Ijarah is one of the basic Islamic financial instruments. Ijarah means leasing. Normal operating lease is a temporary transfer of an investment good to a pre-determined price. This form of ijarah has several features that distinguish it from other forms of leasing.
First, the sponsor is the owner of the item, and therefore bears the associated risk and responsibility. For all the defects that prevent the user from using the object normally, the sponsor is responsible, although a contract is also possible, in which the user is obliged to maintain the facility and make its basic repairs.
Secondly, operating lease is a temporary contract, and so it is not valid for the entire period in which the subject has utility properties. In practice, these are short-term contracts, and good returns to the financing party after the contract expires if it has not been extended. Operational leasing, due to the liability of the financing party, poses a risk of improper use by the user.
This problem does not occur with financial leasing, where the lease period is long enough for the financing company to be able to absorb the costs and earn a profit. After the expiration of the contract, the user has the option to buy the item at the current market price. Leasing can not be terminated before its expiration if the mutual consent of the parties has not been reached. The subject of financial leasing acts as a security for the financing party, who, if the client fails to pay the fee, may take good without a court order.
The advantage of this form of ijaraha for the user is the reduction of obligations towards the tax office, thanks to the tax benefits set in the legislation of most countries. In contrast to a bank loan, the cost of capital at lease is lower, and payments are matched to the budgetary assumptions of the user. It may also sell the rights flowing from the contract before its completion and transfer the existing payments to the buyer's account. Such a transaction enables you to raise cash in case of liquidity problems. This would not be possible with ordinary debt because of Islamic law. The Shari'a allows the sale of physical assets, while it is forbidden to sell financial liabilities at a cost different from the nominal one.
Some of the Islamic scholars express their doubts about the permission to use financial leasing, due to the long-term nature of the contract and the inability to resolve it. In this way, the entire risk is borne by the user, especially if the "remaining" value of the item is determined in advance. Financial leasing may therefore turn out to be less advantageous for the lessee than an ordinary interest loan. This illustrates an example in which an entrepreneur leases a machine for a period of five years and after two years he ceases to use it. The contract can not be terminated, so the user must pay back further installments. If the payment is not made within the time limit, the lessee may lose his previous participation in the object, even if its value exceeds the fee required for operating leasing. Using an ordinary interest loan, the trader would sell the machine on the market and thus reduce the losses. According to another approach, financial leasing is acceptable if certain conditions are met. First, the sponsor, as the owner of the object, must assume the risks associated with leasing. It is therefore forbidden to contract ijarah, where the sponsor only acts as an intermediary between the supplier and the client, while the property is a legal security and a guarantee of payment. In this case, the lessor would lease the object before it was purchased and, despite not taking any risk, he would receive a remuneration. Secondly, payments can not be made before the delivery of the goods and after its usefulness ceases. Thirdly, all factory defects and defects resulting from the normal use of the leased asset should be borne by the financing party. The user may at most be obliged to use and maintain the object entrusted to him.
Ijarah in modern Islamic banking
In practice, the form of financing used by Islamic banks consists in placing an order by the customer for the purchase of a specific item and declaring it to be leased. Installments are calculated in a manner that takes into account the recovery of costs incurred for the purchase of the facility and provides the bank with an appropriate profit margin. Ijarah therefore consists of a purchase order, a leasing declaration and a leasing contract that provides the beneficial owner with the ownership of the item upon termination of the contract. The transfer of rights to an object is connected with a new document in which the bank makes a donation to the previous beneficiary or requests payment of the nominal amount. According to the Islamic Fiqh Academy recommendation, the second type of property transfer can only take place after the end of the contract in which the parties have agreed such a condition.
- Shariff, R. A. M., & Rahman, A. R. A. (2003). An exploratory study of Ijarah accounting practices in Malaysian financial institutions. International Journal of Islamic Financial Services, 5(3), 1-15.
- Abdullah, N. I., & Dusuki, A. W. (2004). A critical appraisal of Al-Ijarah Thumma al-Bay’(AITAB) operation: issues and prospects. In 4th International Islamic Banking and Finance Conference (p. 10-11).
- Usmani, M. T. (2006). Ijarah. Islamic Finance Information Service.