Salam

Salam (also bai' salam or salaf) is a sale contract in Islamic commercial law in which the buyer pays the entire price at the time of contracting for goods that the seller will deliver at a specified future date. The goods must be described precisely by type, quality and quantity, and the delivery date and place must be fixed. Salam is one of the few sales in which the object of sale need not exist or be owned by the seller when the contract is made.

Because it combines immediate payment with deferred delivery, salam works as a form of pre-financing for producers. It is used by Islamic banks to finance farmers, manufacturers and commodity traders, and it underpins some government short-term instruments.

Salam predates Islam and was common in Medina, where farmers sold future harvests of dates for cash in advance. A well-known hadith reports the Prophet Muhammad directing that whoever pays in advance should do so for a known measure, a known weight and a known period. Jurists treat salam as an exception to the general rule against selling what one does not own, permitted because of the economic need it serves. In the modern industry, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) sets out the detailed requirements in its Sharia standard on salam and parallel salam. The contract belongs to fiqh al-muamalat, the Islamic law of transactions.

• Full advance payment: the price is paid at the session of contract. Most schools require immediate payment; the Maliki school tolerates a short delay of a few days. Deferring the price would turn the deal into an exchange of a debt for a debt, which is forbidden.
• Fungible, describable goods: the goods must be of a kind that can be specified so that any unit meeting the description is acceptable, such as wheat of a stated grade. Unique items, such as a particular piece of land, cannot be sold by salam.
• Precise specification: type, quality, quantity, and delivery date and place must be stated to remove gharar (excessive uncertainty).
• No exchange of ribawi items: gold, silver or currency cannot be sold against each other on a salam basis, because that would breach the rules on riba al-nasiah; currency exchange requires immediate qabd (possession).

A bank that buys goods by salam usually does not want to take physical delivery. It can enter a separate parallel salam in which it sells goods of the same description to a third party for delivery on or near the same date. The two contracts must be independent: the bank's obligation to deliver under the second contract cannot be made conditional on receiving goods under the first. The bank's profit is the difference between the price it paid and the price it receives. Alternatively, the bank may appoint an agent to sell the goods on delivery or rely on a wa'd (unilateral promise) from a third party to buy them.

A wheat farmer needs 50,000 in local currency to plant a crop. An Islamic bank pays the farmer 50,000 today under a salam contract for 100 tonnes of a specified grade of wheat to be delivered at the bank's warehouse in six months. The bank simultaneously agrees by parallel salam to sell 100 tonnes of the same grade to a flour mill for 54,000, payable at delivery. If both contracts perform, the bank earns 4,000 for financing the crop and bearing delivery and price risk in the interval.

Salam resembles a conventional forward contract, but in a forward neither side normally pays until settlement, while salam requires full prepayment. It differs from a futures contract in that it is bilateral, not standardized or exchange-traded, and it cannot be resold before delivery in the view of most scholars. It is close to istisna, which also sells goods not yet in existence, but istisna is used for manufactured or constructed items and allows the price to be paid in installments. Unlike murabaha, salam finances the seller rather than the buyer.

The buyer bears credit risk on the seller's ability to deliver, commodity price risk between payment and delivery, and storage and quality risk once goods arrive. Because the salam debt cannot be sold, the bank's position is illiquid. Some central banks, including those of Bahrain and Sudan, have used salam-based instruments to manage short-term liquidity in their Islamic banking sectors, but in commercial banking salam remains a niche product compared with murabaha and ijarah.