Essential for Islamic Finance

“Ijara (Leasing)”

By Yousuf Ibn-ul-Hasan

Iqra University

DefinitionLeasing is a contract in which asset is transfers to user for an agreed period on an

agreed consideration

“Ijarah is a lease contract as well as a hire contract”.

Both the contract are similar to each

In Islamic Finance Ijarah is a lease contract under which financial institution leases equipment or a building to one of its clients against

agreed rentals or installments equal to the

value of the assets.

Lesser or Lessee The financier is known as lesser who

financer equipment for lessee.

The equipment provider through financing is

LESSOR.

The equipment user is LESSEE

Ijarah

Ijara basically facilitate the cost to be spread for large purchases into

affordably installments for payment.

In Ijara either the end of the transaction is the ownership of

assets that acquired through lease financing or in another case the

equipment is returned to financier.

Ijarah Financing is a contract in which a lessee request for an equipment or a property and Lesser provide through its financing the specified and requested equipment or property.

The Lessee agree to pays a monthly, quarterly, semi-annual or annual rent to lesser for the right to use equipment a specific amount within agreed time of time i.e. 12, 24, 36, 48, or 60 months OR what ever time agreed.

Historical Perspective Although leasing began in 2010 B.C. but

modern leasing began in the early fifties. The creation of the Investment Tax Credit in

1962 encourage growth through "tax-oriented" leasing.

New products were quickly developed to meet the growing demand.

Over the last 50 years, many leasing companies developed non-tax oriented products such as income funds, operating leases, limited partnerships, vendor programs, and end sharing in order to remain competitive.

Equipment leasing flourished over the last

20 yrsBanking industry started leasing by giving

credibility to a market place which had been previously regarded as a last-resort financing alternative.

Accounting profession produced a documents to help standardize lease reporting in financial statements.

Internal Revenue Service issued guidelines to aid lesser and lessees in structuring leasing transactions.

Why do Lease Business ?

Cash flow - Monthly payments are generally smaller for leases than for loans and they usually require a smaller or no down payment.

Use vs. ownership - Many businesses have discovered they don't need to own the equipment they use.

In past renting and leasing were limited. Today's psychology it more to economics rather

than moralities of ownership

The Modern Concept of Ijarah

Leasing is the modem technique which can be compared with Islamic technique of Ijarah.

Leasing is based on fundamental concept of Ijarah, according to which one does not have to own an asset in order to enjoy benefits of it.

There are business examples which benefited from their investment in fixed assets and made substantial capital profits from the sale of assets or been able to improve their balance sheets by the revaluation of assets.

Primarily profitability of a business lies in the effective utilization of its resources. Therefore USE is important rather OWNERSHIP.

For exampleInvestment appraisal made on some new

venture. The choice of purchasing or leasing is partially a matter of arithmetic and partially a question of the availability of the capital.

ComparisonA comparison between leasing and

other similar forms of transactions, such as rental, will give a clearer picture.

"Rent a Car business is a contract according to which the objects are leased to individuals or a number of users for a much shorter period than their actual useful life.

In contract law, the "rental contract" specifies the lease and the usage for an indefinite period.

Like IBM's computer sales system which has an overwhelming world market share.

To promote sales in an attempt to outstrip its competitors, with the belief that it could control the progress of technological innovation of computers.

Users of equipment leased on a rental system are major enterprises with continuous usage of rented equipment in a short-lived, but the lesser is charged with the responsibility for maintenance.

In the case of "rental" the lesser is moreover charged with the responsibility for coping with the products obsolescence, so that it may be termed as a service-oriented business.

Economic Role of ljaraLease financing due to its special features

supplement existing conventional forms of financing and further increase speed investment in the private sector.

There is a large requirement of balancing and modernizing for existing industry.

Lease financing through balancing and modernization of existing industry improve the capacity utilization, quality, production cost, profitability, internal generation of cash for future investment and international competitive capability to increase exports.

Lease financing is most suited to the programs of balancing,

modernization and replacement. It would involve a small dosage of investment which would carry

relatively smaller investment risks but would result in a quick value

added production. It would increase capacity utilization and thus contribute to the growth of

the economy.

Leasing is the contractAsset transfer to another for use on an agreed

period with financial consideration.The subject of lease must have a valuable use.It is necessary for a lease contract that body

of leased property remains in the ownership of the seller and only its usage is transferred to the lessee.

Any thing that cannot be used cannot be leased.

Lease cannot be affected in respect of money, edibles, fuel and ammunition etc. due to consuming nature of products.

If anything of this nature is leased out, it would be consider as a loan with all rules concerning the transaction of loan that would accordingly be applied.

Any rent charges on this invalid lease would be treated as interest that is usually charged on a loan.

All the liabilities emerging from the ownership shall be borne by the lesser, but the liabilities referable to the use of the property shall be borne by the lessee.

Example Mr. Ahmed leased his House to Mr. Badar. All taxes on the house shall be borne by Mr. Ahmed as he is the

owner While water tax, electric bills and all expenses pertain to the use of house shall be borne by Mr.

Badar the lessee.

The terms and conditions of the agreement would remain as:

Period of lease must be determined in clear terms.

Lessee cannot use leased asset for any purpose other than a purpose specified in the lease agreement.

If purpose not specified in the agreement, lessee is allowed to use assets it for whatever purpose in the normal course.

If Lessee use it for an abnormal purpose he cannot do so unless the lesser allows him in specific terms.

The lessee is liable to compensate lessee for any harm caused to leased asset by any lapse or carelessness from the part of the lessee.

Leased asset shall remain in the risk of lesser throughout lease period.

Any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lesser.

Asset jointly owned by two or more person can be leased out and rental shall be distributed between joint owners according to the proportion of their respective shares in the property.

Lessee is not responsible for interfere with any kind of share and distribution of share amount.

Lease in proportion share only allowed to the

co-share only not to any other individual.

It is necessary for a valid lease that the leased asset is fully identified by the parties.

Example “A said to B “I lease you out my cars”.

Lease is void unless leased car is clearly identified.

Rental must be determined for whole period of lease at the time of contracting a lease.

It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of lease agreement.

If the rent for a prior phase of the lease period has not been determined or left at the option for the lesser, the lease will not be valid.

Example

Mr. A leases his house to Mr. B for a period of 5 years.

The rent for the first period is fix at an amount on monthly

basis and it is also agreed that the rent of every subsequent year shall be 10% more than

the previous one. The leases remains valid

In this example Mr. A laid down a condition in the agreement that rent of an amount per month is fixed for the first year only.

Rent for subsequent year shall be fixed each year at the option of the lesser.

The lease is void, because the rent would be uncertain.

Mostly in the long-term lease agreement it is not in the benefit of the lesser to fix one amount of rent for the whole period due to the fact the market conditions differ from time to time.

In this case, the lesser has two options, either (a) He can contract a lease with a condition

that the rent shall be increased at a specified proportion after a specified period. Like six months or one year.

Or(b) He can contract the lease for a shorter

period after which the parties of lease in fresh terms and conditions, but the renewal shall be affected by mutual consent with full liberty to each one of them to refuse the renewal.

In such case the lessee is bound to vacate the leased assets and return it back to the lesser.

Lesser cannot raise rent unilaterally for that reason any agreement to the contrary is null and void.

Rent or part thereof may be payable in advance before delivery of asset, but the amount collected by lesser shall remain with him as account payment and shall be adjusted to the rent after it is due.

Lease period shall commence from the date on which leased asset has been delivered to lessee, no matter whether the lessee has started using it or not.

If leased asset has totally lost the function for which it was leased for and no repair is possible then lease shall terminate on the day on which

such loss has been caused. However, if the loss caused by the misuse or by the negligence of the

lessee he will be liable to compensate the lesser with the

depreciated value of the asset as it was immediately before the loss.

Like other modes of financing, lease is not originally treated as one.

It is simply a transaction meant to transfer the use of an asset from one person to another for an agreed consideration.

Certain financial institutions have adopted leasing as a mode of finance used in place of interest.

This kind of lease, generally known as the financial lease notable from the operating lease that has many basic features of actual leasing transactions with which it is distribute with.

When the financial institutions on interest free modes established in the recent past they found that leasing was a recognized mode of finance throughout the world.

On the other hand, they realized that leasing was a lawful transaction according to Shariah and it could be used as an interest free mode of finance.

Leasing has been adopted by the Islamic Financial Institutions, yet very few of them paid attention to the fact that the financial lease has a number of characteristics more similar to interest as the actual lease transaction.

They started using same model agreements for leasing as were in vogue among the traditional financial institutions without any modification, while a number of their provision was not in conformity with the Shariah.

The primary advantage of Ijarah over the conventional forms of borrowing to finance equipment is that the ownership of the asset remains with the lesser.

The financing is largely unrelated to the size of assets and the capital base of the lessee, depending principally on the ability of cash flow to service payments of lease rentals.

ConclusionIjara is probably the most suitable mean to raise

investment funds especially for industries where rapid technological innovation is either underway or desired, top class firms which are quickly expanding their business or small & medium enterprises and firms which have normally insufficient assets and capital base to meet normal collateral requirements of most other forms of long term financing. The basic security under the Ijarah arrangement is the "ownership of the equipment". The title of ownership to the equipment remains with the leasing company but in case of serious default, the equipment is repossessed