IjarahIjarah-based Financing

LEASING/ IJARAH

LEASING/ IJARAH
 Basit

wants to purchase a car via Islamic Financing  He wants to know whether he can lease the car without owning it.  What is the difference between conventional financing to purchase a car and Leasing from the Islamic perspective.  What are the other shariah compliant alternatives for him

Slide #1

Some Applications: Direct Leasing Sale and Leaseback Decreasing sale and Joint lease Ijarah Contract

Islamic Perspective on Financial Lease

4a. Ijarah Based Financing

Ijarah Based Vehicle Financing AITAB

Financial Lease

AL- IJARAH

PROPERTY

BANK

Bank- Bought the Property Lessor

Lease CUSTOMERLessee

Ijarah Contract Sale of usufruct (bay al manfaah) )  Usufruct : The right to use and enjoy the profits and advantages of something belonging to another as long as the property is not damaged or altered in any way  Al-ijarah has two types of usufruct  Usufruct of property or capital assets (manfaah al-ayn)  Usufruct of labour, employment and service (manfaah al-amal)


In conventional leasing, there are two types of leases  Operating lease where the lessor owns the asset and bears maintenance costs as well as ownership risks  Financial lease where the lessor only technically owns the asset, maintenance costs and ownership risks are borne by the lessee

Ijarah Contract In ijarah-based financing, ijarah ayn is ijarahapplied  Lessor (mujir) leases property to the mujir) lessee (mustajir) in exchange for mustajir) 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 conventional leasing contract


Salient features of the ijarah contract (1)



Asset to be leased must have a valuable use  Note that value here is defined in Shariah 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.

Salient features of the ijarah contract (2) (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

Salient features of the ijarah contract (3)

  

Period of the ijarah arrangement must be clearly specified Purpose and mode of usage should be agreed upfront The leased asset is a trust in the hands of the lessee  Lessee liable for damage to leased asset only to the extent of the lessees negligence  Lessee does not guarantee the safeguarding of the leased asset nor indemnifies the lessor of damages

Salient features of the ijarah contract (2)



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

Issues
 What

if there is a gap between time of disbursement by the lessor and delivery of the leased asset to the lessee by vendor? jurists opine that the lessor can demand a security which will constitute advanced rental

 Some

IjarahIjarah-based Vehicle Financing

Generally, consumers seek vehicle financing for the purpose of eventually owning the vehicle StrictlyStrictly-speaking, the ijarah contract will not result in ownership of the property by the lessee (person seeking financing) As such, a special type of ijarah contract is required to enable eventual ownership of the leased property by the lessee 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

 

AL- IJARAH THUMMA AL- BAY -AITAB (Vehicle- Financing)

BANK

Bank- Bought the Car Lessor

Lease and Sell

CUSTOMERLessee-Owner

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

AITAB comprises two different contracts  Contract of leasing (ijarah) (ijarah)  Contract of sale (bay) (bay)  Contract of AITAB not readily found in classical books of fiqh  A creation of modern day fuqaha


AITAB Fiqh Issues

AITAB cannot be constructed to imply that it is a combination of two different contracts  That is, it is not a leasing (ijarah) (ijarah) contract with a condition to sell (bay) bay)  Rather, it is a contract of leasing (ijarah) with a promise (waad) to ijarah) (waad) sell


AITAB Fiqh Issues (2)



Two different contracts are executed at two 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 Fiqh Issues (4) 

Critical issue  Despite the fact that the bank is the lessor and owner of the vehicle, all risks and liabilities of ownership are effectively transferred to the lessee


Insurance, road tax, major maintenance

AITAB Fiqh Issues (5)




Critical issue-cont issue-

Absence of element of iwad in the banks 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

Bought Machine 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, The lease is between the bank and customer. Ownership only takes place at the end of the period.

AITAB Fiqh Issues (6)

 

Additional fiqh issues In the event of late payment, can the bank levy late payment charges?  Is it appropriate or permissible for the bank to demand a down payment prior to the leasing arrangement?  Can rental payment be on floating rate basis?  Is sub-leasing allowed? sub Can leased assets be securitized?  What if the lessee wishes to terminate the lease agreement early?  Does the lessor have the right to repossession in the event of default payment?

Asset Securitization -Taqi Usmani (2002)

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

rental

lease

lease A Sell
B C D E

rental

According to the proportionate ownership of the leased asset

rental rental

Financial Lease


The application of ijarah as a mode of financing extends beyond vehicle financing Businesses often require financing to purchase machinery, equipment, other fixed assets and even land and buildings To address this need, Islamic financial institutions have resorted to a type of ijarah contract which is loosely comparable to the conventional financial lease

Financial Lease


The terms al-ijarah wa al-iqtina, al-ijarah alal-iqtina, alal-montahia bel tamleek and al-ijarah alalthumma al-bay have been used alinterchangeably 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)



Key features of a financial lease  The lease period equals the expected useful life of the asset  Acquisition of the lease asset is part of the leasing arrangement, that is, the bank (lessor) would not purchase the asset without first securing the lease contract with the lessee  Total lease payments equal the cost of the asset plus the banks profit margin, which reflects its opportunity cost of funds (typically the market interest rate)  All risks and liabilities associated with asset ownership are transferred to the lessee

Financial Lease (3)

  

In effect, the financial lease is simply an interestinterest-bearing loan So why would businesses lease instead of borrowing? The motive is purely for tax and/or accounting purposes, where in certain circumstances it is advantageous to lease instead of borrow  The leasing option can result in the business paying less tax  Leasing can sometimes be used to window dress accounting figures and ratios, giving the impression that the business is less leveraged

The Islamic Perspective on Financial Lease ( 1)

A key characteristic of lease is the predetermined and fixed income or return (in the form of lease rental payments)  One could ask, how is this different from an interest-bearing loan? interest Conceptually, the difference is, with ribabased 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)



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

The Islamic Perspective on Financial Lease (3)

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


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

The Islamic Perspective on Financial Lease (4)



In this sense, the Shariah 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 Ijarah-based Financing Ijarah  

A number of applications of financing using the contract of ijarah are being practised These essentially are leasing contracts that end with the lessee owning the asset Some examples  Direct leasing (al-ijar al-mubashir) (alal-mubashir)  Sale and leaseback (al-bay wa iadah al(alalistijar) istijar)  Decreasing sale and joint lease (al-bay al(alaltadriji wa ikhtisas al-sharik bi al-ijarah) alal-ijarah)

Direct Leasing
3. Bank pays airplane manufacturer

Bank

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

Airline
2. Airline approaches bank to seek financing 1. Airline places order with airplane manufacturer

Sale and Leaseback

1. Company sells plant to bank

2. Bank pays cash for plant

Bank

3. Bank leases plant to company

Manufacturing Company

4. Company pays periodic lease rental payments

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

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

Decreasing Sale and Joint Lease

Bank
3. Airline makes periodic payments to bank comprising: (i) Installment payment for purchase of banks share (ii) Lease rental payments 2. Bank simultaneously sells its share of ownership to the airline and leases its share to the airline

Airplane Manufacturer

1. Bank and airline jointly purchase airplane

Airline

 

Sale of the banks share in ownership of the airplane to the airline is made on deferred payment basis (BBA) At the end of lease period, the airline has complete ownership of the airplane

Forward Lease
   

 

AlAl-ijarah al-mudafah ila al-mustaqbal alalAllowed by a minority view of the Hanbali school Can be used to structure the financing of an asset under construction In effect, an asset under construction is leased, with lease obligations beginning upon completion of the asset Used as an alternative to istisna An example of its application is the Sukuk al-Intifa alIslamic security  Financing of the construction of the Zam Zam Tower in Mecca

Lease and Lease Back

lease 1.5 million payable monthly payment (deferred)

lease

1 lump sum rental payment in advance 1m

Opinions: Minority consider this as valid. Majority consider this as Bai al-Inah. alMiddle 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 banks 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