1.

0 Introduction

Every individual in this world needs some investment or funds to carry out their
respective businesses in a profitable way. Some of them have enough capital to start of
and some depends on the loan from other sources. Conventional Banks is one of the best
source people uses for getting loans sufficient enough to start a new venture. Although
policies, regulation and interest rates are the toughest part the business man suffer when
the loan is acquired from this entity, but it is an easiest door to knock as banks can have a
longer payback or time period which can be easily repaid by an individual.
Islamic banks on the other side has started to give tougher time to conventional banks on
the points of affordability, convenience, lower interest rate and easier terms and
conditions. These banks a part from providing a smoother platform have also laid down
the rules for conducting a business which are mainly shariah compliant, which makes it a
more suitable place to opt for.
Nonetheless these two banks work for profits but the only difference which makes a
Islamic bank a more attractive entity to enter is mainly due to the lower interest rates
these banks offer hence reducing the risk for the default on payment for itself and for the
customers.
Meezan bank is one of those banks which has made itself prominent in this field and is
working on the principle for fulfilling the customer needs on low profit margins.
Customers from lower income group for e.g. the farmers who were deprived of getting
loans from conventional banks now can make connections with Islamic banks to get
loans on easier terms (in case of Istisna and Salam).
Islamic banks have opened the gate for lower income generating groups and for small
business individual to obtain funds these people need to run their business. Islamic banks
contrary to conventional banks differ in their processes as the main element which
Islamic banks focuses is on goods rather than a involvement of money which is the core
USP of conventional banks. Islamic banks work on the rule for earning profits on the
goods rather than money which is completely prohibited by shariah laws and is
considered to be haram.

Salam

• A Salam transaction is the purchase of a commodity for deferred delivery in

exchange for immediate payment.
• Price is fully paid at spot while the delivery of goods is deferred.
• Salam is also known as ‘Salaf’.

Purpose of Salam
• To meet the needs of small farmers who need money to grow their crops and to
feed their family up to the time of harvest.
• To meet the need of Working Capital
• To meet the need of Liquidity Problem.
• To meet the need of traders for import & Export business.

Conditions of Salam
• • It is necessary for the validity of Salam that the buyer pays the price in full to
the seller at the time of effecting the sale, because the basic insight for allowing
Salam is to fulfill the instant need of the seller. If its not paid in full, the basic
purpose will not be achieved.

• Only those goods can be sold through a Salam contract in which the quantity and
quality can be exactly specified e.g. precious stones cannot be sold on the basis of
Salam because each stone differ in quality, size, weight and their exact
specification is not possible.

• Salam cannot be effected on a particular commodity or on a product of a

particular field or farm e.g.. supply of wheat of a particular field or the fruit of a
 particular tree since there is a possibility that the crop is destroyed before delivery
and given such possibility, the delivery remains uncertain.

• The exact date and place of delivery must be specified in the contract.

• The exact date and place of delivery must be specified in the contract.

• Salam cannot be affected in respect of things, which must be delivered at spot.

E.g. Salam b/w wheat and barley.

• The commodity of Salam contract should remain in the market right from day of
contract up to the date of delivery or at least at the date of delivery.

2.0 Contract of Salam

2.1 Master Agreement It is permissible to draw up a general framework or a master

agreement that consists of an understanding to conclude successive salam contracts, each
of which will take place at an appropriate time (Memorandum of Understanding).

• The execution of each Salam contract may then take place separately at the appropriate
time, the contents of memorandum become part and parcel of the contract.

• Necessary details like the specifications of the commodity and the due date, etc will be
expressed in each Salam transaction

2-2 Form of Salam Contract

The contract may be concluded using the word Salam, or salaf, or sale, or any term that
indicates sale of a prescribed commodity for deferred delivery in exchange for immediate
payment of the price.
3- Subject Matter of Salam

3.1 capital of Salam

It is permissible for the capital of Salam to be in the form of fungible goods (such as
wheat and other cereals), in which case the parties must make sure that they do not fall
into Riba.

The capital may also be items of material value (such as livestock) or general usage of a
particular asset. In case when the usufruct is the price the delivery of the asset would be
consider as the payment of the price.

The capital should be made known to the two parties in a manner that removes all
uncertainty and eliminates the possibility of dispute.

In principle, the capital of Salam should be in the form of cash. In this case, the currency
of payment, the amount and the manner of payment shall be clearly defined.

• If the capital of Salam is in the form of fungibles, then the kind, type, specifications and
quantity of these shall be clearly defined.

• The capital of Salam must be paid immediately at the place where the contract is
concluded. However, payment may be delayed for two or three days at most.

The delay in payment will not affect the Salam contract provided it is not equal to or
greater than the delivery period for al-Muslam fihi (subject matter of Salam).
3.2 Subject Matter of Salam

Salam contracts are permitted for fungible goods, like those that may be weighed,
measured and counted.

This will also include products of companies that manufacture goods in approximate
specifications, standardized and are commonly available at any time. Salam is not
permitted for anything specific like ‘this car’. Nor it is permitted for anything for which
the seller may not be held responsible, like land, building or trees; or for any commodity
whose specifications can not be easily defined, like jewellery and antiques.

Subject matter should not be an amount of gold or silver, if the capital of the Salam was
paid in the form of currency or gold or silver.

Subject matter must be the kind of item for which a specification may be drawn up.
Subject matter must be commonly available under normal circumstances on the delivery
date.

There is no Shari’a objection for setting various dates on which the delivery may take
place in installments provided that the full price was paid in advance in the beginning of
the contract.

If the parties to the contract do not determine that place of delivery, then the place at
which contract was concluded will be regarded as the place of delivery.
3.3 Security

Subject matter may be secured by

• A Pledge or
• A Guarantee or
• Any other permissible means of securing payment.

4.0 Changes to the Subject Matter

4.1 Replacement

It is permissible for the buyer to exchange subject matter for other goods, after the
delivery date falls due as long as it was not fixed in the contract.

Replacement is possible provided the substitute is suitable for being exchanged as subject
matter for the capital of Salam contract.

The market value of substitute should not be greater than the market value of subject
matter at the time of delivery.

4.2 Iqala of contract

• It is permissible, when both parties agree, to cancel the entire Salam contract in
return for repayment in full of the amount of capital of Salam.
• Partial cancellation is also permissible.
5.0 Delivery of Goods

5.1 Delivery
The seller is under obligation to deliver the goods to the buyer on the due date according
to the terms of the contract.
The buyer must accept the goods if they meet the required specifications. If the buyer
refuses to accept the goods, he shall be obliged to do so.

5.2 Superior Quality

If the seller delivers goods of a superior quality, the buyer must accept the goods, unless
the seller asks for a higher price for better quality.

5.3 Inferior Quality

If the goods delivered are of inferior then the buyer has the complete right to accept or
reject the goods. Both parties can agree to accept the inferior quality at discounted price.

5.4 Subject Matter not delivered

In case all or part of the subject matter is not available to the seller on due date, the buyer
can either:
• Wait until the commodity is available
• Cancel the contract and recover the paid capital
• Replace the subject matter with some other goods.

5.5 Parallel Salam

It is permissible for the seller/buyer to enter into a separate, independent Salam contract
with a third party in order to acquire/sell goods of a similar specification to those
specified in the first Salam contract
Hence, the seller/buyer in the first contract becomes the buyer/seller in the second
contract.
It is necessary that both the contracts are of independent nature and are not dependent on
each other.
6.0 Export Bills
Exporter comes to the bank and a formal approval will be sought as per bank policy.
• MAFPC – Master Agreement for Purchase of Foreign Currency is signed b/w Bank and
Exporter.
• Whenever the Exporter has need for PKR, he will bring his Export bill to the bank.
• The banks Treasury, based on Market price will set a spot rate range in its rate sheet.
• The branches CANNOT quote any rate other than the SPOT rate range provided by the
treasury.
• After Finalization of the deal the bank purchases the Foreign Currency to be delivered
at a future date (due date) and pay the price in PKR as per the agreed rate.
• The Customer will deliver the foreign Currency to bank, but will not be dependent to
arrival of the LC proceeds.
7.0 Application of Salam
Working capital needs of the industry (such as textile, sugar mills etc.)
• Financing Agricultural operations e.g. sugar ,wheat
• Export Bill (Sight) negotiation.
 Part 2

1.0 Istisna

Istisna is a contract of sale of specified items to be manufactured or constructed, with an

obligation on the part of the manufacturer or builder (contractor) to deliver them to the
Customer upon completion. Istisna is the second exception to the rules of sale where a
sale is allowed without immediate delivery of the goods sold. It relates to the goods that
require manufacturing.
It is necessary for the validity of Istisna that the price is fixed with the consent of the
parties and that the necessary specification of the required items is fully settled between
them. The Istisna price can either be paid in advance, or in installments or at the time of
delivery of Goods.

1.1 Salient Features of Istisna

An Istisna contract is permitted only for raw materials that can be transformed from their
natural state by a manufacturing or construction process involving labor. The subject
matter is always a thing, which needs to be manufactured. Designation

If description of complete specification of the type, kind, quality and quantity of the
subject matter to be produced have been given to the manufacturer and funds have also
been disbursed for construction / manufacturing then the manufacturer is bound to
manufacture the Asset and cannot terminate the contract unilaterally.

The Bank is also bound to fulfill its obligation under the Istisna Agreement once the
production/ manufacturing work has started.
It is a requirement that the price for an Istisna contract be known at the conclusion of the
contract. Price can be in the form of cash or tangible goods or the use of an asset for a
particular duration.

The price of an Istisna contract may be paid in advance or deferred or paid in installments
within a certain period of time. The buyer can also connect payment of price with the
stage of completion of the work.

The price of Istisna transactions may vary in accordance with difference in delivery date.
It is permissible if it is agreed between the parties that in the case of delay in delivery, the
price shall be reduced by a specified amount per day.

It is permissible to revise the contract price and it can be increased or decreased due to
any incident.

The ultimate purchaser cannot be regarded as the owner of the materials in the possession
of the manufacturer for the purpose of producing the subject matter.

The time of delivery of goods does not necessarily have to be fixed in Istisna however; a
maximum time may be agreed upon between the parties.

The delivery of the subject matter may take place through constructive possession. At this
point, the liability of the manufacturer in respect of the subject matter comes to an end
and the liability of the ultimate purchaser begins.

If the manufactured Asset is found to be different at the time of delivery, this would be
considered as an Event of Default

The parties may agree on a period during which the manufacturer will be liable for any
defects or the maintenance of the subject matter.
2.0 Istisna as a mode of finance

Istisna can be used for providing financing facility in transactions where manufacturing
or construction is involved

Unlike Murabaha where only raw material can be financed, Istisna can be easily utilized
to facilitate payment of wages, overheads etc

It is also to be clarified that amount paid out as Istisna price to the manufacturer can be
used by the manufacturer anywhere he considers fit. It doesn’t have to be utilized
exclusively for the production process (In cases of Murabaha, finance can only be utilized
for the purchase of Murabaha subject matter only).

3.0 Parallel Istisna and Agency Agreement

Bank can make a sale to 3rd party after delivery of goods.

Bank can appoint manufacturer as its agent to sell the goods in the market once the goods
are ready to use.

The Bank may ask a 3rd party for ‘promise to purchase’ the goods with same specification
after a certain time period. This will be taken in advance and will mitigate the risk of
price fluctuations.
4.0 Financing to Local Manufacturers.

A Manufacturing company (Manufacturer) has an order for supply of specified goods at a

specified price to a local buyer. The Manufacturer needs funds for purchasing and
processing raw material into finished goods. The Manufacturer has approached MBL
(Meezan Bank Limited) for financing facility based on the mode of Istisna.

4.1 Process flow

After necessary Credit and Shariah approvals, bank & the Customer (Manufacturer) will
enter into a Master Istisna Agreement to manufacture Goods from time to time on
agreed terms & conditions.

Under the Master Istisna Agreement, Bank would then enter into separate Istisna
transaction with the Customer for the manufacturing of the Goods. At this time quantity,
price, specification and delivery date of Goods to be manufactured will be agreed. The
delivery of goods can either take place in full at the delivery date or in the form of
trenches within a specified time period.

Bank could pay the Istisna price to the Customer either in full or in installments.

After the completion of the subject matter of Istisna, the Manufacturer will inform the
bank and request for the acceptance of delivery. A Bank representative will accept the
delivery after physical inspection of the goods at the site.

A Goods Receiving Note will be executed at this moment to evidence the delivery of
goods to bank. The risks and rewards associated with the goods are transferred to bank at
this stage
After receiving delivery of goods, bank will enter into a separate Agency Agreement
with the Customer for sale of goods on Cash basis to credible local buyers on behalf of
bank in a specified number of days. In this manner the Agent will be responsible for
recovery of Sale price and its payment to bank. The Agent (Manufacturer) will be entitled
to a specified Agency Fee for providing these Services.

Banks ownership and risk in goods remains until the Agent sells these goods to the
Buyer in the market. Takaful may be obtained to cover the risk of damage or loss of
goods until they are sold to the final buyer.

The Agent may be entitled to an incentive fee for arranging the proceeds earlier than the
agreed schedule. This increase or decrease in the fee may be on a daily basis.

According to the contract when the buyer will pay the price to the agent, the agent is
bound to pass on the proceeds (agency and incentive fee) to the bank.

4.2 Credit Sale

In case of Credit Sale, the above mentioned process flow will remain the same except for
the Following

In this case the agent will sell the particular goods to the credible buyer on credit and will
collect the sale proceeds in a specified number of days. When goods are being sold it’s a
responsibility of the agent to confirm the bank about the sale through “confirmation of
sale of goods”. After receiving the payment form the buyer the agent is bound to pass on
the proceeds to the bank.

At the time of agency agreement a customer may be asked to give a guarantee that in case
of default from the final buyer the agent is responsible to payback the bank. This
agreement is signed under the guarantee called “Independent Corporate Guarantee”.
5.0 Risk Mitigation in Istisna

5.1 Delivery Risk

If there is a delay in delivery of goods from the manufacturer at time of maturity. Bank
has an option available to mitigate this risk by reducing the price on daily basis in order
to penalize the manufacturer.
5.2 Non-performance
When The Manufacturer may not be able to manufacture the goods during assigned time
and refuses to carry on the responsibility further the bank can terminate the Istisna
agreement and demand the price back from the manufacturer.

5.3 Quality Risk

If the Manufacturer delivers defected/inferior goods, which is realized by the bank when
the ultimate purchaser points out to that. Then bank can exercise khiyar-e-Aib asking the
manufacturer to rectify the defect.

5.4 Price Risk

If the market price of the subject matter decreases after entering into an Istisna agreement
then parallel Istisna can mitigate the risk for the bank.

5.5 Order Cancellation

When the final purchaser cancels the order for purchasing the produced goods than the
bank is permissible to sell those goods in the market.

5.6 Increased cost of Manufacturing

If at any point of time when the manufacturer comes to know that cost of manufacturing
is higher than anticipated causing the manufacturer to default on the performance than the
additional cost will be beard by the manufacturer unless it is caused by some external
forces in which case Istisna price may be increased with mutual consent.

5.7 Storage Risk

When the goods produced are delivered to the bank, they are the ultimate risk holder of
those goods until it is being sold to final purchaser. This risk of carrying those goods can
be covered through Takaful and through minimizing the time duration between
acceptance of delivery and delivery to the ultimate purchaser.
5.8 Non performance of Agent
When an Agent is unable to arrange sale proceeds within a specified time period or
delays in passing on to the proceeds to the bank than a penalty may be imposed which
will be carried forward in the charity account.

5.9 Default by ultimate Purchaser

If by any reason the ultimate purchaser defaults or goes bankrupt, the customer may
asked the agent to provide a Corporate Guarantee to guarantee payment of ultimate
purchaser.

Other Uses of Istisna:

• House financing (construction of houses, residential towers, villas etc
• Construction of buildings, plants, highways, bridges.
• Manufacturing of aircrafts, ships, machines, plant/ factory and equipment.