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QASIM ALI

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 CHAPTER 1

INTRODUCTION & HISTORICAL BACKGROUND

Islamic Banking is a relatively new field but it is progressing at an encouraging pace around the
world. The basic underlying theme behind its establishment is the belief that interest is not
permissible in Islam and therefore a method should be devised so that we can achieve the same
results, or even better, as compared to traditional banks. There are many instruments that have
evolved in recent times like Musharakah, Mudaraba, and Ijara and Shariah boards in different
areas are on their way to introduce even more facilities in the future. However the purpose of this
paper is not to delve into the details of these instruments but to shed light on some of the
misconceptions regarding leasing in Islamic banking and present areas of future challenges in
this field. (Awan, 2009)
Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must
pay a series of contractual, periodic, tax deductible payments. The lessee is the receiver of the
services or the assets under the lease contract and the lesser is the owner of the assets, whereas
the relationship between land lord and tenant is known as tenancy. The consideration for lease is
rent. (Rawanda 1996)

Types of Leasing

There are two types of leasing.

Financial lease:

It is also known as capital lease. Consideration in this kind of lease is based on financial
transactions. Customer or borrower selects assets and finance company will provide him with the
asset by purchasing it and change rentals from him. Though the financing company will be the
legal owner of the asset during that duration of the lease E.g. Car Leasing. (Kamath, 1990)

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Operating Lease:

An operating lease is a lease whose term is short compared to the useful life of the asset or piece
of equipment (an airliner, a ship, or rent a car etc.) being leased. An operating lease is commonly
used to acquire equipment on a relatively short-term basis. Thus, for example, an aircraft which
has an economic life of 25 years may be leased to an airline for 5 years on an operating lease.
(Awan, 2009)
Among financial leasing, leasing a vehicle is commonly practiced in different part of the world
so as in Pakistan. Vehicle leasing is the leasing of the use of a motor vehicle for a fixed or
indefinite period of time. It is commonly offered by banks and dealer as an alternative to vehicle
purchase. According to the statistics of 2008, an amount of 72 million rupees of vehicles were
leased by different commercial and Islamic banks in Pakistan. Pakistan's economy during the
past decade has major revenue contributed by financial leasing. Due to privatization,
deregulation and other industrial policies of the Government of Pakistan, the economy received a
boost after a prolonged period of lively economic activity over the '70s and '80s. (sigma 2000)

HISTORICAL BACKGROUND

Leasing is not a very old trend in Pakistan, but has gained recognition very rapidly. The first
leasing company was established in 1985. The growth of the leasing industry in Pakistan initially
lacked momentum due mainly to a general lack of awareness regarding its nature and benefits.
From 1985 to 1997, 32 leasing companies were incorporated with the minimum capital of Rs.
100 million. The minimum capital requirement was raised to Rs. 200.00 million by June 2000.
This leads to mergers and acquisition. Thereby the number of leasing companies is reduced to
27. (sigma 2000)
In addition 9 leasing Modarabah’s & 3 Investment Banks are actively involved in leasing
business. In the mid-nineties annual average growth was in the range of 30 - 35 percent. The real
growth in the leasing came in the period 1992 - 95, when over 20 leasing companies were set up.
In October 1995, leasing companies' paid-up capital was Rs.7.572 billion, with market
capitalization of Rs: 6.0 billion as on 30-06-2002. (sigma 2000)
The reasons are growing awareness, ease in obtaining the facility compared to conventional
forms of financing (bank loans), inherent tax benefits, simple procedure and flexibility to cater to

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the needs of the customer. Profit is earned through the use of the asset, not the ownership. In
leasing, the ownership is vested in the leasing company and in return for rental payments, the
'lessee' has virtually unrestricted use of the asset. (Islamic banking, 2005)
Leasing is a medium to long term hire of assets. It effectively increases a company's total
availability of capital and leaves other sources of funds available for more profitable usage.
Conventional banks are the backbone of capitalism economy, because capitalism economies are
based on interest system. (Kamath, 1990)
There are four factors of production in capitalist societies or economies, land, labor, capital, and
entrepreneurship. Capitalism factor “capital” is totally interest based. Banks plays an integral
part of this system. On the other hand Islamic banking refers to a system of banking or banking
activity that is consistent with the principles of Islamic law (Sharia) and its practical application
through the development of Islamic economics. (Awan, 2009)
Sharia prohibits the payment or acceptance of interest fees for the lending and accepting of
money respectively, (Riba, usury) for specific terms, as well as investing in businesses that
provide goods or services considered contrary to its principles (Haraam, forbidden). While these
principles were used as the basis for a flourishing economy in earlier times, it is only in the late
20th century that a number of Islamic banks were formed to apply these principles to private or
semi-private commercial institutions within the Muslim community. (Ahmad, 1994)

LITERATURE REVIEW

Islamic banking has the same purpose as conventional banking except that it operates in
accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions).
The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba
(usury). Common terms used in Islamic banking include profit sharing (Mudharabah),
safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah).
(Labib, 1969,)

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 CHAPTER 2
IJARAH AS A MODE OF FINANCING

Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or
service for a fixed price or wage. Under this concept, the Bank makes available to the customer
the use of service of assets / equipments such as plant, office automation, motor vehicle for a
fixed period and price. (Kamath, 1990)

ADVANTAGES OF IJARAH

Ijarah provides the following advantages to the Lessee:

1) Ijarah conserves the Lessee' capital since it allows up to 100% financing.

2) Ijarah gives the Lessee the right to access the equipment on payment of the first installment.
This is important as it is the access and use (and not ownership) of equipment that generates
income.

3) Ijarah arrangements aid corporate planning and budgeting by allowing the negotiation of
flexible terms. (Islamic banking, 2005)

TYPES OF IJARAH

There are two types of ijarah in Islamic Sharia.

IJARAH OF SERVICES:

When a person employees another person on wage.

Employer : Mustajir

Employee : Ajir

Wages: Ujrah

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IJARAH OF ASSETS & PROPERTY:

When a person transfers the right of use of particular asset/property to another person in
exchange of rent as a charge.

Lessor : Mujir

Lessee: Mustajir

Rent: Ujrah

Ijarah is not considered Debt Financing so it does not appear on the Lessee' Balance Sheet as a
Liability. This method of "off-balance-sheet" financing means that it is not included in the Debt
Ratios used by bankers to determine financing limits. This allows the Lessee to enter into other
lease financing agreement without impacting his overall debt rating. All payments toward Ijarah
contracts are treated as operating expenses and are therefore fully tax-deductible. Leasing thus
offers tax-advantages to for-profit operations. (Usman, 2000)

Many types of equipment (i.e computers) become obsolete before the end of their actual
economic life. Ijarah contracts allow the transfer of risk from the Lessee to the Lessor in
exchange for a higher lease rate. This higher rate can be viewed as insurance against
obsolescence. If the equipment is used for a relatively short period of time, it may be more
profitable to lease than to buy. If the equipment is used for a short period but has a very poor
resale value, leasing avoids having to account for and depreciate the equipment under normal
accounting principles. (Usman, 2000)

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 CHAPTER 3

LEASING PRACTICED BY ISLAMIC BANK IN PAKISTAN (MEZAAN

BANK)
The letter and spirit of Islamic Banking rest upon absolute adherence to the Shariah. The
foundations of a strong Shariah underpinning at Meezan Bank were laid from the beginning. A
world renowned Shariah Supervisory Board and a highly qualified and experienced in house
Shariah Advisor are fundamental aspects of the Bank's core USP. The primary role of this board
is to maintain and further strengthen this commitment and to ensure strict Shariah compliance in
all the Bank's operations. (Usman, 2000)
The members of the Shariah Supervisory Board of Meezan Bank are Internationally-renowned
scholars, serving on the boards of many Islamic banks operating in different countries.

Justice (Retd.) Muhammad Taqi Usmani (Chairman)

Dr. Abdul Sattar Abu Ghuddah

Sheikh Essam M. Ishaq

Dr. Muhammad Imran Ashraf Usmani (Advisor)

FATWA OF IJARAH
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As a step towards Meezan Bank’s mission to provide a one-stop shop for innovative value added
Shariah compliant products, Meezan Bank’s ‘Car Ijarah’ unit provides a car financing, based on
the principles of Ijarah and is free of the element of interest.
DOCUMENTATION AND ELIGIBILITY FOR CAR IJARAH IN MEEZAN
BANK
If you meet the requirements and wish to apply for Car Ijarah, simply fill out an application form
and bring the following documents to your nearest Meezan Bank branch. Individuals/Self-
Employed Professionals/Businessmen
REQUIREMENTS

1) Copy of CNIC
2) Two recent passport sized photographs
3) Recent Utility Bill (Electric/Gas/Water) received at the residential address
4) Last Six Month Bank Statement
5) Last Six Month Bank Statement of Business (for Businessmen)
6) Certified/Original copy of Recent Pay slip (for Salaried Individuals)
7) Copy of Rent Agreement (if applicable) Procedure of Car Leasing in Meezan Bank.

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PHASE 1:

When client asks the bank for the purchase of asset, Meezan bank gives a small questionnaire to
the client asking simple questions regarding information of client and his purpose of buying
asset. Purpose of taking information is to verify either client will be able to pay the installments
of car or not.
PHASE 2:

Banks give two options to the lessee in case of ijarah.

1) Identify the name of asset e.g. Suzuki Mehran, bank will arrange the asset itself. (bank
will identify the cost of vehicle to the client)
2) Buy asset your self. This is usually practiced in second hand cars, though ijarah only
allows this kind of act if bank creates client as agent. (Client will identify the asset itself
from market and ensure bank about the price of asset. The Used Car Ijarah facility is
made available at a minimum-security deposit as low as 20%.

THE SECOND HAND CAR SELECTED SHOULD BE FROM ITS FIRST

OWNER.

The vehicle should not be older than 5 years. The minimum security deposit for a vehicle up to 2
years of age is 20%, while minimum security deposit for a vehicle over 2 years of age is 30%. At
the time of termination of the Ijarah agreement, the vehicle should not be more than 8 years old.
This means that if a car is 5 years old, the Car Ijarah tenure is not more than 3 years and if its 4
years old, the tenure may be set for a maximum 4 year term. This facility is for locally
manufactured cars of Suzuki, Toyota, Honda & the new model of Santro only. Second hand
vehicles selected should not be worth more than Rs. 1 million and less than Rs. 250,000/-.
Meezan Bank will have the vehicle valued by an independent valuation company accordingly.

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PHASE 3

Clients identify the mode of financing among two options of phase 2. Banks provide different
schedule of payments according to the pre requisite demand of client. This phase 3 is totally
negotiable phase between client and bank. When client selects the pre requisite vehicle, all the
copies of documents of phase 1, 2 & 3 are given to the Sales department of bank.

PHASE 4

After negotiating with the bank manager, bank agrees or gives sign of acceptance. Bank makes a
contract of ijarah with the client with certain terms and conditions.

TERMS & CONDITIONS OF IJARAH OF PROPERTY

(CAR LEASING) PRACTICED IN MEEZAN BANK

• Well defined period (months) and well defined consideration (payments).

• Subject of lease must have valuable use. luxury items can not be leased under Islamic
modes of IJARAH
• Consumer items can not be leased.
• Body of the leased vehicle & all the liability remains with the bank. (Terms and
conditions for (insurance) takaful only in case of normal wear and tear).
• Contract will be void if disobeys any of the condition.
• Liability of client, if the damage is because of misuse and negligence.
• In case of natural disaster and natural loss of property bank is responsible.
• Rent should be paid immediately after the delivery of vehicle.
• Bank & client can terminate the contract bilaterally.
• Client cannot sell the vehicle to another party unless bank permits client. (Rules of
shariah allows only commodity is sold for money.)

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 • In case of death of client leased will be transferred to the immediate family members of
client, for this purpose new contract is being signed between bank and new client. Now
its up to the new client either to sign or void the contract.

RIGHTS & LIABILITIES

An Islamic Ijarah is an asset-based contract, i.e. the Lesser should have ownership of the asset
during the period of the contract. Under Islamic Shariah, all ownership related rights and
liabilities should lie with the owner while all usage-related rights and liabilities should lie with
the user. A conventional lease contract does not distinguish between the nature of these liabilities
and places all liabilities on the user of the asset, contradictory to Islamic Shariah. (Meezan bank
web source). Under Ijarah, all ownership-related risks lie with the Bank while all usage related
risks lie with the user, thus making the Lessor the true owner of the asset and making the income
generated through the contract permissible (Halal) for the Bank.

CONTINUATION OF LEASE RENTALS IN CASE OF

TOTAL LOSS OR THEFT OF VEHICLE

If the leased vehicle is stolen or completely destroyed, the conventional leasing company
continues charging the lease rent till the settlement of the Insurance claim. Under the Islamic
system, rent is consideration for usage of the leased asset, and if the asset has been stolen or
destroyed, the concept of rental becomes void. As such, in the above-mentioned eventualities,
Meezan bank does not charge the lease rental.

TAKAFUL OF CAR

Legally (in accordance to Pakistan’s Law and Regulations), it is required for all leasing entities
to insure the leased assets. As such, Meezan Bank insures its leased assets. Meezan Bank insured
its assets through Takaful only, which is Islamic product for insurance.

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IN CASE OF LATE PAYMENTS

In most contemporary financial leases, an extra monetary amount is charged, in their income, if
the rent is not paid on time. This extra amount is the considered as Riba and is Haram. Under
Ijarah, the Lessee may be asked to undertake, that if he fails to pay rent on its due date, he will
pay certain amount to a charity, which will be administered through the Islamic Bank. For this
purpose the bank maintains a charity fund where such amounts may be credited and disbursed
for charitable purpose.
VALIDITY OF CONTRACT

Validity of contract rentals are also decided in the terms and conditions. In this case Meezan
bank usually exercise ijarah with the condition that the rent shall be increased according to a
specific proportion after a specified period which is usually one year.
1. 5% for 1000 CC.
2. 7% for 1800 CC.
3. 10% for heavy vehicles.
PHASE 5

Client sign’s the contract. Both of the parties can cancel the contract unilaterally before it is
signed by the parties. (Delivery of assets directly starts from the day on which vehicle is
delivered to client not from the day of contract in case of ijarah financing.)
PHASE 6

Phase 6 will emerge when the ownership will transfer at the end of lease period. Ownership deed
will be made at the expense of bank. Ownership will transfer with the letter of termination of
loan.

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 CHAPTER 4
BANK ALFALAH CAR FINANCING PRACTICED IN CONVENTIONAL
BANKS (BANK ALFALAH)

Bank Alfalah offers conventional car leasing like other banks used to practice. Car with worth
200000 to 2000000 is given on lease to a customer. Bank Alfalah considers its car leasing
program with minimum down payments, quickest delivery and quickest processing.

DOCUMENTATION AND ELIGIBILITY FOR CAR LEASING

You get a car loan form bank Alfalah to purchase a brand new car if you are Pakistani National
Identity Card holder. Over 20 years of age (Maximum 60 years in case of salaried and 62 in case
of a business person or self employed (at the time of maturity of the loan).

REQUIREMENTS

• Two passport size photographs.

• Copy of National ID card.
• Bank statement for the last six months.
• Salary certificate {for salaried individual}.
• Business proof {for a business person}.
• N.T.N Certificate.
• Co-borrower’s NIC copy {if the car is to be in the name of the co-borrower}.

BAL has recently introduced car leasing facility for individuals and corporate sector has set new
dimensions for the product. Now you are provided with the option of either to get the vehicle
leased or financed.

PHASE 1
Client identifies car to the bank in order to give application to the bank via their web sites or they
have car leasing forms when customer visits banks.

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PHASE 2
Banks approves or disapproves after analyzing their credit management policies. If bank approve
his application then banks checks for client eligibility

PHASE 3
Now in phase 3 ball is on client side either to accept or refuse the contract. If the client is willing
to buy vehicle then he is given a contact paper with the terms and conditions. One can also act as
a co-borrower, acting as a co-borrower will enable your family members {spouse, children- 18
year and above} to avail the financing facility and get the car registered in their names as well.

INSURANCE

Renowned and reliable Insurance companies are offering the competitive rates of insurance. Pay
year insurance premium in advance (at the time of down payment) and the remaining in the
subsequent equal monthly installment. So it means that insurance amount is adjusted is the
monthly amortization schedule.

REPAYMENTS

Easily affordable installments on monthly basis in the form of post-dated cheques will set you
free of depositing your rental cheque every month.

SECURITY

Hypothecation of vehicle is in the name of Bank Alfalah Limited. So there is no need of

serucurity bank needs in order to car vehicle on lease because legally that vehicle is the entity of
bank.

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INTEREST RATES

Financing Product 1Yr 2Yr 3Yr 4Yr 5Yr

Car Loan for Brand New Vehicles 17.50% 17.50% 18.00% 18.50% 18.50%
Car Loan for Brand New Imported Vehicles 19.00% 19.00% 19.00% 19.00% 19.00%
Band New Semi Commercial Vehicles (locally manufactured) 20.00% 20.00% 20.00% 20.00% 20.00%
Second Hand Vehicles 21.00% 21.00% 21.00% 21.00% 21.00%

Corporate Discount Rate

A Corporate Discount of 0.5% shall continue to apply on all above mentioned rates.

PHASE 5

Now the contract has reimbursed, no one can void the contract either unilaterally or by mutual
consensus.

IN CASE OF LATE PAYMENTS:

In case of late payments banks will charge RS 500 on every late payment. If the limit exceeds
three months that bank recovery department takes over the asset and creates an auction of that
assets.
IF PAYMENT IS PAID BEFORE MATURITY PERIOD:
If payment (amount of remaining loan) is paid before the maturity period then bank issues a
letter of enquiry for termination of loan.

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 CHAPTER 5

RESEARCH FINDINGS & CONCLUSION

WHY MOST OF THE BANKS ARE NOT PRESENTING CAR LEASING
IN A PRESENT SCENARIO?

Auto finance was at its peak during 2006-2007 and its share in car sales was 70 per cent to 75per
cent, however in the later years it was almost stopped due to higher interest rates, and most
importantly, auto finance default rate was very high and recovery rate was very low which forced
banks to do critical review of their auto finance product.

After this some of the banks completely stopped auto financing and some opted very stringent
policy, entertaining their reliable customers only. At present its share in the sales is 30 per cent.
The current market scenario of consumer car financing shows that only few of the banks are
doing car financing and some of the key players are Meezan Bank, Dubai Islamic, Faysal Bank,
MCB Bank, HBL and Bank Alfalah. On the other hand, Citibank, UBL Ameen and Standard
Chartered Bank and leasing companies had completely stopped this product, said a market
source.

At present, interest rates at which banks are extending auto finance ranges between 17 and 22per
cent. Initially, minimum equity was 30 per cent but banks have reduced it to 20 per cent to attract
more customers.

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RESEARCH FINDINGS:
Comparison between Islamic and conventional bank from the research outlook of MEEZAN
BANK & BANK ALFALAH.

1) It aims at maximizing profit without any restriction. Islamic banks aim is to maximizing profit
but subject to SHARIAH restrictions.
2) The status of a conventional bank, in relation to its clients, is that of creditor and debtors.
On the other side the status of Islamic bank in relation to its clients is that of partners,
investors and trader, buyer and seller.
3) The status of Islamic bank in relation to its clients is that of partners, investors and trader,
buyer and seller. On the other hand Islamic banks give due importance to the public interest. Its
ultimate aim is to ensure growth with equity.
4) It can charge additional money (penalty and compounded interest) in case of defaulters. On
the other hand Islamic banks have no provision to charge any extra money from the defaulters.
Only small amount of compensation and these proceeds is given to charity. Rebates are give for
early settlement at the Bank's discretion.

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 CONCLUSION:

Banks are the backbone of every economy. In the Pakistani economy both Islamic and
conventional banks has a major part. Though concept of Islamic banking in Pakistan is new but
in last two decades, Islamic banks have grown in size and number around the world. Islamic
banks operate in over 60 countries, but in Iran, Pakistan and Sudan, the entire system has been
converted to Islamic banking. In other countries, banking systems are dominated by
secular/conventional banking institutions operating parallel to Islamic banks, yet Islamic banking
is the fastest growing segment of the credit market in Muslim countries (that have Islamic
banks).leasing is most commonly practiced instrument in all the banks either its Islamic or
conventional bank. Islamic banks offer leasing facility under the law of Sharia which is known as
“Ijarah”. is the selling the benefit of use or service for a fixed price or wage. Under this concept,
the Bank makes available to the customer the use of service of assets / equipments such as plant,
office automation, motor vehicle for a fixed period and price. Many Islamic banks in Pakistan
are practicing car leasing so as conventional banks. In this research paper we have tried to create
comparison between Meezan Bank which practices Ijarah and Bank Alfalah Limited which
practice normal car leasing not according to the rules of Sharia. According to our research
findings Meezan Bank practices Ijarah completely under the rules and regulations of Sharia,
there is no um ambiguity of fraud. The main feature in Ijarah which makes different from
conventional car leaing is that rent is charged which is negotiable. This differentiates that
conventional banks are maximizing profit without any restriction. Islamic banks aim is to
maximizing profit but subject to SHARIA restrictions.

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 RECOMMENDATIONS

According to our research of comparative studies of conventional & Islamic banking car leasing,
our recommendations cover interest of all stake holders (convention banks, Islamic Banks and
Shariah Board). For conventional banks like bank Alfalah is that they should adopt the practices
of Islam in banking especially when they are dealing in Muslim countries. Our second
recommendations are for Islamic bank especially Meezan Bank is that in order to mitigate
misconceptions about Islamic banking especially IJARAH. They should create concrete
marketing campaigns in order to create awareness among people who misinterpreted the concept
of Islamic banking. There is also another misconception about Islamic banking that they are
charging high price when it comes to IJARAH and other financing, but the fact is that the price
which they quote to customers has no hidden charges which is unlikely in conventional banks.
So our core recommendations are to the Shariah board of Pakistan that they should keep an eye
on Islamic banks in order to mitigate misconceptions of Islamic banks in Pakistan.

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