Ijarah – Islamic Leasing

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Ayesha Ashraf Jangda

Ayesha Ashraf Jangda works as Section Head, Corporate Strategy and Business Planning at BankIslami Pakistan Limited

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Vol 2 Issue2 IjaraahWhat is Ijarah?

Ijarah means: ‘to transfer the usage of a non-consumable asset by the owner (the lessor) to another person (the lessee) for an agreed period, at an agreed price (rent).’

Basic Rules of Ijarah

  • Transferring the usufruct, not the ownership, for an agreed period, at an agreed price.
  • The non-consumable asset should have identifiable value and quantity.
  • The lessor bears all liabilities of ownership, while the lessee is responsible for those of the use of property. (Example: The property tax should be paid by the lessor, while the water and electricity bills referable to the use of the house should be borne by the lessee.)
  • Throughout the leasing period, the lessee bears the risk of ownership, i.e., the reduction in the value of the real estate or any harm caused by the factors beyond the control of the lessee. However, the lessee is liable to compensate the lessor for any loss due to his/her negligence. After the lease period completes, the remaining asset should be given back to the owner (the lessor).

Additional Rules

  • The asset can be insured, preferably through a Takaful (Islamic insurance) company, at the expense of the lessor, not the lessee.
  • Ideally, the rent charged for the leased asset and its periodical increase should be benchmarked to the current prevailing market rates of the pool of similar assets classes. However, in practice, banks usually use interest rates as benchmarks. Although not preferable, these bank benchmarks can be used, until a suitable Islamic based benchmark becomes available.

Differences between Ijarah and Conventional Leasing

Leasing such as, Murabaha, is not originally an Islamic mode of financing. However, Islamic financial institutions adopted it by making some relevant modifications in the structure of the leasing contract (i.e., its terms and conditions), in order to conform it to the rules of Islamic Shariah.

In conventional leasing, instead of offering an interest-bearing loan, banks and leasing companies provide to the lessee an asset along with the risk of ownership. Many basic features of the conventional lease are Islamic, except these two:

1. In Ijarah, the lessee’s liability for the rent starts, when the lessee takes delivery of the asset and not from the day the price has been paid, either directly or through the lessee.

2. In Ijarah, there is no hire purchase arrangement at the start of the leasing contract. After the leasing period has ended, the lessor can, under a separate contract, sell the previously leased asset to the lessee or any other person. Unlike conventional leasing agreements, the Ijarah contract itself should not contain the ‘express clause,’ a pre-condition of gift or sale at the end of the lease period.

How Ijarah is practiced

An asset, usually a car, machine, equipment or household durables, is leased to the lessee on an agreed fixed rental payments for a maximum of 5 years. After the end of the leasing period, through another contract the asset is usually sold to the lessee at the book value of the asset.

In Pakistan, Ijarah form of financing is provided by Islamic Banks, Islamic windows of Commercial Banks and Modarabas. The Ijarah structuring is the most common method used for Islamic Sukuks (bonds).

Note: The prevalent system of Islamic banking the world over is least permissible and truly not the ultimate and ideal solution. It is only a step towards creating an interest free environment to provide Muslims with an option. Much needs to be achieved keeping in view the injunctions of Quran.

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