Journal of Islamic Accounting and Business Research

Emerald Article: Ijarah contract: a practical dilemma Fahad Zafar

Article information:
To cite this document: Fahad Zafar, (2012),"Ijarah contract: a practical dilemma", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 67 - 69 Permanent link to this document: http://dx.doi.org/10.1108/17590811211216078 Downloaded on: 12-02-2013 To copy this document: permissions@emeraldinsight.com This document has been downloaded 202 times since 2012. *

Users who downloaded this Article also downloaded: *

Fahad Zafar, (2012),"<IT>Ijarah</IT> contract: a practical dilemma", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 67 - 69 http://dx.doi.org/10.1108/17590811211216078 Fahad Zafar, (2012),"<IT>Ijarah</IT> contract: a practical dilemma", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 67 - 69 http://dx.doi.org/10.1108/17590811211216078 Fahad Zafar, (2012),"<IT>Ijarah</IT> contract: a practical dilemma", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 67 - 69 http://dx.doi.org/10.1108/17590811211216078

Access to this document was granted through an Emerald subscription provided by Universitas Muhammadiyah Yogyakarta For Authors: If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service. Information about how to choose which publication to write for and submission guidelines are available for all. Please visit www.emeraldinsight.com/authors for more information. About Emerald www.emeraldinsight.com With over forty years' experience, Emerald Group Publishing is a leading independent publisher of global research with impact in business, society, public policy and education. In total, Emerald publishes over 275 journals and more than 130 book series, as well as an extensive range of online products and services. Emerald is both COUNTER 3 and TRANSFER compliant. The organization is a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation.
*Related content and download information correct at time of download.

The current issue and full text archive of this journal is available at www.emeraldinsight.com/1759-0817.htm

PRACTITIONERS NOTE

Ijarah contract: a practical dilemma

Fahad Zafar
Mayfair Business Consultants, Lahore, Pakistan
Abstract
Purpose This purpose of this paper is to highlight the weakness in vehicle Ijarah contract. Design/methodology/approach A real life example of a vehicle Ijarah contract was studied in which a customer gets a car from an Islamic bank and then misuses the system. Findings The case study provides a path for more research on Ijarah contract for vehicle leasing. Islamic bankers should take into account the amount of down payment requested besides the fullment of other criteria. Vehicle Ijarah contract is only appropriate when the amount of deposit or down payment requested is below 40 per cent threshold, otherwise a diminishing Musharakah contract should be preferred. Research limitations/implications The research is only on one case reported in one of the Islamic banks in Pakistan. The solution is also by only one Shariah scholar. The future research should be on similar contract at entire Islamic Banking Industry. Views of all top Shariah scholars should be taken to mitigate such kind of risks for Islamic banks. Practical implications This paper would trigger management of all Islamic banks to alter the structure of their vehicle Ijarah contracts. Social implications Islamic bankers would be warned against making a vehicle Ijarah contract with individuals wanting to contribute more than a down payment, just for the sake of cheating the system. Originality/value This paper is of great importance to the management of Islamic banks as this would raise ag against any future losses due to loopholes in the structuring of contracts. Keywords Car Ijarah, Islamic car leasing, Ijarah dilemma, Banks, Islam, Leasing, Road vehicles Paper type Case study

Ijarah contract: a dilemma

67

Introduction The word ijarah is derived from the Arabic word ajara ujeru meaning renting. It involves one party (the lessor) allowing another (the lessee) to utilise the benets on a tangible asset for a rental consideration. Two fundamental requirements for ijarah to be recognized as an acceptable mode of business nancing under Shariah are that: (1) the prot must be generated from selling or offering the use of something having intrinsic value, i.e. based on real assets; and (2) the risk element is assumed by the lessor. There are ve steps in the ow of ijarah transaction: (1) Customer identies the asset and asks the bank to acquire it and promise to the bank that it will lease the asset after the bank acquires it. (2) The bank acquires the asset from the supplier at cost price. (3) The bank makes payment to the supplier and receives title of the asset.

Journal of Islamic Accounting and Business Research Vol. 3 No. 1, 2012 pp. 67-69 q Emerald Group Publishing Limited 1759-0817 DOI 10.1108/17590811211216078

JIABR 3,1

68

(4) The bank leases the asset to the customer for a xed rental consideration and depending on the objective of the contract, the customer probably also makes a promise to purchase the asset in the future at a potential price. It should be noted that the promise is not a contractual obligation as there could not be a sale contract executed on an asset which is being leased. (5) The customer makes rental payment according to the agreed upon repayment schedule. It is a widely used trade mode of nancing by Islamic Financial Institutions. In this article, I would like to demonstrate a particular dilemma faced by bankers related to vehicle ijarah contract and the resolution offered by the Shariah scholar. Vehicle ijarah contract: the dilemma Vehicle leasing or vehicle ijarah contract represents a transaction in which benet (usufruct) associated with the vehicle is sold for a payment. In the course of this sale of usufruct, ownership of the vehicle is not automatically transferred to lessee and the bank (lessor) maintains the ownership. In other words, the ijarah contract is designed to return the vehicle to the lessor at the end of the term, thus taking on the features of an operating lease whereby the bank takes title of the asset at the end of the lease term. The other mechanism available is to allow the lessee to agree at the outset, to buy the assets in question at the end of the lease period which basically takes on the nature of a hire purchase known as Ijara wa Iqtina or Ijarah Muntahia Biittamleeek IMB) (i.e. lease & ownership). FAS 8 (para 4) lists four possible conclusions of IMB: as gift (hibah), i.e. transfer of legal title for no consideration; through a token consideration, i.e. transfer of legal title (sale) at the end of a lease term; through price that is equivalent to the remaining ijarah installments, i.e. transfer of legal title (sale) before the end of the lease term; and through gradual transfer of legal title (sale) of the leased asset. A customer approached the Islamic bank for a vehicle lease and was informed of the total cost of the vehicle (above the market price), Rs 1,000,000 and that 20 per cent is required as down payment/security with the remaining 80 per cent adjusted against 36 monthly rental payments. The customer was also told that the contract will be a ijarah Muntahia bittamleek through gift (hibah) whereby the bank will transfer ownership of the vehicle to the customer at the end of the lease term without further consideration and that the bank will also be responsible for any damage to the vehicle. The customer told the banker that he would like to pay 80 per cent as down payment instead of 20 per cent which the banker eagerly accepted as this helps in achieving the branch sales target. The contract was signed and the customer paid the monthly rentals as expected. After paying 35 months rental payment, the customer decided that he does not need the vehicle anymore and demand his 80 per cent down payment back. The banker sought the advice of the Shariah scholar as such case has never been encountered by the bank before. Outcome The Shariah scholar advised the bank to return the 80 per cent down payment back to the customer since the contract was a ijarah muntahia bittamleek. The bank should not have taken more than 40 per cent as down payment or security in the case of ijarah contract and if the customer insists upon giving more than that percentage, the bank

should have entered into a diminishing musharakah contract. This contract will allow the bank to transfer a percentage of ownership to the client upon payment of rentals. If such contract, i.e. diminishing musharakah had been entered by the two parties, then the customer would have attained almost 97 per cent ownership of the vehicle at the end of the 35th month. Lesson learnt Before entering into contract based on ijarah muntahia bittamleek, it is equally important for bankers to take into account the amount of down payment requested besides the fulllment of other criteria. Ijarah contract is only appropriate when the amount of deposits or down payment requested is below 40 per cent (the threshold) and above that, the contract should be diminishing musharakah as risk will be shared between both parties.
About the author Fahad Zafar is the Chief Risk Ofcer and Management Board Member of Azizi Bank Afghanistan. He is also Co Regional Director at Professional Risk Managers International Association (PRMIA). He is a professional trainer and key note speaker on risk and strategy-related topics. He was previously associated with Askari Bank Pakistan as Unit Head Islamic Banking Risk Management. On the educational side, he has an MBA from Bradford University (Yorkshire, UK), BSc (Hons) from Middlesex University (London, UK) and is also a Certied Islamic Banker from NIBAF, Central Bank of Pakistan. Fahad Zafar can be contacted at: fahadzafar@ymail.com

Ijarah contract: a dilemma

69

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com Or visit our web site for further details: www.emeraldinsight.com/reprints