Bai As-Salam and

Bai Istisna
Sales by Order (Tempahan)

Definition
Bai

As-salam or Salam means a contract in

which advance cash payment is made for
goods to be delivered later on.
The seller undertakes to supply some specific
goods to the buyer at a future date in
exchange of an advance price fully paid at the
time of contract.
Salam- also know as sales by order.

Cont.
Salam

transaction occurs if the buyer has paid

the purchase price to the seller in full at the
time of sale. This is necessary so that the
buyer can show that they are not entering into
debt with a second party in order to eliminate
the debt.
Salam - a mechanism that ensures the seller
has the liquidity they expected from entering
into the transaction in the first place. If the price
were not paid in full, the basic purpose of the
transaction would have been defeated.

Rukun Salam
1. Buyer - al muslim
2. Seller - al muslam ilaihi
3. Price - al muslam
4. Commodity - al muslam fihi
5. Ijab & Qabul - sighah with salam

Conditions for As salam

1. Only for the quality and quantity of commodities

which have been specified exactly.

2.The quality of the commodity is fully specified,
leaving no ambiguity.
3.The quantity of the commodity is agreed upon in
unequivocal (clear) terms. If the commodity is
quantified in weights according to the usage of its
traders, its weight must be determined, and if it is
quantified through measures, its exact measure
should be known.
4.The exact date and place of delivery must be
specified in the contract.

Conditions for As salam

5. Salam cannot be effected in respect of things which
must be delivered at spot. It must be in an agreed
period of delivery.
6. Salam cannot be effected 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.

Salam and Istisna

Bai

As-Salam and Bai Al-Istisna are both

deferred delivery contract, however both
instruments have its own application.
Salam is equivalent to a forward sales for
agricultural products while,
Istisna is a forward sales for
manufacturing or construction contract.

Salam and Istisna

Both

Salam and Istina are valid sale and

halal based on al istishan and uruf.
Originally, Salam was used to provide
financing to small farmers and traders.
This trend has expanded to include
commodity futures market and preshipment export finance.

Differences between
Salam and Istisna
Salam
Total payment is paid
in advanced.
Commodityagricultural products,
fungible or generic
goods. E.g. Paddy
rice, wheat, corn etc

Istisna
Total payment can be
done upfront or at the
end or by installment.
Commodityconstruction or
manufacturing products
i.e. it is unique goods.
E.g. Buildings, set of
table, car, gate etc

Original Salam- illustration

Pak Hassan have 5 acres of land that could be

cultivated with paddy. He could produce 5 tonne of
paddy in 6 months. However, Pak Hassan does not
have enough money to start the project. He
approaches an Islamic bank for financing.

The bank bought 5 tonne of paddy from Pak Hassan

using a Salam contract at a price of RM 1.20/kg. The
market price of paddy was RM 1.80/kg. Therefore the
bank paid the total selling price (1.20 x 5,000 kg =
RM6,000) to Pak Hassan on Day 1.

Original Salam- illustration

Pak Hassan used this money to start his project. The

project cost was RM 3,500.

After 6 months. Pak Hassan delivered 5 tonne of

paddy to the Islamic bank.

Pak Hassan would gain a gross profit of RM 2,500

(Salam price Project Cost).

The Islamic bank could make profit by selling the

paddy in the market at RM1.80/kg. Then, the bank
would enjoy a gross profit of RM3,000 [(1.801.20)x5000 kg].

Original Salam-Its concept

Both parties in Salam will face the risk of price

movement.

If the price of paddy goes up, Pak Hassan would have

to forego the opportunity of making higher profit
because he has sold the paddy to the bank at the
salam price, while the bank may enjoy a higher profit
than the above.

On the other hand if the paddy price goes down to say

RM1.00/kg, then Pak Hassan will be in a comfortable
position because he has already sold to the bank at
RM1.20/kg. The bank will now face the risk of loss
because it could not recover its cost.

Parallel Salam
To manage

the risks in first salam

contract, the bank will usually enter into
a parallel salam i.e. the bank will find
another party (maybe paddy wholeseller)
and enter into a another salam contract
so, it could sell the paddy to the
wholeseller at a fixed price.
Parallel salam when there are 3
parties involved in salam contract.

Parallel Salam

Parallel Salam-illustration

Assume the wholesale price of paddy is RM 1.50/kg.

Pak Hassan sold to the bank 5 tonne of paddy at

RM1.00/kg on Salam basis.

The bank paid Pak Hassan RM5,000 on Day 1.

The bank sold the 5 tonne of paddy to the

wholeseller at RM1.30/kg on Salam basis.

Parallel Salam-illustration

The wholeseller paid the bank RM6,500 to the bank

on Day 1 also.

After 6 months, Pak Hassan delivered the paddy to

the bank.The bank consequently sent the paddy to
the wholeseller.

The wholeseller makes profit by selling the paddy to

the retailer at the price of RM 1.50/kg.

Parallel Salam
The

transaction between Pak Hassan and the

Islamic bank is the first Salam (Salam 1) while
the transaction between the Islamic bank and
the wholeseller is the second Salam (Salam 2).

This

is known as Parallel or back to back salam.

Parallel Salam
One

important note is that, if Pak Hassan fails to

deliver in the first Salam, the bank would still
have to honor the second Salam.

Thats

why it is important to finance generic

goods using Salam, because the bank could buy
paddy in the open market and still honor the
second Salam in the event, if the first Salam
fails.

Parallel Istisna
Being

a construction or manufacturing contract,

Istisna is very suitable for project financing.
Example: Commercial or residential
buildings, road construction, aircraft and
vessel construction

The

seller could either manufacture the

commodity on his own or he could find another
sub-contractor to do the job. This will result in
parallel or back to back istisna.

Parallel Istisna-illustration

Client asks the bank to construct a house for him

with clear specification. The cost to construct the
house is RM300,000.

The bank agrees and signs an Istisna contract with

the client. (The bank is the seller in the first Istisna.
The selling price that the bank charges is RM450,000
i.e. Cost of construction plus profit to the bank).

Parallel Istisna-illustration

The bank then finds a contractor for the construction

and asks him to handle the project.

The contractor agrees and signs an Istisna contract

with the bank. (Now the contractor is the seller in the
second Istisna. The contractor charges the full
construction cost, say RM400,000 ).

Upon completion, the contractor delivers to the bank

and the bank delivers to the client.

Parallel Istisna
Payment

in this contract could be very flexible.

Banks would release progressive payment i.e.
payment according to stages of completion of
construction.
Being the seller in the first Istisna, the bank is
liable to any non-completion of the house or any
non-conformance to specification risk.
Therefore, it is very important to have a project
management team to ensure the selection of
projects to be financed using Istisna is carefully
made.

Differences between Salam and Istina

Bai Istina

Bai As Salam

The subject of Istisna is always a

thing which needs manufacturing,

Salam can be effected on any thing,

no matter whether it needs
manufacturing or not.

Payment for Istisna can be made in

staggered basis.

It is necessary for Salam that the

price is paid in full in advance, while
it is not necessary in Istisna

The contract of Istisna can be

cancelled before the manufacturer
starts the work.

The contract of Salam, once

effected, cannot be cancelled
unilaterally,

Differences between Salam and Istina

Bai Istina

Bai As Salam

The asset manufactured must meet

specification of the order and the
buyer has the right not to take
possession of the asset if the
specifications are not met.

The object of the Salam is a liability

on the seller to deliver, thus should
be in the form of fungible goods i.e.
easily replaced from the market
should the seller be unable to deliver.

The time of delivery is fixed.

The time of delivery is an essential

part of the sale in Salam while it is
not necessary in Istina

Any penalty for charged late delivery

can reduce the price of an Istisna
contract

The penalty amount is paid to charity

(not taken as benefit for the buyer).

Why is Salam important?

Salam

contributes to the economic wellbeing as it removes the liquidity

shortages of one party and solves the
requirement of a buyer once the asset /
commodity is delivered.
The contract also allows for large
economic activities as the Salam
contract usually involves substantial
amount of funds.

End of Lecture