IB1005
DEPOSITS AND FINANCING PRACTICES OF
ISLAMIC FINANCIAL INSTITUTIONS CHAPTER
7 : AL-IJARAH THUMMA AL- BAY (AITAB)
VEHICLE/CAR 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 7: Financing –
Al-Ijarah Thumma Al-Bay (AITAB)
Vehicle/Car Financing

Islamic jurists (fuqaha) today have introduced
hire-purchase based on Shariah principles known
as al-ijarah thumma al-bay’ (AITAB), which
means leasing (al-ijarah) ending with sale (albay’). It also means that AITAB is a contract of
lease with an option to purchase the asset.
•
In fiqh, al-ijarah means “to give something on
rent”. Literally, al-ijarah or al-ajr means
substitute, compensation, recompense,
indemnity, consideration, return or countervalue. Al-ijarah has two types of usufruct
(manfa’at):1. Usufruct of property or capital assets
(manfa’at al-‘ayn); and
2. Usufruct of labor, employment and service
(manfa’at al-‘amal)
•
In al-ijarah of services, the employer is called
musta’jir and the employee ‘ajir. The contract
between the two parties involves the
employment of the services of the ‘ajir based on
an agreed pre-fixed wage or salary (‘ujrah) given
to him as reward for the services rendered in the
transaction.
•
In AITAB the contract of ijarah ‘ain is applied.The
lessor is called mu’jir while the lessee or hirer is
known as musta’jir and the rent payable to the
lessor is called ‘ujrah.

In al-ijarah, the lessee has only the right to use
the property but not the ownership of property.
Some basic rules of al-ijarah are as follows:
Al-ijarah is valid only with consent of both parties to
the contract. That is, to avoid gharar, the contracted
usufruct or manfaat has to be absolutely ascertained.

The usufruct must be lawful and must have a valuable
use.

All liabilities arising from ownership shall be borne by
the lessor who owns the rental property.

The rent, period and the purpose of the lease must be
clearly specified.
OPERATING LEASE
(Modus Operandi) - Step 1
Purchase Agreement
Financier
Supplier
Purchase Price
Asset
STEP 1
OPERATING LEASE
(Modus Operandi) - Step 2
Lease Agreement
Financier
Customer
Rental Payment
Asset
STEP 2
AL-IJARAH THUMAA AL-BAY
(AITAB)
•
In theory, the contract of Al-ijarah Thumma alBay’ shall consist of two different contracts,
namely:1. The contract of lease (al-ijarah ‘ain)
2. The contract of sale (al-bay’).
•
Al-ijarah and al-bay’ are both categorised under
the contract of exchange (‘uqud al-mubadalah).
The former relates to the exchange of usufruct
for money while the latter involves the exchange
of goods for money.
•
In AITAB, the contract of al-ijarah runs
separately from the contract of al-bay’. In AITAB,
the contract of al-ijarah runs separately from the
contract of al-bay’. These stages are:Stage 1: Executing the contract of true leasing
(al-ijarah ‘ain)
Stage 2: Executing the contract of sale (al-bay’)
at a nominal value agreed upon by both parties.
•
AITAB is a contract of leasing with a promise to
sell the asset.
•
The AITAB product under the purview of HP ACT
1967 is also required to observe the interestbearing mechanism.
•
Since AITAB has to operate within the Hire
Purchase Act, it is necessary to understand some
features of the Act.

However, it must be noted that the Hire Purchase
Act 1967 remains a law governing an interestbearing term loan granted by a bank to the
borrower.

In this way, AITAB assumes identical structure as
do conventional hire-purchase.
• The bank as a lessor holds the right to sell the
asset if the lessee defaulted on payments.
• But ironically, the bank as an owner does not
seem to fulfill its obligation as an owner of
property since it is the customers who are made
to maintain the property and pay tax and
insurance obligations.
•
By right…it requires the bank as lessor to
maintain the rental asset and fulfills other
obligations as any car owner is supposed to do.

In this manner, the bank must pay for insurance
and road tax as well as car maintenance

This is done to observe the true leasing.

Customer cannot be forced to pay the remaining
balance if he fails to pay rentals.

He can inform the bank his intention to terminate
the contract and not liable to return the lessor
any sum of money.

This is done to conform to the concept of true
leasing.
•
AITAB offers the customer a full-financing
scheme. He does not have to put up a down
payment as practiced by current AITAB under HP
Act 1967.
•
Car maintenance rests on the bank as lessor.
However, if the engine broke down due to
negligence of customer, he shall be liable for the
repair expenses.
•
Rental under true AITAB will be much higher
than that under current AITAB model. The rental
shall include cost of rental assets and cost of
maintenance as mentioned above.
•
Prospective customers will be glad to use the
true AITAB model. Although the rental is a lot
higher, customers will be less burdened with
payments that lessor should be paying in first
place.

In the HP agreement, the bank claims to be a
prospective owner. But why has it been able to
transfer the obligation of maintenance to the
customers while securing the legal rights of
repossession and disposal?

AITAB Car Financing, and indeed AITAB
generally, includes a clause to apply the
provisions of the Hire Purchase Act 1967 that
does not contradict Shari'ah.

Under AITAB (disallowed by AAOIFI), a minimal
late payment fee of 1.00% p.a. of the installment
due may be imposed whereas a Conventional HP
will charge a fee of 8.00% p.a. AAOIFI Shari’a
Standard No.3, item 2/1 (b), p.32/

AITAB lease payments are calculated on the
basis of the Rule of 78/Sum of Digits calculation
The following characteristics are a feature of
AITAB;

Asset ownership as legal title remains with the lessee.

Economic risk – no market risk or capital depreciation risk.

repayments are determined according to the rule of 78,
and the profit rate is pegged to the interest rate.

Major maintenance & repair is assumed by the lessee, but
operational risk remains with the lessee not the lessor.
AITAB (Modus Operandi)
Step 1
Purchase Agreement
Financier
Supplier
Purchase Price
Asset
STEP 1
AITAB (Modus Operandi)
Step 2
Lease Agreement /
Schedule HPA 1967
2nd
Financier
Customer
Rental Payment
Asset
STEP 2
AITAB (Modus Operandi)
Step 3
Sale Agreement
Financier
Customer
Sale Price
Asset
STEP 3

Some jurists have observed that an Islamic lease
is a pure operating lease with operating costs for
the account of the lessor, but this is not the case
with AITAB, which would make it a financial
lease.
Rule 78
•
Under the Rule of 78, profit is calculated for the
life of the financing and then allocated to each
month by proportion using reverse sum of the
digits methodology. You start by adding up the
numbers of months for the note. For example, in
a 12 month financing, counting month 1, plus
month 2, and so forth through month 12 is: 78

An example: 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9
+ 10 + 11 + 12

This totals 78, and hence the name, rule of 78.
For an example:
• Let's look at the example of a $90,000 financing
at 5% profit rate for 1 year. Under the Rule of
78, we first add up the 12 months:1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11
+ 12 = 78

Finally, we divide the profit total by the sum of
the digits (78) and apply in reverse proportion.
•
The profit rate for 1 year RM 90,000x 5% = RM
4,500

The monthly installment is (RM 90,000+ RM
4500) /12 = RM7,875.00
The monthly profit being charged is as follows:





Month # 1: RM 4,500 x (12/78) = RM 720
Month # 2: RM 4,500 x (11/78) = RM 675
Month # 3: RM 4,500 x (10/78) = RM 585
Month # 4: RM 4,500 x (9/78) = RM 540
........ and so on until 12st month
Month #12: RM4,500 x (1/78) = RM 90

AAOIFI has summarized the legitimacy of ijarah
as derived from al-Quran, “said one of them ‘Oh
my father, engage him on wages” and “if you
had wished, surely you could have taken wages
for it”; Shari’a Standards (2004-2005), Shari’a
Standard No.9, Appendix (B), p.151
- Al-Quran 28:26
- Al-Quran 18:77

Whilst it might be argued that istisna is a form of
ijarah, the distinction made by AAOIFI is simply
that “the subject of a lease is its usufruct and not
the asset itself.”

Istisna would be used to construct a bicycle, and
ijarah would be used to hire the bike, but not the
wheels of the bike.
•
The Majallah defines ijarah as “hire to be paid for
a thing, i.e. the price for the benefit.”

the Majallah also defines it more closely as “the
sale (bai’) of a known benefit in return for its
known equivalent.”

And in the case of termination, if the lessee
defaults in punctual payments, foreclosure and
recovery of rentals from the security might seem
to be no different to the risks associated with
secured lending.
- Shari’a Standards (2004-2005), Shari’a
Standard No.9, Art.7, item 7/2/2, p.145
- Shari’a Standards (2004-2005), Shari’a
Standard No.9, Art.6, item 6/5, p.144
 Have
a good day 
 May God bless you
 Thank you & Wassalam