Understanding Islamic Finance - Doha Academy of Tertiary Studies

258 Understanding Islamic Finance10.10.1 Risks in Salam and their ManagementIn Salam, Islamic banks may face the following risks:• counterparty risk;• commodity price risk;• delivery risk/settlement risk;• quality risk/low investment return or loss;• asset holding risk/possibility of extra expenses on storage and Takaful;• asset replacement risk (in case the bank has to buy from the market);• fiduciary risk in case of Parallel Salam (the original Salam seller might not properlyperform with regard to delivery).Box 10.3:Possible Risk Mitigation in SalamRisks1. Counterparty and delivery risk• Since the price of Salam goods is givenin advance, the customer may defaultafter accepting the payment.• In the case of different goods andconsignments, there could be disputesregarding price, quantity and quality.• Defective goods could be supplied.• Goods may be delivered late.2. Commodity – price risk• Since the nature of a Salam contract isthe forward purchase of goods, the priceof the commodity may be lower than themarket price or the price that wasoriginally expected/considered to be inthe market at the time of deliver.3. Commodity – marketing risk• The bank might not be able to market thegoods timely, resulting in possible assetloss and locking of funds in goods.Management• The bank can liquidate the securityand can purchase the same goodsfrom the market.• In the Salam MoU, time, quality,quantity and the time of eachcommodity must be given.• Collateral/security and performancebonds can be taken to mitigate theloss.• A penalty clause can be embeddedin the contract as a deterrentagainst late delivery. The penaltyamount would go to charity.• The bank can undertake ParallelSalam and can also take a “promiseto purchase” from a third party.• The bank should purchase onlythose goods which have goodmarketing potential and takebinding promises from prospectivebuyers along with a sufficientamount of Hamish Jiddiyah.