sub-par quality produced goods.
c) Storage risk: The products once delivered by the producer will be at bank’s risk until the point when they are sold to the original buyer.
d) Non performance: The manufacturer is unable to manufacture the goods during the assigned time and refuse to carry on the obligation.
Following measures are accordingly taken for the mitigation of above risks:
a) Price of istisna to be decrease on a regular basis to penalize the producer.
b) Bank rejects the good and demands the price back or the manufacturer must be asked to fix the defect in case of a defected good.
c) Insurance or Takaful
d) Bank pays the price in portions or link pricing of the istisna to delivery.
DIFFERENCE BETWEEN ISTISNAA AND SALAM
The subject is always a thing which needs to be manufactured. The subject can be anything whether it needs manufacturing or not.
The payment of the price in istisna can be deferred to any time according to the agreement of the parties. It doesn’t need to be paid full in advance. The price has to be paid full in advance.
The delivery time doesn’t have to be fixed. The time of delivery is a necessary part of the sales contract.
This contract can be cancelled if the manufacturing work hasn’t started. This is a binding contract and cannot be cancelled unilaterally.
The term ” Bai istijrar” has been derived from the Arabic Words ??? and ??. The word ??? means ” to purchase and sell” and the word ?? means ” to hoist, to lift up”. Bai istijrar is a transaction in which different quantities of a commodity are purchased from a single seller in installments over a period of time and no bargaining takes place between the buyer and the seller each time of making and taking delivery.
Following are the two kinds of istijrar:
– In which the price is determined after the purchase is complete.
– In which the price is determined in advance but the purchase is executed on installment basis.
CONDITIONS OF BAI ISTIJRAR:
The first kind of bai istijrar is permissible in Islam with certain conditions:
– If the seller communicates the price of the merchandise at the time of each transaction; the sale is valid only when the purchaser has the physical possession of the goods. The total sum is then paid once all the transactions are done.
– If the price is unknown to the buyer at the time of each transaction but both the parties know that it is being sold on market price.
– If there is a signifcant difference between the marker price and the agreed upon price, it may cause conflict. In this case, the sale will not be valid until settlement of the payment is made.
– After the payment, the buyer’s usage of the subject matter will be valid from the time of taking possession.
USE OF BAI ISTIJRAR:
Islamic banks use the concept of Istijrar in Murabah in the following way:
1) The bank goes into an agreement to purchase with the providers that it will buy commodities from them at market price or at a price lower than the market price.
2) Whenever the bank has a purchaser, it receives a purchase requisition letter from the purchaser requesting the purchase of specified commodity.
3) After receiving the purchase requisition letter from the costumer, the bank sends a purchase a purchase requisition letter to the supplier to order him to deliver the goods to the bank.
4) The bank then sells it onwards to the customer on the basis of Murabah.