Ijara {Islamic Leasing}

Definition of Ijara: F Literally means: to give something on rent. F Technically means to transfer the usufruct of a particular property to another person on the basis of rent claimed from him. F It is defined as: ownership of the right to the benefits of using an asset in return for consideration {Rent}.

Elements of Ijara:
1.

Wording.

2. Contracting Parties. 3. Subject Matter {Benefit}.

1. Wording:

An expression of desire by each contracting party {offer & acceptance}. The lesser makes the offer. The Lessee makes the acceptance. Ijara can be deferred to future date {Malikis and Hanbalis}. Ijara can be contingent on future event. Hanafi School considers deferred Ijara non-binding. For Shafis, deferred Ijara is acceptable only in case where specifications of the asset are on the description of the lesser.

2. Contracting Parties:

Two parties in Ijara: Lesser: is the owner of the asset. Lessee: is the person benefiting from use of asset.

Conditions of the contracting parties:

Must be of sound mind and judgment.

Must be competent to the dispose of funds.

Consent of both parties. Lessee has the authority to act.

3. The Subject Matter of Ijara

Contract:
Consideration

{Rent}.

Usufructs

{Benefits}.

Forms of Benefit:

Use of benefit of specified asst. Known act, such as: construction,

technical consultancy, stitching, etc.

Conditions of Benefits:

Benefits from Ijara should fulfill the following conditions:

Must be subject to valuation {i.e. can be valued}.

1.

2. Must be of permissible nature in Islamic Shariah. 3. The ability to fulfill the benefit is real. 4. Must be free of Jahala {ambiquity}.

Specification of Benefits:

Benefit from Ijara is specified by stating:

The duration of Ijara, if the least asset is a real estate. Physical identification of benefit, if the least asset provides certain service or work, such as: machine, vehicle, manpower, etc.

Rent from Ijara:

Lessee in return for benefit from Ijara pays the agreed price {Rent}. The price {rent of the leased asset} must be known. It can be in form of an other benefit. It can be in form of time, place and distance {this is flexibility}. It becomes lessers entitlement when Ijara contract is fulfilled. It can be accelerated or deferred, paid in whole or in part.

Obligations of Lesser:
1. Make the leased asset available.

2. Provide guarantee to cover

defect.

against

3. Maintain and repair the leased asset.

Obligations of Lessee:
1. Utilize asset as specified in the contract or
according to normal practice.

2. Pay the rent as per the contract.

3. Keep asset intact because, it is a trust.

4. Responsible for impairment of the leased asset

only in case of negligence or misconduct.

Sale & Ijara Contract:

In Ijara, leased property remains owned

by lesser, but only its benefit is

transferred to lessee.

But in Sale, ownership of asset will be

transferred to buyer.

Ijara Muntahia Bittamleek {Ij.M.B.}

F It is a lease contract with promise to sell. F It aims at transferring the legal title or ownership to lessee. F It should focus on: Lease or sale contract. Ijara and promise to sell. Specified rent for Ijara. Cost of the asset in sale contract. Time title of asset is transferable. F May take many forms where all end in transferring title of asset to lessee.

Forms of Ijara Muntahia Bittamleek {Ij.M.B.}:

1. Ijara Muntahia Bittamleek through gift. 2. Ijara Muntahia Bittamleek through a token amount. 3. Ijara Muntahia Bittamleek through amount specified in the lease.

4. Ij. M. B. through price equivalent to remaining Ijara installments.

5. Ijara Muntahia Bittamleek through gradual transfer of title. 6. Ijara Muntahia Bittamleek through sale & leaseback.

1. Ijara Muntahia Bittamleek through gift:

F The legal title of the asset is transferred free

as a gift.
F Legal title of asset is transferred conditional

on settlement of installments.
F Transfer of legal title of asset is at the end of Ijara period.

2. Ijara Muntahia Bittamleek through a token amount:

F

An executable contract wherein rent of asset and Ijara period are fixed.

F It has a promise to enter into sale contract. F Sale contract is to be concluded at the end of Ijara period, if the

lessee wishes and has paid the agreed token amount.

F The token amount should be agreed mutually by both parties. Rent should be adjusted if lessee fulfilled his obligation but the legal title is not transferred.

3. Ij. M. B. through amount specified in the lease contract:

F It is a contract that includes: Ijara or lease contract.

Promise to enter into sale contract. F The sale contract includes the price {value} of the sold asset. Payment of the sale price of asset is after the expiry of Ijara period. Lessee is entitled to ownership of asset after paying the agreed specified amount.

4. Ij. M. B. through price equivalent to remaining Ijara installments:

F This arrangement includes: 1. Ijara contract.

2. Promise to transfer legal title of the asset any time lessee wishes.
3. Transfer for amount equivalent to remaining Ijara installments. F It is an Ijara contract until the title of asset is transferred to lessee.

F Ijara contract elapses for the remaining period when the title of asset is transferred to lessee.
F A sale contract is needed to make the transfer of title of asset effective.

5. Ijara Muntahia Bittamleek through Gradual Transfer of Title:

F This arrangement includes: Lease or sale contract. Promise to transfer the legal title gradually during Ijara period. F It requires determination of asset price {asset value} in sale transaction. F Price of asset is allocated over the period of Ijara. F It requires specification of rent for the leased asset. F Time title of the asset is transferable through Ijara duration. F Full transfer of title at the end of Ijara period. F Gradual title transfer needs sale contract for each transferred portion. F Rent should decrease as lessee acquires a share in the leased asset. F If the contract is revoked, then the asset is jointly owned. This is fairness to lessee.

6. Ijara Muntahia Bittamleek through Sale & Leaseback:

F Arrangement of selling an asset to another party and then leasing it from him.

F Sale transaction must not be conditional on the execution of the

lease transaction. F However, both parties can have common understanding between them. F Also it is permissible if one party promises the other to lease to / from

him the asset.

Current Applications of Ijara in Islamic Banks Ijara Wa Iqtina {Lease-Purchase}:

F An application of Ijara in modern Islamic banking. F Also known as Hire Purchase Finance, when the bank rents the asset to consumer who promises to purchase it within a specified period. F Rental payment could be a fixed amount for a percentage directly tied to cash flow of the project and consists of the banks share in the net profit plus rental charges. F When the total rental charge equals cost of asset, ownership of asset transfers to customer. F Ijara Wa Iqtina is like a financing lease, where the rentals during the lease term are sufficient to amortize the investment of the leasing company and provide an element of profit. F Under this mode of financing, the process could be as follows:

1. Banks would buy equipment or machinery and lease it out to their clients who may opt to buy them eventually, where the monthly payments will consist of two components: Rental for the use of the equipment and Installments towards the purchase price. 2. Original amount of rent for the assets should be fixed in advance. 3. Client can also negotiate for purchase of asset at the end of the period. 4. The lease rentals paid in advance will be part of the price less the bank remuneration.

F Ijara Wa Iqtina can either have a purchase option or a purchase obligation at the end of its term. F Profit element in Ijara wa Iqtina is permissible on following grounds:
1. Islamic Shariah allows a fixed charge relating to tangible assets because by converting financial capital into tangible assets the financier has assumed risks for which compensation is permissible. 2. Since the distinguishing feature of Ijara is that assets remain property of Islamic bank, it faces the risk of having them remain unutilized for long period of time after the lease period expires. 3. The bank bears risk of recession or diminishing demand for these assets. 4. By retaining ownership of asset the bank runs the risk of premature obsolescence {collapse or full depreciation}.

F In practice, Islamic leasing is a major activity for Islamic banks. F It is used primarily to finance high-valued equipment, such as aircraft.

It is also used to finance smaller items of equipment, such as medical equipment required by medicos in their private practice.

Principles of Shariah Governing Ijara Investment Fund

F "Islamic Investment Fund" means a joint pool wherein investors contribute their surplus money for the purpose of its investment to earn permissible profits in strict conformity with Islamic Shariah.
F Fund Subscribers may receive a document certifying their subscription and entitling them to pro-rated profits actually accrued to the Fund. F Documents may be called "certificates" "units" "shares" or "sukuk".

Their validity in Shariah, must be subject to two basic conditions:

First, they must carry a pro-rated profit actually earned by the Fund. Therefore, neither principal nor a profit rate can be guaranteed.

Subscribers must enter into the fund with a clear understanding that return on their subscription is tied up with the actual profit earned or loss suffered by the Fund. If the Fund earns huge profits, or suffers loss, they will have to share it proportionately, unless the loss is caused by the negligence or mismanagement, where the management, and not the Fund, will be liable to compensate it.

Second, the amounts so pooled together must be invested in a business acceptable to Shariah. It means that not only channels of investment, but also the terms agreed with them must conform to the Islamic principles.

Ijarah Investment Fund {Ijarah Sukuk}

F It is one possible type of Islamic Investment Fund. F Subscription amounts are used to purchase assets like real estate, motor vehicles, or equipment and leasing them out to their ultimate users. F Ownership of these assets remains with the Fund and the rentals are charged from users. F These Rentals are the source of income for the fund, and distributed pro-rated to subscribers. F Each subscriber is given a certificate to evidence his subscription and to ensure his entitlement to the pro-rated share in the income. Certificates may be preferably called "sukuk"{traditional Islamic term}.

F Since these sukuk represent the pro-rated ownership of their holders

in the tangible assets of the fund, and not the liquid amounts or debts, they are fully negotiable and can be sold and purchased in secondary market. F Anyone who purchases these sukuk replaces the sellers in the prorated ownership of the relevant assets and all the rights and obligations of the original subscriber are passed on to him. F The price of these sukuk will be determined on the basis of market

forces, based on their profitability.

Contracts of leasing must always conform to the principles of Shariah.

Some basic principles of Shariah governing leasing are:

1. The leased assets must have some usufruct. 2. Leased assets must be of nature that their permissible use is possible. 3. Lesser must undertake all responsibilities consequent to ownership of assets. 4. Rental must be fixed and known to parties at the time of the contract. F The management should act as an agent of the subscribers and should be paid a fee for his services. F The management fee may be a fixed amount or a proportion of the rentals received. F Such a fund cannot be created on the basis of Mudarabah, because Mudarabah is restricted to the sale of commodities and does not extend to the business of services and leases. F However, in the Hanbali School, Mudarabah can be affected in services and leases also.

Islamic Ijara versus Conventional Lease

Islamic Ijara Contract
Payments commence after delivery of asset.

Conventional Lease Contract

Payments commence at the time of funding.

Risk of destruction or loss of asset remains with Risk of destruction or loss of asset is transferred to lesser, unless caused by negligence or misconduct. Lessee {the one who lease the asset}. Repairs & maintenance are the responsibility of Repairs & maintenance are passed on to Lessee. lesser. Insurance cost should not indirectly be passed to Insurance cost will indirectly be passed to Lessee. Lessee Ijara payments should be stopped if asset is out of Ijara payments will not stop if the asset is out of order. order. Lesser can ask for collateral to guarantee payment. Penalty should be fixed in the contract in advance. Ijara payments cannot be assigned to third party. Lessee can ask for collateral to guarantee proper functioning of asset. Penalty is an interest charge. Conventional Lease payments can be assigned to third party.