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Diminishing Musharakah


According to this concept, a financier and his client participate either in the joint
ownership of a property or an equipment, or in a joint commercial enterprise. The share
of the financier is further divided into a number of units and it is understood that the
client will purchase the units of the share of the financier one by one periodically, thus
increasing his own share until all the units of the financier are purchased by the client so
as to make him the sole owner of the property, or the commercial enterprise, as the case
may be.
Financing on the basis of Diminishing Musharakah
The proposed arrangement is composed of the following transactions:


   •   Creation of joint ownership in the property (Shirkat-ul-Milk).
   •   Giving the share of the financier to the client on rent.
   •   Promise from the client to purchase the units of share of the financier.
   •   Actual purchase of the units at different stages.
   •   Adjustment of the rental according to the remaining share of the financier in the
       property.
In the above mentioned arrangement, following conditions must be taken care of:
The agreement of joint purchase, leasing and selling different units of the share of the
financier should not be tied-up together in one single contract. However, the joint
purchase and the contract of lease may be joined in one document whereby the financier
agrees to lease his share, after joint purchase, to the client. At the same time the client
may sign one-sided promise to purchase different units of the share of the financier
periodically and the financier may undertake to reduce the rent on remaining units
accordingly.
At the time of the purchase of each unit, sale must be affected by the exchange of offer
and acceptance at that particular date. It will be preferable that the purchase of different
units by the client is affected on the basis of the market value of the asset as prevalent on
the date of purchase of that unit, but it is also permissible that a particular price is agreed
in the promise of purchase signed by the client.
Diminishing Musharakah is commonly used for:
   •   House financing
   •   Car Financing
   •   Fixed Assets financing
   •   Project Financing


Istisna


Istisna’a / Istisna: This is a kind of Sale where a commodity is transacted before it comes
into existance. It means: To order a manufacturer to manufacture a specific commodity
for the purchaser. If the manufacturer under takes to manufacture the goods for him with
material from the manufacturer, the transaction of Istisna’a comes into existence. But it is
necessary for the validity of istisna’that the price is fixed with the consent of the parties
and that necessary specification of the commodity (intended to be manufactured) is fully
settled between them. This kind of Sale also is used as a mode of financing which also
called “Parallel Istisna’a”.Istisna’ is a sale transaction where a commodity is transacted
before it comes into existence. It is an order to a manufacturer to manufacture a specific
commodity for the purchaser. The manufacturer uses his own material to manufacture the
required goods.


In Istisna’, price must be fixed with consent of all parties involved. All other necessary
specifications of the commodity must also be fully settled.
   •   Istisna’ as a mode of financing
Istisna’ may be used to provide financing for construction of house. If the client owns a
land and seeks financing for the construction of a house, the financier may undertake to
construct the house on the basis of an Istisna’. If the client does not own the land and
wants to purchase that too, the financier can provide him with a constructed house on a
specified piece of land. Istisna’ may also be used for similar projects like installation of
an air conditioner plant in the client’s factory, building a bridge or a highway.
The modern BOT (buy, operate and transfer) agreements may be formalized through an
Istisna’ agreement as well. So, if the government wants to build a highway, it may enter
into an Istisna’ contract with the builder. The price of Istisna’ can be the right of the
builder to operate the highway and collect tolls for a specific period.
Ijara


Ijara/ijarahLit: letting on lease. Technically, sale of a definite usufruct in exchange for a
definite reward. Commonly used for wages, it also refers to a contract of land lease at a
fixed rent payable in cash. It is contrary to "Muzarah" when rent is fixed as a certain
percentage of the produce of land. It also refers to a mode of financing adopted by
Islamic banks. It is an arrangement under which an Islamic bank leases equipment, a
building or other facility to a client against an agreed rental. The rent is so fixed that the
bank gets back its original investment plus a profit on it. Ijarah" is a term of Islamic fiqh.
Lexically, it means to give something on rent.


In the Islamic jurisprudence, the term Ijarah is used for two different situations. In the
first place, it means to employ the services of a person on wages given to him as a
consideration for his hired services." The employer is called mustajir while the employee
is called ajir, while the wages paid to the ajir are called their ujrah. The second type of
Ijarah relates to the usufructs of assets and properties, and not to the services of human
beings. Ijarah in this sense means to transfer the usufruct of a particular property to
another person in exchange for a rent claimed from him. In this case, the term Ijarah is
analogous to the English term leasing. Here the lessor is called Mujir, the lessee is called
mustajir and the rent payable to the lessor is called ujrah.
The rules of Ijarah are very much analogous to the rules of sale, because in both cases
something is transferred to another person for a valuable consideration. The only
difference between Ijarah and sale is that in the latter case the corpus of the property is
transferred to the purchaser, while in the case of Ijarah, the corpus of the property
remains in the ownership of the transferor, but only its usufruct i.e. the right to use it, is
transferred to the lessee.
Lease as a mode of financing:
Lease is not originally a mode of financing. It is simply a transaction meant to transfer
the usufruct of a property from one person to another for an agreed period against an
agreed consideration. However, certain financial institutions have adopted leasing as a
mode of financing instead of long term lending on the basis of interest.


This transaction of lease may be used for Islamic financing, subject to certain conditions.
It is not sufficient for this purpose to substitute the name of interest by the name of rent
and replace the name of mortgage by the name of leased asset. There must be a
substantial difference between leasing and an interest-bearing loan. That will be possible
only by following all the Islamic rules of leasing.


Basic Rules of Ijarah
Leasing is a contract whereby the owner of something transfers its usufruct to another
person for an agreed period, at an agreed consideration.
The subject of lease must have a valuable use (which is recognized as Mal-e-
Mutaqawwam in Shariah. Therefore, things having no usufruct at all or whose usufruct is
not permissible according to Shariah cannot be leased.
It is necessary for a valid contract of lease that the corpus of the leased property remains
in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus,
anything which cannot be used without consuming cannot be leased out. Therefore, the
lease cannot be effected in respect of money, eatables, fuel and ammunition etc.
As the corpus of the leased property remains in the ownership of the lessor, all the
liabilities emerging from the ownership shall be borne by the lessor, but the liabilities
referable to the use of the property shall be borne by the lessee.
The period of lease must be determined in clear terms.
The lessee cannot use the leased asset for any purpose other than the purpose specified in
the lease agreement. If no such purpose is specified in the agreement, the lessee can use it
for whatever purpose it is used in the normal course.
The lessee is liable to compensate the lessor for any damage to the leased asset caused by
any misuse or negligence on the part of the lessee.
The leased asset shall remain in the risk of the lessor throughout the lease period in the
sense that any harm or loss caused by the factors beyond the control of the lessee shall be
borne by the lessor.
A property jointly owned by two or more persons can be leased out, and the rental shall
be distributed between all the joint owners according to the proportion of their respective
shares in the property.
A joint owner of a property can lease his proportionate share to his co-sharer only, and
not to any other person.
It is necessary for a valid lease that the leased asset is fully identified by the parties.
The rental must be determined at the time of contract for the whole period of lease.
In the long term lease agreements, it is mostly not in the benefit of the lessor to fix one
amount of rent for the whole period of lease because the market conditions change from
time to time. For this purpose it is allowed to use benchmark rate to determine the rental
amounts. However, rent for the month will be fixed at the start of the month, any change
in benchmark rate during the month will not cause rent for that month to change. It is also
necessary to define a floor and ceiling.
The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.
The rent or any part thereof may be payable in advance before the delivery of the asset to
the lessee, but the amount so collected by the lessor shall remain with him as on account
payment and shall be adjusted towards the rent after its being due.
The lease period shall commence from the date on which the leased asset has been
delivered to the lessee, no matter whether the lessee has started using it or not.
If the leased asset has totally lost the function for which it was leased, and no repair is
possible, the lease shall terminate on the day on which such loss has been caused.
However, if the loss is caused by the misuse or by the negligence of the lessee, he will be
liable to compensate the lessor for such negligence.


Ijarah is commonly used for:
    •   For long and medium term fixed asset financing
    •   Project Financing
    •   Retail products such as Car Financing, House Financing etc.
Murabaha


Murabaha: Lit: sale on profit; Cost plus profit, sale at stated cost price and mark-up, sale
at a specified profit margin. The term is, however, now used to refer to a sale agreement
whereby the seller purchases the goods desired by the buyer and sells them at an agreed
marked-up price, the payment being settled within an agreed time frame, either in
installments or lump sum. The seller undertakes all the management needed for the
purchase and also bears the risk for the goods until they have been delivered to the buyer.
See also bay al-muajjal. This has been adopted as a mode of financing by a number of
Islamic banks. As a financing technique, it involves a request by the client to the bank to
purchase a certain item for him. The bank does that for a definite profit over the cost
which is settled in advance. Some people have questioned the legality of this financing
technique because of its similarity to Riba or interest.


Murabaha is one of the most commonly used modes of financing by Islamic Banks and
financial institutions
Definition:
Murabaha is a particular kind of sale where the seller expressly mentions the cost of the
commodity purchased, and sells it to another person by adding some profit thereon. Thus,
Murabaha is not a loan given on interest; it is a sale of a commodity for cash/deferred
price.


The Bai’ Murabaha involves purchase of a commodity by a bank on behalf of a client and
its resale to the latter on cost-plus-profit basis. Under this arrangement, the bank discloses
its cost and profit margin to the client. In other words rather than advancing money to a
borrower, the bank will buy the goods from a third party and sell those goods to the
customer at an agreed price.


Difference between Murabaha and Sale
A simple sale in Arabic is called Musawamah -a sale without disclosing or referring to
the cost of goods sold.
However when the cost price is disclosed to the client, it is called Murabaha. A simple
Murabaha is one where there is cash payment and MurabahaMuajjal is one on deferred
payment basis.


Basic rules for Murabahah:
Following are the rules governing a Murabahah transaction:


The subject of sale must exist at the time of the sale. Thus anything that does not exist at
the time of sale cannot be sold as this makes the contract void. The subject matter should
be in the ownership of the seller at the time of sale. If the seller sells something that he
himself has not acquired, then the sale becomes void.


The subject of sale must be in physical or constructive possession of the seller when it is
sold to another person. Constructive possession means a situation where the owner has
not taken physical delivery of the commodity yet it has come into his control and all
rights and liabilities of the commodity are passed on to him including the risk of its
destruction.


The sale must be instant and absolute. Thus a sale attributed to a future date or a sale
contingent on a future event is void. The subject matter should be a property having
value in the eyes of Shari’a.


The subject of sale must be specifically known and identified to the buyer. For Example,
‘A’ owner of an apartment building says to ‘B’ that he will sell an apartment to ‘B’. Now
the sale is void because the apartment to be sold is not specifically mentioned or pointed
to the buyer. The delivery of the sold commodity to the buyer must be certain and should
not depend on a contingency or chance. The certainty of price is a necessary condition for
the validity of the sale. If the price is uncertain, the sale is void.


The sale must be unconditional. A conditional sale is invalid unless the condition is
recognized as a part of the transaction according to the usage of the trade.
Salam


Bai al-salam:This term refers to advance payment for goods which are to be delivered
later. Normally, no sale can be effected unless the goods are in existence at the time of
the bargain. But this type of sale forms an exception to the general rule provided the
goods are defined and the date of delivery is fixed. The objects of this type of sale are
mainly tangible things but exclude gold or silver as these are regarded as monetary
values. Barring these, bai salam covers almost all things which are capable of being
definitely described as to quantity, quality and workmanship. One of the conditions of
this type of contract is advance payment; the parties cannot reserve their option of
rescinding it but the option of revoking it on account of a defect in the subject matter is
allowed. It is also applied to a mode of financing adopted by Islamic banks. It is usually
applied in the agricultural sector where the bank advances money for various inputs to
receive a share in the crop, which the bank sells in the market. This kind of sale (Salam)
also used nowadays as a mode of fianancing that is also called ‘Parallel Salam’.
In Salam, the seller undertakes to supply specific goods to the buyer at a future date in
exchange of an advanced price fully paid at spot. The price is in cash but the supply of
purchased goods is deferred.
This mode of financing can be used by the modern banks and financial institutions
especially to finance the agricultural sector.


Purpose of use:
To meet the need of small farmers who need money to grow their crops and to feed their
family up to the time of harvest. When Allah declared Riba haram, the farmers could not
take usurious loans. Therefore Holy Prophet allowed them to sell their agricultural
products in advance. To meet the need of traders for import and export business. Under
Salam, it is allowed for traders to sell the goods in advance so that after receiving their
cash price, they can easily undertake the aforesaid business. Salam is beneficial to the
seller because the price is received in advance and it is also beneficial to the buyer
because the price in Salam is lower than the price in spot sales.

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Islamic banking terminologies

  • 1. Diminishing Musharakah According to this concept, a financier and his client participate either in the joint ownership of a property or an equipment, or in a joint commercial enterprise. The share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically, thus increasing his own share until all the units of the financier are purchased by the client so as to make him the sole owner of the property, or the commercial enterprise, as the case may be. Financing on the basis of Diminishing Musharakah The proposed arrangement is composed of the following transactions: • Creation of joint ownership in the property (Shirkat-ul-Milk). • Giving the share of the financier to the client on rent. • Promise from the client to purchase the units of share of the financier. • Actual purchase of the units at different stages. • Adjustment of the rental according to the remaining share of the financier in the property. In the above mentioned arrangement, following conditions must be taken care of: The agreement of joint purchase, leasing and selling different units of the share of the financier should not be tied-up together in one single contract. However, the joint purchase and the contract of lease may be joined in one document whereby the financier agrees to lease his share, after joint purchase, to the client. At the same time the client may sign one-sided promise to purchase different units of the share of the financier periodically and the financier may undertake to reduce the rent on remaining units accordingly. At the time of the purchase of each unit, sale must be affected by the exchange of offer and acceptance at that particular date. It will be preferable that the purchase of different units by the client is affected on the basis of the market value of the asset as prevalent on the date of purchase of that unit, but it is also permissible that a particular price is agreed in the promise of purchase signed by the client.
  • 2. Diminishing Musharakah is commonly used for: • House financing • Car Financing • Fixed Assets financing • Project Financing Istisna Istisna’a / Istisna: This is a kind of Sale where a commodity is transacted before it comes into existance. It means: To order a manufacturer to manufacture a specific commodity for the purchaser. If the manufacturer under takes to manufacture the goods for him with material from the manufacturer, the transaction of Istisna’a comes into existence. But it is necessary for the validity of istisna’that the price is fixed with the consent of the parties and that necessary specification of the commodity (intended to be manufactured) is fully settled between them. This kind of Sale also is used as a mode of financing which also called “Parallel Istisna’a”.Istisna’ is a sale transaction where a commodity is transacted before it comes into existence. It is an order to a manufacturer to manufacture a specific commodity for the purchaser. The manufacturer uses his own material to manufacture the required goods. In Istisna’, price must be fixed with consent of all parties involved. All other necessary specifications of the commodity must also be fully settled. • Istisna’ as a mode of financing Istisna’ may be used to provide financing for construction of house. If the client owns a land and seeks financing for the construction of a house, the financier may undertake to construct the house on the basis of an Istisna’. If the client does not own the land and wants to purchase that too, the financier can provide him with a constructed house on a specified piece of land. Istisna’ may also be used for similar projects like installation of an air conditioner plant in the client’s factory, building a bridge or a highway.
  • 3. The modern BOT (buy, operate and transfer) agreements may be formalized through an Istisna’ agreement as well. So, if the government wants to build a highway, it may enter into an Istisna’ contract with the builder. The price of Istisna’ can be the right of the builder to operate the highway and collect tolls for a specific period. Ijara Ijara/ijarahLit: letting on lease. Technically, sale of a definite usufruct in exchange for a definite reward. Commonly used for wages, it also refers to a contract of land lease at a fixed rent payable in cash. It is contrary to "Muzarah" when rent is fixed as a certain percentage of the produce of land. It also refers to a mode of financing adopted by Islamic banks. It is an arrangement under which an Islamic bank leases equipment, a building or other facility to a client against an agreed rental. The rent is so fixed that the bank gets back its original investment plus a profit on it. Ijarah" is a term of Islamic fiqh. Lexically, it means to give something on rent. In the Islamic jurisprudence, the term Ijarah is used for two different situations. In the first place, it means to employ the services of a person on wages given to him as a consideration for his hired services." The employer is called mustajir while the employee is called ajir, while the wages paid to the ajir are called their ujrah. The second type of Ijarah relates to the usufructs of assets and properties, and not to the services of human beings. Ijarah in this sense means to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him. In this case, the term Ijarah is analogous to the English term leasing. Here the lessor is called Mujir, the lessee is called mustajir and the rent payable to the lessor is called ujrah. The rules of Ijarah are very much analogous to the rules of sale, because in both cases something is transferred to another person for a valuable consideration. The only difference between Ijarah and sale is that in the latter case the corpus of the property is transferred to the purchaser, while in the case of Ijarah, the corpus of the property remains in the ownership of the transferor, but only its usufruct i.e. the right to use it, is transferred to the lessee.
  • 4. Lease as a mode of financing: Lease is not originally a mode of financing. It is simply a transaction meant to transfer the usufruct of a property from one person to another for an agreed period against an agreed consideration. However, certain financial institutions have adopted leasing as a mode of financing instead of long term lending on the basis of interest. This transaction of lease may be used for Islamic financing, subject to certain conditions. It is not sufficient for this purpose to substitute the name of interest by the name of rent and replace the name of mortgage by the name of leased asset. There must be a substantial difference between leasing and an interest-bearing loan. That will be possible only by following all the Islamic rules of leasing. Basic Rules of Ijarah Leasing is a contract whereby the owner of something transfers its usufruct to another person for an agreed period, at an agreed consideration. The subject of lease must have a valuable use (which is recognized as Mal-e- Mutaqawwam in Shariah. Therefore, things having no usufruct at all or whose usufruct is not permissible according to Shariah cannot be leased. It is necessary for a valid contract of lease that the corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything which cannot be used without consuming cannot be leased out. Therefore, the lease cannot be effected in respect of money, eatables, fuel and ammunition etc. As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property shall be borne by the lessee. The period of lease must be determined in clear terms. The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. If no such purpose is specified in the agreement, the lessee can use it for whatever purpose it is used in the normal course. The lessee is liable to compensate the lessor for any damage to the leased asset caused by any misuse or negligence on the part of the lessee.
  • 5. The leased asset shall remain in the risk of the lessor throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor. A property jointly owned by two or more persons can be leased out, and the rental shall be distributed between all the joint owners according to the proportion of their respective shares in the property. A joint owner of a property can lease his proportionate share to his co-sharer only, and not to any other person. It is necessary for a valid lease that the leased asset is fully identified by the parties. The rental must be determined at the time of contract for the whole period of lease. In the long term lease agreements, it is mostly not in the benefit of the lessor to fix one amount of rent for the whole period of lease because the market conditions change from time to time. For this purpose it is allowed to use benchmark rate to determine the rental amounts. However, rent for the month will be fixed at the start of the month, any change in benchmark rate during the month will not cause rent for that month to change. It is also necessary to define a floor and ceiling. The lessor cannot increase the rent unilaterally, and any agreement to this effect is void. The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee, but the amount so collected by the lessor shall remain with him as on account payment and shall be adjusted towards the rent after its being due. The lease period shall commence from the date on which the leased asset has been delivered to the lessee, no matter whether the lessee has started using it or not. If the leased asset has totally lost the function for which it was leased, and no repair is possible, the lease shall terminate on the day on which such loss has been caused. However, if the loss is caused by the misuse or by the negligence of the lessee, he will be liable to compensate the lessor for such negligence. Ijarah is commonly used for: • For long and medium term fixed asset financing • Project Financing • Retail products such as Car Financing, House Financing etc.
  • 6. Murabaha Murabaha: Lit: sale on profit; Cost plus profit, sale at stated cost price and mark-up, sale at a specified profit margin. The term is, however, now used to refer to a sale agreement whereby the seller purchases the goods desired by the buyer and sells them at an agreed marked-up price, the payment being settled within an agreed time frame, either in installments or lump sum. The seller undertakes all the management needed for the purchase and also bears the risk for the goods until they have been delivered to the buyer. See also bay al-muajjal. This has been adopted as a mode of financing by a number of Islamic banks. As a financing technique, it involves a request by the client to the bank to purchase a certain item for him. The bank does that for a definite profit over the cost which is settled in advance. Some people have questioned the legality of this financing technique because of its similarity to Riba or interest. Murabaha is one of the most commonly used modes of financing by Islamic Banks and financial institutions Definition: Murabaha is a particular kind of sale where the seller expressly mentions the cost of the commodity purchased, and sells it to another person by adding some profit thereon. Thus, Murabaha is not a loan given on interest; it is a sale of a commodity for cash/deferred price. The Bai’ Murabaha involves purchase of a commodity by a bank on behalf of a client and its resale to the latter on cost-plus-profit basis. Under this arrangement, the bank discloses its cost and profit margin to the client. In other words rather than advancing money to a borrower, the bank will buy the goods from a third party and sell those goods to the customer at an agreed price. Difference between Murabaha and Sale A simple sale in Arabic is called Musawamah -a sale without disclosing or referring to the cost of goods sold.
  • 7. However when the cost price is disclosed to the client, it is called Murabaha. A simple Murabaha is one where there is cash payment and MurabahaMuajjal is one on deferred payment basis. Basic rules for Murabahah: Following are the rules governing a Murabahah transaction: The subject of sale must exist at the time of the sale. Thus anything that does not exist at the time of sale cannot be sold as this makes the contract void. The subject matter should be in the ownership of the seller at the time of sale. If the seller sells something that he himself has not acquired, then the sale becomes void. The subject of sale must be in physical or constructive possession of the seller when it is sold to another person. Constructive possession means a situation where the owner has not taken physical delivery of the commodity yet it has come into his control and all rights and liabilities of the commodity are passed on to him including the risk of its destruction. The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void. The subject matter should be a property having value in the eyes of Shari’a. The subject of sale must be specifically known and identified to the buyer. For Example, ‘A’ owner of an apartment building says to ‘B’ that he will sell an apartment to ‘B’. Now the sale is void because the apartment to be sold is not specifically mentioned or pointed to the buyer. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance. The certainty of price is a necessary condition for the validity of the sale. If the price is uncertain, the sale is void. The sale must be unconditional. A conditional sale is invalid unless the condition is recognized as a part of the transaction according to the usage of the trade.
  • 8. Salam Bai al-salam:This term refers to advance payment for goods which are to be delivered later. Normally, no sale can be effected unless the goods are in existence at the time of the bargain. But this type of sale forms an exception to the general rule provided the goods are defined and the date of delivery is fixed. The objects of this type of sale are mainly tangible things but exclude gold or silver as these are regarded as monetary values. Barring these, bai salam covers almost all things which are capable of being definitely described as to quantity, quality and workmanship. One of the conditions of this type of contract is advance payment; the parties cannot reserve their option of rescinding it but the option of revoking it on account of a defect in the subject matter is allowed. It is also applied to a mode of financing adopted by Islamic banks. It is usually applied in the agricultural sector where the bank advances money for various inputs to receive a share in the crop, which the bank sells in the market. This kind of sale (Salam) also used nowadays as a mode of fianancing that is also called ‘Parallel Salam’. In Salam, the seller undertakes to supply specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot. The price is in cash but the supply of purchased goods is deferred. This mode of financing can be used by the modern banks and financial institutions especially to finance the agricultural sector. Purpose of use: To meet the need of small farmers who need money to grow their crops and to feed their family up to the time of harvest. When Allah declared Riba haram, the farmers could not take usurious loans. Therefore Holy Prophet allowed them to sell their agricultural products in advance. To meet the need of traders for import and export business. Under Salam, it is allowed for traders to sell the goods in advance so that after receiving their cash price, they can easily undertake the aforesaid business. Salam is beneficial to the seller because the price is received in advance and it is also beneficial to the buyer because the price in Salam is lower than the price in spot sales.