Salam & Parallel Salam
In this section, some technical words are defined.
Salam: an agreement to purchase, at a predetermined price, a specified kind of commodity which is to be delivered on a specified future date in a specified quantity and quality. The bank as the buyer makes full payment of the purchase price upon execution of a Salam contract or within a subsequent period not exceeding two or three days as deemed permissible by its Sharia Supervisory Board (SSB).
Parallel Salam: In certain cases, the Bank may enter into a back-to-back contract, namely Parallel Salam, to sell a commodity with the same specification as the purchased commodity under a Salam contract to a party other than the original seller. The Parallel Salam allows the Bank to sell the commodity for future delivery at a predetermined price (thus hedging the price risk on the original Salam contract) and protects the Bank from having to take delivery of the commodity and warehousing it.
Hamish Jiddiyyah: in the case of a binding MPO, the risk of selling at a loss is mitigated by securing a Hamish Jiddiyyah (HJ). It's a security deposit held as collateral upon entering into agreement to purchase or agreement to lease.
Sharia: is the body of Islamic religious law. It is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on Islamic principles of jurisprudence. Sharia deals with many aspects of day-to-day life, including politics, economics, banking, business, contracts, family, sexuality, hygiene, and social issues.
PSIA: Profit Sharing Investment Account is a financial instrument that is relatively similar to the time deposits of conventional banks. According to the terms and conditions of PSIA, depositors are entitled to receive a share of the bank's profits, but also obliged to bear all potential losses pertaining to their investment in the bank. This profit-sharing principle is core to Islamic finance, according to which investors and entrepreneurs must share the risks and rewards of a given venture.
A PSIA can be further categorised into: Unrestricted PSIA and Restricted PSIA. The Bank has full discretionary power in making investment decisions for unrestricted PSIA, but in the case of the restricted PSIA the placement of funds by the Bank is subject to investment criteria contract or agreed between the investment account holders (IAH) and the Bank at the time of contracting.
In this section, some principles which must be respected by a Salam & Parallel Salam contract are described and an example is presented.
Salam is a type of contract connected to a commercial operation. It is the opposite of a sale with deferred payment. Indeed, it happens that the customer has some money and wishes to acquire an unavailable product on the local market. The Islamic bank cashes the money and makes a commitment in the operation of purchase of this product which it will pass on to its customer.
Because the interest loan is prohibited in Islam, Salam is established in Sharia to facilitate certain economic activities. Indeed, its advantages show themselves particularly in the agrarian domain where the farmers have financial needs in the beginning of the season. By means of Salam, these last ones can surmount their needs in liquid assets by appealing to financiers.
So that a Salam & Parallel Salam contract complies with Sharia, it is necessary to respect some rules:
§ Salam contract must comply with the prescripts of the Sharia: no financing of products prohibited by Islam like alcohol, weaponry, pork...
§ The capital must be determined and passed on at the contract's time of the signature: a payment delay of two or three days is possible.
§ Determination of all characteristics of the goods to be delivered.
§ Determination of The delivery date.
The forward contracts allow the contracting parties to fix the future prices according to their own anticipations. The farmer of wheat for example incurs the risk of unfavourable fluctuation of the future prices. For a harvest which will take place in six months, the farmer anticipates certain price for his wheat which could be superior or lower than the real price in the daytime of the harvest. If the farmer does not like take risk concerning the fluctuation of prices, he has to find a buyer within a contract Salam which agrees to pay the price in cash of a harvest which will take place in a future date.
If he succeeds to conclude the affair, the farmer will have surmounted the uncertainty by selling his wheat to the price of his own anticipations. The elimination of the risk of the price of wheat urges the agriculture to make calculations of forecasts exactly, particularly when big sums of money are at stake.
2- Salam stages
A Salam & parallel Salam contract can be divided in two stages:
· Stage I: The period between the signature of the contract and the disbursement of funds (This period can't exceed 3 days).
· Stage II: The Bank has paid and is waiting for the commodity delivery.
· Stage III: Receipt of the purchased commodity by the Bank.
The calculation and the type of the risk faced by the Bank are different at the various stages of the contract for the two categories.