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Ijarah ( (

The Islamic alternative for Leasing

HASSAN KAMRAN

Contents
What is Ijarah
Essentials of Ijarah
Ijarah as a mode of Finance (Conditions of Ijarah)
Difference b/w Islamic Lease & Conventional Lease
Process Flow & documentation
Ijarah risk & its mitigation
Practical Issues
Accounting Entries

What is Ijarah ( (?
Ijarah is a term of Islamic fiqh. Lexically, it means to
give something on rent. In the Islamic jurisprudence, the
term Ijarah is used for two different situations. In the
first place, it means to employ services of a person on
wages given to him as a consideration for his hired
services. The employer is called mustajir while the
employee is called ajir.

What is Ijarah ( (?
The second type of Ijarah related to the usufructs of assets
and properties, and not the services of human beings.
Ijarah in this sense means to transfer the usufruct of a
particular property to another person in exchange for a
rent claimed from him. In this case, the term Ijarah is
analogous to the English term leasing. Here the lessor is
called Mujir, the lessee is called mustajir and the rent
payable to the lesser is called ujrah.

Essentials of Ijarah ( (
1.

A Contract

2.

A Particular Asset

3.

Transfer of Usufruct

4.

Specified Time Period

5.

Agreed-upon Rentals

Essentials of Ijarah ( (
1. Contract
Ijarah is a contract (AQD) just like sale.
All elements of a valid contract (e.g., offer and acceptance,
qualification of parties etc.) must be present.
2. A particular asset
A subject matter of lease should be identifiable, existing,
valuable, usable, capable of ownership/possession,

Essentials of Ijarah ( (
3. Transfer of usufruct

Only the use of the asset is transferred from the lessor to the Lessee.
Ownership & risk of the leased asset remains with the Lessor.
All rights and liabilities relating to ownership are borne by the Lessor.
All rights and liabilities relating to use are borne by the Lessee.

Lessee as Ameen
is liable to use the asset only for the purpose specified in the
agreement.
is liable for loss to the asset due to his negligence
cannot be made liable for loss caused by factors beyond his control.

Essentials of Ijarah ( (
4. Specified Time Period
For the lease to be valid the period for which the usufruct is
transferred should be clearly specified.
5. Agreed upon Rentals
The rent must be determined at the time of contract for the
whole period of lease.
Rental for either the entire period of lease should be fixed at
the outset or should be fixed for a specific period, based on
bench-mark acceptable to both the Parties.

Essentials of Ijarah ( (
5. Agreed upon Rentals (Cont.)
It is permissible to decide different rent for different phases of
lease.
Lessor builds all the procurement expenses of the asset (e.g,
freight, transportation etc.) into the cost of the assets and
then determines the lease rentals.
The rent or any part thereof may be payable in advance before
the delivery of the asset to the lessee.
The lease period shall commence from the date on which the
leased asset has been delivered to the lessee.

Ijarah As A Mode Of Financing


Ijarah is an Islamic alternate to leasing & not
originally a mode of financing.
Leasing should not be interest-based loan or
replacing interest with rent, rather it should
comply with all of the following conditions of
Islamic leasing:

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Conditions of Ijarah ( (

1. The commencement of lease


Unlike the contract of sale, the agreement of Ijarah can be
effected for a future date. Hence, it is different from
Murabaha.
2. Rent should be charged after the delivery of the leased asset
to the lessee
and not from the day the price has been paid. If the supplier
has delayed the delivery after receiving the full price, the
lessee should not be liable for the rent of the period of delay.
3. Different relations of the parties
There are two separate relations between the institution and
the client: one of an agent and the other of a lessee.

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Conditions of Ijarah ( (
4. Expenses consequent to ownership to the lessor
As the lessor is the owner of the asset, he is liable to pay all
the expenses incurred in the process of its purchase and its
import to the country of the lessor for example expenses of
freight and customs duty etc.
5. Lessee as Ameen
The lessee is responsible for any loss caused to the asset by his
misuse or negligence. He can also be made liable to any
normally occurring wear and tear.

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Conditions of Ijarah ( (
6. Variable Rentals in Long Term Leases
In this case the lessor has two options:
A lease contract can have a condition that the rent shall be
increased according to a specified proportion (e.g. 5%) after a
specified period (like one year).
He can contract lease for a shorter period after which the
parties can renew the lease at new terms and by mutual
consent.
7. Charity for late payment of Rent
The lessor cannot charge an additional amount in case the
lessee delays payment of the rent. Penalty of late payment is
given to charity by lessee.

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Conditions of Ijarah ( (
8. Termination of Lease
If the lessee contravenes any term of the agreement, the
lessor has a right to terminate the lease contract unilaterally.
If not then it can be terminated through mutual consent only.
However, in such a case he cannot charge rentals of remaining
period. Further more, the destruction of the asset also
terminates the lease.
9. Insurance of the assets/Takaful
If the leased property is insured under the Islamic mode of
Takaful, it should be at the expense of the lessor and not at
the expense of the lessee.

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Conditions of Ijarah ( (
10. The residual value of the leased asset
Through a mutual agreement of Lease, after the expiry of the
lease period, the corpus of the leased asset cannot be
transferred to the lessee, otherwise it becomes hire purchase.
It is a well-settled rule of Islamic jurisprudence that one
transaction cannot be tied up with another transaction so as to
make the former a pre-condition for the other.
However, the lessor may enter into a unilateral undertaking to
sell the leased asset to the lessee at the end of the lease
period. This undertaking will be binding on the lessor only.

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Conditions of Ijarah ( (
11. Ijarah Wa Iqtina
The lessor may sign a separate promise to gift/Sale the leased
asset to the lessee at the end of the lease period, subject to
his payment of all amounts of rent. The validity of this
arrangement is subject to two basic conditions:
Firstly, the agreement of Ijarah itself should not be subjected
to signing this promise of sale or gift.
Secondly, the promise should be unilateral and binding on the
promisor only.
12. Sub-Lease
If the leased asset is used differently by different users, the
lessee cannot sub-lease the leased asset except with the
express permission of the lessor.

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Difference b/w Islamic Lease


and Finance Lease
Islamic Lease
Rent can only be charged after
delivery of leased assets.
Penalty of late payment of
rental is given to charity.
At the end of lease term,
security deposit can be
refunded to lessee.
Transfer of asset at the end of
lease period to lessee is not
included in the lease
agreement.
All risks and rewards of assets
will be held with bank.

Finance Lease
Rent charged from the days the
price has been paid even if
delivery is delayed.
Penalty of Late payment of
rental is taken into Income.
At the end of lease, down
payment is not refunded to
lessee.
Transfer of asset at the end of
lease period to lessee is a part
of the lease agreement.
All risks and rewards of assets
transferred to lessee.

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Process Flow of Ijarah


1.

The customer approaches the Bank with the


request for financing and provides a promise to
lease the requested asset.

2.

The bank makes payment to the vendor and


purchases the requested asset for leasing.

3.

The Bank acquires the ownership of the asset from


the vendor and takes physical or constructive
possession.
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Process Flow of Ijarah


4.

The bank leases the asset to the customer after


execution of the Lease Agreement, and obtains (through
a separate document) a unilateral promise to purchase
the asset at maturity or earlier from the customer.

5.

The customer makes regular payments of the lease


rentals.

6.

At maturity or earlier the title may be transferred to the


customer in terms of the promise to purchase submitted
by him and at the sole discretion of the bank.

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Flow of Direct Lease


Letter of Request

Lease Application Form

Credit Memorandum
Offer Letter

Signing of Lease Agreement


And Other Documents
Security Deposit and
Documentation Charges
Security Documents
(Post Dated Cheques)

Acceptance
Pay Order to Supplier
Undertaking to Purchase
lease asset

Payment of Rental
By Lessee

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Ijarah Documents

Letter of Request
Lease Agreement
Letter of Agency
Schedule of lease Rentals
Insurance Agency Agreement
Promise to purchase the leased assets
Misc. Undertaking
Promissory Note
Post dated cheques
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Ijarah & Ijarah Muntahia


Bittamleek
Ijarah is the transfer of ownership of a service for an
agreed upon consideration.
Operating Ijarah do not end up with the transfer of
ownership of leased assets to the lessee.
Ijarah Muntahia Bittamleek ends up with the
transfer of ownership of leased assets to the lessee.

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Types of Ijarah Muntahia


Bittamleek

There are several types of Ijarah Muntahia


Bittamleek. These are characterized based
on the method by which the ownership
transfers to the user:
For no consideration (through a gift)
For token consideration
For price specified in the lease
For remaining amount (if lease is
terminated before period)
Gradual transfer
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Ijarah Muntahia Bittamleek


(General Mechanics)
.
VENDOR

ISLAMI BAN
C

Agreement

CUSTOMER

1. The customer approaches the Bank with the


request for financing
2. The Bank purchases the item required for leasing
and receives title of ownership from the vendor
3. The Bank makes payment to the vendor
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Ijarah Muntahia Bittamleek


(General Mechanics)
.
VENDOR

ISLAMI BAN
C

Agreement

CUSTOMER

4. The Bank leases the asset to the customer


5. The customer makes periodic payments as per the
contract
6. The asset title transfers to the customer based on
the method disclosed in the agreement
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Ijarah Risks & its Mitigants


Risk: Theft or Damage of leased asset.
Mitigant: Through takaful arrangements.
Risk: Delay in rental payments
Mitigant: Penalty for late payment (to charity)
Risk: Doubtful Customers
Mitigant: Through KYC Analysis
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