ISLAMIC LEASING – “IJARAH”

BALOCHISTAN UNIVERSITY OF INFORMATION TECHNOLOGY AND

MANAGEMENT SCIENCES

Islamic Leasing - Ijarah

Submitted To Sir Bilal Sarwar

This Report is a collective work of

Farah nagi

Asma batool

Fizzah erum

Qurat-ul-ain

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ContentsWHAT IS LEASING...............................................................................................................................5

Types of Leases ..................................................................................................................................5

1. Operating Lease ......................................................................................................................5

2. Finance Lease..........................................................................................................................5

Components of a Lease .......................................................................................................................5

Adjusted Lease Amount or Adjusted Capitalized Cost............................................................................6

Security Deposit /Down Payment ........................................................................................................6

Lease Term.........................................................................................................................................6

Rental ................................................................................................................................................6

Residual Value....................................................................................................................................6

Termination .......................................................................................................................................7

Forms of Lease Financi ng ....................................................................................................................7

1. Sale and Lease Back .................................................................................................................7

2. Direct Leasing..........................................................................................................................7

3. Leveraged Leasing ...................................................................................................................8

4. Conditional sale Lease..............................................................................................................8

Benefits of Leasing..............................................................................................................................8

Lease vs. Buy............................................................................................................................... .......9

Ijarah .................................................................................................................................................9

Basic rules governing Leasing under Islamic Law .................................................................................10

Lease as a Mode of Financing ............................................................................................................11

The Commencement of Lease ...........................................................................................................12

Different Relations of the Parties.......................................................................................................13

Difference between Murabaha and leasing ........................................................................................13

Expenses Consequent to Ownership ..................................................................................................14

Liability of the Parties in case of Loss of Asset.....................................................................................14

Variable Rentals in Long Term Leases.................................................................................................14

Penalty for Late Payment of Rent ......................................................................................................16

Termination of Lease ........................................................................................................................17

Insurance of the Assets .....................................................................................................................18

The Residual Value of the Leased Asset..............................................................................................18

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Sub-Lease.........................................................................................................................................19

Assigning of the Lease...................................................................................................................... .20

Securitization of Ijarah ......................................................................................................................20

Head-Lease ......................................................................................................................................21

Types of Ijarah..................................................................................................................................22

a) Ijarah Thumma Al Bai' (Hire Purchase) ........................................................................................22

b) Ijarah-Wal-Iqtina ...................................................................................................................... .22

Advantages of Ijarah .........................................................................................................................23

Applications of Ijara ..........................................................................................................................23

Meezan Bank’s Example................................................................................................................23

Economic Benefits of Islamic Leasing .................................................................................................24

Healthy Islamic banking sector reaches new heights in Pakistan ..........................................................25

Statistical Over View of Leasing Sector in Pakistan..............................................................................27

Overview of Islamic Finance in Pakistan .............................................................................................28

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WHAT IS LEASINGLeasing is, in essence, an agreement betwee n two parties for the rental of prope rty (land or asset). It allows one party, the Lessee, to use an asset or prope rty owned by another party, the Lessor. In this regard, leasing is equivalent to an Ijara, an Islamic mode of acqui ring prope rty. The lessee makes the economic use of the lessor’s assets and pays in the form of a re ntal for this privilege.

Types of Leases

Leases can be conducted in several different ways by varying the te rms and conditi ons of the contract. Howeve r, these can be divided in two broad categories - Finance Leases and Operating Leases.

1. Operating Lease

An Operating Lease is a pure rental agreement with three distinctive features: (i) the cost of the asset is not fully amortized ove r the lease period, (ii) the lessor provides maintenance of the asset, and (iii) the asset is usually returned to the lessor. Theref ore, the lessee has the advantage of procuring an asset, utilizing it for its benefit and returning the same when it has served its purpose.

2. Financ e Leas e

A Finance Lease is in essence similar to a loan because substantially all risks and rewards r elated to the leased assets pass on to the lessee. It is mainly characterized by (i) the asset being fully amortized over the lease period, (ii) the lessee is responsible for maintenance costs, and (iii) the owne rship is usually transferred to the lessee a t the end of the lease. In this respect, the involveme nt of the lessor is restricted to financier.

Components of a Lease

These components are essential to a lease contract. By varying these, the type of the lease is determine d. In order to analyze any lease, the following elements should be carefully studied:

Adjusted Lease Amount or Adj usted Capitalized Cost

Security Deposit / Down PaymentLease TermRentalResidual Value

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TerminationThese elements are explored in detail below.

Adjusted Lease Amount or Adjusted Capitalized Cost

The starting point in the calculation of any lease payment is the capitalized cost. This cost is equivalent to the "purchase price" of the asset and generally known as the lease amount. It is reduce d by the amount of any securi ty de posit /down payme nt, and miscellaneous charges. These adjustments are called capitalized cost reductions. After all adjustments are made, the final amount is referred to as the adjusted lease amount or adj usted capitalized cost. This is the amount of financing provide d by the lessor to the lessee.

Security Deposit /Down Payment

The security deposit, often termed as a Down Payment or Equity Contribution, is the a mount most Lessors obtain at the onset of a lease. This amount serves as a security for the lessor (apart from the asset itself) and is refunded to the lessee at the end of the lease provided the terms and conditi ons of the lease contract have been met. For the lessee, a higher amount yields a lower adjusted lease amount resulting in reduced rentals. Therefore, the lessee has to make a trade-off between a higher security deposit and higher rentals.

Lease Term

The lease term can vary considerably from lease to lease. However, in Pakistan, it is usually betwee n three to five years. The length of the lease term has a vital role in determi ning the payments. In a fully amortized lease, a longer lease period can reduce the payme nts while a shorte r period has the opposite effect.

Rental

The rental represents periodic payments of agreed rent over the lea se term. It represents a charge for the depreciating asset as well as a rent charge. The rent charge includes the cost of funds, ove rheads and services being provide d by the lessor. It is the compensation that a lessor claims for providing the lessee the economic use of the asset.

Residual Value

The residual value is the amount the asset is considered to be worth at the end of the lease. It is generally expressed as a percentage of the lease amount. In cases where the ownership is

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transferre d to the lessee, the residual value forms the sale price. Like the security deposit, a higher residual value can lower the re ntal payments.

Termination

Most leases cannot be terminated before the end of the lease by design. Terminations are possible if the lessee wants to payoff the lessors or when a forced termination is undertaken in the event that the underlying assets are destroyed, i.e. stolen or made unproductive. If one terminates the lease early, he has to pay for the privilege. For the lessor, an early terminatio n results in generating an unexpected cash inflow. The lessor looses the expected income from the lease until the terminate d amount is redeployed in anothe r investme nt. Gene rally, lessors charge a penalty for early termination to avoid this loss of income.

Forms of Lease Financing

Following are some important forms of lease financing, these forms are varied with respect to the process, time period and othe r terms and conditions upon which the lease contract is finalized;

1. Sale & Lease Back2. Direct Lease3. Leveraged Lease4. Conditional sale lease

1. Sale and Le ase BackThis form lease involves an arrangement where a pa rty sells an asset and again it is taken on lease back to the vendor. The rental and the sales price are usually interdepende nt and sold at marke t value. The firm receives the sale price in cash and the economic use of the asset during the basic lease period. In turn promise to pay pe riodic lease payments and gives up title of the asset to the lessor. As a result, the lessor realizes any residual value at the end of lease term.

2. Direct Leas ingUnde r direct leasing, a company acquires the use of an asset it did not own previously. A firm may lease an asset from the manufacture r, e.g. IBM leases compute rs, Xerox leases copiers and Honda Breeze leases cars. Indeed capital goods are abundantly available today on a lease. In certain cases, a lessor may achieve economies of scale and may pass it to the lessee in form of lower lease payments.Initial direct costs are usually charged to income at the ince ption of lease because they aremainly related to earning the dealer’s or manufacturer’s

profit.

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3. Leverag ed LeasingIn recent years a new type of lease, the leveraged lease, has come into widespread use. There are three pe rsons involved in leveraged leasing namely lessor, lessee, and lender. From the lessee point of view, the re is no difference be tween a leveraged and othe r lease. However, the lessor arranges to borrow part of the require d funds, generally giving the lender a first mortgage on plant and equipme nt being leased. The lessor is also called the equity participant by investing 20% in leased asset. The lessor still receives the tax shelter associated with accelerated depreciation. Howeve r, the lessor now has a riskier position, because he is j unior to that of the lende r, who has first mortgage on plant or e quipment and future lease rentals. Typically, a leveraged lease provides the lessor with a higher expected NPV per dollar of invested capital than non-leveraged lease because the interest component would re present anothe r tax deduction, while the loan re payme nt would constitute additional cash outlays. The initial cost would be reduced by the amount of loan.

4. Conditional sale LeaseIf any of the conditi ons just involved in leasing are violated in lease arrangements, then the lease becomes a conditional lease. A conditional sale lease is one in which simply you can say that lessee has purchased the lease rather tha n prope rly involving into a prope r lease agreement, the lessor is viewed as having financed this purchase via a loan. For tax purpose the lessee treats the property as owned and claims the depreciation. Lease payments are treated as loan payments.

Benefits of Leasing

Leasing offers many substantial benefits both for the lessee and the lessor. The following are some of the benefits that a lessee can derive from a lease.

1. Leasing is acceptable within the Islamic modes of finance as fixed rental payments are made and inte rest is not involved.

2. Large lease payments are fully tax deductible a t the time of payment; the refore an

incentive may exist to load payments into a particular tax year.3. Lower present value of after-tax leasing costs compared to purchase costs.4. Leasing provides long-term lending at fixed rentals.5. Leasing assures maximum conservation of capital as it makes large investments in fixed

assets unnecessary. The lessee can use this for other purposes such as working capital, trade debts, and seasonal expenditures.

6. Leasing permits conservation of existing lines of credit that can be used for other purposes.

7. Leasing guards against technological obsolescence.8. The terms and conditions are flexible and can be customized for the lessee.9. Lease rentals can be structured in accordance with the Lessee’s cash flow require ments.

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10. Leasing being long-term provides a hedge against inflation.11. Facilitates capital budgeting as rental payments are fixed.12. Off balance sheet financing may enhance ability to borrow by improving appare nt

liquidity and enhancing return on investme nt.

Lease vs. Buy

The primary difference betwee n Leasing and Buying is the owne rship of the asset. A straight purc hase gives a person an immediate ownership of the asset. However, in a lease, the owne rship of the asset vests with lessor. The lessee benefits from the economic use of an asset that does not belong to him. A closer look reveals that it is the usage of the asset that is important rathe r than its ownership. The economic benefit of the asset lies with a person whether he leases or buys the asset. For personal usage, it is the pleasure of say, driving a new car. For business purposes, it’s the usage that translates into profits.

Another differe nce is the initial cash outlay requireme nt. Whe n buying, a person pays the cost of the asset as a lump-sum a mount at the onset. Howeve r, leasing enables a person to pay only a part of the cost (down payment) and begin utilization of the asset before repaying the full amount. The re maining amount is repaid with fixed payments over a period of time.

Ijarah“Ijarah” is a term of Islamic fiqh. Lexically, it means ‘to give something on rent’. In the Islamic jurisprudence, the te rm ‘Ijarah’ is used for two different situations. In the first place, it means‘to e mploy services of a person on wages given to him as a consideration for his hired services’. The employe r is called ‘musta’jir’ while the employee is called ‘ajir’.

Therefore, if A has employed B in his office as a manager or as a clerk on a monthly salary, A is a musta’jir, and B is an ajir. Similarly, if A has hired the services of a porte r to carry his baggage to the airport, A is a musta’jir while the porte r is an ajir, and in both cases the transactions between the parties is termed as Ijarah. This type of Ijarah includes every transaction where the services of a person are hired by someone else. He may be a doctor, a lawyer, a teacher, a laboure r or any other person who can render some valuable services. Each one of them may be called an ‘ajir’ according to the te rminology of Islamic Law, and the person who hires their services is called a ‘musta’jir’ while the waged paid to the ‘ajir’ are called their ‘ujrah’.

Ijarah means lease, rent or wage. Generally, Ijarah concept means

selling benefit or 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.

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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 prope rty to another pe rson in exchange for a rent claimed from hi m. ’ In this case, the term ‘Ijarah’ is analogous to the English term ‘leasing’. Here the lessor is called ‘Mu’jir’, the lessee is called‘musta’jir’ and the rent payable to the lesser is called ‘ujrah’.

The rules of Ijarah, in the sense of leasing, are very analogous to the rules of sale, because in both cases somethi ng is transferred to anothe r person for a valuable consideration. The only difference between Ijarah and sale is that in the latter case the corpus of the prope rty is transferre d to the purchaser, while in the case of Ijarah, the corpus of the property re mains in the ownership of the transferor, but only its usufruct i.e. the right to use it, is transferred to the lessee.

Therefore, it can easily be seen that ‘Ijarah’ is not a mode of financi ng in its origin. It is a normal business activity like sale. However, due to certain reasons, and in particular, due to some tax concessions it may carry, this transaction is being used in the Western countries for the purpose of financing also. Instead of giving a simple interest – bearing loan, some financial institutions started leasing some equipments to their custome rs. While fixing the rent of these equipments the y calculate the total cost they have inc urred in the purchase of these assets and add the stipulated inte rest they could have claimed on such an amount during the lease period. The aggregate amount so calculated is divided on the total months of the lease period, and the monthly rent is fixed on that basis.

The question whe the r or not the transaction of leasing can be used as a mode of financing in Shari’ah depe nds on the te rms and conditions of the contract. As me ntioned earlier, leasing is a normal business transaction and not a mode of financing. Therefore, the lease transaction is always governed by the rules of Shari’ah prescribed for Ijarah. Let us, therefore, discuss the basic rules governing the lease transactions, as enumerated in the Islamic Fiqh. After the study of these rules, we will be able to understand unde r what conditions the Ijarah may be used for the purpose of financing.

Basic rules governing Leasing under Islamic Law

1. Lease is a contract where by the owne r of an asset transfers its benefits to another person for an agreed period, at an agreed consideration.

2. The object being leased must have a valuable use.3. It is necessary for a valid lease contract that the leased asset remains in the owne rship

of the seller, and only its usage is transferred to the lessee. A lease cannot be affected in respect of consumables, fuel, ammunition, etc. because their use is not possible unless they are consumed.

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4. As the leased prope rty remains in the ownership of the lessor, all the liabilities emerging from the owne rship shall be borne by the lessor, but the liabilities arising from the use of the prope rty shall be borne by the lessee.

5. The period of lease must be defined.6. The lessee cannot use the leased asset for any purpose other than the purpose specified

in the lease agreement.

7. The lessee is liable to compensate the lessor for any damag e to the leased asset caused

by any misuse or negligence on the part of the lessee.

8. Any harm or loss incurred during the lease period and caused by factors beyond thecontrol of the lessee shall be borne by the lessor.

9. A prope rty jointly owned by two or more persons can be leased out, and the rental shall

be distributed be tween all the joint owne rs according to the proportion of their respective shares in the prope rty.

10. It is necessary for a valid lease that the leased asset is fully identified by the parties.11. The rental must be de termine d at the time of contract for the whole peri od of

lease. It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent f or each phase is specifically agreed upon at the time of affecting a lease. If the rent for a subsequent phase of the lease period has not been de termine d or has been left at the option of the lessor, the lease is not valid.

12. The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of the Sha ri’ah, if both pa rties agree to it, provided that all other conditions of a valid lease prescribed by the Shari’ah are fully adhered to.

13. The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.14. The rent or any other part the reof may be payable in advance before the delive ry of

the asset to the lessee, but the amount so collected by the lessor shall remain with hi m as‘on account’ payment and shall be adjusted towards the rent after its being due.

15. The lease period shall comme nce from the date on which the leased asset has beendelivered to the lessee, no matter whethe r the lessee has started using it or not.

16. If the leased asset has totally lost the function for which it was leased, and no repair is

possible, the lease shall terminate on the day in which such loss has been caused. Howeve r, if the loss is caused by the misuse or by the negligence of the lessee, he will be liable to compensate the lessor for the depreciated value of the asset as, it was imme diately before the loss.

Lease as a Mode of Financing

Like Muraba ha, lease is not originally a mode of financing. It is simply a transaction meant to transfer the usufruct of a prope rty from one person to another for an agreed period against an agreed consideration. Howeve r, certain financial institutions have adopted leasing as a mode of financing instead of long term lending on the basis of interest. This kind of lease is generally

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known as the ‘financial lease’ as distinguished from the ‘ope rating lease’ and many basicfeatures of actual leasing transaction have been dispensed with therein.

When inte rest-free financial institutions were established in the near past, they found that leasing is a recognized mode of finance throughout the world. On the other hand, they realized that leasing is a lawful transaction according to Shari’ah and it can be used as an interest -free mode of financing. Therefore, leasing has been adopted by the Islamic financial institutions, but very few of them paid attention to the ‘financial lease’ have a number of characte ristics more similar to interest tha n to the actual lease transaction. That is why they starte d using the same model agreements of leasing as were in vogue among the conventional financial institutions without any modification, while a numbe r of their provisions were not in conf ormity with Shari’ah.

As mentione d earlier, leasing is not a mode of financing in its origin. However, the transaction may be used for financing, subject to certain conditions. It is not sufficient for this purpose to substitute the name of ‘interest’ by the name of ‘rent’ and replace the name ‘mortgage’ by the name of ‘leased asset’. There must be a substantial difference between leasing and an interest - bearing loan. That will be possible only by following all the Islamic rules of leasing.

To be more specific, some basic differences between the conte mporary financi al leasing andthe actual leasing allowed by the Shari’ah are indicated below.

The Commencement of Lease

Unlike the contract of sale, the agreement of Ijarah can be affected for a future date. Thus, while a forward sale is not allowed in Shari’ah, an ‘Ijarah’ for a future date is allowed, on the condition that the rent will be payable only after the leased asset is delivered to the lessee.

In most cases of the ‘financial lease’ the lessor i.e. the financial institution purchases the asset through the lessee himself. The lessee purchases the asset on behalf of the lessor who pays its price to the supplier, either directly or through the lessee. In some lease agreements, the lease commences on the very day on which the price is paid by the lessor, irrespective of whethe r the lessee has affected payme nt to the supplier and take n delivery of the asset or not. It may mean that lessee’s liability for the rent starts before the lessee takes delivery of the asset. This is not allowed in Shari’ah, because it IJARAH amounts to charging rent on the money given to the custome r which is nothing but inte rest, pure and simple.

The correct way according to Shari’ah, is that the rent be charged after the lessee has taken delivery of the asset, and not from the day the price ha s been paid. If the supplier has delayed the delivery afte r receiving the full price, the lessee should not be liable for the rent of the period of delay.

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Different Relations of the Parties

It should be clearly unde rstood that when the lessee himself has been entrusted with the purc hase of the asset intended to be leased, there are two separate relations between the institution and the client which come into ope ration one afte r the othe r. In the first instance, the client is an agent of the institution to purchase the asset on latter’s behalf. At this stage, the relation between the parties is nothing more than the relation of a principal and his agent. The relation of lessor and lessee has not yet come into operati on.

The second stage begins from the date when the client takes delivery from the supplier. At this stage, the relation of lessor and lessee comes to play its role.

These two capacities of the parties should not be mixed up or confused with each othe r. During the first stage, the client cannot be held liable for the obligations of a lessee. In this period, he is responsible to carry out the functions of an agent only. But when the asset is delivered to him, he is liable to discharge his obligations as a lessee.

Difference between Murabaha and leasing

In Murabaha, as mentioned earlier, actual sale should take place after the client takes delivery from the supplier, and the previous agreement of Murabaha is not e nough f or affecting the actual sale. Therefore, after taking possession of the asset as an agent, he is bound to give intimation to the institution and make an offer for the purchase from him. The sale takes place after the institution accepts the offer.

In Murabaha actual sale should take place after the client takes delivery from the supplier, and

the previous agreement of Murabaha is not enough for

affecting the actual sale.

The procedure in leasing is different, and a littleshorte r. Here, the parties need not affect the lease contract after taking delivery. If the institution, while appointing the client its agent, has agreed to lease the asset with effect from the date of delivery, the lease will automatically start on the date without any additional proce dure.

There are two reasons for this difference between Murabaha and leasing: Firstly, it is a necessary condition f or a valid sale that it should be affected instantly. Thus, a sale attributed to a future date is invalid in Shari’ah. But leasing can be attributed to a future date. Therefore, the previous agreement is not sufficient in the case of Murabaha, while it is quite enough in the case of leasing.

Secondly, the basic principle of Shari’ah is that one cannot claim a profit or a fee for a prope rtythe risk which was never borne by him.

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Applying this principle to Murabaha, the seller cannot claim a profit over a prope rty which never remaine d under his risk for a moment. The refore, if the previous agreement is held to be sufficient for affecting a sale between the client and the institution, the asset shall be transferre d to the client simultaneously when he takes its possession, and the asset shall not come into the risk of the seller even for a moment. That is why the simul taneous transfer is not possible in Murabaha, and the re should be a fresh offer and acceptance after the delivery.

In leasing, however, the asset remains under the risk and owne rship of the lessor throughout the leasing period, because the ownership has not been transferred. Theref ore, if the lease period begins right from the time when the client has taken de livery, it does not violate the principle mentione d above.

Expenses Consequent to Ownership

As the lessor is the owner of the asset, and he has purchased it from the supplier through his agent, he is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor. Consequently, he is liable to pay the freight and the customs duty etc. He can, of course, include all these expenses in his cost and can take them i nto consideration while fixing the rentals, but as a matter of principle, he is liable to bear all these expenses as the owner of the asset. Any agreeme nt to the c ontrary, as is found in the traditional financial leases, is not in conformity with Shari’ah.

Liability of the Parties in case of Loss of Asset

As mentioned in the basic principles of leasing, the lessee is responsible for any loss caused to the asset by his misuse or negligence. He can also be made liable to the wear and tea r which normally occurs during its use. But he cannot be made liable to a loss caused by the factors beyond his control. The agreeme nts of the traditional ‘financial lease’ generally do not differentiate between the two institutions. In a lease based on the Islamic principles, both the situations should be dealt with separa tely.

Variable Rentals in Long Term Leases

In the long term lease agreements it is mostly not in the benefit of the lessor to fix one a mount for rent for the whole period of lease, because the market conditions change from ti me to ti me.

In this case the lessor has two options:

a) He can contract lease with a condition that the rent shall be increased accordingly to a specified proportion (e.g. 5%) after a specified period (like one year).

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b) He can contract lease for a shorte r pe riod after which the partie s can renew the lease at new terms and by mutual consent, with full liberty to each one of them to refuse the renewal, in which case the lessee is bound to vacate the leased property and return it back to the lessor.

These two options are available to the lessor according to the classical rules of Islamic Fiqh. Howeve r, some conte mpora ry scholars have allowed, in long te rm leases, to tie up the re ntal amount with a variable benchmark which is so well -known and well-defined that it does not leave room for any dispute. For exa mple, it is permissible according to provide in the lease contract that in case of any increase in the taxes imposed by the gove rnment on the lessor, the rent will be increased to the extent of the s ame amount. Similarly it is allowed by the m that the annual increase in the rent is tied up with the rate of inflation. Therefore if there is an increase of 5% in the rate of inflation, it will result in an increase of 5% in the rent as well.

Based on the same principle, some Islamic banks use the rate of interest as a benchmark to determine the re ntal amounts. They want to earn the same profit through leasing as is earned by conve ntional banks through advancing loans on the basis of interest. Therefore, th ey wa nt to tie up the re ntals with the rate of interest and instead of fixing a definite amount of re ntal, they calculate the cost of purchasing the lease assets and want to earn through rentals an amount equal to the rate of inte rest. Therefore, the agreeme nt provides that the re ntal will be equal to the rate of interest or to the rate of interest plus something. Since the rate of inte rest is variable, it cannot be determine d for the whole lease period. Therefore, these contracts use the interest rate of a particular country (like LIBOR) as a benchmark for dete rmining the periodical increase in the rent.

This arrangement has been criticized on two grounds:

The first objection raised against it is that, by subjecting the rental payme nts to the rate of interest, the transaction is rendere d akin to an inte rest based financing. This objection can be overcome by saying that, as fully discussed in the case of Murabaha, the rate of inte rest is used as a benchmark only. So far as other require ments of Shari’ah for a valid lease are properly fulfilled, the contract may use any benchmark for dete rmining the amount of re ntal. The basic difference betwee n an interest – based financing and a valid lease does not lie in the amount to be paid to the financier or the lessor. The basic difference is that in the case of the lease, the lessor assumes the full risk of the corpus of the leased asset. If the asset is destroyed duri ng the lease period, the lessor will suffer the loss. Similarly, if the leased asset looses its usufruct without any misuse or negligence on the lessee, the lessor cannot claim the re nt, while in the case of an interest-based financing, the financier is entitled to receive interest, even if the debtor did not at all benefit from the mone y borrowed. So far as this basic difference is maintained, (i.e. the lessor assumes the risk of the leased asset) the transaction cannot be categorized as an interest-bearing transaction, even though the amount of rent claimed from the lessee is equal to the rate of interest.

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It is thus clear that the use of the rate of interest me rely as a benchmark does not rende r the contract invalid as an interest-based transaction. It is, however, advisable at all times to avoid using interest even as a benchmark, so that an Islamic transaction is totally distinguished from an un-Islamic one, having no resemblance of interest whatsoever.

The second objection to this arrangeme nt is that the variations of the rate of inte rest being unknown, the re ntal tied up with the rate of interest will imply Jahalah and Gharar which is not permissible in Shari’ah. It is one of the basic require ments of Shari’ah that the consideration in every contract must be known to the parties when they enter into it. The consideration in a transaction of lease is the rent charged from the lessee, and therefore it must be known to each party right at the beginning of the contract of lease. If we tie up the rental with the future rate of interest, which is unknown, the amount of rent will re main unknown as well. This is the Jahalah or Gharar which re nde rs the transaction invalid.

Responding to this objection, one may say that the Jahalah has been prohibi ted for two reasons: One reason is that it may lead to dispute between pa rties. This reason is not applicable here, because both parties have agreed with mutual consent upon a well defined benchmark that will serve as a criterion for de termining the rent, and whateve r am ount is determined, based on this benchmark, will be acceptable to both parties. Therefore, there is no question of any dispute betwee n the m.

The second reason for the prohibition of Jahalah is that it renders the parties susceptible to an unforeseen loss. It is possible that the rate of interest, in a particular period, zooms up to an unexpecte d level in which case the lessee will suffer. It is equally possible that the rate of interest zooms down to an unex pected level, in which case the lessor may suffer.

In order to mee t the risks involved in such possibilities, it is suggested by some contemporary scholars that the relation be twee n rent and the rate of inte rest is subjected to a limit or ceiling. For example, it may be provide d in the base contract that the rental amount after a given period will be changed according to the change in the rate of interest, but it will in no case be higher than 15% or lower than 5% of the previous monthly rent. It will mean that if the increase in the rate of interest is more than 15% the re nt will be increased only up to 15%. Conve rsely, if the decrease in the rate of interest is more than 5% the re nt will not be dec reased to more than5%.

In our opinion, this is a mode rate view which takes care of all the aspects involved in the issue.

Penalty for Late Payment of Rent

In some agreeme nts of financial leases, a penalty is imposed on the lessee in case he delays the payment of rent afte r the due date. This penalty, if meant to add to the income of the lessor, is not warrante d by the Sha ri’ah. The reason is that the rent after it becomes due, is a debt payable by the lessee, and is subject to all the rules prescribed for a debt. A monetary charge

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from a debtor for his late payme nt is exactly the riba prohibite d by the H oly Qur’ a n. Theref ore, the lessor cannot charge an additional amount in case the lessee delays payment of the rent.

Howeve r, in order to avoid the adverse consequences resulting from the misuse of this prohibition, anothe r alternative may be resorted to. The lesse e may be asked to undertake that, if he fails to pay rent on its due date, he will pay a certain amount to a charity. For this purpose the financier / lessor may maintain a charity fund where such amounts may be credited and disbursed for charitable purpos es, including advancing interest-free loans to the needy pe rsons. The amount payable for charitable purposes by the lessee may vary according to the period of default and may be calculated at per cent, per annum basis. The agreement of the lease may contain the following clause for this purpose:

“The Lessee hereby undertakes that, if he fails to pay rent at its due date, he shall pay an amount calculated at …% p.a. to the charity Fund maintained by the Lessor which will be used by the Lessor exclusively for charitable purposes approved by the Shari’ah and shall in no case form part of the income of the Lessor.”

This arrangement though does not compensate the lessor for his opportunity c ost of the pe riod of default, yet it may serve as a strong deterrent for the lessee to pay the rent promptly.

The justification for such unde rtaking of the lessee, and inability of any penalty or compe nsation claimed by the lessor for his own be nefit is discussed in full in the chapter‘Murabaha’ in the present book which may be consulted for details.

Termination of Lease

If the lessee contravenes any term of the agreement, the lessor has a right to terminate the lease contract unilaterally. However, if there is no contravention on the part of the lessee, the lessee cannot be terminated without mutual consent. In some agreements of the ‘financial lease’ it has been noticed that the lessor has been given an unrestricted powe r to te rminate the lease unilaterally whenever he wishes, according to his sole judgement. This is again con tra ry to the principles of Shari’ah.

In some agreements of the ‘financial lease’ a condition has been found to the effect that in case of the te rmi nation of the lease, even at the option of the lessor, the rent of the re maining lease period shall be paid by the lessee.

This condition is obviously against Shari’ah and the principles of equity and justice. The basic reason for inserting such conditions in the agreement of lease is that the main concept behind the agreement is to give an interest-bearing loan under the ostensible cover of lease. That is why every effort is made to avoid the logical consequences of the lease contract.

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Naturally, such a condition cannot be acceptable to Shari’ah. The logical consequence of the termination of lease is that the asset should be taken back by the lessor. The lessee should be asked to pay the re nt as due up to the date of te rmination. If the termination has been effected due to the misuse or negligence on the part of the lessee, he can also be asked to compensate the lessor for the loss caused by such misuse or negligence. But he cannot be compelled to pay the rent of the re maining period.

Insurance of the Assets

If the leased property is insured unde r the Islamic mode of takaful, it should be at the expense of the les sor and not at the expe nse of the lessee, as is generally provided in the agreements of the current ‘financial leases’.

The Residual Value of the Leased Asset

Another i mportant feature of the modern ‘financial leases’ is that after the expiry of the lease period, the corpus of the leased asset is normally transferred to the lessee. As the lessor already recove rs his cost along with an additional profit there on, which is normally equal to the amount of interest which coul d have been earned on a loan of that amount advance d for that period, the lessor has no furthe r inte rest in the leased asset. On the other hand, the lessee wants to retain the asset after the expiry of the leased period.

For these reasons, the leased asset is generally transferred to the lessee at the end of the lease, either free of any charge or at a nominal token price. In order to ensure that the asset will be transferre d to the lessee, sometimes the lease contract has an express clause to this effect. Sometimes this condition is not mentioned in the contract expressly; however, it is understood betwee n the parties that the title of the asset will be passed on to the lessee at the end of the lease term.

This condition, whethe r it is express or implied, is not in accordance with the principles of Shari’ah. It is a well settled rule of Islamic jurisprude nce that one transaction cannot be tied up with another transaction so as to make the former a pre-conditi on for the other. Here the transfer of the asset at the end has been made a necessary condition for the transaction of lease which is not allowed in Shari’ah.

The original position in Shari’ah is that the asset shall be the sole property of the lessor, and after the ex piry of the lease period, the lessor shall be at liberty to take the asset back, or to renew the lease or to lease it out to anothe r party, or sell it to the lessee or to any other person. The lessee cannot force him to sell it to him at a nominal price, nor can such condition be imposed on the lessor in the lease agreement.

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But after the lease period expires, and the lessor wants to give the asset to the lessee as a gift or sell it to him, he can do so by his free will.

Howeve r, some contemporary scholars, keeping in view the needs of the Islamic financial institutions have come up with an alternative. They say that the agreement of Ijarah itself should not contain a condition of gift or sale at the end of the lease period. Howeve r, the lessor may ente r into a unilateral promise to sell the leased asset to the lessee at the end of the lease period. This promise will be binding on the lessor only. The principle, according to them, is that a unilateral promise to enter into a contract at a future date is allowed where by the promisor is bound to fulfill the promise, but the promisee is not bound to ente r into that contract. It means that he has an option to purchase which he may or may not exercise. However, if he wants to exercise his option to purchase, the promisor cannot refuse it because he is bound by his promise. Therefore, these scholars suggest that the lessor, after entering into the lease agreement, can sign a separate unilateral promise where by he unde rtakes that if the lessee has paid all the amounts of rentals and wants to purchase the asset at a specified mutually acceptable price, he will sell the leased asset to him for that price.

Once this promise is signed by the lessor, he is bound to f ulfill it and the lessee may exercise his option to purchase at the end of the period, if he has fully paid the amounts of rent according to the agreeme nt of lease. Similarly, it is also allowed by these scholars that, instead of sale, the lessor signs a separate promise to gift the leased asset to the lessee at the end of the lease period, subject to his payment of all amounts of rent.

This arrangement is called ‘Ijarah wa iqtina’. It has been allowed by a large numbe r of conte mporary scholars and is widely a cted upon by the Islamic banks and financial institutions. The validity of this arrangement is subject on two basic conditions:

Firstly, the agreement of Ijarah itself should not be subjected to signing this promise of sale or gift but the promise should be recorded in a separate docume nt.

Secondly, the promise should be unilateral and binding on the promisor only. I t should not be a bilateral promise binding on both pa rties because in this case it will be a full contract effected to a future date which is not allowed in the case of sale or gift.

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. If the lessor permi ts the lessee for subleasing, he may sublease it. If the rent claimed from the sub-lessee is equal to or less than the rent payable to the owne r / original lessor, all the recognized schools of Islamic jurisprudence are una nimous on the permissibility of the sublease. However, the opini ons are different in case the rent charged from the sub lessee is higher than the rent payable to the owne r. I mam al-Shafi’i and some other scholars allow it and hold that the sub lessor may e njoy

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the surplus received from the sub-lessee. This is the preferre d view in the Hanbali school as well. On the other hand, Imam abu Hanifah is of the view that the surplus received from the sub lessee in this case is not permissible for the sub –lessor to keep and he will have to give that surplus to charity. Howeve r, if the sub-lessor has developed the leased property by adding something to it or has rente d it in a currency different f rom the currenc y in which he hi mself pays rent to the owne r / the original lessor, he can claim a higher rent from his sub-lessee and can enjoy the surplus.

Although the view of I mam Abu Hanifah is more precautious which should be acted upon to the best possible extent, in cases of need the view of Shafi’ and Hanbali schools may be followed because there is no express prohibition in the Holy Qur’an or in the Sunnah against the surplus claimed from the lessee. Ibn Qudamah has argued for the permissibility of surplus on forceful grounds.

Assigning of the Lease

The lessor can sell the leased property to a third pa rty where by the relation of lessor and lessee shall be established between the new owner and the lessee. However, the assigning of the lease itself (without assigning the ownership in the leased asset) f or a monetary consideration is not permissible.

The difference between the two situations is that in the latter case the ownership of the asset is not transferre d to the assignee, but he becomes entitled to receive the re nt of the asset only. This kind of assignment is allowed in Shari’ah only whe re no moneta ry consideration is charged from the assignee for this assignment. For example, a lessor can assign his right to claim rent from the lessee to his son, or to his friend in the form of a gift. Similarly, he can assign this right to any one of his creditors to set off his debt out of the re ntals received by him. But if the lessor wants to sell this right for a fixed price, it is not permissible, because in this case the money (amount of rentals) is sold for money which is a transaction subject to the principle of equality. Otherwise it will be tantamount to a riba transaction, hence prohibited.

Securitization of Ijarah

The arrangeme nt of Ijarah has a good potential of securitization which may help c reate a secondary marke t for the financiers on the basis of Ijarah. Since the lessor in Ijarah owns the leased assets, he can sell the asset, in whole or in part, to a third party who may purc hase it and may replace the seller in the rights and obligations of the lessor with regard to the purchased part of the asset.

Therefore, if the lessor, after entering into Ijarah, wished to recover his cost of purchase of the asset with a profit the reon, he can sell the leased asset wholly or partially either to one party or to a number of individuals. In the latter case, the purchase of a proportion of the asset by each

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individual may be evidenced by a certificate which may be called ‘Ijarah certificate’. This certificate will represent the holde r’s proporti onate owne rship i n the leased asset and he will assume the rights and obligations of the owne r / lessor to that extent. Since the asset is already leased to the lessee, the lease will continue with the ne w owne rs, each one of the holde rs of this certificate will have the right to e njoy a part of the rent according to his proporti on of owne rship in the asset. Similarly, he will also assume the obligations of the lessor to the extent of his ownership. Theref ore, in the case of total destruction of the asset, he will suffer th e loss to the extent of his ownership. These certificates, being an evidence of proportionate owne rship in a tangible asset, can be negotiated and traded in freely in the marke t and can serve as an instrument easily convertible into cash. Thus they may hel p i n solving the problems of liquidity management faced by the Islamic banks and financial institutions.

It should be re membere d, howeve r, that the ce rtificate must re present ownership of an undivide d part of the asset with all its rights and obligations. Misunderstanding this basic concept, some quarte rs tried to issue Ijarah certificates representing the holder’s right to claim certain amount of the rental only without assigning to him any kind of owne rship in the asset. It means that the holde r of such certificate has no relation to the leased asset at all. His only right is to share the rentals received from the lessee. This type of securitization is not allowed in Shari’ah. As explained earlier in this chapter, the re nt after being due is a debt payable by the lessee. The debt or any security representing debt only is not a negotiable instrume nt in Shari’ah, because trading in such an instrument a mounts to trade in mone y or in mone tary obligation which is not allowed, except on the basis of equality, and if the equality of value is observed while trading in such instrume nts, the very purpose of securitization is defeated. Therefore, this type of Ijarah certificates cannot serve the purpose of creating a secondary marke t.

It is, therefore, necessary that the Ijarah certificates are designed to represent real owne rship of the leased assets, and not only a right to receive rent.

Head-Lease

Another concept develope d in the mode rn leasing business is that of ‘head leasing’. In this arrangeme nt a lessee sub-leases the prope rty to a number of sub-leases. Then, he invites othe rs to participate in his business by making them share the rentals received by his sub - lessees. For making the m participate in receiving rentals, he charges a specified amount from the m. This arrangement is not in accordance with the principles of Shari’ah. The reason is obvious. The lessee does not own the prope rty. He is entitled to benefit from its usufruct only. That usufruct he has passed on to his sub lessees by contracting a sub-lease with them. Now he does not own anything, neither the corpus of the property, nor its usufruct. What he has is the right to receive re nt only. Theref ore, he assigns a part of this right to other pe rsons. It is already explained in detail that this right cannot be traded in, because it amounts to selling a receivable debt at a discount which is one of the forms of riba prohibited by the Holy Qur’an and Sunnah. Therefore this concept is not acceptable.

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These are some basic features of the ‘financial lease’ whic h are not in conformity with the dictates of Shari’ah. While using the lease as an Islamic mode of finance, these shortcomi ngs must be avoided.

The list of the possible shortcomings in the lease agreement is not restricted to what has been mentioned a bove, but only the basic errors found in differe nt agree ments have bee n poi nted out, and the basic principles of Islamic leasing have been summa rized. An Islamic lease agreement must conform to all of them.

Types of Ijarah

Ijarah Thumma Al Bai' (Hire Purchase)These are variations on a theme of purchase and lease back transactions. There are two contracts involved in this concept. The first contract, an Ijarah contract (leasing/renting), and the second contract, a Bai contract (purchase) are undertake n one after the other. For example, in a car financing facility, a customer ente rs into the first contract and leases the car from the owne r (bank) at an agreed rental over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed price. In effect, the bank sells the product to the de btor, at an above marke t -price profit margin, in return for agreeing to receive the payment over a period of time ; the profit ma rgin on the lease is equivalent to interest earne d at a fixed rate of return.

This type of transaction is particularly reminiscent of contractum tri nius, a complicated legal trick used by European banke rs and merchants during the Middle Ages, which involved combini ng three individually legal contracts in orde r to produce a transaction of an inte rest bearing loan (something that the Church made illegal).

a) Ijarah-Wal-Iqtina

A contract unde r which an Islamic bank provides equipment, building, or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the owne rship in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the le ase contract to make it condi tional. The rentals as well as the purchase price are fixed in such manner thatthe bank gets back its principal sum along with profit over the period of lease.

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Advantages of Ijarah

The following are the advantage of Ijarah to lessee:

1. Ijarah conserves capital as it may provide 100% financing.2. Ijarah enables the Lessee to have the use of the equipment on payme nt of the first

rental. This is importa nt since it is the use (and not ownership) of the equipment that generates income.

3. Ijarah arrangeme nts are flexible because the terms and re ntal provision may be tailored to suit the needs of the Lessee. Therefore, it aids corporate planning and budgeting

4. Ijarah is not borrowing and is therefore not re quire d to be disclosed as a liability in the Balance Sheet of the Lessee. Being an “off balance sheet” financing, it is not included in the computation of gearing ratios imposed by bankers. The borrowing capacity of the Lessee is therefore not impaired when leasing is resorted to as a me an of financing.

5. All payments of rentals are treated as payment of ope rating expenses and are therefore,

fully tax-deductible. Leasing therefore offers tax-advantages to profit making concerns.

6. There are many types of equipment, which becomes obsolete before the end of itsactual economic life. This is particularly true in high technology equi pme nt like compute rs. Thus the risk is passed onto the Lessor who will undoubtedly charge a pre mium into the lease rate to compensate for the risk. A Lessee may be wil ling to pay the said premium as an insurance against obsolescence.

7. If the equipment use is for a relatively short pe riod of time, it may be more profitable to lease than to buy.

8. If the equipment is for short duration and the equipment has a very poor second hand value (resale value), leasing would be the best method for acquisition.

Applications of Ijara

Meezan B ank’s Ex ample (Car Ijarah, Pakistan’s First Islamic Car Financing )

As a step towards Meezan Bank’s mission to provide a one -stop shop for innovative value added Sha ri’ah compliant produc ts, Meezan Bank’s ‘Car Ijarah’ unit provi des a car financing, based on the principles of Ijarah and is free of the element of interest.

Car Ijarah is Pakistan’s first "Interest Free" car financing based on the Islamic financing mode of Ijarah (Islamic leasing). This product is ideal for individuals looking for car financing while avoiding an interest-based transaction. Car Ijarah is unique and is approved by Meezan Banks Shari’ah Board. Car Ijarah, designed under the supervision of Meezan Banks Shari’ah

Supe rvisory Boa rd, is unique to car leasing facilities provide d by other banks.

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Economic Benefits of Islamic Leasing

Let us proceed to discuss the economic benefits of Islamic leasing. Five distinct benefits of

Islamic leasing can be mentioned:

1. As noted above, Islamic leasing necessarily involves real assets. This ensures and strengthens the linkage between the financial sector of the economy and the real sector contributing to economic stability. In this way lease finance relates to a distinctive feature of Islamic finance, a feature missing in the conventional system. Proliferation of financial assets without any counte rpa rt in the real sector of the economy makes the financial markets vulnerable to speculative games threatening to turn these marke ts into a casino. It also engages a large numbe r of highly skilled people into mane uvers that have nothing to do with producti on of goods and services. Incomes generated by these activities have contribute d to the increase in the inequality in the distribution of income and wealth in the society.

2. Islamic leasing creates a great potential for securitization. Sukuk based on ijara can be traded in the market, affording a convenient instrume nt for investing savings to the people of small incomes who constitute the overwhel ming majority in the developing countries in general and in the Muslim countries in particular.

3. Islamic leasing is especially suitable for some sectors of the economy for which sharing - based modes proved to be rather difficult to practice, e.g. the consumers sector and the public sector. It can take care of the public sector projects related to infrastructure building, e.g ., roads and bridges, airports, irrigation systems, hospitals, schools, etc. As a matter of fact most of the leasing based sukuk issued recently belong to this category.

4. Lease finance is easier to practice as it involves less documentation and takes less time to conclude a deal. Unlike lending, it does not need collateral and no thorough enquiries into the creditworthiness of the lessee are called for. The physical presence of a tangible asset, the subject of the lease, whose ownership may remain with the lessor, makes these formalities unnecessary. This may make it especially suitable for the rural sector, whe re formalities may hampe r ope rations.

5. Lease finance has some of the good features of debt finance and, at the same ti me, is free of some of the weaknesses of sharing-based modes of finance. There is less possibility of moral hazard/adverse selection than the sharing modes. There is no agency relationship between the lessor and the lessee, as is in the case of mudarabah (profit sharing), for example. The payment obligation of the lessee, the rent, is fixed, as in case of debt. It is not a case for adverse selection as no part of unforeseen losses/costs can be passed over to the lessor.

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Healthy Islamic banking sector reaches new heights in Pakistan

Sta te Ba nk of Pa ki s ta n

The Islamic banking industry is healthy and continues to grow in Pakistan. This is the finding that comes out of a report published by the State Bank of Pakistan (SBP). Set up as Pakistan’s central bank following independence in 1948, the SBP is the organisation responsible for running the country’s economy. I n its most recent Islamic banking bulletin, SBP has published the figures for the last

quarte r of 2006, and announced continuing growth f or the Islamic banking sector.Around 90 per cent of the Pakistani population is Muslim, and the provision of Shari’ah - compliant banki ng products is an important area to help people comply with their faith. The provision of Islamic banking has in turn led to an increase in the branch ne twork for Islamic banks. There are currently six exclusively Islamic banks in Pakistan having 100 branches. Add to this 13 othe r banks which offe r Islamic banking services and their 58 branches, and a healthy backdrop for the industry with good access to the general population can be seen.

The last quarter of 2006 was a very good one for the Islamic banking industry. Figures from the SBP show that the total assets portfolio within the sector expande d by 24 pe r cent to just unde r $2 billion (Rs118.183 billion). The cash held by Islamic banks also increased by a quarter to around $250 million (Rs15.266 billion). These figures show that the growth in the Islamic sector is not matched by Shari’ah-compliant money ma rket instrume nts, and hence there are excess liquid funds that can not be properly utilised.

The increase for the last quarte r of 2006 is part of a growing trend. Comparing the Islamic banking assets, deposits, and financing and investment over the same last quarter period for the previous three years shows that all areas of Islamic finance are increasing at an ever improved rate. I n the last year, total assets have increased by $758

million (Rs46 billion), deposits have increased by $544 million (Rs30 billion), and financing and investment by $395 mi llion (Rs24 billion). These are all good improveme nts for one year, but whe n comparing them back as far as

2003, the amount of money as assets and deposits is around te n times higher, and the financing and

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investment money is now seven times the size it was in December 2003.

The most favoured form of Islamic financing in Pakistan is murabaha. This mirrors a global trend where murabaha leads the field with the majority of Islamic banks. In Pakistan it accounts for almost 40 per cent of the total financing done by Islamic banking institutions. The second most widely used form of financing is ijara. With this accounting for 30 per cent, these two financing models represent nearly three-qua rte rs of the financing from Islamic banks in Pakistan.

(Graphs adapted from SBP Islamic Banking Bulletin, October 2007)

Number of Licensed Islamic Banks and IBBs as at 24 October 2007Bank’s Name No. of BranchesA) Islamic Banks

1 Meezan Bank Limited 622 Albaraka Islamic Bank 113 Bank Islami Pakistan Limited 104 Dubai Islamic Bank Pakistan Limited 105 Emirates Global Islamic Bank Limited 66 First Dawood Islamic Bank 1

Total of A 100B) Islamic Banking Branches

1 MCB Bank Limited 62 Bank of Khybe r 53 Bank Alfalah Limited 234 Habib Metro Bank 45 Standard Charte red Bank 36 Bank Al Habib Ltd 37 Habib Bank Ltd 18 Sone ri Bank Limited 29 Prime Comme rcial Bank 2

10 Askari Commercial bank 611 National Bank of Pakistan 112 United Bank Limited 113 ABN AMRO 1

Total of B 58A+B 158

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Consolidated statistics / overview of Leasing sector

(All figures are in Rs. Million)2004 2005 2006

31 31 29

10,459 11,716 12,185

4,885 7,835 8,599

52,218 65,333 75,15116,134 18,912 21,687

404 287 268

52,947 70,563 78,882

9,925 11,712 14,665

2,290 2,700 2,044

3,139 4,386 7,419

4274 4,392 5,009

223 236 193839 660 900

83,962 109,770 123,501

Islamic Leasing - Ijarah

Statistical Over View of Leasing Sector in Pakistan

No of Companies Paid up Capital Retained Earnings

Investment in Lease FinanceInvestments

Cash & Bank Balance (OnlyModarabas)Borrowings Revenues Net Profit

Financial ChargesOperating ExpenditureTaxationCash Dividend

Total Assets

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Overview of Islamic Finance in Pakistan

Starte d in 1977-78, which included the elimination of interest from the operation of specialized institution and comme rcial banks.

Financial and corporate system was amended on June 26, 1980 to permit issuance of new interest-free instrument of corporate financing named Participation Term Certificate (PTC).

In the same ti me Ordi nance was promulgated to allow the establishment of Mudarabah companies and floatation of Mudarabah certificates for rising risk based capital.

July 1, 1985, all commercial banks in Pak Rupee was made interest free which was mark -up technique with or without buy-back agreement. This was however declared un-Islamic by the Fede ral Shari at Court (FSC) in Nov 1991.

Commission for Transformati on of Financial System (CTFS) was constituted in January 2000 in the State Bank of Pakistan.

It introduced Shari’ah compliant modes of financing which include d creating legalinfrastructures conductive for working of Islamic financial system, launching a massive

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education and training progra m for bankers and their clients and an effective through media for the general public to create awareness about the Islamic financial system.

It also dealt with major products of banks and financial institution, both f or assets and liabilities side.

In September 2001 it was decided by Government that the shift to interest free economy would be made in a gradual and phased manne r and without causing any disruptions and was also agreed that state bank Pakistan would consider for

Setting up subsidiaries by the commercial banks for the purpose of conductingShari’ah compliant transactions

Specifying branches by the comme rcial banks exclusively dealing in Islamic products, and

Setting up new full-fledged commercial banks to carry out exclusively banking business based on proposed Islamic products.

In January, 2002 State Bank of Pakistan gave first Islamic Banking License to Meezan BankLtd.

The progress of Islamic Banking in Pakistan has been comme ndable during the last two years.

There is huge appetite for Islamic financial services. The growth, is howeve r, constraine d by the lack of infrastructure support & dearth of professional Islamic Bankers .

Currently, the re are 6 licensed full fledged Islamic Banks with 100 branches 13 conventional banks with standalone Islamic Banking Branches with the total

branch network of 58 branches ope rating in thirteen cities of all the four provi nces in the country (as of October 2007)

Applications for a few more banks are under consideration

The central bank is pursuing a three-pronged strategy to promote Islamic Banking in

Pakistan establishing full-fledged Islamic banks in the private sector; setting up of subsidiaries by the existing comme rcial banks; and allowing stand-alone branches for Islamic banking by the existing commercial banks

The Governme nt of Pakistan intends to continue promoting Islamic Banking in the country while keeping in view its linkages with the global economy & existing commitments to local& foreign investors .

There is a great need to develop instrume nts for liquidity manageme nt by banks &

monetary management by the SBP. The pace of Islamization of the financial system will crucially depend on the developme nt

ofShari’ah compliant instruments to be used for gove rnment transactions.

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There is need for innovative products i.e., developme nt of financial instrume nts on the basis of Musharika, Mudarabah, Leasing, & Salam – related to wide spectrum of maturities,projects & issuing entities .

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Islamic Leasing - Ijarah

References1. Leasing & Modarabas in 2007, Pakistan & Gulf Economist, January 1 -14, 20072. http : / / w ww . c b a .e d u . k w / e l s a kk a / i s la m _ i j a r a h . p d f 3. ht t p : / / w w w . d a r u l u l o o m k h i .e du . p k / f i q h / i s la m i c f i n a n c e / i j a r a h . h t m l 4. http : // w ww . s t a nd a r d c h a r t e r e d . c o m . m y / i b / i n f o / c o n c e pt . h t m l 5. http : // w ww . i s la m i c - b a n k i n g . c o m / s h a r ia h / s r _ m u r a b a h a . p h p 6. http : // w ww . s bp . o r g . p k / i bd / I BB . p d f 7. http : // e n . w i k i p e d ia . o r g / w i k i / I s la m i c _ b a n k i n g #I j a r a h 8. siddiqi.com/mns/Economic_Benefits_of_Islamic_Leasing.htm9. ht t p : / / w w w . b o k . c o m . p k / i s la m i c / m u r i j a . h t m 10. ht t p : / / w w w . m ee z a nb a n k .c o m / k n o w l e d g e c e nt e r / k n o w l e d g e - i s l a m i c - s e c t i o n - 4 - 8 . a s p 11. http : // w ww . m e e z a n b a n k . c o m / k n o w l e d g e c e nt e r / k n o w l e d g e - i s la m i c - s e c t i o n - 4 - 9 . a s p 12. www . s bp . o r g . p k / i bd / bu ll e t i n / 200 7 / F e b- B u ll e t i n . pd f 13. http : // w ww . n e w h o r i z o n - i s la m i c b a n k i n g . c o m / i n d e x . c f m

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