The document discusses the Islamic financing contracts of Salam and Istisna. Salam allows payment in advance in exchange for deferred delivery of goods, while Istisna is used for manufacturing goods where the price is paid in installments over time or on delivery. Both contracts aim to fulfill financing needs and provide alternatives to interest-based loans. Key conditions and differences between the two contracts are outlined.

1. SALAM

2. SALAM Introduction The basic conditions for a validity of a sale in Shriah are three: (1)The purchased commodity must be existing, (2)The seller should have acquired the ownership of that commodity, (3)The commodity must be in the physical or constructive possession of the seller, There are only two exceptions to this principle in Shariah : (1)Salam (2)Istisna

3. Definition &Concept Seller agrees to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot. Price is in cash but the supply of goods is deferred.

4. Background of Salam Before prohibition of interest farmers used to get interest based loans for growing crops and harvesting. After prohibition of interest, they were allowed to do Salam transactions. This helped them to get money in advance for their needs. During the days of our prophet (S.W.) the caravans used to get interest based loans for purchasing the commodities. After prohibition of interest, they were allowed to do Salam.

5. Purpose of Salam To meet the needs of small farmers who need money to grow their crops and to feed their family up to the time of harvest. To meet the need of working capital To meet the needs of liquidity problem. To meet the need of traders for import and export business.

6. Benefits Salam is beneficial to the seller,because he receives the price in advance,and it is beneficial to the buyer also,because normally,the price in salam used to be lower then the price in spot sales.

7. Conditions of Salam It is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of effecting the sale, because the basic wisdom for allowing Salam is to fulfill the instant need of the seller. If its not paid in full, the basic purpose will not be achieved. (2) Only those goods can be sold through a Salam contract in which the quantity and quality can be exactly specified e.g.precious stones cannot be sold on the basis of Salam because each stone differ in quality, size, weight and their exact specification is not possible. (3) All details in respect to quality of goods sold must be expressly specified leaving no ambiguity which may lead to a dispute.

8. (4)It is necessary that the quantity of the commodity is agreed upon in absolute terms. It should be measured or weighed in its usual measure. (5) Salam cannot be effected on a particular commodity or on a product of a particular field or farm e.g.. supply of wheat of a particular field or the fruit of a particular tree since there is a possibility that the crop is destroyed before delivery and given such possibility, the delivery remains uncertain. (6)The exact date and place of delivery must be specified in the contract.

9. (7) Salam cannot be effected in respect of things, which must be delivered at spot. e.g Salam b/w wheat and barley. (8)The commodity of Salam contract should remain in the market right from day of contract up to the date of delivery . (9) there should be actual delivery of commodity. (10) Salam is not possible for rare products.

10. Salam In Salam, purchased goods are deffered, price is paid on spot. In Salam price has to be paid in full in advance. Murabaha In Murabaha purchased goods are delivered at spot, price may be either on spot or differed. In Murabaha price may be on spot or differed. Difference b/w Salam & Murabaha

11. Salam Salam is not executed in the particular commodity but commodity is specified by specifications. Murabaha Murabaha can be executed in particular commodity. Difference b/w Salam & Murabaha

12. Delivery of Salam goods Before delivery, goods will remain at the risk of seller. After delivery, risk will be transferred to the purchaser. Possession of goods can be physical or constructive. Transferring of risk and authority of use and utilization/consumption are the basic ingredients of constructive possession.

13. Khiyar (option) After taking delivery, the purchaser has the “option of defect” (Khiyar-e-Aib). Not “option of seeing” (Khiyar-e-ruyat)

14. Options available for purchaser after taking delivery Parallel Salam After the execution of Salam agreement with one party,seller executes another salam agreement with third party, Conditions for Parallel Salam: (a) there must be two different and independent contracts, these two contracts cannot be tied up and performance of one should not be contingent on the other. (b) Parallel Salam is allowed with third party only.

15. Parallel Salam Diagram Delivery of Commodity Salam Sale Parallel Salam Islamic Bank Islamic Bank Purchaser Seller 1 st Salam Seller 2 nd Salam Purchaser Delivery of Commodity

16. 2. Agency agreement If the bank has no expertise to sell the commodities received under Salam contract, then the bank can appoint the customer as its agent to sell the commodity in the market/third party, subject to Salam agreement and Agency agreement are separate from each other. A price must be determined in agency agreement on which the agent will sell the commodity but if the price is increased, the benefit can be given to the agent .

17. 3. Selling in the market If the bank has expertise in the relevant commodity, it can sell the commodity in the market/third party, Or hold the commodity to fetch a better market price to maximize its profit .

18. 4. Promise to purchase Before maturity the bank can give promise to sale the commodity to third party, after taking delivery, bank will sell the same commodity to the promissee, This promise should be unilateral .

19. 5. Salam combining with Murabaha Bank can sell the Salam commodity to the seller of Salam on Murabaha subject to following terms: Salam agreement and Murabaha agreement should be independent, not contingent and with free will of the parties. Murabaha will be executed after taking the possession of Salam goods. Bank shall assume the risk of loss b/w taking delivery and execution of Murabaha. Bank cannot take undertaking from seller of Salam that he will purchase the Salam commodity from Bank on Murabaha basis.

20. Revoking the Salam contract After execution of Salam agreement, it cannot be revoked unilaterally without mutual consent of both parties.

21. Penalty for non performance Seller can undertake in the Salam agreement that in case of late delivery of Salam goods, he shall pay to the charity account maintained by the bank a sum calculated on the basis of….% per annum for each day of default,bank will spend this amount in charity purpose on behalf of the client. This undertaking is infact a sort of self-imposed penalty to keep oneself away from default.

22. Security A security in the form of a guarantee, mortgage or hypothecation may be required for a Salam in order to ensure that the seller shall deliver the commodity on the agreed date. In the case of default in delivery,the guarantor may be asked to deliver the same commodity and if there is a mortgage, the buyer can sell the mortgaged property and the sale proceeds can be used either to realize the required commodity by purchasing it from the market or to recover the price advanced by him.

23. Scope and potential of Salam The Salam sale has the flexibility to cover the needs of various sectors of people such as farmers, industrialists, contractors, exporters or traders. It can be used to meet the capital requirements as well as to meet the cost of operations. Salam sale is suitable to finance the agricultural operations Where the Bank transact the farmer to fulfill the promise to deliver the commodity. Salam can fulfill all the requirement of farmer i-e liquidity, Purchase of inputs, fertilizers, render the transportation etc.

24. Salam sale is also used to finance the commercial and industrial activities, especially in phases prior to production and export of commodities and that is purchasing it on Salam and marketing them for lucrative prices. The bank can financing craftsman and small producers to improve productivity.

25. Istisna

26. Introduction Istisna’ is sale transaction where commodity is transacted before it comes into existence. Definition It is an order to producer to manufacture a specific commodity for the purchaser.

27. Istisna’: Legitimacy The Prophet (PBUH) required that a pulpit (platform) be built for preaching [Bukhari 2/908] The Prophet (PBUH) required that a finger ring be manufactured for Him [Bukhari 5/220 and Muslim 3/1655]

28. Conditions of Istisna (1)The subject of Istisna is always a thing which needs manufacturing (2)Manufacturer use his own material (3)Quality and Quantity should be agreed in absolute term (4)Purchase price should be fixed with mutual consent (5)The manufacturer uses his own material to manufacture a good to differentiate from Ijarah

29. Price of Istisna Price of istisna may be in the form of money,commodity and usufruct. Price of Istisna may be spot and differed therefore Istisna is applicable where Salam is not applicable. Price of Istisna is can be paid in installments. The installments may be tied up with different stages of projects. Option When the required goods have been manufactured by the manufacturer purchaser can exercise his option of defect,but he cant use his option of seeing,

30. Revoking of Istisna The contract of Istisna can be cancelled unilaterally before the manufacturer starts working. After starting the work, Istisna cannot be cancelled unilaterally.

31. Difference between Istisna’ & Salam ISTISNA The subject of istisna is always a thing which needs manufacturing. The price in istisna does not necessarily need to be paid in full in advance. SALAM The subject can be any thing. The price has to be paid in full in advance.

32. Difference between Istisna’ & Salam ISTISNA Time of Delivery does not have to be fixed The contract can be cancelled before the manufacturer starts working . SALAM Time of delivery is an essential part of the sale The contract cannot be cancelled unilaterally .

33. Difference between Istisna’ & Ijarah ISTISNA The manufacturer either uses his own material IJARAH The material is provided by the customer and the manufacturer uses only his labor and skill.

34. Security A security in form of a guarantee, mortgage or hypothecation may be required for Istisna in order to ensure that the manufacturer shall deliver the commodity on the agreed date, in the case of default in delivery,the guarantor may be asked to deliver the same commodity,and if there is a mortgage,the buyer can sell the mortgaged property and the sale proceed can be used either to realize the required commodity by purchasing it from the market,or to recover the price advanced by him.

35. Time of Delivery It is not necessary in Istisna that the time of delivery is fixed. However, The purchaser my fix a maximum time for delivery after the appointed time,he will not be bound to accept the goods and pay the price. In order to ensure that the goods will be delivered within the specified period, some modern agreement of this nature contain a penalty clause to the effect that in case the manufacturer delays the delivery after the appointed time, the price shall be reduced by a specified amount per day.

36. Delivery of Manufacturing goods Before delivery, goods will remain at the risk of seller. After delivery, risk will be transferred to the purchaser. Possession of goods can be physical or constructive. Transferring of risk and authority of use and utilization/consumption are the basic ingredients of constructive possession. If manufactured goods are delivered before agreed date, purchaser can refuse to accept the goods.

37. Parallel Istisna and its applications After the execution of Istisna agreement with one party, buyer or seller executes another Istisna agreement with third party, Conditions for Parallel Istisna : (a) there must be two different and independent contracts, these two contracts cannot be tied up and performance of one should not be contingent on the other. (b) Parallel Istisna is allowed with third party only.

38. Parallel Salam Diagram – Example I Delivery of Commodity Istisna Sale Parallel Istisna Islamic Bank Islamic Bank Purchaser Seller 1 st Istisna Manufacturer 2 nd Istisna Purchaser Delivery of Commodity

39. 1 Parallel Istisna’ Example II Manufacturer/ Builder [ISTISNA’] Delivery of Commodity 1 Aug 06 Bank Purchaser/ Seller Customer [ISTISNA’] Delivery of Commodity 1 Aug 06 or 15 Aug 06 Istisna Sale Contract 1 June 06 2 3 5 4 6 Istisna Price Payment 1 June 06, 1 Jul 06, 1 Aug 06 Pays 15 May + 15 Aug – 31 Dec 06 Istisna’ Contract 15 May 06

40. Potential of Istisna The client can get finance for raw material, working capital and other overhead expenses by the execution of Istisna agreement. House financing, import and export products can be easily designed on Istisna basis.

41. Istisna as Mode of Financing House Financing Project Financing BOT Arrangement Export Pre Shipment