ijarah new sem 2201011

IjarahIjarah-based Financing-based Financing

LEASING/ IJARAH

LEASING/ IJARAHLEASING/ IJARAH Basit wants to purchase a car via Islamic Basit wants to purchase a car via Islamic

FinancingFinancing He wants to know whether he can lease the He wants to know whether he can lease the

car without owning it.car without owning it. What is the difference between conventional What is the difference between conventional

financing to purchase a car and Leasing from financing to purchase a car and Leasing from the Islamic perspective.the Islamic perspective.

What are the other shariah compliant What are the other shariah compliant alternatives for himalternatives for him

4a. 4a. IjarahIjarah Based Based FinancingFinancing

4a. 4a. IjarahIjarah Based Based FinancingFinancing

Ijarah Contract

Ijarah Based Vehicle Financing -

AITAB

Some Applications:

Direct Leasing

Sale and Leaseback

Decreasing sale and Joint lease

Islamic Perspective on

Financial Lease

Financial Lease

Slide #1

BANK

PROPERTY

CUSTOMER-Lessee

Lease

Bank- Bought the PropertyLessor

AL- IJARAH

IjarahIjarah Contract Contract

Sale of usufruct (bay’ al manfa’ah)) Usufruct :: The right to use and enjoy the The right to use and enjoy the

profits and advantages of something profits and advantages of something belonging to another as long as the belonging to another as long as the property is not damaged or altered in any property is not damaged or altered in any wayway

Al-ijarah has two types of usufruct Usufruct of property or capital assets

(manfa’ah al-’ayn) Usufruct of labour, employment and

service (manfa’ah al-’amal)

In conventional leasing, there are two types In conventional leasing, there are two types of leasesof leases

Operating lease – where the lessor owns Operating lease – where the lessor owns the asset and bears maintenance costs the asset and bears maintenance costs as well as ownership risksas well as ownership risks

Financial lease – where the lessor only Financial lease – where the lessor only “technically” owns the asset, maintenance “technically” owns the asset, maintenance costs and ownership risks are borne by costs and ownership risks are borne by the lesseethe lessee

IjarahIjarah Contract Contract

In In ijarahijarah-based financing, -based financing, ijarah ‘aynijarah ‘ayn is is appliedapplied

Lessor Lessor ((mu’jirmu’jir) leases property to the ) leases property to the lesseelessee ( (musta’jirmusta’jir) in exchange for ) in exchange for lease or rental payment (lease or rental payment (‘ujrah‘ujrah))

The ijarah contract is differentiated with the bay’ (sale) contract in that with ijarah, ownership of property is not transferred

Comparable (but not identical) to Comparable (but not identical) to conventional leasing contractconventional leasing contract

Salient features of the Salient features of the ijarahijarah contract contract (1)(1)

Asset to be leased must have a valuable use

Note that value here is defined in Note that value here is defined in Shari’ahShari’ah terms terms

Asset to be leased must not be consumable, that is, cannot be returned to the lessor in its original form at the end of the lease period

Normal wear and tear accepted.Normal wear and tear accepted.

Salient features of the Salient features of the ijarahijarah contract (2) contract (2)

Ownership of the asset remains with the lessor and only the usufruct is transferred to the lessee

Liabilities and risks incidental to ownership will reside with the lessor

Except liabilities, risks and expenses associated with the use of the leased asset


Period of the Period of the ijarahijarah arrangement must be arrangement must be clearly specified clearly specified

Purpose and mode of usage should be agreed Purpose and mode of usage should be agreed upfrontupfront

The leased asset is a trust in theThe leased asset is a trust in the hands of the hands of the lesseelessee

Lessee liable for damage to leased asset Lessee liable for damage to leased asset only to the extent of the lessee’s only to the extent of the lessee’s negligencenegligence

Lessee does not guarantee the Lessee does not guarantee the safeguarding of the leased asset nor safeguarding of the leased asset nor indemnifies the lessor of damagesindemnifies the lessor of damages


Rental payment must commence after the delivery of the leased asset either actually or constructively (e.g. give keys to house)

Upon loss or non-existence of usufruct, the ijarah contract is terminated

IssuesIssues

What if there is a gap between time of What if there is a gap between time of disbursement by the lessor and delivery of disbursement by the lessor and delivery of the leased asset to the lessee by vendor?the leased asset to the lessee by vendor?

Some jurists opine that the lessor can Some jurists opine that the lessor can demand a security which will constitute demand a security which will constitute advanced rentaladvanced rental

IjarahIjarah-based Vehicle Financing-based Vehicle Financing

Generally, consumers seek vehicle financing for Generally, consumers seek vehicle financing for the purpose of eventually owning the vehiclethe purpose of eventually owning the vehicle

Strictly-speaking, the Strictly-speaking, the ijarahijarah contract will not contract will not result in ownership of the property by the lessee result in ownership of the property by the lessee (person seeking financing)(person seeking financing)

As such, a special type of ijarah contract is As such, a special type of ijarah contract is required to enable eventual ownership of the required to enable eventual ownership of the leased property by the lesseeleased property by the lessee

This type of ijarah contract is known as This type of ijarah contract is known as Al-Ijarah Thumma Al-Bay’ (AITAB) or “leasing ending with sale” or in Bahrain (BIsB), it is known as l- Ijarah Montahia bel Tamleek

BANK

CUSTOMER-Lessee-Owner

Lease and Sell

Bank- Bought the CarLessor

AL- IJARAHTHUMMA AL- BAY

-AITAB (Vehicle- Financing)

Al-Ijarah Thumma Al-Bay’Al-Ijarah Thumma Al-Bay’ (AITAB) (AITAB)

AITAB comprises two different AITAB comprises two different contractscontracts

Contract of leasing (Contract of leasing (ijarahijarah)) Contract of sale (Contract of sale (bay’bay’))

Contract of AITAB not readily found Contract of AITAB not readily found in classical books of in classical books of fiqhfiqh

A creation of modern day A creation of modern day fuqahafuqaha

AITAB AITAB FiqhFiqh Issues Issues

AITAB cannot be constructed to AITAB cannot be constructed to imply that it is a combination of two imply that it is a combination of two different contractsdifferent contracts

That is, it is not a leasing (That is, it is not a leasing (ijarahijarah) ) contract with a condition to sell contract with a condition to sell ((bay’bay’))

Rather, it is a contract of leasing Rather, it is a contract of leasing ((ijarahijarah) with a promise () with a promise (wa’adwa’ad) to ) to sellsell

AITAB AITAB FiqhFiqh Issues (2) Issues (2)

Two different contracts are executed at Two different contracts are executed at two different stagestwo different stages

1. Execute contract of leasing (ijarah) with a promise to sell

2. Once the lease expires and lessee has made all payments, the lessor is obliged to fulfill his promise to sell by executing the contract of sale (bay’)

AITAB AITAB FiqhFiqh Issues (4) Issues (4)

Critical issueCritical issue Despite the fact that the bank is Despite the fact that the bank is

the lessor and owner of the the lessor and owner of the vehicle, vehicle, all risks and liabilities of all risks and liabilities of ownership are effectively ownership are effectively transferred to the lesseetransferred to the lessee

Insurance, road tax, major Insurance, road tax, major maintenancemaintenance

AITAB AITAB FiqhFiqh Issues (5) Issues (5) Critical issue-contCritical issue-cont

Absence of element of ‘iwad in the bank’s profit in the leasing arrangement• The bank does not undertake any market risk

as it does not function as a true lessor of vehicles, merely providing the financing

• Similarly there is no value-added effort on the part of the bank as it is the customer who identifies the vehicle and merely sources financing from the bank

• In the event of product defect, recourse is with the car dealer/manufacturer, not the bank

BoughtMachine from abroad

In practice, once disbursed, the bank starts charging rental

-when the goods have not been delivered to the customer

lease

From Shariah perpectives,From Shariah perpectives,

The lease is between the bank and The lease is between the bank and customer. customer.

Ownership only takes place at the end Ownership only takes place at the end of the period.of the period.

AITAB AITAB FiqhFiqh Issues (6) Issues (6) Additional Additional fiqhfiqh issues issues In the event of late payment, can the bank levy late In the event of late payment, can the bank levy late

payment charges?payment charges? Is it appropriate or permissible for the bank to Is it appropriate or permissible for the bank to

demand a down payment prior to the leasing demand a down payment prior to the leasing arrangement?arrangement?

Can rental payment be on floating rate basis?Can rental payment be on floating rate basis? Is sub-leasing allowed?Is sub-leasing allowed? Can leased assets be securitized?Can leased assets be securitized? What if the lessee wishes to terminate the lease What if the lessee wishes to terminate the lease

agreement early?agreement early? Does the lessor have the right to repossession in Does the lessor have the right to repossession in

the event of default payment?the event of default payment?

Asset SecuritizationAsset Securitization-Taqi Usmani (2002)-Taqi Usmani (2002)

Since the lessor owns the leased asset, he Since the lessor owns the leased asset, he can sell the asset (whole or part) to a third can sell the asset (whole or part) to a third party and my replace the seller in the rights party and my replace the seller in the rights and obligation of the lessor with regard to and obligation of the lessor with regard to the purchased part of the asset.the purchased part of the asset.

rental

leaseA

lease

Sell

Arental

BC

D

E

rental

rental

According to the proportionate ownership of the leased asset

Financial LeaseFinancial Lease

The application of ijarah as a mode of financing The application of ijarah as a mode of financing extends beyond vehicle financingextends beyond vehicle financing

Businesses often require financing to purchase Businesses often require financing to purchase machinery, equipment, other fixed assets and machinery, equipment, other fixed assets and even land and buildingseven land and buildings

To address this need, Islamic financial To address this need, Islamic financial institutions have resorted to a type of institutions have resorted to a type of ijarahijarah contract which is loosely comparable to the contract which is loosely comparable to the conventional financial leaseconventional financial lease

Financial LeaseFinancial Lease

The terms The terms al-ijarah wa al-iqtinaal-ijarah wa al-iqtina, , al-ijarah al-ijarah al-montahia bel tamleekal-montahia bel tamleek and and al-ijarah al-ijarah thumma al-bay’thumma al-bay’ have been used have been used interchangeablyinterchangeably

The basic idea is for the bank to finance the purchase of an asset via a leasing arrangement and at the end of lease period, ownership of the asset is transferred to the customer

Financial Lease (2)Financial Lease (2)

Key features of a financial leaseKey features of a financial lease The lease period equals the expected useful life The lease period equals the expected useful life

of the assetof the asset Acquisition of the lease asset is part of the Acquisition of the lease asset is part of the

leasing arrangement, that is, the bank (lessor) leasing arrangement, that is, the bank (lessor) would not purchase the asset without first would not purchase the asset without first securing the lease contract with the lesseesecuring the lease contract with the lessee

Total lease payments equal the cost of the asset Total lease payments equal the cost of the asset plus the bank’s profit margin, which reflects its plus the bank’s profit margin, which reflects its opportunity cost of funds (typically the market opportunity cost of funds (typically the market interest rate)interest rate)

All risks and liabilities associated with asset All risks and liabilities associated with asset ownership are transferred to the lesseeownership are transferred to the lessee

Financial Lease (3)Financial Lease (3)

In effect, the financial lease is simply an In effect, the financial lease is simply an interest-bearing loaninterest-bearing loan

So why would businesses lease instead of So why would businesses lease instead of borrowing?borrowing?

The motive is purely for tax and/or accounting The motive is purely for tax and/or accounting purposes, where in certain circumstances it is purposes, where in certain circumstances it is advantageous to lease instead of borrowadvantageous to lease instead of borrow

The leasing option can result in the business The leasing option can result in the business paying less taxpaying less tax

Leasing can sometimes be used to window Leasing can sometimes be used to window dress accounting figures and ratios, giving dress accounting figures and ratios, giving the impression that the business is less the impression that the business is less leveragedleveraged

The Islamic Perspective on Financial Lease The Islamic Perspective on Financial Lease (1)(1)

A key characteristic of lease is the A key characteristic of lease is the predetermined and fixed income or predetermined and fixed income or return (in the form of lease rental return (in the form of lease rental payments)payments)

One could ask, how is this different from One could ask, how is this different from an interest-bearing loan?an interest-bearing loan?

Conceptually, the difference is, with riba-based loans, money is treated as the commodity whereas in leasing or ijarah, the usufruct of a tangible property is the commodity or object of sale

The Islamic Perspective on Financial Lease (2)The Islamic Perspective on Financial Lease (2)

More importantly, with ijarah, although the rental payments are fixed, return to the lessor is not

This is because the lessor has to bear two types of risk• Market risk

In a true leasing business, the lessor acquires the lease asset prior to securing any leasing contracts

Thus the lease asset is subject to price risk, the risk that the lessor is not able to profitably lease out the asset

• Operational risk Maintenance costs can sometimes exceed rental

income thereby resulting in a loss to the lessor It is for this reason (undertaking of risk which constitutes

‘iwad) that Islam has permitted ijarah and prohibited riba


Hence, from a Hence, from a Shari’ahShari’ah perspective, one perspective, one critical factor in determining the critical factor in determining the permissibility of any permissibility of any ijarahijarah arrangement arrangement is whether the lessor actually bears risks is whether the lessor actually bears risks expected of a true lessor (ownership expected of a true lessor (ownership risks and maintenance costs)risks and maintenance costs)

That is, is there an element of That is, is there an element of ‘iwad‘iwad in in the the ijarahijarah contract? contract?


In this sense, the Shari’ah only recognizes operational leases and not financial leases (as implemented in the conventional manner) as valid forms of the ijarah contract

In other words, financial leases, as practised conventionally, are in substance nothing other than interest-based loans

Any attempt to structure ijarah arrangements to this effect is merely means of circumventing the prohibition of riba on technical grounds

Some Applications of Some Applications of IjarahIjarah-based Financing-based Financing

A number of applications of financing using A number of applications of financing using the contract of the contract of ijarahijarah are being practised are being practised

These essentially are leasing contracts that These essentially are leasing contracts that end with the lessee owning the assetend with the lessee owning the asset

Some examplesSome examples Direct leasing (Direct leasing (al-ijar al-mubashiral-ijar al-mubashir)) Sale and leaseback (Sale and leaseback (al-bay’ wa i’adah al-al-bay’ wa i’adah al-

isti’jaristi’jar)) Decreasing sale and joint lease (Decreasing sale and joint lease (al-bay’ al-al-bay’ al-

tadriji wa ikhtisas al-sharik bi al-ijarahtadriji wa ikhtisas al-sharik bi al-ijarah))

Direct LeasingDirect Leasing

Airplane ManufacturerBank

Airline1. Airline places order with

airplane manufacturer2. Airline approaches bank

to seek financing

3. Bank pays airplane manufacturer

4. Airplane manufacturer delivers airplane to bank

5. Bank leases airplane to airline in exchange for lease rental payments; at the end of lease term, ownership of airplane

transferred to airline

Sale and LeasebackSale and Leaseback

Bank Manufacturing Company

1. Company sells plant to bank

2. Bank pays cash for plant

3. Bank leases plant to company

4. Company pays periodic lease rental payments

5. At the end of lease period, company repurchases the plant

With this arrangement, the With this arrangement, the manufacturing company obtains manufacturing company obtains liquidity, using its existing assetsliquidity, using its existing assets

Decreasing Sale and Joint LeaseDecreasing Sale and Joint Lease

Airplane Manufacturer

Bank

Airline

1. Bank and airline jointly purchase

airplane

2. Bank simultaneously

sells its share of ownership to the airline and leases

its share to the airline

3. Airline makes periodic payments to

bank comprising:

(i) Installment payment for purchase

of bank’s share

(ii) Lease rental payments

Sale of the bank’s share in ownership of the airplane to Sale of the bank’s share in ownership of the airplane to the airline is made on deferred payment basis (BBA)the airline is made on deferred payment basis (BBA)

At the end of lease period, the airline has complete At the end of lease period, the airline has complete ownership of the airplaneownership of the airplane

Forward LeaseForward Lease Al-ijarah al-mudafah ila al-mustaqbalAl-ijarah al-mudafah ila al-mustaqbal Allowed by a minority view of the Hanbali schoolAllowed by a minority view of the Hanbali school Can be used to structure the financing of an asset Can be used to structure the financing of an asset

under constructionunder construction In effect, an asset under construction is leased, with In effect, an asset under construction is leased, with

lease obligations beginning upon completion of the lease obligations beginning upon completion of the assetasset

Used as an alternative to Used as an alternative to istisna’istisna’ An example of its application is the An example of its application is the Sukuk al-Intifa’Sukuk al-Intifa’

Islamic securityIslamic security Financing of the construction of the Zam Zam Tower Financing of the construction of the Zam Zam Tower

in Meccain Mecca

Lease and Lease Lease and Lease BackBack

lease

lease

1 lump sum rental payment in advance 1m

1.5 million payable monthly payment (deferred)

Opinions:Opinions:

Minority consider this as valid.Minority consider this as valid.

Majority consider this as Bai’ al-Inah.Majority consider this as Bai’ al-Inah.

Middle East: Sale and Lease BackMiddle East: Sale and Lease Back

Shamil Islamic Bank offers Islamic Banking services to its customers. One of the services it offers is its Islamic Asset Leasing. The bank refers to you to certify that its practices in the Islamic Asset Leasing are Shariah compliant. The practice is as follows:

-The bank transfers all the risks and liabilities and expenses related to the leased property to the customer.

-The rental of the leased property is made floating where after the 1st year, the rental will increase according to the bank’s cost of fund.

-The bank charges the rental even before the customer takes possession of the property.

-The bank reserves the right to terminate the leasing contract at any time the bank likes.

-The bank also says that it has right to repossess the property in the case of default in payment of rental.

Advice Shamil Islamic Bank accordingly

ijarah new sem 2201011

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