Let us explore and learn about the Salam contract, which you widely use in Islamic banks today.
Salam contract (forward sale) is different from other types of sale contracts. Everyone must satisfy the following three primary conditions for the validity of a sale in Islam. Only two exceptions from the following conditions are the Salam and Istisna.
- Commodity or product for sale must exist;
- The seller must have an ownership right of the commodity or product
- Commodity or product must be in physical possession of the seller
According to the Salam contract, you can carry out a sale whereby the buyer agrees to pay the price in advance. And the buyer expects to receive the commodity when it is delivered at a future specified time by the seller. In Salam’s contract, the seller gets a moral obligation to provide the goods at a future date. You can not cancel the salam contract once you sign it.
Salam contract in the past
In the pre-Islamic era, people have practised Salam contracts by selling a specific crop in a specific field without defining the measure, weight, or date of delivery. Hence, this contract is not permissible because it had components of gharar.
When Prophet Muhammad (Peace Be Upon Him) lived in Madinah, he found that people paid in advance for fruits and dates. That is, you can deliver the goods within one, two, and three years based on agreement. However, almost no one specified the quality, measure, weight of the commodity, or delivery time during the contract. As a result, the Prophet Muhammad (Peace Be Upon Him) ordained that:
“Whoever pays money in advance for fruit to be delivered later should pay it for a known quality, specified measure, and weight of dates or fruit, of course, along with the price and time of delivery.”
Based on the hadith, it is necessary that the quality, measure, weight, or date, must be specified to avoid the ambiguity that may lead to disputes.
Applications of Salam in Islamic Banking
Generally, Salam is an essential mode of finance for farmers and small traders. Islamic micro banks and financial institutions use Salam contracts to support small industries. Banks use Salam contract mainly for:
- Agriculture financing;
- Working Capital Financing;
- Commercial and industrial financing;
- Export Financing; and;
- Operations and capital cost financing.
Example
There are two types of Salam; ordinary Salam contract and parallel Salam contract. Ordinary salam contracts only involve the buyer and seller. While parallel Salam is the one that most Islamic banks use for financing. Let us understand it with the help of an example.
- The farmer signs Salam contract with the bank to sell a specified commodity at a specified future date (say 100kg of rice that will be delivered on 1st March).
- The bank pays in full of the comodity price
- The bank enters an agreement with the customer to sell the commodity from the first salam. The customer promises to purchase the commodity in specific amount and time. The price of the commodity will be higher than the agreed price with the farmer for bank’s profit.
- upon harvesting, the commodity is delevired to the bank.
- Then, the bank instructs the customer to execute and pick up the delivery.
The Islamic financial institutions usually use Salam contract for short-term financing. It is a good way of financing of agriculture production as it allows the farmer to get the capital first to start its plantation. Therefore, this contract brings a win-win situation for both farmers and financiers.
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