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Salam and Istisnaa'. Essentials of Islamic Banking and Finance IRSHAD AHMAD AIJAZ irshad786@gmail.com. Salam. Scope of presentation. Introduction; Definition of Salam; Conditions of Salam; Comparison with Murabahah; Parallel Salam; Parallel Salam: important points; Application; and
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Salam and Istisnaa' Essentials of Islamic Banking and Finance IRSHAD AHMAD AIJAZ irshad786@gmail.com
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.
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.
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;
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 ( ﷺ ) 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 ( ﷺ ) with some conditions;
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;
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’ ( ذوات ﺍﻷﻣﺜﺎﻝ ); • 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;
Conditions of Salam • Conditions for validity of Salam (contd.): • On the other hand, Salam is not allowed in heterogeneous ( ذوﺍت ﺍﻟﻘﻴﻢ ) 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.
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 be simultaneous;
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 set-off; • 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;
Murabahah In Murabahah Price is deferred; The delivery of subject matter is at spot. Comparison with Murabahah Salam • In Salam Price is paid at Spot; • In Salam delivery of subject is deferred.
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';
A parallel Salam transaction Salam 1 Contract on 25 June Delivery on 20 August Salam 2 Contract on 05 July Delivery on 23 August Mr Ahmed Mr Khalid 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
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.
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.
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;
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);
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;
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;
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;
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;
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'.
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.
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.
