Ethica Institute of Islamic Finance™

How does Salam financing work?

A Salam transaction is a means by which party A advances money, in full and on spot, to party B, and party B promises to deliver an item on a specified date in the future. The Prophet (Allah bless him and give him peace) said: “Whoever wishes to enter into a contract of Salam, he must effect the Salam according to the specified measure and the specified weight and the specified date of delivery.”

A Salam is the exception to the Islamic rule forbidding forward sales and stipulating that party B possess the item to be sold in the present. The Salam agreement has the dual benefit of providing liquidity to party B, who normally would not realize any income until he invests large sums of capital in advance over extended periods of time, like farmers preparing seasonal crops; and benefiting party A because the Salams are priced lower than spot sales because the money is paid in advance.

When entering into a Salam, there should be certainty about the item’s quantity, quality, deliverability and availability at the time of delivery, including agreement on the date and location of delivery; quantitative descriptions should be specified in a manner proper to the item, whether by weight, volume, size or count (ie. it would be impermissible to sell in volume something customarily sold in weight); in the Hanafi school it is a condition of a valid Salam agreement that the item be readily available in the market at the time of contracting and expected to be readily available at the time of delivery; in the Shafi’i, Maliki and Hanbali schools it is sufficient that the item be readily available in the market at the time of delivery only.

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