Al Ijarah

Essentials of Islamic Banking and Finance

Talha Saleem Kapadia

talhasaleemkapadia@gmail.com

Contents
Definition of Ijarah;
Explanation;
Features of Ijarah;
Difference with conventional lease;
Practical application;
Q & A

Definition of Ijarah
Ijarah is an Arabic word whose origin is 'Ujrah'

(compensation/fee/fare);
Ijarah means giving something to other for use against a fee
or rent or fare;
In conventional finance concept of Leasing is similar to Ijarah;
Conventional lease is defined as 'a right to use or occupy a
property given by owner of the property (lessor) to another
person (lessee or tenant) for a period of time, whereby the
lessee obtains exclusive possession of the property in return
for payment of fixed or determinable (floating) consideration
(fee or rent) to lessor';
So it is act of giving a physical thing to other person for use
against a return (rent or fee);
Leasing does not include employment which means activity
or service performed by a person (employee) for another
person (employer) for compensation (fee) or as an occupation
(salary);

Definition of Ijarah
This concept of Ijarah is broader than of the leasing;
Its literal meaning is to give something on rent;
In Islamic Fiqh the term of Ijarah has two meanings:
To employ the services of a person on wages or fee (Ijarah

al-Shakhsiyyah services Ijarah); and

To give a right to use a property or an asset to a person
for a period of time against payment of a
rent/charges/fee;
In Islamic finance second type of Ijarah is discussed;

Expalnation of Ijarah
Ijara in simple terms, implies leasing or hiring of a physical

asset;
It is a popular product in which the Islamic bank assumes the
role of an aajir or moojir (lessor) and allows its client to use a
particular asset that it owns;
The client or mustajir (lessee) receives through Ijarah the
benefits associated with ownership of the asset against
payment of predetermined rentals (ujrat);
There are two famous types of lease:
Operating lease;
Operating lease is a contract that allows the use of an asset, but does
not convey rights of ownership of the asset to lessee;
Finance lease/Capital lease;
A lease contract that allows the use of an asset and considered to
have the characteristic of ownership during the period of lease and
automatically convey rights of ownership of the asset to lessee at the
end of lease period.

Islamic financial system recognizes only Operating Lease

Expalnation of Ijarah
Capital lease has two basic problems:
Two contract of different nature (sale and lease) are use

combined. Therefore it is neither a sale nor a lease

contract completely;
Two different types of contract have different types of
effects;

Proper distribution of rights and obligation of ownership is necessary

according to Islamic law;
No such distribution is present since it is a mixture of two different
contracts: hire and purchase;

As a rule of thumb Islam does not allow combining to

different contract in one contract in a manner that each of

them is dependent on the other;
Like rent agreement and sale are merged in one contract
in the manner that both are dependent on each other.

Features of Ijarah
Ijara is for a known time period called Ijara period;
Since operating lease is the only allowed way of leasing the

rules of operating lease shall apply;

Bank acquires ownership upon receiving a request from its
client. Title or equitable ownership of the asset will remain
with the bank as owner of the asset;
Right of use of the property is transferred to the lessee;
Ijara rentals are also paid in installments over time, and are
supposed to cover the cost of the asset or value of
investment for the bank and to provide a fair return on
investment;

Features of Ijarah
In Ijara, the bank continues to be the owner throughout the

Ijara period while the client receives the benefits of ownership

or the benefits of using the asset;
As such, risks associated with ownership of the asset remain
with the bank and the asset is supposed to revert back to the
bank at the end of the Ijara period;
The rentals could be fixed or flexible and be made to reflect
the changing economic and business conditions;

Rules of Ijarah
As per the Islamic laws of contract the:
Subject matter of Ijarah should be Valuable, Identified

and Quantified;
The period of Lease must be determined in clear terms;
Any damage to the asset not caused by the Lessees
neglect, is to be borne by the Lessor;
Lessee will be responsible for Normal maintenance;
The Lessee is responsible for damage to the asset caused
by fraud or negligence;
The lease period starts when the asset has been delivered
to the lessee in usable condition whether or not the
lessee has started using it;
Lease rentals for the entire lease period should be fixed
(element of Gharar);
Rent can be fixed on periodic basis (periodic
revision/floating) but periodic increment should be agreed
upon;
The rent may be tied to a known benchmark, acceptable
to both the parties.

Rules of Ijarah
Termination of Lease:
The lease will suspend if the leased asset becomes

unusable;
The lease will terminate if the leased asset is destroyed;
However, if it is due to fault of the lessee, he is liable to
compensate the lessor for the loss;
Contravention of any term of the lease agreement gives
right to lessor for unilateral termination of the
agreement;
Conventional Leases are of two types:
Sale & Leaseback
Leasing the asset which has already purchased by the lessee;
The Lessor purchases the asset from the Lessee and leases it back to
him;
This is a kind of implicit interest;
Direct lease

Leasing an asset which is not already owned by lessee;

Lessor purchases the asset from the supplier (open market or a third
person) and then leases it to lessee;

Rules of Ijarah
Both types of leases are possible under Ijarah;
However, as discussed before Sale & Lease Back arrangement

may be a kind of implicit interest therefore it is a less

preferred option according to Islamic Shari'ah;
However, if the mode is employed, then following restriction
should be strictly adhered:

Sale deed should be completely independent of the Ijarah

agreement;
Sale Deed should be executed before the execution of
Ijarah Agreement;
The assets should be sold back to the customer after a
reasonable time;
A year may be good time difference.

Rules of Ijarah
Variable rentals in Ijarah:
Fixed and floating rate rentals are possible in Ijarah like

lease;
This rate will be effective for whole period;
Agreeing on a fixed rent for a long-term lease may not be
feasible for lessor and he may wish to adopt market
changes;
Floating rates are allowed with certain conditions;
The whole period should be divided into different periods
(10 year may be divided into 10 equal periods);
The rent should be set for a period before its start;
After start of period the rental can not be changed
because of any reason (delay in payment, market rate
change etc. etc.);

Practical application
Application for asset on Ijarah basis

ISLAMIC BANK

Agreement to Ijarah

CUSTOMER

Submission of initial deposit

Delivery to bank or as per its order to customer
Transfer of ownership with delivery to owner
(the bank)

Delivery or time of delivery

Payment or Order to vendor/seller

VENDOR

.
Rental payment to owner
Rental payment to owner

At the end of lease period customer

At
thethe
endasset
of lease
customer
buys
fromperiod
owner/bank
buys theaasset
fromagreement
owner/bank
through
separate
through a separate agreement

Practical application
Consumer Finance:
Automobile;
Machinery;

Corporate Sector:
Machinery;
Automobile;

Investment Banking;

QUESTION
S