Islamic Finance CH 8-11

• A valid Islamic Shariah sales contract must meet certain conditions: The asset must exist at the time of the contract, be owned by the seller, and be in the seller's physical or constructive possession.
• Salam and Istisna are exceptions to these rules and are permitted.
• A Salam contract calls for full payment upfront, asset delivery deferred to a specific future date and it is like a forward sale contact in conventional finance.
• Muslam describes the asset buyer, Muslam Ileihi is the seller, payment is the Ras al Maal, and the purchased commodity is the Muslam Fihi.
• It is used for production finance, Salam is a trade contract, usually short term but can be medium or long term
• Salam is suited to homogenous goods like sugar, coffee, etc., not unique assets like animals.

Salam Contract - Important Characteristics

• Assets in Salam contracts require detailed descriptions, quality and quantity specifications and are suitable for agriculture, trade, construction etc.
• In Murabaha, assets are delivered on the spot, payment is in installments including a markup, which makes the price higher than spot while In Salam, payment is made in advance, making it a discounted price.
• Goods in Salam must allow trading by counting, measuring, or weighing, expected to be available upon delivery
• Specifications needed include description, quantity, and quality to avoid uncertainty
• Attributes of contracted goods should be clearly specified, not directly tied to any specific supply source
• Gold and silver cannot be used in Salam
• Buyers pay the price fully in advance, and the difference from spot price is benefit for the buyer.
• An exact delivery date and place is needed and must be specified in the contract
• A sale of debt against debt is prohibited
• Delivery date and place can only change only by mutual consent
• The contract needs actual delivery of goods
• Buy-back conditions are not permitted
• Guarantees need to ensure timely commodity delivery
• If sellers fail on the delivery date, appropriate measures can be taken to ensure complete the bond
• Security amount can be taken to guarantee the goods value
• Penalties can be agreed upon if delays occur, but must be offered as charity.
• Courts may award damages, excluding time value of money.
• No revocation once signed unless both mutual parties agree

History and Benefits of Salam

• Salam contracts were used in agriculture during the Prophet's time and it meets needs of small farmers facing interest prohibition.
• Prophet said that all must sell with clear specification of volume, weight and due date.
• Sellers must purchase at the open market at a higher price should the commodity be unavailable by the contracted delivery date
• It benefits the seller through advanced payment, and buyer through discounted price as the contracts are free of Gharar and Maisir

Islamic Banks and Salam

• Common for modern islamic banks
• Facilitates Shariah-compliant financing, avoids involvement with interest.
• A Salam contract also benefits buyers by providing assets at a discounted rate.
• Islamic banks use Salam by using Parallel Salam, where they are the buyer committing to buy items from a supplier to be delivered in the future at a specific price, they then act as the seller to the client who pays in full at a date and place in the Salam contract.
• Shariah requires both contracts to be independent and not be contingent on the other
• The client approaches the bank to buy an asset using Salam financing, the bank contracts separately with manufacturer and with the client
• Asset specifications, delivery date, and place match each other from the supplier and with the client
• The Islamic bank provides purchase finance or forward finance to the customer

Diagram and Practical uses for Salam

• Client approaches bank, then bank agrees and the client completes the application
• Bank signs contract with the supplier, based on the client's application
• Client is buyer, banks the seller
• In Parallel Salam contract, the quality and specifications are exactly the same.
• The Client makes the advance payment for the parallel Salam contract much later, similar date and place but purchase finance from the bank
• Bank orders from Supplier and pays in advance for the commodity to the client
• Often the bank only receives the ownership title and then passes it on to the client, while the physical delivery of the asset is made directly to the client.
• Salam is used when the asset's production isn't ready but payment can be made in advance
• They are commonly used for agriculture,natural resources and international trade finance
• Alpha Superstore pays Big Bank for boxes of candy via Parallel Salam contract
• B enters exact candy contract with Candy Maker paying spot in advance
• Physical Delivery is from Candy Maker to Alpha Store
• The Parallel Seller contracts the delivery to A from B is not conditional on C delivering to B.

Problems and Differences

• Credit risk exists: Supplier defaults which forces bank to purchase and deliver
• Market risk exists: Price changes mean losses for the bank purchasing at a higher price or selling at a lower price than purchased amount
• Quality & Quantity risk exists: if parallel contracts do not completely match, the contracted goods needs to be supplied
• Conventional banks provide funds against fixed interest while Islamic banks buy goods in advance at low price then sell at a high rice and offer their profit pro-rata with depositors

Istisna and Parallel Istisna

• Istisna is the second sales contract where the buyer contracts with the seller to construct, fabricate, assemble or process any asset like equipment building, etc based on the requirements made in advance with mutual consent, and where a sample model is provided
• Al Masnu is the specific asset to be manufactured
• Al Mustasni is the buyer
• Al Musania is the seller
• Unlike Salam, the price isn't paid fully during the contract and instead in at spot or deferred
• Work can't be unilaterally cancelled by either party once started
• Istisna is suitable to constuction and project financing
• Islamic banks don't do the manufacturing work and so can use Istisna as seller with customer and a Parallel Islam as the buyer as the same manufacturer
• Shariah rulings around Istisna contracts as they are an exception to the rules of sales contracts so they need to reduce amibuity
• Responsibility of manufacturers match agreed specifications
• Price agreed must be through mutual consent
• Seller has a given day and so needs to deliver
• Clear specifications need to be met to be delivered
• A variety of options is available to pay the debt
• Cannot unilaterally cancel the contract by either party once work has begun
• 4 Different possible ways contract to default
• A default seller where they are not delivering must return buyers
• Buyers may have already partially paid and the value of their installments is more/less than the damages
• After delivery, the seller failed to meet the post construction issues and still can't be used
• Buyers who are going to have to to go collect damages through court procedure.
• Often the bank has to make repayments for the property

Takaful and Salam

• Islamic banks offers loans and security collateral is often taken from buyer
• Penalties can be applied to buyers and have to be donated
• the bank typically get only make only certain adjustments, and it's going to require all of that. As far as what they actually can do to this market there's several parties involved as the bank who doesn't do it
• After death contracts of support is something
• Banks are acting like a middle man while the bank offers the service to the client to get all support

Financial Terms

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Wakala

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Benefits of Salam

• The Prophet also had multiple mechanisms of this so

Takaful

• Istisna is a type of a type of business called them
• Not everything could be transferred and not

Mudaraba

• After Mudaraba the loan contracts
• It's only if your company defaults to to make up the contract like they're trying This is some information about the loans to the contract.

Types of Ijarah

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Takamful

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Important Figures

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