Shari’ah Aspects of Salam Contract

The two parties in Salam are the seller who is not necessarily a farmer and the buyer, who is mostly a merchant. The subject of the contract can be any fungible, other than money, silver or gold. If the good (or goods) can be pinpointed at the time of contracting, then Salam is not applicable, subject should be something that is going to be produced or purchased at time of delivery by seller from the open market. Therefore, a given automobile or a known building cannot be the subject matter of Salam. The subject matter of the contract must be described precisely enough to dismiss and restrict any future conflict, yet it is a sale of goods that are not in the hands of the seller, but known to be available in the market at the time of delivery. Even if the seller owns such goods at the time of concluding salam contract, the subject of the salam in the denoted goods not the own in existence then. Clearly he can deliver the sa… at maturity. But only then they become the salam goods.

Sale price has to be determined at the time of contracting and must be paid in full to the seller. Some Shari’ah scholars permitted a delay of no more than 3 days, but majority insist are of simultaneously. This is one of the most important conditions m Salam, which gistiugist it from ordinary forward contract.

The term, i.e. the period of the duration of the contract must also be specified, either as a date in the future or a number of days, weeks or months. Buyer is not allowed to sell the goods brought before actual delivery, i.e. possession. Constructive possession is not permitted. Failure to follow these conditions will make the Salam contract void.

Salam as mode of Finance

Unlike other sale contracts in Shari’ah, Salam is basically a mode of finance. By advancing the price and deferring the goods a farmer(or merchant) is actually financed by that buyer. An Islamic bank can be the buyer in a Salam contract, providing funds as a consideration to acquire the goods for delivery in 90 days for example. The time value of money will then be the difference between the price in the Salam contract of the underlying commodity and the one that is going to prevail at the time of delivery at which the goods will be sold.

Risks

In addition to the credit risk (seller default) which is normal for any type of finance, the bank will be facing a high degree market risk. While prices at the time of delivery will most probably be higher than that of the Salam price, market may fluctuate in any direction. Unfortunately not many measures can be taken to mitigate this. Goods bought under a Salam contract can't be sold before actual delivery and possession by the bank. Hence, bank will not be able to “unload” the contract if forecast of future prices changes before delivery. One possibility of hedging may be adopted through what is called “parallel Salam”. In this case the bank will enter the market as a seller of goods of similar specification. Once Salam contract is concluded, the term of the new salam can be designed to fall on same date of delivery of the first one. It is important to note here that bank is not actually selling those same goods which were the subject of the first Salam, she is only selling similar description goods. Hence there are two separate contracts, in the first the bank is the buyer in the other a seller.

Guarantees and Securities in a Salam Contract

Salam Contract creates a debt obligation, albeit in goods not money. It is natural, therefore, to support this obligation by guarantees and securities equal or more than the value of these goods.

Constructing a Salam Deal

Salam contracts offered Islamic banking with attractive investment opportunities. This is because many manufactured goods satisfy the “fungibility” requirement of the salam contract. By introducing an agency agreement, Salam contract can work very efficiently as working capital mode of finance.

For example, the bank can sign a contract with the local soft drink bottling company to buy 50,0000 cans of soft drinks to be delivered after 3 months at $ 0.25 each. Total price is paid upfront or this is a requirement by salam. The bank can appoint the company as an agent to market the quantity at the time of delivery through its channels of distribution. It will be sold at the going market price of say $ 0.30 each. The difference is the profit to the bank. The company may charge an agency fee, but it is not allowed to repurchase these goods. Shipment sod the bank must be adequately identified so that bank will bear the risk of price fluctuation if any, as well as loss or damage.

Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.