Ijarah
Table of Contents
CHAPTER # 1
INTRODUCTION TO THE TOPIC ......................................................................................................... 4
IJARAH ...................................................................................................................................................... 5
TYPES OF IJARAH ..................................................................................................................................... 5
IJARAH IN QURAN AND SUNNAH .............................................................................................................. 6
IJARAH UNDER FOUR SCHOOLS ............................................................................................................... 7
CHAPTER # 2
IJARAH AS A MODE OF FINANCING ................................................................................................. 8
IJARAH FOR ISLAMIC FINANCE SOLUTION ............................................................................................. 9
PROCESS OF IJARAH ................................................................................................................................. 9
FINANCING MIX OF ISLAMIC BANKS ...................................................................................................... 10
CHAPTER # 3
IJARAH AS A MODE OF FINANCING ............................................................................................... 11
IJARAH BONDS ....................................................................................................................................... 12
IJARAH SUKUK ...................................................................................................................................... 12
IJARAH SUKUK STRRUCTURE ............................................................................................................. 12
SECURITIZATION OF IJARAH .............................................................................................................. 13
CHAPTER # 4
DISCUSSION AND ANALYSIS ............................................................................................................. 15
SALE AND LEASE BACK ................................................................................................................................... 16
LIABILITY FOR LOSS ........................................................................................................................................ 16
RULES OF IJARAH ............................................................................................................................................. 17
REVOCATION OF IJARAH ............................................................................................................................... 18
IJARAH FINANCING CALCULATION ........................................................................................................... 19
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CHAPTER # 5
CONCLUSION & RECOMMENDATION............................................................................................ 20
ECONOMIC BENEFITS OF ISLAMIC LEASING .......................................................................................... 21
CONCLUSION ...................................................................................................................................................... 22
RECOMMENDATION ........................................................................................................................................ 22
ISLAMIC FINANCIAL GLOSSARY .................................................................................................... 23
REFERENCES .......................................................................................................................................... 25
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ABSTRACT
This report is presented in two parts and several sections. The first part provides a fairly
detailed examination of the fiqh rules pertaining to the contract of Ijarah. It begins with the
definition of Ijarah and reviews the leading schools of Islamic law on the basic conditions
and requirements of this contract. This is followed by a review of the two varieties of
Ijarah known to the market, namely operational lease, and financial lease. The discussion
proceeds with a review of contractual options (khiyarat) and their relevance to Ijarah,
liability for loss and insertion of penalty clauses in the Ijarah, and then the fiqh rules
pertaining to the termination of this contract.
The second part deals with the sukuk (bonds) in general and the Islamic bonds in
particular. It also discusses potential benefits of Islamic bonds and their effects on
economic development and examines experts' opinions on issues of concern to Islamic
bonds that have drawn the attention of commentators. A brief review of some recent
issuances of Islamic bonds is followed by a discussion of hybrid assets in the sukuk.
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CHAPTER # 1
INTRODUCTION TO THE TOPIC
Learning Objectives:
1.
2.
3.
4.
What is Ijarah?
Types of Ijarah
Concept of Ijarah in Quran & Sunnah
Ijarah under four Schools
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IJARAH
Ijarah derives from the root word ajara “to recompense, compensate or give
consideration and return”. Ajr refers to a worker’s wage, and ujrah to rental payment. In
its juristic usage, Ijarah primarily refers to both a rental as well as a hire contract that
engages the services of persons. In its current usage Ijarah also occurs in two types, namely
operational lease and financial lease, the latter is known as Ijarah wa iqtina‘.
The word Ijarah refers to a transaction that involves giving something on a rental basis. It
can denote the paying of wages to employees (Ijarah Amal) as well as the renting of an
asset (Ijarah Ain). In the Ijarah Aina contract, there is no option for the lessee to acquire
the asset at the end of the lease. However, there is another type of Ijarah contract, referred
to as Al-Ijarah Thumma Al-Bai (AITAB), wherein the lessee can acquire the asset at the
end of the lease.
In Ijarah Aina (hereafter, Ijarah), the lessor rents the assets to benefit from their use
without having ownership transferred to the lessor. The legal term for this arrangement in
English is “usufruct” and the price for this use is referred to as “rent.” There is no element
of interest in the transaction, since ownership of the asset always remains with the lessor,
and there is no option for the lessee to gain title to the asset.
Since title (ownership) to the asset is not being transferred, there is no sale of a tangible
asset, only the sale of an intangible asset, namely the right to its use for a specific period of
time. This right to use or usufruct is known as manfa’a in Arabic. Unlike the conventional
lease, an Ijarah is a “contract” whereby a financial institution, using Islamic principles,
purchases and then leases the asset required by the client in exchange for a rental fee that is
not related to interest. Under the contract, the lessor owns the property and may have the
right to renegotiate the lease payments at various intervals agreed to in advance in the
contract with the lessee, thereby ensuring that the rental payments are equal to the residual
balance value of the asset as well as the opportunity cost of the lessor, that is, his forgoing
the use of the assets. The risks of ownership of the asset stay with the lessor.
In this structure, Ijarah’s legal characteristics are similar to those of a sale-and-purchase
transaction, with the exception that the physical asset is not transferred and there is a
specific time limit on the use of the asset. It should be noted that the source of funds used
by the financial institution to finance Ijarah transactions must be halal. Ijarah can be
contracted on an asset that is yet to be constructed or manufactured, as long as it is fully
described in the contract, provided that the lessor should normally be able to acquire,
construct, manufacture, or buy the asset being leased by the time set for its delivery to the
lessee.
TYPES OF IJARAH
Islamic financial institutions use the lease for the usufruct as an instrument of financing.
They purchase the assets and rent them out to customers in return for rental. They use two
models, namely
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1. Finance lease
2. Operating lease
A finance lease is mostly used to raise long term capital to pay for assets. It enables the
lessor to earn reasonable profit along with full recovery of the cost of the asset. The
corporations uses this mode of Ijarah to acquire high cost assets such as heavy machinery,
production plants etc without investing large amount of funds. The ownership of the
asset is retain with the lessor but hand over the rewards and benefits associated with
the asset to the lessee on certain consideration.
Finance lease basically allows business to used as asset over a fixed time period on regular
installments i.e. rent, The bank purchases the asset on behalf of customer, and after all the
payments have been made the ownership of asset is transfer to the lessee. The rent is fixed
and it is not dependant on the benefits and performance of the asset. The lessor usually
does not provide any service relating to the usage of the asset but responsible for
insurance, registration etc. The finance lease is non cancelable and the lessee cannot return
the asset to the bank in normal circumstance.
On the other hand, operational lease is similar to financial lease but its short term that’s
the reason, it is also called as a “non-full payout” leases, because the amount of the rental
does not cover the lessor full cost of asset and the period of lease is always less than the
useful life of the asset. The rate of return in operating lease is dependent on the asset
performance and benefits associated with it so it is not confirmed and there is probability
and uncertainty in it. The lessor may also provide the services related to asset maintenance
or operations. During the whole useful life of asset, it remains in the ownership of the
lessor who can re-lease it every time after the lease period end. The lessor also carries the
risk of, recession, obsolescence or diminishing demand. So the main difference in between
the finance lease and the operational lease is that in operational lease the lessee does not
have the option to purchase the asset.
IJARAH IN QURAN AND SUNNAH
Ijarah is validated by the Qur’an, Sunnah, and general consensus (ijma‘a). Several verses
are found in the Qur’an (al-Kahf,77:al-Qasas, 26: al-Talaq, 65-6) on the worker’s
entitlement to a wage where references are also made to the practices of previous
Prophets on Ijarah, thus indicating that Ijarah represents an instance of continuity in the
Qur’an of the laws of previous nations. References also occur in hadith to Ijarah and the
employer-employee relations, including, for example, the instruction, in symbolic terms, to
the employer to “pay the employee his wages before the sweat of his brow dries up”.
Whereas the Qur’an and Sunnah only refer to Ijarah as an employment contract, the
companions of the Prophet practiced Ijarah, in the sense of employment as well as rental of
real property. The validity of Ijarah is thus upheld by conclusive ijma‘a of the companions,
as well as general custom (‘urf) among Muslims that prevails to this day.
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IJARAH UNDER THE FOUR SCHOOLS
Ijarah comes from the root word ajr, which means compensation and, at the same time,
means the sale of usufruct.
Hanafi School: Ijarah is defined as a contract that enables possession of a particular
intended usufruct of the leased asset (ayn) for a consideration. Some jurists have stipulated
that the usufruct from the leased asset should be intended, while others explained that what
is meant by it are considered intentions in light of Shariah and reasoning, and not merely
intentions.
Maliki School: The Maliki School of fiqh defines Ijarah as a contract that relates to
permissible usufructs for a particular period and a particular consideration not arising from
usufruct.
Shafie School: The Shafie School of fiqh defines Ijarah as a contract for a defined
intended usufruct liable to utilization and accessibility for a particular recompense.
Hanbali School: The Hanbali School of fiqh defines Ijarah as a contract for a particular
permissible usufruct that is taken gradually for a particular period and a particular
consideration.
Although there are various definitions of Ijarah given by the scholars of Islamic
jurisprudence via their various schools of thought, it is agreed among them that Ijarah is a
contract on the use of benefits or services in return for compensation. The definition of
Ijarah according to AAOIFI is “the ownership of the right to the benefit of using an
asset in return for consideration”. While in Financial Reporting Standard 117 (“FRS
117”), a lease is “an agreement whereby the lessor conveys to the lessee in return for a
payment or series of payments the right to use an asset for an agreed period of time”.
In summarizing all the definitions, Ijarah may be regarded as a leasing of property pursuant
to a contract under which a specified permissible benefit in the form of a usufruct is
obtained for a specified period in return for a specified permissible consideration.
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CHAPTER # 2
IJARAH AS A MODE OF FINANCING
Learning Objectives
1. Ijarah for Islamic Finance Solution
2. What is the process of Ijarah?
3. Financing mix of Islamic banks
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IJARAH FOR ISLAMIC FINANCE SOLUTION
The arrangement of finance to purchase asset is the major issue for businesses. Leasing
allows businesses to acquire asset without investing the total cost in onetime payment and
spread the cost of asset over the time period and it also helps the business to meet its
current finance requirements. Leasing allows a logical way to separate ownership and the
use of asset. It means to acquire the use of asset over a fixed period on rent. The amount of
the rent can be re-bargain after some interval between the bank and client. In Islamic
finance Ijarah is a very popular shariah way to asset finance without involving interest. It
enables the customer to use durable inconsumable goods, equipment and heavy machinery
e.g. Aircrafts, ships, heavy machinery and production plants without directly purchasing
them. The bank itself is not interested in the asset so if option is added in the Ijarah
contract then the lessee correspondingly gets the ownership of the asset at the end of the
period which makes simple Ijarah to Ijarah wa iqtina. Ijarah is also favored because of its
tax advantage as the amount of rental is offset against firm tax rate by the lessee. As the
client renting the equipment is not the owner so it’s also not included in Zakat.
The decision of Islamic banks to provide Ijarah financing depends upon the amount of cash
flows from the leased asset and the financial position of the customer but without interest.
The bank can directly purchase the asset itself or may appoint client as agent to purchase
the asset on behalf of bank. As long as the client is agent all the risk associated with the
asset is of bank that’s the difference between Ijarah and conventional lease. As soon the
agent gets the delivery of the asset, he becomes lessee. The rental is due from the time of
delivery of the asset in full working condition whether the lessee start using it or not. The
amount of rent can be re-priced by the Islamic banks to ensure that return on Ijarah
financing is profitable and competitive to the prevailing market.
PROCESS OF IJARAH
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The client” Lessee” contact the bank “Lessor” with the request for Ijarah leasing and
enters into a promise for lease contract. It includes the offer and acceptance by the
client.
The bank buys the asset required for Ijarah and gets title of ownership from the
manufacturer.
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The bank makes payment to the manufacturer.
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The Bank leases the asset to the customer after execution of lease agreement.
The customer makes periodic payments as per the contract.
At the end of the tenure customer can purchase the asset from the bank with the help of
separate Sale agreement.
FINANCING MIX OF ISLAMIC BANKS
Islamic principles stipulate certain conditions that need to be adhered to while developing
Islamic banking products. Having left with no choice due to the absence of attractive
investment avenues, Islamic banking products mainly rely on asset based financing to
generate returns for their depositors. Although no less Shariah‐compliant, these fixed rate
trade based products draw criticism from certain quarters of the economy due to their
apparent resemblance with conventional, interest bearing counterparts, usually in terms of
returns only.
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CHAPTER # 3
IJARAH BONDS
Learning Objectives



What are Ijarah bonds?
What is Ijarah Sukuk?
How to securitize bonds?
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IJARAH BONDS
Ijarah sukuk or bonds are the securities that shows the ownership of clearly specified
existed and known asset that is link up to a lease contract, rent of which is the return that is
distributed among sukuk holders.
Ijarah bonds depict the leased asset without actually relating the bond holders with the
corporation. For example, an air craft on Ijarah leased can be delineated in bonds and these
bonds are owned by thousands of people as bond holder, reach of them is individual and is
not associated with each other. In simple words they all are the owner of the air craft and
they are entitled to receive regular income which does not have any risk like in common
stocks, because the rent is fixed and predetermined.
However Ijarah bonds are exposed to the risk from the general market conditions, real sate
rates, ability of the lessee to pay rentals, insurance cost etc. This means that the expected
returns on some form of Ijarah bonds are not able pay pre determined & fixed rentals but
most of the time the rentals are predetermined and is fixed or floating depending upon the
contract of Ijarah. Ijarah Sukuk is completely transferable and can be traded in the
secondary markets like common stocks and conventional bonds.
IJARAH SUKUK
Ijarah sukuk are the securities representing ownership of well defined existing and known
assets tied up to a lease contract, rental of which is the return payable to sukuk holders.
Payment of Ijarah rentals can be unrelated to the period of taking usufruct by the lessee. It
can be made before beginning of the lease period, during the period or after the period as
the parties may mutually decide. This flexibility can be used to evolve different forms of
contract and sukuk that may serve different purposes of issuers and the holders.
IJARAH SUKUK STRUCTURE
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1. The borrower buys the asset from the seller and sells it to the special purpose vehicle
(SPV). Alternatively, SPV buys the asset directly from the seller according to the needs of
the borrower.
2. To pay for the acquisition, the SPV issues sukuk to sukuk holders.
3. a. Sukuk holders pay sukuk proceeds to the SPV.
b. The SPV distributes the proceeds received from sukuk holders to the borrower to pay for
the asset acquisition. If the SPV buys the asset from the seller, the proceeds are used to pay
the purchase payment to the asset seller.
4. The SPV leases back the asset to the borrower (the lessee).
5. a. As return on the lease transaction, the lessee pays regular lease payments to the SPV.
b. The SPV distributes the lease payment to sukuk holders as the periodic distribution
amount; this amount is equal to the lease payment received from the borrower or the
lessee.
6. At the maturity of the sukuk, the borrower repurchases the asset from the SPV.
7. a. The borrower pays the repurchase price to the SPV.
b. The SPV distributes the repurchase price received from the borrower to sukuk holders as
a dissolution distribution amount.
SECURITIZATION OF BONDS
The arrangement of Ijarah has a good potential of securitization which may help create a
secondary market for the financiers on the basis of Ijarah. Since the lessor in Ijarah owns
the leased assets, he can sell the asset, in whole or in part, to a third party who may
purchase it and may replace the seller in the rights and obligations of the lessor with regard
to the purchased part of the asset.
Therefore, if the lessor, after entering into Ijarah, wishes to recover his cost of purchase of
the asset with a profit thereon, he can sell the leased asset wholly or partly either to one
party or to a number of individuals. In the latter case, the purchase of a proportion of the
asset by each individual may be evidenced by a certificate which may be called 'Ijarah
certificate'. This certificate will represent the holder's proportionate ownership in the leased
asset and he will assume the rights and obligations of the owner/lessor to that extent. Since
the asset is already leased to the lessee, lease will continue with the new owners, each one
of the holders of this certificate will have the right to enjoy a part of the rent according to
his proportion of ownership in the asset. Similarly he will also assume the obligations of
the lessor to the extent of his ownership. Therefore, in the case of total destruction of the
asset, he will suffer the loss to the extent of his ownership. These certificates, being an
evidence of proportionate ownership in a tangible asset, can be negotiated and traded in
freely in the market and can serve as an instrument easily convertible into cash. Thus they
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may help in solving the problems of liquidity management faced by the Islamic banks and
financial institutions.
It should be remembered, however, that the certificate must represent ownership of an
undivided part of the asset with all its rights and obligations. Misunderstanding this basic
concept, some quarters tried to issue Ijarah certificates representing the holder's right to
claim certain amount of the rental only without assigning to him any kind of ownership in
the asset. It means that the holder of such a certificate has no relation with the leased asset
at all. His only right is to share the rentals received from the lessee. This type of
securitization is not allowed in Shariah. As explained earlier in this chapter, the rent after
being due is a debt payable by the lessee. The debt or any security representing debt only is
not a negotiable instrument in Shariah, because trading in such an instrument amounts to
trade in money or in monetary obligation which is not allowed, except on the basis of
equality, and if the equality of value is observed while trading in such instruments, the very
purpose of securitization is defeated. Therefore, this type of Ijarah certificates cannot serve
the purpose of creating a secondary market. It is, therefore, necessary that the Ijarah
certificates are designed to represent real ownership of the leased assets, and not only a
right to receive rent.
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CHAPTER # 4
DISCUSSION AND ANALYSIS
Learning Objectives
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Sales and lease back
Liability for Loss
Rules of Ijarah
Revocation of Ijarah
Ijarah financing calculation
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SALE AND LEASE BACK
When the client sells the asset to the bank the entire risk and rewards are transferred to the
bank who is then is responsible for the ownership related expenses.
In this case the bank is allowed to lease the asset to the client but there are conditions
which have to be followed to make the entire transaction Shariah compliant.
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There should be at least one year lease period
There should be separate contracts for sale and lease
The agreement to sell at the end of the lease must be separate
The intention of the client is to avoid interest related transactions
LIABILITY FOR LOSS
Since the lessor, in a financial lease, bears ownership responsibilities, in the event the asset
is destroyed during the lease period, he alone stands to suffer the loss. Similarly if the
leased asset loses its utility and function without the lessee’s fault or negligence, the
lessor's entitlement to rent discontinues. This may also be said to be one of the differences
between Ijarah and conventional leasing, as the latter entitles the lessor to receive rent even
if the lessee could not obtain any benefit from the leased asset.
Long term leases with fixed rent may be liable to market fluctuations of rent and inflation
which may present loss-incurring factors for the lessor. To prevent excessive uncertainty in
this regard, the lessor may insert a condition in the lease that the rent may be reviewed or
made renewable on new terms at specified intervals. This would be tantamount to what is
now known as floating Ijarah, as opposed to fixed rate Ijarah.
If the lessee contravenes any of the terms of the agreement, he may be held liable for
compensation of the loss caused, but he cannot be compelled to pay the rent of the
remaining period. The lease asset normally reverts to the lessor when the lease is
terminated. Should there be no contravention on the part of the lessee, the lease cannot be
terminated without mutual consent. Hence any stipulation which gives the lessor
unrestricted power to terminate the lease would be contrary to Shariah. Similarly, any
clause which obligates the lessee to payment of rent for the remaining of the lease period
would be ultra vires the Shariah.
If the leased asset has totally lost its utility and function, accidentally destroyed, or its
usufruct value substantially reduced and no restoration or repair is feasible, the lease
terminates as of the day of the loss of its utility. However, in modern practice, the leased
assets are usually insured against such contingencies, in which case, it may be unnecessary
to insert additional stipulations in the lease contract.
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The lessee's control over the leased article is in the nature of a trust (amanah) which means
he is not liable for loss and damage that occurs through normal use of the leased object.
But he is liable to pay compensation when he violates the terms of the trust and uses the
leased article contrary to what is normal and customary, or when proved deliberately
negligent and abusive.
Financial lease agreements often stipulate a penalty if the lessee defaults on payment.
Uthmani observed that a penalty of this kind is not valid in an Islamic lease. The reason
given is that the rent after it becomes due is a debt payable by the lessee and a monetary
charge on it is tantamount to riba. A stipulation may, however, be inserted in the Ijarah
agreement making late payment by the lessee over a period of time liable to a certain
amount of charity. This may provide a deterrent to late payment even though it does not
compensate the lessor for his opportunity cost over the period of default.
RULES OF IJARAH
Ijarah/Leasing is a contract whereby the owner of something transfers its usufruct to
another person for an agreed period, at an agreed consideration.
1. The subject of Ijarah must have a valuable use. Therefore, things having no usufruct at
all cannot be given on Ijarah.
2. It is necessary for a valid contract of Ijarah that the corpus of the Ijarah property remains
in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus,
anything which cannot be used without consuming cannot be given on Ijarah basis.
Therefore, the Ijarah facility cannot be affected in respect of money, eatables, fuel and
ammunition etc. because their use is not possible unless they are consumed. If anything of
this nature is given on Ijarah basis, it will be deemed to be a loan and all the rules
concerning the transaction of loan shall accordingly apply. Any rent charged on this
invalid Ijarah transaction shall be an interest charged on a loan.
3. As the corpus of the Ijarah Assets remains in the ownership of the lessor, all the
liabilities emerging from the ownership shall be borne by the lessor, but the liabilities
referable to the use of the property shall be borne by the lessee.
4. The period of Ijarah must be determined in clear terms.
5. Lessees cannot use the Ijarah asset for any purpose other than the purpose specified in
the Ijarah agreement. If no such purpose is specified in the agreement, the lessee can use it
for whatever purpose it is used in the normal course. However if he wishes to use it for an
abnormal purpose, he cannot do so unless the lessor allows him in express terms.
6. The lessee is liable to compensate the lessor for every harm to the Ijarah asset caused by
any misuse or negligence on the part of the lessee.
7. The Ijarah asset shall remain in the risk of the lessor throughout the Ijarah period in the
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sense that any harm or loss caused by the factors beyond the control of the lessee shall be
borne by the lessor.
8. A property jointly owned by two or more persons can be given on Ijarah basis, and the
rental shall be distributed between all the joint owners according to the proportion of their
respective shares in the property.
9. A joint owner of an Asset can given on Ijarah basis his proportionate share to his cosharer only, and not to any other person.
10. It is necessary for a valid Ijarah that the Ijarah asset is fully identified by the parties.
REVOCATION OF IJARAH
Since the principal purpose of Ijarah is to enable the lessee to enjoy the usufruct of the
leased object, the majority of schools, excepting the Hanafis, allow revocation (faskh) of
Ijarah in basically one situation only, which is when the leased article loses its utility and
benefit. The majority consequently do not allow revocation of Ijarah on grounds of any
personal disability that befalls the lessor or the lessee. Hence a lease contract may not be
revoked on any other ground.
The Hanafis also permit revocation of Ijarah on ground of disabilities affecting the parties
even when the leased item remains intact. Revocation is thus allowed of the lease, for
example, of a shop if prior to taking occupancy, the lessee loses all his merchandise.
Similarly, when someone hires a chef for an event which is, however, unexpectedly
postponed or cancelled, the hire contract may be revoked. Disagreement among the schools
has also arisen over the dissolution of Ijarah in the event of death of one of the contracting
parties. The majority of schools maintain that Ijarah remains intact even after the death of
one of the contracting parties and hold that their legal heirs would inherit the contract. The
latter would consequently step into the shoes of their deceased relative and would
consequently be bound to honor the contract. The Hanafis maintain, on the other hand, that
the contract is dissolved upon the death of one of the contracting parties. This is because
usufruct according to the Hanafis is a manfa‘a (benefit) which is not mal and therefore not
inheritable. Transfer of ownership by way of sale, gift and inheritance also does not vitiate
the Ijarah, which according to the majority including the Hanafis survives the transfer and
the new owner must observe it until the end of its period.
Ijarah basically expires when its period of validity comes to an end unless it is for a reason
that necessitates its extension beyond the due date. Thus when the hire period of an animal
or a vehicle comes to end during the continuation of a journey they have been hired for, the
Ijarah continues until the time the carrier reaches destination.
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EXAMPLE OF IJARAH FINANCING CALCULATIONS
Generally, the financial institutions calculate the rental amounts as follows:
Assumptions:
1. The financial institution determines that it wants to have a profit rate (PR) of 10 percent.
2. The purchase price (PP), including all costs, is $1,000,000 (cost borne by the financial
institution).
3. The term (T) of the lease is 5 years.
Calculations:
1. Profit (P) = Purchase price x profit rate x period of financing
$1,000,000 x 0.10 x 5 = $500,000
2. Total lease rental = Purchase price plus the profit
$1,000,000 + $500,000 = $1,500,000
3. Monthly rental = Total lease rental divided by the term (in months)
$1,500,000/ (5 x 12 months) = $25,000 per month
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CHAPTER # 5
CONCLUSION & RECOMMENDATION
Learning Objectives
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Economic benefits of Islamic leasing
Conclusion
Recommendation
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ECONOMIC BENEFITS OF ISLAMIC LEASING
Let us proceed to discuss the economic benefits of Islamic leasing. Five distinct benefits of
Islamic leasing can be mentioned:
1. Islamic leasing necessarily involves real assets. This ensures and strengthens the linkage
between the financial sector of the economy and the real sector contributing to economic
stability. In this way lease finance relates to a distinctive feature of Islamic finance, a
feature missing in the conventional system. Proliferation of financial assets without any
counterpart in the real sector of the economy makes the financial markets vulnerable to
speculative games threatening to turn these markets into a casino. It also engages a large
number of highly skilled people into maneuvers that have nothing to do with production of
goods and services. Incomes generated by these activities have contributed to the increase
in the inequality in the distribution of income and wealth in the society.
2. Islamic leasing creates a great potential for securitization. Sukuk based on Ijarah can be
traded in the market, affording a convenient instrument for investing savings to the people
of small incomes who constitute the overwhelming majority in the developing countries in
general and in the Muslim countries in particular.
3. Islamic leasing is especially suitable for some sectors of the economy for which sharingbased modes proved to be rather difficult to practice, e.g. the consumers sector and the
public sector. It can take care of the public sector projects related to infrastructure building,
e.g., roads and bridges, airports, irrigation systems, hospitals, schools, etc. As a matter of
fact most of the leasing based sukuk issued recently belong to this category.
4. Lease finance is easier to practice as it involves less documentation and takes less time
to conclude a deal. Unlike lending, it does not need collateral and no thorough enquiries
into the creditworthiness of the lessee are called for. The physical presence of a tangible
asset, the subject of the lease, whose ownership may remain with the lessor, makes these
formalities unnecessary. This may make it especially suitable for the rural sector, where
formalities may hamper operations.
5. Lease finance has some of the good features of debt finance and, at the same time, is
free of some of the weaknesses of sharing-based modes of finance. There is less possibility
of moral hazard/adverse selection than the sharing modes. There is no agency relationship
between the lessor and the lessee, as is in the case of mudarabah (profit sharing), for
example. The payment obligation of the lessee, the rent, is fixed, as in case of debt. It is not
a case for adverse selection as no part of unforeseen losses/costs can be passed over to the
lessor.
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CONCLUSION
The basic advantages of Ijarah and how it can be used to avoid some of the controversial
features of bay‘ al-‘inah and bay‘ al-dayn have generated much interest in Ijarah-based
financing and sukuk in recent years. Ijarah can also be used as an incentive to economic
development as it is usually long term and offers potential for stimulating productive
industries. The fact that Ijarah is not dependent on collaterals also means that it has greater
in-built stability to contain inflationary pressures in the economy.
RECOMMENDATION
Our analysis of the Shariah related issues pertaining to Ijarah based financing also suggests
that there are basically no major departures from Shariah principles in the contemporary
applications of this contract. Some of the issues to which attention has been drawn in this
essay have featured in the existing literature on Ijarah and the quest continues for better
solutions. With regard to financial leasing, the main critique is that the Ijarah certificates
should represent a portion of the bearer's ownership in the leased assets and not a mere sale
of the right to charge rent. This is not also an insurmountable issue.
Another issue raised is over the obligatory manner of committing the lessee to acquire
ownership of the leased asset at the end of the contract period. This practice is
inconsistent, as explained earlier, with the requirements of Islamic law. For stipulation of
such terms in the original lease not only amounts to combining two contracts in one, but
can also lead to injustice. There is no objection to drawing a basic memorandum of
understanding, or exchange of promises, between the parties that would help secure the
desired purposes of the parties, provided it does not bind the lessee to acquire ownership.
The lessor may also make a unilateral commitment to offer the lessee an option to buy the
leased assets at the end. For those who accept the legality of traded options from the
Islamic perspective, one may suggest perhaps that the lessor may offer a put option to the
lessee to sell the leased assets to the latter at the end of the contract period. The option so
provided would only commit the lessor but would not bind the lessee to exercise the
option.
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ISLAMIC FINANCIAL GLOSSARY
Amana/amanah: Literally means reliability, trustworthiness, loyalty and honesty, and is
an important value of Islamic society in mutual dealings. It also refers to deposits in trust,
sometimes on a contractual basis.
Bai/bay: Contract of sale, sale and purchase.
Diminishing musharaka: A form of partnership that ends with the complete ownership of
a partner who purchases the share of another partner in that project by a redeeming
mechanism agreed between both of them.
Fiqh: Practical Islamic jurisprudence. Can be regarded as the jurists’ understanding of the
Shariah. There are four Islamic schools of jurisprudence: al-Shafie, al-Hanafi, al-Maliki
and al-Hanbali.
Hadith: The narrative record of the sayings, doings and implicit approval or disapproval
of the Prophet.
Halal: Permissible, allowed, lawful. In Islam, there are activities, professions, contracts
and transactions that are explicitly prohibited (haram) by the Qur’an or the Sunnah.
Barring these, all others are halal. An activity may be economically sound but may not be
allowed in Islamic society if it is not permitted by the Shariah.
Haram: Unlawful, forbidden (see halal). Describes activities, professions, contracts and
transactions that are explicitly prohibited by the Qur’an or the Sunnah.
Ijarah/Ijarah: Lease, hire or the transfer of ownership of a service for a specified period
for an agreed lawful consideration. This is an arrangement under which an Islamic
financial institution leases equipment, a building or other facility to a client for an agreed
rental.
Ijarah muntahla bittamleek/ Ijarah wa iqtina: A leasing contract used by Islamic
financial institutions that includes a promise by the lessor to transfer the ownership of the
leased property to the lessee, either at the end of the lease or by stages during the term of
the contract.
Manfa’a: A form of contract in which one party gains the right to use or benefit from the
use of an asset.
Mudaraba/mudarabah: A form of contract in which one party (the rab-al-maal) brings
capital and the other (the mudarib) personal effort. The proportionate share in profit is
determined by mutual consent, but the loss, if any, is borne by the owner of the capital,
unless the loss has been caused by negligence or violation of the terms of the contract by
the mudarib. A mudaraba is typically conducted between an Islamic financial institution or
fund as mudarib and investment account holders as providers of funds.
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Mudarib: The managing partner or entrepreneur in a mudaraba contract.
Murabaha: A contract of sale with an agreed profit mark-up on the cost. There are two
types of murabaha sale: in the first type, the Islamic financial institution purchases the
goods and makes them available for sale without any prior promise from a customer to
purchase them, and this is termed a normal or spot murabaha. The second type involves a
promise from a customer to purchase the item from the financial institution, and this is
called murabaha to the purchase order. In this latter case, there is a pre-agreed selling price
that includes the pre-agreed profit mark-up. Normally, it involves the financial institution
granting the customer a murabaha credit facility with deferred payment terms, but this is
not an essential element.
Musharaka/musharakah: An agreement under which the Islamic financial institution
provides funds that are mingled with the funds of the business enterprise and possibly
others. All providers of capital are entitled to participate in management but are not
necessarily obliged to do so. The profit is distributed among the partners in a predetermined manner, but the losses, if any, are borne by the partners in proportion to their
capital contribution. It is not permitted to stipulate otherwise.
Rab-al-maal: The investor or owner of capital in a mudaraba contract.
Riba: Interest. Sometimes equated with usury, but its meaning is broader. The literal
meaning is an excess or increase, and its prohibition is meant to distinguish between an
unlawful exchange in which there is a clear advantage to one party in contrast to a
mutually beneficial and lawful exchange.
Shariah /Shari’a/Shari’ah: In legal terms, the law as extracted from the sources of law
(the Qur’an and the Sunnah). However, Shariah rules do not always function as rules of
law as they incorporate “obligations, duties and moral considerations that serve to foster
obedience to the Almighty.”
Sukuk: Plural of saak
Sunnah: The way of the Prophet Muhammad including his sayings, deeds, approvals, and
disapprovals as preserved in the hadith literature. It is the second source of revelation after
the Qur’an.
Urf: The customs of a community.
Zakah/zakat: A tax that is prescribed by Islam on all persons having wealth above an
exemption limit at a rate fixed by the Shariah. Its objective is to collect a portion of the
wealth of the well-to-do and distribute it to the needy. The way it is distributed is set out in
the Qur’an. It may be collected by the state, but otherwise it is down to each individual to
distribute the zakat.
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REFERENCES
Mohammad, H., (2005). A Shariah Analysis of Issues in Islamic Leasing. Retrieved from
http://islamiccenter.kau.edu.sa/arabic/Magallah/Pdf/20_1/20-1_Kamali_05.pdf
Dr. Abdul, S., (n.d.). Ijarah (lease). Department of Research and Development. Retrieved
from http://www.albaraka.com/media/pdf/Research-Studies/RSIJ-200706201-EN.pdf
Dinna, R., (2008). Design of Ijarah Sukuk. Retrieved from
http://www.philadelphia.edu.jo/courses/Markets/Files/Markets/c44.pdf
Maulana, T., (n.d.). “Ijarah”. Retrieved from
http://www.accountancy.com.pk/docs/islam_ijarah.pdf
Umer, A., (2010). Challenges Facing Islamic Banking Industry. Retrieved from
http://www.meezanbank.com/docs/brecorder.pdf
Dr. Muhammad, I., (n.d.). Meezan Bank’s Guide to Islamic Banking. Retrieved from
http://www.meezanbank.com/docs/s7c28.pdf
n.a., (n.d.). Focused Toolkit Islamic Leasing (“Ijarah”). Retrieved from
http://leasingtoolkit.org/files/Islamic%20Leasing%20(Ijarah).pdf
Ahmad, A., (n.d.). Islamic financial Accounting Standard -2 Ijarah. Retrieved from
http://www.scribd.com/doc/18644133/Islamic-Financial-Accounting-IJARAH-byMEZAAN-BANK
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