Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advanced price fully paid at spot.
Here the price is cash, but the supply of the purchased goods is deferred. Salam was allowed by the Holy Prophet (PBUH) subject to certain conditions. The basic purpose of this sale was to meet the needs of the small farmers who needed money to grow their crops and to feed their family till the time of harvest. After the prohibition of Riba they could not take usurious loans. Therefore, it was allowed for them to sell the agricultural products in advance.
Similarly, the traders of Arabia used to export goods to other places and to import some other goods to their homeland. They needed money to undertake this type of business. They could not borrow from the usurers after the prohibition of riba. It was, therefore, allowed for them that they sell the goods in advance. After receiving their cash price, they could easily undertake the aforesaid business.
Salam was beneficial to the seller, because he received the price in advance, and it was beneficial to the buyer also, because normally, the price in Salam used to be lower than the price in spot sales. The permissibility of Salam was an exception to the general rule that prohibits the forward sales, and therefore, it was subjected to strict conditions. The Shari'ah aspects of Salam are:
a. It is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of affecting the sale. It is necessary because in the absence of full payment by the buyer, it will be tantamount to sale of a debt against a debt. All the Muslim jurists are unanimous on the point that full payment of the price is necessary in Salam. However, Imam Malik is of the view that the seller may give a concession of two or three days to the buyers, but this concession should not form part of the agreement.
b. Salam can be affected in those commodities only the quality and quantity of which can be specified exactly. The things whose quality or quantity is not determined by specification cannot be sold through the contract of Salam.
c. Salam cannot be affected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply the wheat of a particular field, or the fruit of a particular tree, the Salam will not be valid, because there is a possibility that the crop of that particular field or the fruit of that tree is destroyed before delivery, and, given such possibility, the delivery remains uncertain. The same rule is applicable to every commodity the supply of which is not certain.
d. The exact date and place of delivery must be specified in the contract.
e. Salam cannot be affected in respect of things which must be delivered at spot. For example, if gold is purchased in exchange of silver, it is necessary, according to Shari'ah, that the delivery of both be simultaneous. Here, Salam cannot work.
f. The object of Salam cannot be pinpointed by the seller at the time of entering into Salam contract. If it can be pinpointed Salam would not be valid.
Salam as a mode of Financing
It is evident from the foregoing discussion that Salam was allowed by Shari'ah to fulfill the needs of farmers and traders. Therefore, it is basically a mode of financing for small farmers and traders. This mode of financing can be used by the modern banks and financial institutions, especially to finance the agricultural sector. As pointed out earlier, the price in Salam may be fixed at a lower rate than the price of those commodities delivered at spot. In this way, the difference between the two prices may be a valid profit for the banks or financial institutions. In order to ensure that the seller shall deliver the commodity on the agreed date, they can also ask him to furnish a security, which may be in the form of a guarantee or in the form of mortgage or hypothecation. 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 / the financier 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.
The only problem in Salam which may agitate the modern banks and financial institutions is that they will receive certain commodities from their clients, and will not receive money. Being conversant with dealing in money only, it seems to be cumbersome for them to receive different commodities from different clients and to sell them in the market. They cannot sell those commodities before they are actually delivered to them, because it is prohibited in Shari'ah.
But whenever we talk about the Islamic modes of financing, one basic point should never be ignored. The point is that the concept of the financial institutions dealing in money only is foreign to Islamic Shari'ah. If these institutions want to earn a halal profit, they shall have to deal in commodities in one way or the other, because no profit is allowed in Shari'ah on advancing loans only. Therefore, the establishment of an Islamic economy requires a basic change in the approach and in the outlook of the financial institutions. They shall have to establish a special cell for dealing in commodities. If such a special cell is established, it should not be difficult to purchase commodities through salam and to sell them in the spot markets.
However, there are two other ways of benefiting from the contract of Salam.
Firstly, after purchasing a commodity by way of Salam, the financial institutions may sell it through a parallel contract of Salam for the same date of delivery. The period of Salam in the second (parallel) transaction being shorter, the price may be a little higher than the price of the first transaction, and the difference between the two prices shall be the profit earned by the institution. The shorter the period of salam, the higher the price, and the greater the profit. In this way the institutions may manage their short term financing portfolios.
Secondly, if a parallel contract of Salam is not feasible for one reason or another, they can obtain a promise to purchase from a third party. This promise shoud be unilateral from the expected buyer. Being merely a promise, and not the actual sale, their buyers will not have to pay the price in advance. Therefore, a higher price may be fixed and as soon as the commodity is received by the institution, it will be sold to the third party at a pre-agreed price, according to the terms of the promise. A third option is sometimes proposed that, at the date of delivery, the commodity is sold back to the seller at a higher price. But this suggestion is not in line with the dictates of Shari'ah. It is never permitted by the Shari'ah that the purchased commodity is sold back to the seller before the buyer takes its delivery, and if it is done at a higher price it will be tantamount to Riba which is totally prohibited. Even if it is sold back to the seller after taking delivery from him, it cannot be pre-arranged at the time of original sale. Therefore, this proposal is not acceptable at all.
Some Rules of Parallel Salam
Since the modern Islamic Banks and Financial Institutions are using the instrument of parallel Salam, some rules for the validity of this arrangement are necessary to observe:
1. In an arrangement of parallel Salam, the bank enters into two different contracts. In one of them, the bank is the buyer and in the second one the bank is the seller. Each one of these contracts must be independent of the other. They cannot be tied up in a manner that the rights and obligations of one contract are dependant on the rights and obligations of the parallel contract. Each contract should have its own force and its performance should not be contingent on the other. For example, if A has purchased from B 1000 bags of wheat by way of Salam to be delivered on 31 December, A can contract a parallel Salam with C to deliver to him 1000 bags of wheat on 31 December. But while contracting Parallel Salam with C, the delivery of wheat to C cannot be conditioned with taking delivery from B. Therefore, even if B did not deliver wheat on 31 December, A is duty bound to deliver 1000 bags of wheat to C. He can seek whatever recourse he has against B, but he cannot rid himself from his liability to deliver wheat to C. Similarly, if B has delivered defective goods which do not conform with the agreed specifications, A is still obligated to deliver the goods to C according to the specifications agreed with him.
2. Parallel Salam is allowed with a third party only. The seller in the first contract cannot be made purchaser in the parallel contract of Salam, because it will be a buy-back contract, which is not permissible in Shari'ah. Even if the purchaser in the second contract is a separate legl entity, but it is fully owned by the seller in the first contract the arrangement will not be allowed, because in practical terms it will amount to 'buy-back' arrangement. For example A has purchased 1000 bags of wheat by way of Salam from B, a joint stock company. B has a subsidiary C, which is a separate legal entity but is fully owned by B. A cannot contract the parallel Salam with C. However, if C is not wholly owned by B, A can contract parallel Salam with it, even if some share-holders are common between B and C.
Risks associated with Salam:
Credit risk due to seller default is one of the risk associated with Salam.
The price of the object of Salam will be higher at the time of delivery. This may lead some dishonest people to sell the goods at other places and thus dishonoring the Salam contract.
Goods bought under Salam contract cannot be sold by the bank before actual delivery of the product. Hence banks will not be able to get its invested money back, with profit, before he actually possesses the good with him.