Week # 10

Salam(Deferred Delivery Sale) Facility Istisna ( Manufacturing Sale) Facility

Debt Based Financing Product-II Presented By: Huma Ayub Assistant Professor Bahria University, Islamabad.

Source: Islamic Banking Bulletin Dec 2010

Presentation Outline Fiqh Principles on Counter values (CV)

Bay al-Salam Bay al-Istisna

Fiqh principles on CV
In principle, based on the texts of the Shariah, the counter values (price and good) must be

Present during the time of the contract Exchanged on the spot

Fiqh principles on CV
However, the Shariah text made exception in two situations where one of the counter values may be deferred and hence absent during the time of the contract:
Al-Bay Bithamanin Ajil (price deferred) Bay al-Salam (good deferred)

Bay al-Salam
Definition Literally al-Salam means to advance or to pay upfront. Another term for alSalam is al-Salaf. Technically, it is a sale where the price is paid upfront and the good is delivered in future. Salam was originally designed as a financing mechanism for small farmers and traders.

Bay al-Salam
Shariah Evidence Al-Quran: 2:282, Ibn Abbas r.a.: reported that this verse was revealed in relation to al-Salam. O you who have believed, when you contract a debt for a specified term, write it down. Al-Sunnah: The prophet s.a.w. prohibited the sale of what is not in possession but made a concession in relation to al-Salam. (Narrated in all the sunan)

Bay al-Salam
Necessary Conditions: The kind, type and attributes of price and good must be known and specified.

The amount or unit of price and good must be specified.

Bay al-Salam
Necessary Conditions: The price should be paid upfront and the good delivered later in future. Al-Imam al-Shafii opines that the good can also be delivered in the immediate future because the term specific time frame in the hadith refers to point in time and not duration. On the other hand, al-Imam Malik is of the opinion that advancing the price could be delayed but not exceeding 3 days

Bay al-Salam
The good should be homogeneous and real. Currencies cannot be the object of al-Salam. The exchange must be free from ribawi items. The good must be present any time during the duration of the contract. No Khiyar al-Shart, i.e. the option of condition that would change the nature of al-Salam such as deferring payment or spot delivery of good. The point of delivery must be specified, e.g. port etc especially when cost is involved

How to get Profit from Salam?

Since the spot price that the bank

pays is pegged lower than the expected future price, the transaction should result in a profit for the bank. Possession condition before bank can get back its investment and profits. Islamic banks are exposed to Price Risk (mitigation technique Parallel

Bay al-Salam: Application

Model 1 Direct involvement of Islamic Bank in Bay al-Salam
1) Cash Bank Farmer

4) Produce

6) Revenue

5) Produce 3) Produce o

Market

Farm

Bay al-Salam: Application

Model 2:Involvement of IB as an intermediary (Parellel Salam)
Bank
1) Installment 4) Asset 3) Asset 2) Cash/Installment

Client

Supplier

* Duration between Bank and Client is longer that the duration between Bank and Supplier. Two separate contracts.

Bay al-Salam: Application

Model 3: Hybrid
BBA
Al-Salam
2) Asset Bank

Installment
3) Asset

Client

1) Cash

Supplier

* Duration between Bank and Client is longer that the duration between Bank and Supplier.

Back to back Salam Facility (to mitigate Price Risk)

Steps in Back to back Salam Facility

Application of Salam
Pre-shipment Export Finance:
This is undertaken in the following steps. 1. Bank receives an export letter of credit (LC) in favor of its client, covering certain goods; Client gives the letter of credit under bank's lien. Thus, allowing the bank to assume the role of seller to the foreign buyer. 2. To comply with the LC requirement, bank agrees to buy the goods from its client under a salam contract and makes upfront payment to him. Salam contract devised for this purpose should include specific delivery date and place. Delivery date should be reasonably ahead of the latest shipment date stated

Application of Salam
3. As for the place, it should be the port of destination mentioned in the LC. Submission of in-order shipping documents (viz. bill of lading and certificate of origin) by the client may be deemed equivalent to the satisfactory delivery. 4. The agreed payment (pre-shipment finance) made by the bank to its client will be lower than the amount of the export LC, difference being bank's profit.

Al-Istisna
Definition Literally al-Istisna means to create or Manufacture something. Technical it is a contract with artisan or manufacturer to make something of a given description (An artisan is a skilled workman).

Al-Istisna
Shariah Evidences The Jumhur deem al-Istisna invalid on the basis of Qiyas because both counter values (price and good) are absent during the time of initiating the contract. The Jumhur secure al-Istisna by al-salam (if the material is provided by the manufacturer or al-Ijarah (if the material is provided by the customer).

Al-Istisna
Shariah Evidences However, al-Istisna has been allowed (especially by the Hanafi scholars) on the basis of Istihsan (hidden qiyas). How?

Al-Istisna
Necessary Conditions

The good must be of specific kind, type, amount and attribute. The good must be known and familiar to the two contracting parties.

Al-Istisna
Necessary Conditions Conditions before the good is manufactured Conditions after the good is manufactured

Al-Istisna

Model 1:Involvement of IB as an intermediary (Parellel al-Istisna)

Bank 1) Installment 4) Asset 3) Asset 2) Cash/Installment * Duration between Bank and Client is longer that the duration between Bank and Supplier. Two separate contracts. Client

Supplier

Al-Istisna
Model 3: Hybrid
BBA
Bank Installment 3) Asset 2) Road 1) Cash * Duration between Bank and Govt is longer that the duration between Bank and PLUS. Govt

Istisna

PLUS