Salam Contract in Islamic Finance

This contract (also known as ‘advance payment sale’) is an advance payment for deferred delivery. In this case, the bank pays the agreed amount of the financing to the client in advance, and the goods are delivered to the bank at a specified future date and place.’ (Khan 2000: 25) To avoid any misunderstanding, it should also be added that the goods in question have to be based on a client’s demand. Of such contracts, Shirazi says the following:

When, during the process of production, the producer feels a financial constraint on part of his or her working capital needs … forward deals are signed only to help the producer by supplying part of the working capital needs. Banks [can be] authorized to sign such deals only at the request of a producer. (Shirazi 1988: 201)

It must be added, though, that the produced goods could have been used either in another process for further value-adding or, if they are needed in society, the request could have been made by a third party. The Islamic bank does not receive the goods, rather, it acts as a facilitating agent. A producer’s need for working capital does not alone justify payment from the bank. One of the uses of the Qard-ul Hassan contract mentioned earlier is to pay the working capital of those producers, which have already been financed by the Islamic bank and thus enjoy a good reputation. Such an instrument can be used as a trilateral contract involving the bank, the client, and the client’s supplier or producer.

As to the price of the commodity in question, a Salam purchase is usually cheaper than a spot purchase (Khan 2000:25). There is no need for an Islamic bank to enter into any conceivably profitable transaction, and to ensure that it is entirely Shari’ah compliant, the price of the forward purchase should never exceed the cash price of similar products at the time the goods are delivered.

Khan sees Salam as ‘an exception to the general rule that the seller must possess the goods he is selling.’

Source: Prof. Iraj Toutounchian, Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Narrated by Camille Paldi. Republished with permission.