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Al IjarahAl Ijarah

Essentials of Islamic Banking and Finance

Talha Saleem Kapadia talhasaleemkapadia@gmail.com

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ContentsContents

Defnition o Ijarah;

Explanation;

Features o Ijarah;

Dierence with conventional lease; Practical application;

Q & A

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Defnition o IjarahDefnition o Ijarah

Ijarah is an Arabic word whose origin is 'Ujrah'(compensation/fee/fare);

Ijarah means giving something to other for use against a feeor rent or fare;

In conventional nance concept of easing is similar to Ijarah; !onventional lease is dened as 'a right to use or occup" a

propert" given b" owner of the propert" (lessor) to anotherperson (lessee or tenant) for a period of time# whereb" thelessee obtains e$clusive possession of the propert" in returnfor pa"ment of $ed or determinable (%oating) consideration

(fee or rent) to lessor'; &o it is act of giving a ph"sical thing to other person for use

against a return (rent or fee);

easing does not include emplo"ment which means activit"or service performed b" a person (emplo"ee) for anotherperson (emplo"er) for compensation (fee) or as an occupation(salar");

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Defnition o IjarahDefnition o Ijarah

 his concept of Ijarah is broader than of the leasing;

Its literal meaning is to give something on rent;

In Islamic i*h the term of Ijarah has two meanings+− o e!plo" the services o a person on wa#es or ee $Ijarah

al%ha'hsi""ah ( services Ijarah); an*− o #ive a ri#ht to use a propert" or an asset to a person

or a perio* o ti!e a#ainst pa"!ent o arent+char#es+ee;

In Islamic nance second t"pe of Ijarah is discussed;

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Expalnation o IjarahExpalnation o Ijarah

Ijara in simple terms# implies leasing or hiring of a ph"sicalasset;

It is a popular product in which the Islamic ban, assumes therole of an aajir or moojir (lessor) and allows its client to use aparticular asset that it owns;

 he client or mustajir (lessee) receives through Ijarah thebenets associated with ownership of the asset againstpa"ment of predetermined rentals (ujrat);

 here are two famous t"pes of lease+− ,peratin# lease;

► Operating lease is a contract that allows the use of an asset, but doesnot convey rights of ownership of the asset to lessee;

− Finance lease+Capital lease;►  A lease contract that allows the use of an asset and considered to

have the characteristic of ownership during the period of lease andautomatically convey rights of ownership of the asset to lessee at theend of lease period.

Islamic nancial s"stem recogni-es onl" .perating ease

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Expalnation o IjarahExpalnation o Ijarah

!apital lease has two basic problems+− wo contract o *ierent nature $sale an* lease) are use

co!-ine*. hereore it is neither a sale nor a leasecontract co!pletel";

− wo *ierent t"pes o contract have *ierent t"pes o

eects;► Proper distribution of rights and obligation of ownership is necessary

according to Islamic law;

► No such distribution is present since it is a mixture of two dierentcontracts! hire and purchase;

− As a rule o thu!- Isla! *oes not allow co!-inin# to

*ierent contract in one contract in a !anner that each othe! is *epen*ent on the other;

− /i'e rent a#ree!ent an* sale are !er#e* in one contractin the !anner that -oth are *epen*ent on each other.

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Features o IjarahFeatures o Ijarah

Ijara is for a ,nown time period called Ijara period;

&ince operating lease is the onl" allowed wa" of leasing therules of operating lease shall appl";

an, ac*uires ownership upon receiving a re*uest from itsclient0 itle or e*uitable ownership of the asset will remainwith the ban, as owner of the asset;

1ight of use of the propert" is transferred to the lessee;

Ijara rentals are also paid in installments over time# and aresupposed to cover the cost of the asset or value ofinvestment for the ban, and to provide a fair return on

investment;

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Features o IjarahFeatures o Ijarah

In Ijara# the ban, continues to be the owner throughout theIjara period while the client receives the benets of ownershipor the benets of using the asset;

As such# ris,s associated with ownership of the asset remainwith the ban, and the asset is supposed to revert bac, to the

ban, at the end of the Ijara period; he rentals could be $ed or %e$ible and be made to re%ect

the changing economic and business conditions;

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0ules o Ijarah0ules o Ijarah

As per the Islamic laws of contract the+− u-ject !atter o Ijarah shoul* -e 1alua-le2 I*entife*

an* Quantife*;

− he perio* o /ease !ust -e *eter!ine* in clear ter!s;

− An" *a!a#e to the asset not cause* -" the /essee3sne#lect2 is to -e -orne -" the /essor;

− /essee will -e responsi-le or 4or!al !aintenance;

− he /essee is responsi-le or *a!a#e to the asset cause*-" rau* or ne#li#ence;

− he lease perio* starts when the asset has -een *elivere*to the lessee in usa-le con*ition whether or not thelessee has starte* usin# it;

− /ease rentals or the entire lease perio* shoul* -e fxe*$ele!ent o 5harar);

− 0ent can -e fxe* on perio*ic -asis $perio*icrevision+6oatin#) -ut perio*ic incre!ent shoul* -e a#ree*upon;

− he rent !a" -e tie* to a 'nown -ench!ar'2 accepta-leto -oth the parties.

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0ules o Ijarah0ules o Ijarah

 ermination of ease+− he lease will suspen* i the lease* asset -eco!es

unusa-le;

− he lease will ter!inate i the lease* asset is *estro"e*;

− 7owever2 i it is *ue to ault o the lessee2 he is lia-le toco!pensate the lessor or the loss;

− Contravention o an" ter! o the lease a#ree!ent #ivesri#ht to lessor or unilateral ter!ination o thea#ree!ent;

!onventional eases are of two t"pes+− ale & /ease-ac' 

► "easing the asset which has already purchased by the lessee;► #he "essor purchases the asset from the "essee and leases it bac$ to

him;► #his is a $ind of implicit interest;

− Direct lease► "easing an asset which is not already owned by lessee;► "essor purchases the asset from the supplier %open mar$et or a third

erson and then leases it to lessee

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0ules o Ijarah0ules o Ijarah

oth t"pes of leases are possible under Ijarah;

2owever# as discussed before &ale 3 ease ac, arrangementma" be a ,ind of implicit interest therefore it is a lesspreferred option according to Islamic &hari'ah;

2owever# if the mode is emplo"ed# then following restrictionshould be strictl" adhered+− ale *ee* shoul* -e co!pletel" in*epen*ent o the Ijarah

a#ree!ent;

− ale Dee* shoul* -e execute* -eore the execution oIjarah A#ree!ent;

−

he assets shoul* -e sol* -ac' to the custo!er ater areasona-le ti!e;

− A "ear !a" -e #oo* ti!e *ierence.

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0ules o Ijarah0ules o Ijarah

4ariable rentals in Ijarah+− Fixe* an* 6oatin# rate rentals are possi-le in Ijarah li'e

lease;

− his rate will -e eective or whole perio*;

− A#reein# on a fxe* rent or a lon#%ter! lease !a" not -eeasi-le or lessor an* he !a" wish to a*opt !ar'etchan#es;

− Floatin# rates are allowe* with certain con*itions;

− he whole perio* shoul* -e *ivi*e* into *ierent perio*s$89 "ear !a" -e *ivi*e* into 89 e:ual perio*s);

− he rent shoul* -e set or a perio* -eore its start;

− Ater start o perio* the rental can not -e chan#e*-ecause o an" reason $*ela" in pa"!ent2 !ar'et ratechan#e etc. etc.);

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Practical applicationPractical application

ISLAMIC BANK    CUSTOMER 

Application for asset on Ijarah basis

Agreement to Ijarah

Submission of initial deposit

 VENDOR 

. .

At the end of lease period customerbuys the asset from owner/bankthrough a separate agreement

At the end of lease period customerbuys the asset from owner/bankthrough a separate agreement

Rental payment to ownerRental payment to owner

P  a  ym e n t   or  Or  d  e r  t   o v e n d  or 

 /   s  e l  l   e r 

D e l  i   v e r  y t   o b  ank  or  a s  p e r i   t   s  or  d  e r  t   o c  u s  t   om e r 

Tr 

 an s f   e r  of   o wn e r  s h i   p wi   t  h  d  e l  i   v

 e r  y t   o o wn e r 

 (   t  h  e  b  ank  )  

D e l  i   v e r  y or  t  i  m e  of   d  e l  i   v e r  y

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Practical applicationPractical application

!onsumer inance+− Auto!o-ile;

− achiner";

!orporate &ector+

− achiner";− Auto!o-ile;

Investment an,ing;

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Q