Ijarah

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.

Doubts

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.

Examples of Ijarah

• Car Leasing: Car leasing is a form of Ijarah in which the lessee pays a predetermined amount of money to the lessor for the use of a car for a specific period of time. At the end of the lease term, the lessee has the option to either purchase the car or return it to the lessor.
• Real Estate Leasing: Real estate leasing is a form of Ijarah in which the lessee pays a predetermined amount of money to the lessor for the use of a property for a specific period of time. At the end of the lease term, the lessee has the option to either purchase the real estate or return it to the lessor.
• Equipment Leasing: Equipment leasing is a form of Ijarah in which the lessee pays a predetermined amount of money to the lessor for the use of equipment for a specific period of time. At the end of the lease term, the lessee has the option to either purchase the equipment or return it to the lessor.
• Aircraft Leasing: Aircraft leasing is a form of Ijarah in which the lessee pays a predetermined amount of money to the lessor for the use of an aircraft for a specific period of time. At the end of the lease term, the lessee has the option to either purchase the aircraft or return it to the lessor.
• Machinery Leasing: Machinery leasing is a form of Ijarah in which the lessee pays a predetermined amount of money to the lessor for the use of machinery for a specific period of time. At the end of the lease term, the lessee has the option to either purchase the machinery or return it to the lessor.

Advantages of Ijarah

Ijarah is a form of Islamic financing that offers several advantages to both the lessor and the lessee. These advantages include:

• Flexibility: Ijarah offers flexibility to the lessee because it is a temporary transfer of an investment good, allowing the lessee to use the asset for a specific period of time.
• Cost-effectiveness: Ijarah leases are usually more cost-effective than other forms of financing, since the lessee does not need to commit to long-term loan repayments.
• Asset Protection: Ijarah leases also protect the asset being leased, since the lessee is responsible for any damage or deterioration to the asset.
• Risk Management: Ijarah leases also provide risk management, as the lessee is not responsible for any losses or damages to the asset.
• Access to Credit: Ijarah leases provide access to credit for people who may not be able to obtain traditional financing, since the lease is not based on the lessee’s creditworthiness.

Limitations of Ijarah

Ijarah has several limitations that must be taken into consideration when utilizing this form of financing. These include:

• The duration of the lease is fixed and predetermined, making it difficult to terminate or renew the contract.
• The lessee usually has to pay a large sum up front, which may be difficult for small businesses or individuals.
• The lessee is responsible for any damage to the asset during the lease period.
• The lessee is not able to customize the asset to their specific needs.
• The leasing company will usually retain ownership of the asset and the lessee will not be able to sell or transfer the asset.
• The lessee may be liable for any taxes or fees associated with the asset.

Other approaches related to Ijarah

Ijarah is one of the basic Islamic financial instruments, which encompasses many different approaches. Such approaches include:

• Murabaha, which is a sale of goods or services at a cost plus a predetermined profit margin.
• Istisna, which is a contract between a buyer and a seller whereby the seller agrees to manufacture a specific good or service for the buyer at a pre-determined price.
• Bai al-inah, which is a sale and buy-back transaction between two parties, where the seller sells a commodity to the buyer and then buys it back at a higher price.
• Salam, which is a contract whereby the seller agrees to supply a specific good or service to the buyer at a pre-determined price.
• Diminishing Musharaka, which is a form of joint venture financing where two or more partners share the cost of an investment and the profits are shared in predetermined ratios.

In conclusion, Ijarah encompasses a range of approaches, including Murabaha, Istisna, Bai al-inah, Salam and Diminishing Musharaka. These approaches enable Islamic financial institutions to offer leasing services in a way that is compliant with Sharia law.

Ijarah — recommended articles

Lombard loan — True lease — Staged payments — Vendor take-back mortgage — Credit Facility — Mudaraba — Contract hire — Direct lease — Residual payment

References

• 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.