IB1005

DEPOSITS AND FINANCING PRACTICES OF

ISLAMIC FINANCIAL INSTITUTIONS CHAPTER
7 : AL-IJARAH THUMMA AL- BAY (AITAB)
VEHICLE/CAR FINANCING
COMPILED BY
HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance)
Certified Professional Trainer (MIM)
Industry Expert
INCEIF

PRESENTED BY
HJ MAHMUD HJ BUNTAT, MBA (AUOL, UK), DBM (Swansea Inst., UK), CIL (UIA)
Part-time Lecturer (INCEIF)
Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd

Chapter 7: Financing
Al-Ijarah Thumma Al-Bay (AITAB)
Vehicle/Car Financing
Islamic

jurists (fuqaha) today have introduced

hire-purchase based on Shariah principles known
as al-ijarah thumma al-bay (AITAB), which
means leasing (al-ijarah) ending with sale (albay). It also means that AITAB is a contract of
lease with an option to purchase the asset.

In fiqh, al-ijarah means to give something on

rent. Literally, al-ijarah or al-ajr means
substitute, compensation, recompense,
indemnity, consideration, return or countervalue. Al-ijarah has two types of usufruct
(manfaat):1. Usufruct of property or capital assets
(manfaat al-ayn); and
2. Usufruct of labor, employment and service
(manfaat al-amal)

In al-ijarah of services, the employer is called

mustajir and the employee ajir. The contract
between the two parties involves the
employment of the services of the ajir based on
an agreed pre-fixed wage or salary (ujrah) given
to him as reward for the services rendered in the
transaction.

In AITAB the contract of ijarah ain is applied.The

lessor is called mujir while the lessee or hirer is
known as mustajir and the rent payable to the
lessor is called ujrah.

In

al-ijarah, the lessee has only the right to use

the property but not the ownership of property.

Some basic rules of al-ijarah are as follows: Al-ijarah

is valid only with consent of both parties to

the contract. That is, to avoid gharar, the contracted
usufruct or manfaat has to be absolutely ascertained.

The

use.

usufruct must be lawful and must have a valuable

All

liabilities arising from ownership shall be borne by

the lessor who owns the rental property.

The

rent, period and the purpose of the lease must be

clearly specified.

OPERATING LEASE
(Modus Operandi) - Step 1
Purchase Agreement

Financier

Supplier
Purchase Price

Asset
STEP 1

OPERATING LEASE
(Modus Operandi) - Step 2
Lease Agreement

Financier

Customer
Rental Payment

Asset
STEP 2

AL-IJARAH THUMAA AL-BAY

(AITAB)

In theory, the contract of Al-ijarah Thumma alBay shall consist of two different contracts,
namely:1. The contract of lease (al-ijarah ain)
2. The contract of sale (al-bay).

Al-ijarah and al-bay are both categorised under

the contract of exchange (uqud al-mubadalah).
The former relates to the exchange of usufruct
for money while the latter involves the exchange
of goods for money.

In AITAB, the contract of al-ijarah runs

separately from the contract of al-bay. In AITAB,
the contract of al-ijarah runs separately from the
contract of al-bay. These stages are:Stage 1: Executing the contract of true leasing
(al-ijarah ain)
Stage 2: Executing the contract of sale (al-bay)
at a nominal value agreed upon by both parties.

AITAB is a contract of leasing with a promise to

sell the asset.

The AITAB product under the purview of HP ACT

1967 is also required to observe the interestbearing mechanism.

Since AITAB has to operate within the Hire

Purchase Act, it is necessary to understand some
features of the Act.

 However,

it must be noted that the Hire Purchase

Act 1967 remains a law governing an interestbearing term loan granted by a bank to the
borrower.

In

this way, AITAB assumes identical structure as

do conventional hire-purchase.

The bank as a lessor holds the right to sell the

asset if the lessee defaulted on payments.

But ironically, the bank as an owner does not

seem to fulfill its obligation as an owner of
property since it is the customers who are made
to maintain the property and pay tax and
insurance obligations.

By rightit requires the bank as lessor to

maintain the rental asset and fulfills other
obligations as any car owner is supposed to do.

In

this manner, the bank must pay for insurance

and road tax as well as car maintenance

This

is done to observe the true leasing.

 Customer

cannot be forced to pay the remaining

balance if he fails to pay rentals.

He

can inform the bank his intention to terminate

the contract and not liable to return the lessor
any sum of money.

This

is done to conform to the concept of true

leasing.

AITAB offers the customer a full-financing

scheme. He does not have to put up a down
payment as practiced by current AITAB under HP
Act 1967.

Car maintenance rests on the bank as lessor.

However, if the engine broke down due to
negligence of customer, he shall be liable for the
repair expenses.

Rental under true AITAB will be much higher than

that under current AITAB model. The rental shall
include cost of rental assets and cost of
maintenance as mentioned above.

Prospective customers will be glad to use the

true AITAB model. Although the rental is a lot
higher, customers will be less burdened with
payments that lessor should be paying in first
place.

 In

the HP agreement, the bank claims to be a

prospective owner. But why has it been able to
transfer the obligation of maintenance to the
customers while securing the legal rights of
repossession and disposal?

AITAB

Car Financing, and indeed AITAB

generally, includes a clause to apply the
provisions of the Hire Purchase Act 1967 that
does not contradict Shari'ah.

 Under

AITAB (disallowed by AAOIFI), a minimal

late payment fee of 1.00% p.a. of the installment
due may be imposed whereas a Conventional HP
will charge a fee of 8.00% p.a. AAOIFI Sharia
Standard No.3, item 2/1 (b), p.32/

AITAB

lease payments are calculated on the basis

of the Rule of 78/Sum of Digits calculation

The following characteristics are a feature of

AITAB;

Asset ownership as legal title remains with the lessee.

Economic risk no market risk or capital depreciation risk.

repayments are determined according to the rule of 78,

and the profit rate is pegged to the interest rate.

Major maintenance & repair is assumed by the lessee, but

operational risk remains with the lessee not the lessor.

AITAB (Modus Operandi)

Step 1
Purchase Agreement

Financier

Supplier
Purchase Price

Asset
STEP 1

AITAB (Modus Operandi)

Step 2
Lease Agreement /
2 Schedule HPA 1967
nd

Financier

Customer
Rental Payment

Asset
STEP 2

AITAB (Modus Operandi)

Step 3
Sale Agreement

Financier

Customer
Sale Price

Asset
STEP 3

 Some

jurists have observed that an Islamic lease

is a pure operating lease with operating costs for
the account of the lessor, but this is not the case
with AITAB, which would make it a financial
lease.

Rule 78

Under the Rule of 78, profit is calculated for the

life of the financing and then allocated to each
month by proportion using reverse sum of the
digits methodology. You start by adding up the
numbers of months for the note. For example, in
a 12 month financing, counting month 1, plus
month 2, and so forth through month 12 is: 78

An

example: 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9
+ 10 + 11 + 12

This

totals 78, and hence the name, rule of 78.

For an example:
Let's look at the example of a $90,000 financing
at 5% profit rate for 1 year. Under the Rule of 78,
we first add up the 12 months:1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10 + 11
+ 12 = 78
Finally,

we divide the profit total by the sum of

the digits (78) and apply in reverse proportion.

The profit rate for 1 year RM 90,000x 5% = RM

4,500

The

monthly installment is (RM 90,000+ RM

4500) /12 = RM7,875.00

The monthly profit being charged is as follows: Month # 1: RM 4,500

Month # 2: RM 4,500
Month # 3: RM 4,500
Month # 4: RM 4,500
........ and so on until
Month #12: RM4,500

x (12/78) = RM 720
x (11/78) = RM 675
x (10/78) = RM 585
x (9/78) = RM 540
12st month
x (1/78) = RM 90

 AAOIFI

has summarized the legitimacy of ijarah

as derived from al-Quran, said one of them Oh
my father, engage him on wages and if you
had wished, surely you could have taken wages
for it; Sharia Standards (2004-2005), Sharia
Standard No.9, Appendix (B), p.151
- Al-Quran 28:26
- Al-Quran 18:77

 Whilst

it might be argued that istisna is a form of

ijarah, the distinction made by AAOIFI is simply
that the subject of a lease is its usufruct and not
the asset itself.

Istisna

would be used to construct a bicycle, and

ijarah would be used to hire the bike, but not the
wheels of the bike.

The Majallah defines ijarah as hire to be paid for

a thing, i.e. the price for the benefit.

the

Majallah also defines it more closely as the

sale (bai) of a known benefit in return for its
known equivalent.

 And

in the case of termination, if the lessee

defaults in punctual payments, foreclosure and
recovery of rentals from the security might seem
to be no different to the risks associated with
secured lending.
- Sharia Standards (2004-2005), Sharia
Standard No.9, Art.7, item 7/2/2, p.145
- Sharia Standards (2004-2005), Sharia
Standard No.9, Art.6, item 6/5, p.144

Have

a good day
May God bless you
Thank you & Wassalam