Sasana Kijang, Bank Negara Malaysia
th
27 November 2012 | 13 Muharram 1434H
2
nd
“Islamic Finance in a
Challenging Economy:
Moving Forward”
INNOVATION IN ISLAMIC
BANKING: THE PRACTICAL
APPLICATION OF FORWARD IJARAH
AND ITS ISSUES AND CHALLENGES
Khaled Morad Amer
Ninasrin Radenarmad
INNOVATION IN ISLAMIC BANKING : THE PRACTICAL
APPLICATION OF FORWARD IJARAH AND ITS ISSUES AND
CHALLENGES
Khaled Morad Amer 1& Ninasrin Radenarmad2
ABSTRACT
Forward Ijarah (Ijarah Mawsufah Fi Zimmah) is the new innovation of Ijarah contract that
used to finance the usufruct. This contract is considered as one of the popular contract in the
Middle East. It has been applied in the variety of applications in the practice i.e. for the
delayed financing of human services, such as medical treatment, education, ordinary tourism
as well as the performance of Umrah and Haji, accommodation and other auxiliary services,
communications and so on. Moreover, the application of Forward Ijarah has expanded to
include a type of real estate lease for building and developments and also using for issuing
Sukuk. However, recently in Malaysia Forward Ijarah is practiced by a few Islamic Banks
and mainly used for home financing products either as a standalone product on its own or as a
hybrid along with other products, i.e. Musharah Mutanaqisah. This paper therefore aims to
review the concept of Forward Ijarah and its advantages. Specifically this paper highlights
how Forward Ijarah is applied and implemented in the product structuring. Moreover, the
paper will discuss the practical issues and challenges surrounding the implementing of
forward Ijarah by Islamic Banks. The structure of this paper is as follows. In section 1 starts
with the introduction of the paper which describes briefly the performance of Forward Ijarah
contract and its achievements. The concept of Forward Ijarah and its advantages is discussed
in section 2. In section 3 we present the sample of Forward Ijarah products that applied in the
Middle East. In Section 4 represents the practical Application of Forward Ijarah by Islamic
Banks in Malaysia, section 5 analyzes the practical issues and challenges related to the
implementing of the product and section 6 concludes the paper and provides suggestions.
Keywords: Forward Ijarah, Ijarah Mawsufah Fi Zimmah, Islamic Banking Innovation
1
2
Khaled Morad Amer is a Master candidate in Islamic Banking and Finance at IIUM
Ninasrin Radenarmad is a Master candidate in Islamic Economics and Finance at IIUM
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1. INTRODUCTION
It is over 30 years that Islamic Banks have been operated around the world,
particularly in Malaysia, according to the record of Bank Negara Malaysia, there are 17
Islamic banks that operated in this country in 2011. The purpose of Islamic Banking is to
serve their consumer preferences by offering the Shari’ah compliance products such as
Mudharabah, Musharakah, Murabahah and so on.
One of the most popular product nowadays is leasing based product or Ijarah (Tag ElDin and Irwani Abdullah, 2007), there are two different types have been practiced widely in
reality that types of leasing, and its permissibility of any one of them would depend
essentially on whether the terms and conditions of the lease are in conformity with the
Shari'ah principle (Chapra, 1998).
Nowadays Islamic financial institutions in Middle East have started applying Forward
ijarah (al-Ijarah al-Mawsufah fi al’Dhimmah) to finance the usufruct which it can be consider
as the new innovation of Ijarah. The application of this kind of Ijarah is partly different
compared to the application of other types of leases. The idea of Forward Ijarah is the lease
contract where the assets involved does not exist at the time of signing the contract. The
usufruct can only be realized on a future date and thus the rent can be realized in the future
date (Nassar, 2009). The main purpose of Forward Ijarah is to meet the needs of each party in
the transaction that consists of the Islamic bank, the lessor, the lessee and the banking
business in general.
Furthermore, there have been applying forward Ijarah for the delayed financing of
human services, such as medical treatment, education, ordinary tourism as well as the
performance of Umrah and Haji, celebrations, providing plane tickets by themselves or along
with accommodation and other auxiliary services, communications, etc. Now the application
of forward Ijarah has expanded to include a type of real estate lease for building and
developments. Also, there is the adoption of the concept of Forward Ijarah to issue Sukuk in
the practice by combination both Shari’ah compliance contracts which are Istisna and Ijarah.
Recently in Malaysia Forward Ijarah is practiced by a few Islamic Banks and mainly
used for home financing products either as a standalone product on its own or as a hybrid
along with other products, i.e. Musharah Mutanaqisah. As the result, it is an interesting
product that to be discussed, this innovation has a huge advantages to be emphasized,
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however, there are many people which do not know and understand what forward is, and this
type of Ijarah seems not familiar compared with other types. Furthermore, this is one of the
challenges which must be faced and answered by the researcher, to be well known.
This paper therefore aims to review the concept of Forward Ijarah and its advantages.
Specifically this paper highlights how Forward Ijarah is applied and implemented in the
product structuring. Moreover, the paper will discuss the practical issues and challenges
surrounding the implementing of forward Ijarah by Islamic Banks. The structure of this paper
is as follows. In section 1 starts with the introduction of the paper which describes briefly the
performance of Forward Ijarah contract and its achievements. The concept of Forward Ijarah
and its advantages is discussed in section 2. In section 3 we present the sample of Forward
Ijarah products that applied in the Middle East. In Section 4 represents the practical
Application of Forward Ijarah by Islamic Banks in Malaysia, section 5 analyzes the practical
issues and challenges related to the implementing of the product and section 6 concludes the
paper and provides suggestions.
2. THE CONCEPT OF FORWARD IJARAH AND ITS ADVANTAGES
Forward Ijarah ((al-Ijarah al-Mawsufah fi al’Dhimmah) is used to finance the
usufruct which it can be consider as the third type of Ijarah by Islamic Financial institutions
in Middle East. The application of this kind of Ijarah came late as compared to the
application of other types of leases. And the reason why this lease is a sale of benefits or
usufruct came late due to it has become completely settled in people’s mind that a person
must not rent what he does not possess or for which he does not possess the usufruct. This
was base on an analogy with the prohibition of selling what one does not possess. Indeed, this
basic rule is one of the controversial issues that the researcher is going to discuss in this
paper.
The idea of Forward Ijarah is the lease contract where the assets involved does not
exist at the time of signing the contract. The usufruct can only be realized on a future date
and thus the rent can be realized in the future date. However, there are many scholars’
recognized that this Ijarah is the combination of Salam contract and Ijarah contract. But
sometimes they defined this contract as sale of future benefits for immediate cash or,
alternative, a salam contract for benefits (Nassar, 2009). The main purpose of Forward Ijarah
is to meet the needs of each party in the transaction that consists of the Islamic bank, the
lessor, the lessee and the banking business in general.
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Furthermore, Middle East Islamic Financial institution in reality have now begun
applying forward Ijarah for the delayed financing of human services, such as medical
treatment, education, ordinary tourism as well as the performance of Umrah and Haji,
celebrations, providing plane tickets by themselves or along with accommodation and other
auxiliary services, communications, etc.
Now the application of forward Ijarah has expanded to include a type of real estate
lease for building and developments. The way it works is to develop the real estate process a
customer may enter into a contract with a developer so as not to miss an opportunity, and
then the customer will turn to a bank for funding. Then, bank signs a contract by which it
undertakes responsibility to provide a building of agreed specifications for the customer and
another Istisna contract with the developer. As a result, the bank takes full responsibility for
the contractual requirements of the lease. And the solution to this arrangement by means of
forward Ijarah that ends in ownership which means that subject of the contract is not a
specific item and banks uses of it to finance the customer does not lead to the bank financing
a debt owes to the developer. It also turns the relationship between the two of them into a
three-way relationship with which all the parties are able be comfortable. Moreover, there are
adoption the concept of Forward Ijarah to issue Sukuk in the practice by combination both
Shari’ah compliance contracts which are Istisna and Ijarah, thus the researcher is going to
discuss the Sukuk operation in this paper also.
According to the previous discussion, there is one major different in forward Ijarah in
theory and practice. In theory, this contract combines between Salam and Ijarah contract
while practical situation, forward Ijarah is the combination of Istisna’ and Ijarah. This is
because Istisna’ is the exchange contract with both the task and the payment is specified
before delivery to the buyer. In fact, Istina’ assembles with Ijarah due to relating with a
request for work to be done and also both elements are dissolved upon the death of either
party to the contract.
However, The difference between Istisna’ and Ijarah is the essential element of
Istisna’ in the requesting of the work. If the natural task requires that the worker, for example,
changing the material, he would obtain the material since he is more knowledgeable about the
material for that is pursuant to the task, and the job orderer comes to the manufacturer emptyhanded. In Ijarah, the owner of a garment would come to the dyer with his own garment to be
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dyed, so that is a difference between the two. As for the difference between forward Ijarah, in
particular, and Istisna, it lies in the following points
Firstly, it is permissible to pay the worker by instalments in particularized Ijarah and
Istisna’, but that is not allowed for forward Ijarah, since it is salam of usufruct, according to
the most correct opinion, as was previously mentioned.
Secondly, Istisna’ is actually the sale of a commodity, which may be a consumable or
non-consumable, and that is the subject matter of the contract, while Forward Ijarah is
actually a form of rental, and the subject of the contract is a benefit from a commodity that
must be non-consumable. And last but not lease the commodity manufactured in Istisna’ is
the property of the job orderer, and while it is in the custody of the manufacturer he is
responsible for any damage to it. On the other hand, the ownership of the commodity in
forward Ijarah is not transferred to the renter, only the usufruct.
There are several advantage of application of Forward Ijarah in the reality, first this
contract is the alternative contract that is able to reach all prayers’ need in the transaction
includes the Islamic bank, the lessor, the lessee, and the banking business. For example
suppose the lessor is the Islamic Bank, if it is sure of its ability to provide the needed Ijarah
asset and wants a commitment from the potential duration, it is able to enter into a forward
Ijarah contract, then possess the asset and then hand it over in the maturity.
Thus, this contract is stronger than a promise to rent secured from the party who
interested to rent a specific asset, because this promise does not bind the promisor to proceed
with the contract. In case of the customer cannot fulfill the promise, the only response is
compensation for actual damage. And for reaching the need of renter by using the forward
Ijarah contract, it is firstly to confirm the strong possibility of obtaining the expected usufruct
by useful of the strength of a contract better than only mere promise. Next, to ensure the
continuity of the usufruct due to the destruction of asset leased using forward Ijarah cannot
terminate the contract, rather the lessor must provide a substitute in order to permit the renter
the continued utilization of the benefit.
5
Moreover, for the practice of banking, forward Ijarah has allowed banks to finance
activities that is not contradict with Shari’ah principle as an exchange of money for money to
earn a profit .Thus, forward Ijarah is the choice that focus on the usufruct for which the
financing is done and obtained with an upfront payment, while the user of the benefit pays by
a delayed payment, which may even be before the bank possesses the item or subject matter
of the contract.
Due to it is impermissible for Islamic bank finances for making the up-front fees for
the service of desires to the customer, so Islamic bank have only the capability of taking
possession of a stipulated usufruct through forward Ijarah and making an up-front payment to
its actual provider. Then, it can enter into the contract of forward Ijarah with its customer for
a similar service that is parallel to the first contract, without any contractual link between it
and what the bank contracted which is the service provider. This allows it to avoid trading in
debts by selling asset particularly before owned it. The next section will discuss on the
controversial issues about applying this contract in the reality which are the issue of making
contract in Islamic law, the issue of making a payment and so on.
3. THE SAMPLE OF FORWARD IJARAH IN MIDDLE EAST
Middle East Islamic Financial institution have now begun applying Forward Ijarah
for the delayed financing of human services, namely medical treatment, education, ordinary
tourism as well as the performance of Umrah and Haji. (Lakshamanan, 2010). Now, the
application of Forward Ijarah has expanded to include real estate lease for building and
developments.

Forward Ijarah for Real Estate
- A 3 way relationship between customer – bank – developer.
- Customer enters into a contract with the developer.
- Then, customer goes to the financial institution for funding. The bank signs a contract with
2 parties:
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Customer – Financial institution undertakes responsibilities to provide a building of agreed
specification to the customer;
Developer – Financial institutions signs Istisna contract and agreed to deliver the above
subject matter.
Essentially, the financial institutions take full responsibility for the contractual requirement of
the lease.
The way it works is to develop the real estate process a customer may enter into a
contract with a developer so as not to miss an opportunity, and then the customer will turn to
a bank for funding. Then, bank signs a contract by which it undertakes responsibility to
provide a building of agreed specifications for the customer and another Istisna’ contract with
the developer. As a result, the bank takes full responsibility for the contractual requirements
of the lease. And the solution to this arrangement by means of Forward Ijarah that ends in
ownership which means that subject of the contract is not a specific item and banks uses of it
to finance the customer does not lead to the bank financing a debt owes to the developer. It
also turns the relationship between the two of them into a three-way relationship with which
all the parties are able be comfortable.

Forward Ijarah for Sukuk
Zamzam Tower is one of first projects and one of the largest real estate projects in the
region that have been underlined under the Forward Ijarah contract. It is one of the biggest
towers in the project of Abraj Al-Bait, within the endowments of King Abdullaziz , assigned
for serving the Two Holy Mosques – Ajyad Castle. The project is established on a plot
owned by the endowments of King Abdullaziz, assigned to the Two Holy Mosques. The law
of Saudi Arabia does not allow for foreigner to own land or property that is located on the
holy city Makah. This was the main obstacle and challenge facing munsha’t company to start
their project under this law. Hence the foreign investors cannot invest in this project under
the popular transaction on that time which depended on assets-backed. Therefore the
undertaking company of the project started looking for alternative that is in compliant with
shariah law as well as with Saudi Arabia law.
Using forward Ijarah contract was the solution to the issue of ownership to enable the
foreign investor to invest and enjoy the stay at the holy city for all Muslim around the
world.However structuring that sukuk under forward Ijarah was not aneasy job for the issuer,
due to the reason that this contract contains high risk for the lessor.
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Diagram B shows ZamzamSukuk Structure
The Zamzam Tower Sukuk Structure:
STEPS
PROCESS
The Binladin Group signs Ijarah contract with The King Abdul Aziz
1
Waqf on the basis of Build-Operate-Transfer agreement for 28 years.
Under this agreement, the Binladin group will build a shopping complex,
four towers and a hotel.
The Binladin Group appoints Munshaat Real Estate Projects KSC as
2
Special Purpose Vehicles (SPV) to finance the construction and operate
the project and then transfer it to the Waqf at the end of the 28-years lease
period.
3
4
5
6
The Binladin Group signs Forward Ijarah contract with Munshaat Real
Estate Projects KSC to construct the required asset for its customer.
Munshaat Real Estate Projects KSC packages the Forward Ijarah’s
Asset into the Sukuk Unit for issuance to potential investors.
Munshaat Real Estate Projects KSC issues the Sukuk Certificates to
investors at fixed profit rates
Investors subscribe to Sukuk for future benefits
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8
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Sukuk subscription generates required cash proceeds valued USD 390
Millions
Munshaat Real Estate Projects KSC disburses progress payments to
Contractor and Consultants
Contractor delivers completed asset to Munshaat Real Estate Projects
KSC on behalf of the investors on the agreed date
Investors have the right to use the property or sell this right to the third
party.
 Forward Ijarah for Education
Forward ijrah contract as applied in financing educational services does not differ in
its mechanism from how it’s been applied in other financing services. That is, educational
service is obtained by leasing educational seats for an immediate payment. Students who are
in need of such benefits are then financed by leasing to them comparable services for
payment paid in instalments or at some later date. The service provider is requested to allow
the student clients to utilize the aforementioned benefits (Abu Gudah, 2007). It is interesting
to know that forward Ijarah has been applied in previous decades, as was cited by al-Minhaj
in Jawahir al-Uqud in teaching the holy Quran and calligraphy. However, due to complexity
of today’s life, the way forward Ijarah is being used today is different from the way it was
applied in the past (Usmani, 2002).
European Council for Fatwa and Research has mentioned some general rules about
the application of forward Ijarah financing for education services. The financial institution
and education institution (university, institute, center) enter into financing services agreement
under Forward Ijarah contract. In this agreement both parties are required to determine the
educational services through accurate descriptions for the services namely the price and
tenure of the education services (Kahf, 2003).
They also mentioned that financial institution can offer Murabaha sale to student who
study at the financial institution and does not have enough money to pay the tuition fee. The
Murabaha sale is when the financial institution offer to sell the usufruct on a higher price.
9
For the purpose of this paper, it is extracted from Nassar (2009), some important
condition and rules from the legal documentation of a bank on the current practice of forward
Ijarah in education:
1. Financial institution and education institution enter into financing services agreement
under Forward Ijarah contract.
2. Bank begins the first agreement with the applicant (student) by selling education service
based on murabahah sale to the student.
3. The bank becomes obligated to pay the rental fee immediately when the student starts
receiving the education services from the education institution. In the event the bank delays
in paying the rental fee, the university has the right to approach the bank and ask the bank to
settle the payment on time. If the bank refused to pay rental payment as agreed in the
agreement, the education institution have the right to ask for compensation.
4. The bank has the right to use the subject matter in any way they like, i.e. by selling it to
other party. However, the bank cannot make any changes on the subject matter without the
permission of the education institution.in case it’s been offered to other party, In the event of
termination of the usufruct, the education institution could stop providing the services to
student and the student have the right to ask the bank to find any other university who can
offer the same services to student.
4. Finally, the education institution has the right to terminate the contract if the bank does any
of the following:
- The bank does not pay the rental payment that is due; or
- The bank uses incorrect document to conclude the contract.
4. THE PRACTICAL APPLICATION OF FORWARD IJARAH IN MALAYSIA
In Malaysia, Forward Ijarah is practiced by a few Islamic Banks only. There are at least 2
financial institutions that currently offer IMFZ, either as a standalone product on it is own or
as a hybrid along with other products.
1. Forward Ijarah for House Financing – stand alone basis
The abovementioned product is offered for purposes of home financing where the property
financed is not completed yet or under construction. As the usufruct is not available due to
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non-completion of property, the Bank uses the concept of Forward to enable collection of
payment for progressive releases made pending completion of the property.
2. Forward Ijarah for House Financing (Hybrid – combined with Musharakah
Mutanaqisah)
Forward Ijarah Portion
Musharakah Mutanaqisah Portion
 Bank and Customer enters into a
 Customer also commences gradual
Musharakah, say 90 % contribution by
payment to buy over Bank’s portion of
Bank
the Musharakah. As the payment is
and
10%
contribution
by
gradual, the Bank’s portion diminishes
Customer.
 Property is not completed at the point
gradually, hence the contract is called
Musharakah is contracted, and takes
Musharakah
say, 2 years for completion (called
Diminishing Musharakah from the
construction period).
perspective of the Bank
charging
rental
based
or
 Customer’s Musharakah portion, on
 During the construction period, Bank
starts
Mutanaqisah
the other hand, will gradually increase
on
until Customer has fully bought over
progressive disbursements made.
Bank’s portion.
 Rental is on an increasing basis until

the completion of the property at the
At that stage, the Musharakah
end of 2 years in tandem with increase
contract
in disbursements.
terminated and the property fully
 Upon completion, the forward lease
will
be
deemed
as
belongs to the Customer

ceased and replaced by normal lease
There will also not be any more
which quantum is higher than the
Ijarah as the usufruct has been
forward lease as full usufruct is now
transferred in full to the Customer
provided to customer
who holds 100% ownership.
 At this stage, the risk of the forward
lease is fully mitigated as property is
completed, hence there is no risk of
having to refund the forward lease
collected.
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5. THE PRACTICAL ISSUES AND CHALLENGES
5.1 From Shariah Perspectives
It is known that in Islamic law of contract, there are certain elements, pillars and
condition should be existed in the time of contract as a condition to be valid. In forward
Ijarah contract, the existence of subject matter has no place at the time of signing contract
(Nassar, 2009). As well as the payment, according to the opinion of the Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI) in Bahrain referred to
forward Ijarah contracts and the permissibility of delayed payment for them in its Shari’ah
standard No. 9 specifically for Ijarah and Ijarahending in ownership, article 3, points 3 and
5:
 It is not a condition of validity that payment be immediate as long as the contract is not
formulated using the terms salamor salaf. And if the lessor provides the renter with
something that does not meet the specifications stipulated in the contract, the renter may
refuse to accept it and demand that which does meet the specifications (Kamali, 2007).
 From what has been presented it is clear that the issue requires further research and deep
Ijtihad due to its importance in the applications of leasing human services by Islamic
financial institutions. The sound foundation for that will be research into the objectives of the
Shari’ah that relate to this contractual form in particular. Guidance can be taken from that in
real-world practice by considering the financial and economic effects. The only manifest rule
that can rely upon for the time being is that in AAOIFI’s Shari’ah Standards, since the
Islamic Fiqh Academy has not issued a clarification of this issue (Kamali, 2007).
 However, based on Nassar (2009) there are a number of observations that may serve as a
basis that would help in the issuance of a decision on this matter:
1. If considering delay of payment to be permissible in consideration of the contract
wording, which rules will be apply? Are they the rules for the lease of a particular object
or the rules for forward Ijarah? That makes a difference, since the rules differ.
2. If allowing delay of payment, the contract enters into the domain covered by the
prohibition of initiating the sale of a debt for a debt.
3. The apparent meaning of the juristic texts that mention taking into consideration the
contract wording is that they rely upon the wording to indicate the intent of the contracting
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parties, but if that can be apprehended by customary practice, particularly in the case of
modern societies, which rely upon documentation and authentication to clarify
transactions, that would be more helpful in understanding the transaction and the
objectives of the contracting parties. Therefore, this issue will have to be settled by means
of the various Fiqh councils after copious and painstaking research of the topic. And Allah
knows best.
5.2 From Legal Perspectives
5.2.1 Liability of lessor in event of default
If a lessor defaults on his obligations under the lease, the lessee may sue the lessor for
damages. The measure of damages can vary. If a lessor breaches the lease by sending
nonconforming goods, or goods that were not ordered by the lessee, the lessee may reject the
goods, cancel the lease, and sue the lessor to recover any monies already paid and for
damages caused by the shipment of the nonconforming goods. If the lessee defaults on
obligations under the lease, the lessor may cancel the lease, withhold or cancel delivery of the
goods, or lease the goods to another party and recover from the original lessee any difference
between the amount the lessor would have earned under the original lease and the amount the
lessor earns on the new lease.
a)
Lease Rental not reflective of actual market lease value

In Malaysia, the lease rental is determined by Banks based on annuity table where it
has the equivalent of profit and principal portion. The profit portion represents the lease while
the balance represents the principal repayment. For non-banking scenario, lease rentals are
normally benchmarked against prevailing rate of rental of assets of similar nature.

However, when Banks provide Forward Ijarah, the lease rental, either forward lease
or normal lease do not reflect the true prevailing rental rate of the asset. Instead, it is based
on the prevailing cost of funds and market interest rates charged which can be likened to
conventional loans. Hence, the issue of ‘rental’ may not be what is is really intended to be
under Islamic financing.
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b)
Legal Issues

The FORWARD IJARAH is structured in such a manner that a Bank is protected in
the event of default. Despite the asset being sold only at the end of the Ijarah tenor, in the
event of default, the sale from Bank to Customer is accelerated via a ‘Put Option’

A Put Option is a legal obligation of the Customer to purchase the asset in the event
the said Option is put by the Bank to the Customer. If Customer failed to take up the Option,
which means paying the full sum of the amount owing for purchase of the asset, the Bank
will have the right to sue Customer to recover all amounts owing.

The Put Option effectively imply that the Bank is not interested in owning the asset. It
will only own so long as Customer fulfills the rental payment, failing which the Bank will
force the Customer to buy over the asset before maturity of the Ijarah

On the other hand, while the Bank is protected via Put Option, the Bank also takes a
risk in a non payment situation. In order exercise the Put Option, the Bank must first
terminate the Ijarah. All is well and fine if Customer honours the Put Option. However, if
Customer defaults, Bank will have to bear the cost of holding the assets as it cannot accrue
anymore rental from Customer on the basis that the Ijarah has been terminated.
5.2.2 Payment issue
According to the previous discussion, there is one major different in Forward Ijarah in
theory and practice. In theory, this contract combines between Salam and Ijarah contract
while practical situation, Forward Ijarah is the combination of Istisna’ and Ijarah. This is
because Istisna’ is the exchange contract with both the task and the payment is specified
before delivery to the buyer. In fact, Istina’ assembles with Ijarahdue to relating with a
request for work to be done and alsoboth elements are dissolved upon the death of either
party to the contract (Abu Guddah, 2009).
6. CONCLUSION
The growing popularity of Ijarah for purposes of Home Financing is due to the nature
of Ijarah which is leasing in nature, whereby a Bank can vary the leasing price at it is
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discretion. The same is not possible under Sale-based contracts as the Selling Price is fixed
upfront and cannot be changed until expiry of the contract. With such fixed Selling Price for
a long term contract such as Home Financing, a Bank essentially has to take long term risk of
fixed rate, which may pose problem in terms of matching short term funding against long
term asset. Funding is normally on short term basis as it is difficult for a Bank to project
funding position beyond 1 to 3 years. For any longer period than 3 years, Bank will have to
impose significant price premium which then makes the product expensive as compared to
conventional product which can change it is pricing at any juncture. With Forward Ijarah, a
Bank will have the flexibility of Ijarah variable payment where it can change the lease rental
as and when it’s funding position changes, hence removing asset-liability mismatch.
However, the forward lease feature of Forward Ijarah may pose risk to a Bank where
the Bank is leasing an asset which is under construction, hence not in existence yet. If the
asset is not made available to the Lessee for any reason whatsoever on the promised date,
then the Bank will have to refund all sums collected during the forward lease period due to its
failure to avail the asset. Effectively, since usufruct failed to the given but rental has been
collected, such rental has to be refunded. Given the high risk Forward Ijarah, a Bank is
normally very selective in offering the product. In the case of properties under construction
using Forward Ijarah, a Bank will choose Developers that have established track records
only. This is so as to minimize non-completion risk. In other words, Forward Ijarah will only
be offered where the probability of non-delivery of the asset with is minimal.
Based on our analysis above, Forward Ijarah has its merits and demerits. However, at
this juncture, it is the closest alternative to compete and match with Conventional, especially
in terms of the ability to vary the leasing payments. This is not to say that other Islamic
contracts are less useful or less applicable. In fact, the various sale based, partnership and
agency contracts in Islam have their distinct superiority. However, given that the world
economy has been dominated by Conventional for thousands of years, Islamic Finance may
have no choice but to promote Islamic alternatives that can compare to Conventional on a
more like to like manner, especially in the area of risks to be undertaken. Ijarah or Forward
Ijarah maybe the solution for the present day. This is to avoid other Islamic contracts from
being packaged in a conventional manner just to appease the market, as in the case of
BaiBithamanAjil or BaiInah, which have many controversial issues, yet are still being offered
in the market in order to be competitive with Conventional.
15
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