Ijarah in Islamic Banking

Ijarah is an Arabic word and it means “to give something on rent”. Under the concept of Ijarah in Islamic banking, a customer can use an asset or equipment, which is owned by an Islamic bank, for a fixed period against a fixed price. Al Ijara is very similar to a leasing contract, and the asset under the Ijarah contract could be a car, home, plant, or a machinery. The Ijarah may be defined as:

“A legal binding contract, where the owner of something with value, transfers its usufruct to another party, for a pre-defined period, in exchange of an agreed consideration”.

Major Conditions for Ijarah:

  • Transferring of usufruct of an asset to another person for an agreed period, at an agreed consideration.
  • The Asset should be valuable, identified and quantified.
  • Anything which cannot be used without consuming cannot be leased out. e.g.. Money, Wheat etc.<

Types of Ijarah:

  • Hiring/Employment: To employ/hire the service of a person on wages.
  • Leasing: To transfer the usufruct of a particular thing to another person in its exchange for a rent.

Types of Leasing:

Operating Lease:

Simple rental agreement in which the leased asset remains in the ownership of lessor and comes back to him after the lease period.

Hire Purchase:

Where the intention of lessee is to acquire the ownership of asset, but due to certain reasons, and in particular, due to some tax concessions they show Ijarah and after the lease period corpus of the leased asset transfers to the lessee without any new contract and paid rental becomes price. It is not permissible.

Financial Lease:

The intention is same, only difference is that the corpus of leased asset is transferred to the lessee by execution of sale agreement or by gift, lease agreement has an express clause to this effect it is also impermissible for two reasons:

  • One transaction is tied up with another transaction.
  • Lessor does not bear the responsibility of lessor.
  • Islamic Lease (Ijarah muntahia bettamleek): Intention is same, but the Ijarah agreement does not contain a condition of sale or gift at the end of lease period and lessor bears the responsibility of lessor and assumes the full risk of the corpus of the leased asset.
ijarah

Basic Rules for Ijarah or Islamic Lease:

Rental of Lease:

  • The rental must be determined at the time of contract.
  • It is permissible that different amount of rent are fixed for different phases of rental period.
  • It is permissible to tie up the rental amount with a variable benchmark, the ceiling and floor should be determined.
  • Rental will be charged when the Leased asset is handed over to the lessee and not from the day the price has been paid.
  • The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.

Period of Lease:

  • Period of lease must be determined in clear terms at the time of contract.

Lease for Specific Purpose Only:

  • If no specific purpose is identified in the agreement, then it can be used for any purpose for which it is used in normal course.

Responsibility of Lessor:

  • As the owner of the leased asset lessor bears and assumes the full risk of the corpus of the leased asset. If the asset is destroyed during the lease period, the lessor will suffer the loss.
  • Similarly, if the leased asset looses its usufruct without any misuse or negligence on the part of the lessee, the lessor can not claim the rent.
  • Lessor is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor, for example: freight, custom duty and clearing charges.
  • Taxes related to ownership and registration charges of car will be borne by the lessor, including agent fee if any.
  • Insurance of leased asset is responsibility of lessor. But he can appoint the lessee as an agent to arrange insurance on behalf of him.

Responsibility of Lessee:

  • The Ijarah lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence.
  • Taxes related to use of asset will be borne by the lessee.
  • He is liable to the wear and tear which normally occurs during its use.

Determination of Rental:

  • It is permissible in Ijarah 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 affecting a lease.
  • The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shariah.
  • The lessor in Ijarah cannot increase the rent unilaterally, and any agreement to this effect is void.
  • The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee.
  • The lease period shall commence from the date on which the leased asset has been delivered to the lessee.

Note: This lecture on Ijarah is a part of Islamic banking certification, Islamic finance certification and master in Islamic finance, designed for AIMS’ Institute of Islamic banking and finance

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