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Essentials

for
Islamic Finance
Ijarah
(Leasing)
Definition
Leasing is a contract in which asset is
transfers to user for an agreed period on an
agreed consideration

“Ijarah is a lease contract as well as a hire


contract”.

Both the contract are similar to each


In Islamic Finance Ijarah is a
lease contract under which
financial institution leases
equipment or a building to
one of its clients against
agreed rentals or
installments equal to the
value of the assets.
Lesser or Lessee
The financier is known as lesser who
financer equipment for lessee.

The equipment provider through


financing is LESSOR.

The equipment user is LESSEE


Ijarah
Ijarah basically facilitate the cost to be
spread for large purchases into affordably
installments for payment.

In Ijarah either the end of the transaction is


the ownership of assets that acquired
through lease financing or in another case
the equipment is returned to financier.
Ijarah Financing is a contract in which a lessee
request for an equipment or a property and
Lesser provide through its financing the
specified and requested equipment or property.

The Lessee agree to pays a monthly, quarterly,


semi-annual or annual rent to lesser for the
right to use equipment a specific amount within
agreed time of time i.e. 12, 24, 36, 48, or 60
months OR what ever time agreed.
Historical Perspective
 Although leasing began in 2010 B.C. but
modern leasing began in the early fifties.
 The creation of the Investment Tax Credit in
1962 encourage growth through "tax-oriented"
leasing.
 New products were quickly developed to meet
the growing demand.
 Over the last 50 years, many leasing companies
developed non-tax oriented products such as
income funds, operating leases, limited
partnerships, vendor programs, and end
sharing in order to remain competitive.
Equipment leasing blossomed
over the last 20 years
 Banking industry started leasing by giving
credibility to a market place which had been
previously regarded as a last-resort financing
alternative.
 Accounting profession produced a documents
to help standardize lease reporting in financial
statements.
 Internal Revenue Service issued guidelines to
aid lesser and lessees in structuring leasing
transactions.
Why do Lease Business ?
 Cash flow - Monthly payments are generally
smaller for leases than for loans and they
usually require a smaller or no down payment.

Use vs. ownership - Many businesses have


discovered they don't need to own the
equipment they use.
In past renting and leasing were limited.
Today's psychology it more to economics rather
than moralities of ownership
The Modern Concept of Ijarah
 Leasing is the modem technique which can be
compared with Islamic technique of Ijarah.
 Leasing is based on fundamental concept of
Ijarah, according to which one does not have to
own an asset in order to enjoy benefits of it.
 There are business examples which benefited
from their investment in fixed assets and made
substantial capital profits from the sale of assets
or been able to improve their balance sheets by
the revaluation of assets.
 Primarily profitability of a business lies in
the effective utilization of its resources.
Therefore USE is important rather
OWNERSHIP.
For example
 Investment appraisal made on some new
venture. The choice of purchasing or
leasing is partially a matter of arithmetic
and partially a question of the availability
of the capital.
Comparison
 A comparison between leasing and other
similar forms of transactions, such as
rental, will give a clearer picture.
 "Rent a Car business is a contract

according to which the objects are leased


to individuals or a number of users for a
much shorter period than their actual
useful life.
 In contract law, the "rental contract" specifies the
lease and the usage for an indefinite period.
 Like IBM's computer sales system which has an
overwhelming world market share.
 To promote sales in an attempt to outstrip its
competitors, with the belief that it could control the
progress of technological innovation of computers.
 Users of equipment leased on a rental system are
major enterprises with continuous usage of rented
equipment in a short-lived, but the lesser is charged
with the responsibility for maintenance.
 In the case of "rental" the lesser is moreover charged
with the responsibility for coping with the products
obsolescence, so that it may be termed as a service-
oriented business.
Economic Role of ljara
 Lease financing due to its special features
supplement existing conventional forms of
financing and further increase speed
investment in the private sector.
 There is a large requirement of balancing and
modernizing for existing industry.
 Lease financing through balancing and
modernization of existing industry improve the
capacity utilization, quality, production cost,
profitability, internal generation of cash for
future investment and international
competitive capability to increase exports.
Lease financing is most suited to the
programs of balancing,
modernization and replacement. It
would involve a small dosage of
investment which would carry
relatively smaller investment risks
but would result in a quick value
added production. It would increase
capacity utilization and thus
contribute to the growth of the
economy.
Leasing is the contract
 Asset transfer to another for use on an agreed
period with financial consideration.
 The subject of lease must have a valuable use.
 It is necessary for a lease contract that body of
leased property remains in the ownership of
the seller and only its usage is transferred to
the lessee.
 Any thing that cannot be used cannot be
leased.
 Lease cannot be affected in respect of money,
edibles, fuel and ammunition etc. due to
consuming nature of products.
 If anything of this nature is leased out, it
would be consider as a loan with all rules
concerning the transaction of loan that
would accordingly be applied.
 Any rent charges on this invalid lease
would be treated as interest that is usually
charged on a loan.
 All the liabilities emerging from the
ownership shall be borne by the lesser, but
the liabilities referable to the use of the
property shall be borne by the lessee.
Example
Mr. Ahmed leased his House to Mr.
Badar. All taxes on the house shall be
borne by Mr. Ahmed as he is the owner
While water tax, electric bills and all
expenses pertain to the use of house
shall be borne by Mr. Badar the lessee.

The terms and conditions of the


agreement would remain as:
 Period of lease must be determined in
clear terms.
 Lessee cannot use leased asset for any
purpose other than a purpose specified
in the lease agreement.
 If purpose not specified in the
agreement, lessee is allowed to use
assets it for whatever purpose in the
normal course.
 If Lessee use it for an abnormal
purpose he cannot do so unless the
lesser allows him in specific terms.
 The lessee is liable to compensate
lessee for any harm caused to leased
asset by any lapse or carelessness
from the part of the lessee.

 Leased asset shall remain in the risk


of lesser throughout lease period.
 Any harm or loss caused by the
factors beyond the control of the
lessee shall be borne by the lesser.
 Asset jointly owned by two or more
person can be leased out and rental shall
be distributed between joint owners
according to the proportion of their
respective shares in the property.
 Lessee is not responsible for interfere
with any kind of share and distribution of
share amount.
 Lease in proportion share only allowed to
the co-share only not to any other
individual.
 It is necessary for a valid lease that the
leased asset is fully identified by the
parties.
Example
“A said to B “I lease you out my cars”.
 Lease is void unless leased car is clearly identified.
 Rental must be determined for whole period of lease at
the time of contracting a lease.
 It is permissible that different amounts of rent are
fixed for different phases during the lease period,
provided that the amount of rent for each phase is
specifically agreed upon at the time of lease
agreement.
 If the rent for a prior phase of the lease period has not
been determined or left at the option for the lesser, the
lease will not be valid.
Example
Mr. A leases his house to Mr. B for a
period of 5 years.
The rent for the first period is fix at
an amount on monthly basis and it
is also agreed that the rent of every
subsequent year shall be 10%
more than the previous one.
 In this example Mr. A laid down a
condition in the agreement that rent of
an amount per month is fixed for the first
year only.
 Rent for subsequent year shall be fixed
each year at the option of the lesser.
 The lease is void, because the rent would
be uncertain.
 Mostly in the long-term lease agreement
it is not in the benefit of the lesser to fix
one amount of rent for the whole period
due to the fact the market conditions
differ from time to time.
 In this case, the lesser has two options, either
 (a) He can contract a lease with a condition
that the rent shall be increased at a specified
proportion after a specified period. Like six
months or one year.
 Or
 (b) He can contract the lease for a shorter
period after which the parties of lease in fresh
terms and conditions, but the renewal shall be
affected by mutual consent with full liberty to
each one of them to refuse the renewal.
 In such case the lessee is bound to vacate the
leased assets and return it back to the lesser.
 Lesser cannot raise rent unilaterally for
that reason any agreement to the
contrary is null and void.
 Rent or part thereof may be payable in
advance before delivery of asset, but
the amount collected by lesser shall
remain with him as account payment
and shall be adjusted to the rent after it
is due.
 Lease period shall commence from the
date on which leased asset has been
delivered to lessee, no matter whether
the lessee has started using it or not.
If leased asset has totally lost the function
for which it was leased for and no repair is
possible then lease shall terminate on the
day on which such loss has been caused.
However, if the loss caused by the misuse or
by the negligence of the lessee he will be
liable to compensate the lesser with the
depreciated value of the asset as it was
immediately before the loss.
 Like other modes of financing, lease is not
originally treated as one.
 It is simply a transaction meant to transfer the
use of an asset from one person to another for
an agreed consideration.
 Certain financial institutions have adopted
leasing as a mode of finance used in place of
interest.
 This kind of lease, generally known as the
financial lease notable from the operating lease
that has many basic features of actual leasing
transactions with which it is distribute with.
 When the financial institutions on interest free
modes established in the recent past they
found that leasing was a recognized mode of
finance throughout the world.
 On the other hand, they realized that leasing
was a lawful transaction according to Shariah
and it could be used as an interest free mode of
finance.
 Leasing has been adopted by the Islamic
Financial Institutions, yet very few of them paid
attention to the fact that the financial lease has
a number of characteristics more similar to
interest as the actual lease transaction.
 They started using same model agreements for
leasing as were in vogue among the traditional
financial institutions without any modification,
while a number of their provision was not in
conformity with the Shariah.
 The primary advantage of Ijarah over the
conventional forms of borrowing to
finance equipment is that the ownership
of the asset remains with the lesser.

 The financing is largely unrelated to the


size of assets and the capital base of the
lessee, depending principally on the
ability of cash flow to service payments of
lease rentals.
 Ijarah is probably the most suitable mean to
raise investment funds especially for industries
where rapid technological innovation is either
underway or desired, top class firms which are
quickly expanding their business or small &
medium enterprises and firms which have
normally insufficient assets and capital base to
meet normal collateral requirements of most
other forms of long term financing. The basic
security under the Ijarah arrangement is the
"ownership of the equipment". The title of
ownership to the equipment remains with the
leasing company but in case of serious default,
the equipment is repossessed