Salam and Istisnaa'

Essentials of Islamic Banking and Finance

Talha Saleem Kapadia

talhasaleemkapadia@gmail.com

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Salam

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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.

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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.
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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;
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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 ( )
allowed 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 ( ) with some conditions;

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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

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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 DhawatulAmthal ( ;)
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;
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Conditions of Salam
Conditions for validity of Salam (contd.):
On the other hand, Salam is not allowed in
heterogeneous ( ) 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.
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Conditions of
Salam
Conditions for validity of Salam (contd.):
Both the quality and quantity of the goods should be very clearly
agreed upon;
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 exact date and place of delivery must be specified in the
contract;
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
simultaneous;
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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;

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Comparison with Murabahah

Salam

Murabahah

In Salam Price is paid

at Spot;
In Salam delivery of
subject is deferred.

In Murabahah Price is
deferred;
The delivery of
subject matter is at
spot.

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PARALLEL SALAM

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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';

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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

Mr Ahmed

A parallel Salam transaction

Salam 2
Contract on 05 July
Delivery on 23 August

Mr Khalid

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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.
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Istisn
aa'

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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.

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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;
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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);
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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;

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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 with different stages of manufacturing/projects;
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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;

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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;
May change with the
consent of the
contractors;

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;

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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'.

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PARALLEL ISTISNAA'

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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.
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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.

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Questions

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