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ESSENTIALS OF ISLAMIC FINANCE

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IJARAH

Ijarah derives from the

root word ajara “to

recompense,

compensate or

give consider

ation and

return”. Ajr

refers to a

worker’s wage, and

ujrah to rental

payment. In its juristic usage, Ijarah

primarily refers to both a rental as well

as a hire contract

that engages

the services

of persons.

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TYPES OF IJARAH

IJARAH

Finance lease is mostly used to

raise long term

capital to pay for

assets. It enables

the lessor to earn

reasonable profit along

with full recovery

of the cost of

the asset.

operational lease it is also called as a “non-full

payout” leases, because the amount of the rental does

not cover the lessor full cost of asset and the period of

lease is always less than the useful life of the asset.

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IJARAH IN QURAN AND SUNNAH Ijarah is also validated by the Quran,

Sunnah, and ijmah.

QURAN•Several verses are found in the Quran (al-Kahf, 77: al-Qasas, 26: al-Talaq, 65-6) on the worker’s entitlement to a wage

SUNNAH•References also occur in hadith to ijarah and the employer-employee relations“pay the employee his wages before the sweat of his brow dries up”.

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IJARAH AS A MODE OF FINANCING

In Islamic finance Ijarah is a very popular sharyah way to asset finance without

involving interest.It enables the customer to use durable inconsumable goods, equipment and

heavy machinery

The amount of rent can be re-priced by the Islamic banks

Leasing allows a logical way to separate ownership and the use of asset.

The decision of Islamic banks to provide Ijarah financing depends upon the amount of cash flows from the leased asset and the financial position of

the customer but without interest.

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PROCESS OF IJARAH

The client” Lessee” contact the bank “Lessor” with the request for ijarah leasing and enters into a promise for lease contract. It includes the offer and acceptance by the client.

The bank buys the asset required for ijarah and gets title of ownership from the manufacturer.

The bank makes payment to the manufacturer.

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The bank leases the asset to the client after execution of the ijarah contract which takes place after the client gets the delivery of the asset.

The lessee makes periodic fixed rental payments according to the contract of ijarah

At the end of contract period the lessee can purchase the asset from the bank under a separate sale agreement at a nominal price

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FOUR SCHOOLS

Hanafi School• Defines as a

contract that enables possession of a particular usufruct of the leased asset (ayn) for a consideration.

Maliki School• Defines

Ijarah as a contract that relates to permissible usufructs for a particular period.

Shafie School• Defines

Ijarah as a contract for a defined usufruct liable to utilization and accessibility for a particular recompense.

Hanbali School• Hambali

definition is that the benefit or services of ijarah appear in the future

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IJARAH BONDS AND SUKUK

Ijarah sukuk or bonds are the securities that shows the ownership of clearly specified existed and known asset

For example, An air craft on ijarah leased can be represented in bonds Less risk as compare to common stocks

Ijarah Sukkuk are completely transferable and can be traded in the secondary markets

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SECURITIZATION OF BONDS

•The arrangement of Ijarah has a good potential of securitization which may help create a secondary market for the financiers on the basis of Ijarah.

•The lessor in Ijarah owns the leased assets, he can sell the asset, in whole or in part, to a third party who may purchase it and may replace the seller in the rights and obligations of the lessor with regard to the purchased part of the asset. 

•In the case of total destruction of the asset, he will suffer the loss to the extent of his ownership.

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IJARAH SUKUK STRUCTURE

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SALES AND LEASE BACK

There should be at least one year lease period

There should be separate contracts for sale and

lease

The agreement to sell at the end of the lease must

be separateThe intention of the client is to avoid interest related

transactions

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LIABILITY FOR LOSS

Lessor in a financial lease, bears ownership responsibilities, in the

event the asset is destroyed during the lease period, he alone

stands to suffer the loss.

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RULES OF IJARAH

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REVOCATION OF IJARAH contract of ijarah can only be revoked

where the asset lost its utility or function

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EXAMPLE OF IJARAH FINANCING CALCULATIONS Generally, the financial institutions

calculate the rental amounts as follows:The financial institution determines that it wants to have a profit rate (PR) of 10 percent.

The purchase price (PP), including all costs, is $1,000,000 (cost borne by the financial institution).

The term (T) of the lease is 5 years.

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ECONOMIC BENEFITS

Lease finance is easier to practice

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CONCLUSION As method of financing ijarah is still in its

early stage of development and there is a lot more opportunities to expand its application.

In majority of the countries the contribution of Ijarah financing is low and the Muslim countries are also not utilizing Ijarah bonds as a mode of financing.

The research on Ijarah also shows that there is basically no major deviation to sharyah rules in ijarah contract practiced by Islamic banks.

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Some of the issues that should need to be addressed are that, there is very less information on Ijarah contract is available.

The other issue that should be

addressed in the light of sharyah is the compensation on late payment to the lessor, as penalty on late payment is given to the charity so it does not compensate the lessor.

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