Salam is a forward financing transaction, where the financial institution pays in advance for buying specified assets, which the Seller will supply on a pre-agreed date. What is given in exchange for the advance payment of the price should not in itself be in the nature of money. For the payment in advance, the contracting parties stipulate a future date for the supply of goods of specified quantity and quality.
Salam may be considered as a kind of debt, because the object of the Salam contract is the liability of the seller, up to the agreed future date, to deliver the object for which advanced payment of the price has already been made. There is consensus among Muslim jurists on the permissibility of Salam, notwithstanding the general principle of the Shari´ah that does not permit the sale of a commodity which is not in the possession of the seller, because the object of the contract is that the goods are a recompense for the price paid in advance, just as the price is recompense paid for getting the goods in advance. The transaction is considered Salam if the buyer has paid the purchase price to the seller in full at the time of sale. The idea of Salam is to provide a mechanism that ensures that the seller has the liquidity they expected from entering into the transaction in the first place. Muslim jurists are unanimous that full payment of the purchase price is key for Salam to exist. However, Salam cannot take place in money or currencies as these are subject to rules relating to bai al-sarf, wherein exchange has to be simultaneous.
Image Courtesy: (AIMS Institute of Islamic banking and finance image taken from books of Islamic banking courses and diploma in Islamic finance).
Because the Salam contract deals with the delivery of an asset which is not in existence, the Shari´ah highlights that strict rules must be adhered to in order to ensure that the right of all parties are protected. In fact, it is necessary that the quality of the commodity is fully specified leaving no ambiguity which may lead to a dispute. All the possible details in this respect must be expressly mentioned. Salam can be effected in those commodities only the quality and quantity of which can be specified exactly. The commodity should be generally available in the market at the time of delivery. And all goods that can be categorized as belonging to the same species can be the subject of Salam. However, Salam cannot take place between identical goods. Besides, the time and place of delivery of the goods should be precisely fixed; and the quality and the quantity of the goods should be clearly specified. The specification of goods should particularly cover all those characteristics which could cause variation in price.
Other rules applied to Salam contract, is that the seller in Salam need not be the manufacturer or producer of the asset. The seller may be an agent to deliver the asset. Furthermore, a Salam contract can stipulate that that, in the event of late delivery of the goods, the supplier pays a certain amount as a penalty to the buyer, which amount must be used for a charitable purpose; it cannot be taken into the buyer’s income. The buyer has also the right to demand security or collateral from the seller to ensure that the seller delivers the goods on the agreed date, the buyer has the right to dispose of the security and purchase the specified goods from the market; the buyer is entitled to deduct the advance payment from the proceeds of the security realized and return any surplus to the seller.
Note:when I was taking classes of Islamic finance course for my certificate in Islamic banking I learn that important topic and saved it in my notes then I completed my Islamic finance certification and a awarded Islamic finance certificate and allowed to start my diploma Islamic finance. Now I am teaching students of diploma in Islamic banking and finance so I am sharing this note for them.
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