What are common mistakes to avoid in Salam contracts?

Typical errors include vague specifications, partial upfront payment, goods that are not commonly available at the delivery time, and linking Parallel Salam contracts so that one depends on the other. These issues create gharar and invalidate the structure.

How is delivery handled in Salam and what if it is delayed?

Delivery must occur on the agreed date and place. Penalties for late delivery generally cannot be profit-taking but can include actual loss compensation where permitted. Parties often mitigate this risk using a Parallel Salam or performance guarantees.

What types of goods are suitable for Salam?

Standardized, fungible goods that can be precisely specified—such as agricultural produce or commodities—are suitable. The goods must be deliverable and typically available in the market at the agreed future time.

How does Salam differ from Murabaha or Istisnau02b9?

In Salam, price is paid in full upfront for future delivery of existing-type goods. Murabaha is a cost-plus sale of an identified asset, often with deferred payment. Istisnau02b9 is a manufacturing or construction order where payment and delivery can be scheduled flexibly.

Can the Salam goods be sold before delivery?

The specific Salam goods generally should not be sold before taking possession. However, a Parallel Salam can be used to pre-arrange an independent forward sale that settles upon delivery without trading the original undelivered goods.

What are the benefits of Salam financing for producers and banks?

Producers receive upfront liquidity to fund production. Banks gain access to real-sector assets and can manage price and delivery risks using Parallel Salam or hedging via inventory planning, while maintaining Sharia compliance.

Salam Contract in Islamic Banking & Parallel Salam

What is Salam Contract?

The Salam contract, often referred to as ‘Salam financing’ or “بيع سلم”, is a sale contract whereby the purchaser pays the price in advance and the delivery of the subject matter is postponed to a specified time in the future”. Salam in Islamic banking may also be defined as: “A type of sale in which the seller undertakes to supply goods at a future date, against an advanced spot price, paid fully in cash”.

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Comparison of Salam Contract with General Rules for Sale in Islam:

According to general Islamic Shariah rules, a sale must fulfill the following three conditions. However, only the Salam and Istisna are exceptional from these conditions:

Commodity for sale must exist;
The seller should acquire ownership of that commodity; and;
The commodity must be in the physical or constructive possession of the seller.

Applications of Salam in Islamic Banking:

It is mostly a mode of finance for farmers and small traders. It is used by micro banks and financial institutions to support small industries. It is mostly used for:

Agriculture financing;
Working Capital Financing;
Commercial and industrial financing;
Export Financing; and;
Operations and capital cost financing.

What is Parallel Salam?

After the execution of a Salam agreement with one party, the buyer or seller executes another contract with a third party. Parallel Salam contract is allowed with third party only. They must be two different and independent contracts, and these two contracts cannot be tied up.

Parallel Salam Example:

Let us understand it with the help of an example:

Bank purchases 500 Bags of Rice from “Ali” through this contract, with full prepayment and to be delivered on June 30th.
“Ali” delivers 500 bags of rice to the Bank on June 30th.
The bank sells this commodity to a third party, called a “Company”, on credit.
After taking its delivery on an agreed date, Bank delivers it to the “Company”.
After taking delivery from the Bank, the “Company” signs a promissory note against payment, on an agreed-upon specified time.

This lecture is a part of the AIMS Islamic banking certificate course and diploma Islamic banking and Islamic finance programs. AIMS’ curriculum includes all AAOIFI-compliant Islamic finance products and instruments that Islamic Financial Institutions use.

Role of Salam and Parallel Salam Contracts:

These contracts offer Shariah Compliant financing mechanisms, especially in agriculture financing, to empower Shariah Compliant and Ethical financial solutions to Muslims and Non-Muslims, globally. They eliminate the prohibited elements, such as riba, gambling, and uncertainty, which are prohibited in Islam and against Islamic banking principles.

Frequently Asked Questions

Q1: What is a Salam contract in Islamic banking?

Salam is a forward sale where the buyer pays in full now for goods delivered later, with detailed specs set upfront.

Q2: How does Salam financing work in practice?

The bank prepays for specified goods to be delivered on a fixed date and later sells them to clients or the market.

Q3: What are the key conditions of a valid Salam transaction?

Full advance payment, precise specifications, and a defined delivery time/place for goods commonly available at delivery.

Q4: When is Parallel Salam used and why?

To manage delivery and price risks by independently arranging a second Salam as seller with matched quantities and dates.

Q5: What mistakes should be avoided in Salam contracts?

Vague specs, partial prepayment, goods not typically available at delivery, and linking obligations across Parallel Salam deals.

Q6: How is delivery handled and what if it is delayed?

Deliver on the agreed date/place; use performance guarantees or Parallel Salam to mitigate delays and compensate actual losses.

Q7: Which goods are suitable for Salam?

Standardized, fungible goods—e.g., agricultural produce or commodities—that can be precisely defined and delivered later.

Q8: How does Salam differ from Murabaha or Istisnaʿ?

Salam: prepaid for future delivery; Murabaha: cost-plus sale of an identified asset; Istisnaʿ: made-to-order with flexible payment.

Q9: Can Salam goods be sold before delivery?

Not directly; instead, use a Parallel Salam to arrange an independent forward sale that settles upon delivery.

Q10: What are the benefits of Salam financing?

Producers gain upfront liquidity; banks access real-sector assets and manage risk via Parallel Salam and careful inventory planning.