ESSENTIALS OF ISLAMIC FINANCE 1 IJARAH Ijarah derives

ESSENTIALS OF ISLAMIC FINANCE 1

IJARAH Ijarah derives from the root word ajara “to recompense, compensate or give consideration and return”. Ajr refers to a worker’s wage, and ujrah to rental payment. In its juristic usage, Ijarah primarily refers to both a rental as well as a hire contract that engages the services of persons. 2

Finance lease is mostly used to raise long term capital to pay for assets. It enables the lessor to earn reasonable profit along with full recovery of the cost of the asset. operational lease it is also called as a “non-full payout” leases, because the amount of the rental does not cover the lessor full cost of asset and the period of lease is always less than the useful life of the asset. IJARAH 3

� Ijarah is also validated by the Quran, Sunnah, and ijmah. QURAN SUNNAH • Several verses are found in the Quran (al-Kahf, 77: al. Qasas, 26: al. Talaq, 65 -6) on the worker’s entitlement to a wage • References also occur in hadith to ijarah and the employer-employee relations“pay the employee his wages before the sweat of his brow dries up”. 4

In Islamic finance Ijarah is a very popular sharyah way to asset finance without involving interest. It enables the customer to use durable inconsumable goods, equipment and heavy machinery The amount of rent can be re-priced by the Islamic banks Leasing allows a logical way to separate ownership and the use of asset. The decision of Islamic banks to provide Ijarah financing depends upon the amount of cash flows from the leased asset and the financial position of the customer but without interest. 5

� The client” Lessee” contact the bank “Lessor” with the request for ijarah leasing and enters into a promise for lease contract. It includes the offer and acceptance by the client. � The bank buys the asset required for ijarah and gets title of ownership from the manufacturer. � The bank makes payment to the manufacturer. 6

� The bank leases the asset to the client after execution of the ijarah contract which takes place after the client gets the delivery of the asset. � The lessee makes periodic fixed rental payments according to the contract of ijarah � At the end of contract period the lessee can purchase the asset from the bank under a separate sale agreement at a nominal price 7

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Hanafi School Maliki School Shafie School Hanbali School • Defines as a contract that enables possession of a particular usufruct of the leased asset (ayn) for a consideration. • Defines Ijarah as a contract that relates to permissible usufructs for a particular period. • Defines Ijarah as a contract for a defined usufruct liable to utilization and accessibility for a particular recompense. • Hambali definition is that the benefit or services of ijarah appear in the future 9

Ijarah sukuk or bonds are the securities that shows the ownership of clearly specified existed and known asset For example, An air craft on ijarah leased can be represented in bonds Less risk as compare to common stocks Ijarah Sukkuk are completely transferable and can be traded in the secondary markets 10

• The arrangement of Ijarah has a good potential of securitization which may help create a secondary market for the financiers on the basis of Ijarah. • The lessor in Ijarah owns the leased assets, he can sell the asset, in whole or in part, to a third party who may purchase it and may replace the seller in the rights and obligations of the lessor with regard to the purchased part of the asset. • In the case of total destruction of the asset, he will suffer the loss to the extent of his ownership. 11

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There should be at least one year lease period There should be separate contracts for sale and lease The agreement to sell at the end of the lease must be separate The intention of the client is to avoid interest related transactions 13

Lessor in a financial lease, bears ownership responsibilities, in the event the asset is destroyed during the lease period, he alone stands to suffer the loss. 14

The subject of Ijarah must have a valuable use. Therefore, things having no usufruct at all cannot be given on Ijarah. The period of Ijarah must be determined in clear terms. Lessees cannot use the Ijarah asset for any purpose other than the purpose specified in the Ijarah agreement. The lessee is liable to compensate the lessor for every harm to the Ijarah asset caused by any misuse or negligence on the part of the lessee. A joint owner of an Asset can given on Ijarah basis his proportionate share to his cosharer only, and not to any other person. It is necessary for a valid Ijarah that the Ijarah asset is fully identified by the parties 15

� contract of ijarah can only be revoked where the asset lost its utility or function 16

Generally, the financial institutions calculate the rental amounts as follows: The financial institution determines that it wants to have a profit rate (PR) of 10 percent. The purchase price (PP), including all costs, is $1, 000 (cost borne by the financial institution). The term (T) of the lease is 5 years. 17

Islamic leasing necessarily involves real assets Islamic leasing creates a great potential for securitization Islamic leasing is especially suitable for some sectors of the economy Lease finance is easier to practice Lease finance has some of the good features 18

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