IB1005
DEPOSITS AND FINANCING PRACTICES
OF ISLAMIC FINANCIAL INSTITUTIONS
CHAPTER 11 : SALAM FINANCING &
ISTISNA FINANCING
COMPILED BY
HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance)
Certified Professional Trainer (MIM)
Industry Expert
INCEIF
PRESENTED BY
HJ MAHMUD HJ BUNTAT, MBA (AUOL, UK), DBM (Swansea Inst., UK), CIL (UIA)
Part-time Lecturer (INCEIF)
Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd
Chapter 11 :
Salam & Istina’ Financing
Salam
• Bai’ as-Salam is the sale of a deferred item in
exchange for an immediate forward price.

A salam contract referred to a commodity for
deferred delivery in exchange for an immediate
cash payment.

The salam concept has been used by banks to
hedge against inflation on other receivables due
(on other assets such as murabahah); the
forward income on salam being worth more.

In Sudan, one example of commercial financing
is the application of salam for agricultural
transactions (with funds utilized to pay for seeds,
fertilizers and wages), but also to finance
industrial and commercial activities.

Salam contracts can be developed between a
farmer and IFIs, and a parallel salam between
the IFI and a wholesaler/distributor whom in turn
will generate retail income from the consumer.

AAOIFI stipulates that since the payment has
been made in advance, the object matter of the
salam contract (al-muslam fihi) is considered a
debt, so no penalty clauses are permitted in
salam “because it is not permitted to stipulate
payment in excess of the principal amount of
debts”.
Istina’ (Manfacturer’s contract)

The Majallah al-Ahkam al-Adliyyah (Ottoman
code of Islamic civil law) defines istisna as “a
contract with a skilled person to make
something. The person who makes the thing is
called sani, the person who causes it to be made
mustasni, the thing made masnu.
•
The emphasis in istisna is the specificity of
subject matter to avoid gharar (uncertainty)
ensuring that the seller cannot transact with
something that cannot be accurately described;
one can describe equipment, a factory or an
industrial plant, but not fish in the sea prior
catching them since their type and volume is
unknown.

Malaysian Accounting Standards Board (MASB) in
its Financial Reporting Standards (FRS) for
Islamic Financial Institutions (IFI) defines the
ististna contract as follows, “Bai al-istisna (lit.
order sale) - A contract of exchange whereby an
IFI, at the request of the customer, acquires an
asset for purchase or construction based on
specifications by the customer. The payment of
acquisition price to manufacturer, developer or
vendor of the asset is made up-front by
determined future date.

Upon delivery, the IFI sells it to the customer at
a prevailing market price comprising original
acquisition price and a margin of profit.

The customer repays by instalments within a
period and in the manner agreed between the IFI
and the customer.”
•
AAOIFI also explains the differences between
istisna and ijarah, a standard construction
contract, and salam; Shari’a Standards (20042005), Shari’a Standard No.11, Appendix (C),
p.195. “The contract of istisna differs from the
contract of ijarah in the sense that the latter is a
contract of services without any commitment to
supply materials whereas the former requires
[the supply of] materials in the form of finished
items.’’ Majallah al-Ahkam al-Adliyyah, Book II
(Ijarah), Ch.1, Article 421.

Istisna differs from a salam contract [as an]
istisna contract is applicable to materials that
require transformation by a manufacturing or
construction process.

The salam, on the other hand, is a contract of
sale of specified goods, the validity of which is
not attached to a condition that the goods must
be manufactured or constructed.”

Companies and corporations may seek to obtain.
1. Housing projects
2. Construction of industrial/commercial building
3. Commercial projects
Under the Istisna’ principle, the bank will enter
into an agreement to purchase from the project/
asset to be developed (Istisna Purchase by
order) at an agreed Purchase Price.

Subsequently, the bank will immediately sell
back the projects / assets (Sale by order), to the
customer at a selling price which will include the
original Purchase Price and the bank’s profit
margin.

The customer is required to settle the selling
price by instalments within the agreed period or
by redemption exercise (if applicable). The
Bank’s Purchase Price is normally released on a
staggered basis i.e. upon the presentation of
valid Architect’s Certificate and/or other
acceptable documentary evidence.
•
The bank may also provide an end-financing
package to the individual purchasers of
housing/commercial building developed by the
customer.
•
With a parallel `istisna, the main istisna’ contract
between the customer and the bank involves
deferred repayments, and subsequently, the
bank enters into a parallel istisna’ with subcontractor(s) for all or part of the project with
cash released during the construction period.
Salam and Istina’ Financing
•
To protect public interest (maslahah al ammah),
has the Islamic commercial law failed to
recognize that not all objects of sale must be
delivered on the spot in a physical form?
•
Certainly, the answer is a no, because both
salam and istisna are exempted from this
requirement.

The permissibility of salam and istisna’ in Islamic
commercial law can make us realize that
prevailing bai-bithaman-ajil contracts has been
applied in a rather crude manner.

Basically, Salam and Istisna are sale contracts
whereby the seller undertakes to supply some
specific goods to the buyer at a future date in
exchange for an advance price fully or partially
paid on the spot.

In other words, the price is paid cash (full or
partial) while the supply of the goods is deferred
to a future date.
•
It seems the bay' bithaman ajil contracts
involving future delivery have violated the
principle of mahallul 'aqdi violated, that " the
subject matter must be in existence at the time
of sale".
•
This is because the contract of al-bay, whether
cash or deferred (bay’ bithaman ajil or bay
'murabahah) assumes that the goods are
delivered on the spot

We see many instances today where in bay'
bithaman ajil transactions, not all goods have
been delivered on the spot.

Apparently, deferred delivery is only allowed in
Salam and Istisna based transactions, but
deferred sale products such as bay’ bithaman ajil
tends to include deferred delivery as one of their
prominent features.

This may not be accurate because in salam and
istisna the main feature is deferred delivery while
in bai-biithaman ajil, it is the deferred payment.

Salam usually involves agricultural products,
while the subject of istisna is always a thing that
needs manufacturing in which more attention is
given to specifications of goods under order.
Workflow of Istina’ Financing
Each party has the option to rescind the contract before it is implementer but
binding once it has been constituted. Once constituted, if the Al-Masnoo does not conform to
specifications, the mustasni has the right to revoke the contract
Payment in:
a) Spot Cash
b) Installment
c) Bullet
Price
a) Known
b) Cannot be increased
Decreased on account
Of increases or decreases
In price of inputs
Al-Sani’
(The ultimate
Seller)
Al-Mustasni’
(The ultimate
Buyer)
Subject matter Al-Masnoo of certa
In specification ( can be manufactured
or obtained
from the market)
1) Kind
2) Type
3) Quality
4) Quantity
Delivery :
a. Fixing delivery date is necessary

In salam, the price is paid in advance while in
Istisna it may be paid in cash or by installment.

This has a lot to do with the nature of agriculture
production when most activities took place in the
planting stage. It is important to release all
capital during this critical stage after which less
capital is required

In contrast, istisna’ production, unlike salam
deals with production in stages all of which
require capital injection

The time of delivery is an essential part of the
sale of salam while it is not necessary in istisna'
that the time of delivery be fixed.

Lastly, the contract of salam, once effected
cannot be cancelled unilaterally, while the
contract of istisna' can be cancelled before the
manufacturer begins work.
•
The contract of istisna' can be more relevant
relative to salam. But salam is also applicable to
manufacturing. It is not accurate to say that
salam is specially made for agriculture.

today, bay' bithaman ajil contract, seem to take
advantage of the twin benefits of deferred
payment sale and deferred delivery but are
unable to allow the customer to exercise his right
to cancel the order.
 Have
a good day 
 May God bless you
 Thank you & Wassalam