Treatment of security when using an Ijara

We will continue with our understanding of Islamic leasing in the wake of the finalisation of two high-profile Ijara transactions: the Department of Civil Aviation ($1 billion) and Emirates National Oil Company ($500 million), totalling $1.5 billion (Dh5.5 billion), this month, thus proving the viability of Islamic leasing in the echelons of the UAE's business and financial circles.

In principle, an Ijara contract is executed for an asset already owned by the lessor. However, in the banking environment, it is for a customer to request an Islamic Financial Institution (IFI) to purchase the asset from a third party or from the customer itself which is then taken on lease by the customer from IFI.

Such unilateral undertaking is binding upon the customer alone and its mere submission does not oblige the IFI to proceed with the Ijara transaction if it does not deem it appropriate.

Cash guarantee

It is permitted that an IFI demands from the customer some kind of cash security or guarantee in support of the customer's undertaking. The security is termed "Daman Jiddiyya" or "Hamish Jiddiyya" if it is in shape of cash.

The security may be continued untouched and returned to the customer upon successful completion of the lease term. Here, the customer may ask the IFI to invest the Hamish Jiddiyya (or cash security) in its common pool on a Mudaraba basis so that the customer may earn certain return during the period that it is retained by the IFI.

It is also possible that the security is released to the customer upon commencement of the lease or in phases proportionate to the completed period of the lease term. It all depends on the lessor's assessment of the lessee's credibility.

The lessor may also hold on to the security till the end of lease term simply to compensate itself for any damage caused to the leased asset by the lessee.

If the customer fails to fulfill its promise and does not turn up to take the asset on lease after it has been purchased by the IFI, Sharia authorises the IFI to lease the same to a third party or sell it in the market in order to retrieve its investment in the asset.

Advance rent

In such a situation the customer will be responsible to compensate the IFI for the difference between the IFI's cost of the asset intended to be leased and the total lease rentals agreed to by the IFI with the third party. Another Sharia compliant treatment to the cash security could be to treat it as the advance rent. The advance rent will then be subject to Sharia principles whereby either it is adjusted in the first lease period or the adjustment can be evenly spread over the entire lease term whereby a portion of the security is liquidated pro-rata towards payment of the lease rental for each rental period within the overall lease term.

The lease term is the total period for which an asset is taken by the customer which is then broken into smaller parts called lease periods.

The author is Vice President and Head Sharia Structuring, Documentation and Product Development Dubai Islamic Bank