Islamic Finance: A radically different form of leasing

Today we will discuss Ijara or leasing, which is another popular Islamic financing product.

In simple terms, Ijara refers to the right of use of an asset by a person for a specified period of time at a financial consideration paid to the owner of the asset. This right is called usufruct.

In Islamic banking, rather than lending money to a customer and earning interest - which is forbidden by Sharia - the bank purchases the asset for the purpose of leasing it to the customer at an agreed rent for a specified tenure.

Ijara wa Iqtina

Extending the concept further, Ijara wa Iqtina (also called Ijara Muntahiya Bil Tamleek) is a leasing contract whereby an Islamic bank purchases an asset upon the request of a customer who pays rent for an agreed term.

Upon completion of the term the ownership and the title to the asset is transferred by the bank to the customer. The possession of the asset continues to remain with the customer.

The lease rent is fixed by the Islamic bank in such a way that upon completion of the agreed term, the bank is able to collect the cost of the asset plus its anticipated profit.

As such, at the end of the lease tenure, the asset has a nominal value which is then sold to the customer or presented to him by the bank.

The arrangement could be compared to the hire and purchase concept in a conventional financial lease. However, Islamic leasing is radically different from its conventional counterpart in many ways.

Leasing of human services

The above explanation deals with the leasing of a tangible asset. Can human services also be leased under Sharia? Yes. Sharia allows this in the sense of employing or hiring the services of a person against some financial consideration. Let us understand this by way of examples.

If Ahmed has hired Badar as an accountant in his office at an agreed salary, this arrangement will be called Ijara. Similarly, if one needs to build a house, one would hire the services of a civil engineer and, in case of a dispute, the parties lease the services of lawyers.

Terminology

The person rendering the services is called Aajir, the one who does the hiring is termed Mustajir while the financial consideration is Ujra and the transaction is Ijara.

Apply these terms to an asset, for example, a car rental. In this case, the owner of the car will be Aajir, Mustajir the person currently using it, the amount paid by Mustajir will be Ujra and the complete transaction will be called Ijara.

Comparison with Murabaha

While the basic concept is similar to a sale (Murabaha) where an asset is transferred to another party for a monetary consideration, the Ijara merely allows transfer of the 'right of use' to the Mustajir (lessee) for a certain period of time whereas the title and ownership to the asset continue to remain with Aajir (lessor).

As such, physical possession of the leased asset is returned to the owner of the asset upon culmination of the lease term.

Comparison with conventional lease

The core difference between a conventional financial lease and Ijara is that in Ijara the lessor assumes all risks related to the ownership of the leased asset.

Therefore, all withholding taxes, taxes on rent revenue, insurances and structural repair and maintenance will be the responsibility of the lessor. This is in contrast to conventional leasing where these are the responsibilities of the lessee.

Under Sharia, if the asset is destroyed beyond economic repair during the lease period, the lease will terminate with immediate effect and the lessor will be required to bear the loss besides losing the benefit of continuing to earn rent.

In addition, the lessor will be required to refund any prepaid rent paid by the lessee but not consumed until the date of total damage to the asset or termination of the lease. However, if the asset is lost due to the lessee's negligence, he will be required to make up the loss to the lessor.

The author is vice-president, Sharia structuring, documentation and product development at Dubai Islamic Bank