Salam for import operations: mitigating commodity macro risk

Purpose This paper aims to present the idea of using classic Islamic finance instrument Salam to conduct import transactions. It documents the complete framework of the proposed model. At present, this mode is not used by Islamic Financial Services Industry although it is capable of becoming a viable risk-sharing instrument. Design/methodology/approach First, the features of existing import financing products are explored and compared with various contractual features of Salam . Second, a discussion on why banks are reluctant in practicing Salam is included. Third, the pricing techniques, accounting treatment and collateral arrangements related to proposed product are discussed. Finally, the feasibility of this product in present industry environment is assessed. Findings The proposed model carries certain features that make it a true risk-sharing product. For example, it suggests changing bank’s role from intermediary to entrepreneur and favours better alignment of risk between the related parties. This work has also proposed using market-based returns, instead of the existing interest-based benchmarks, for pricing the contract. To practice this product, a dedicated effort of all the stakeholders is required. The product features can contribute to the goal of practicing responsible financing, engrained in true economic reality. Research limitations/implications The present work is a technical paper, and the product features may be improved in the light of feedback from the industry and academia. Practical implications The proposed model views Islamic bank as a trader instead of a lender, who will assume the effective ownership of imported goods before selling them to the customers. The pricing structure will also be unique, as the margins will be decided upon the basis of market-driven returns of the underlying assets. Indeed, by entering into such contract, Islamic Banks will be exposed to market-related risks. They will be required to design their risk management frameworks accordingly. Originality/value It is widely argued that many Islamic finance products are similar to their conventional counterparts in substance. There is a need for the instruments that carry risk sharing attributes. This paper aims to bridge this gap by investigating the potential of classical Islamic finance product Salam for conducting foreign trade transactions.