Leasing or Renting (Ijara) in Islamic Finance - dummies

Leasing or Renting (Ijara) in Islamic Finance

By Faleel Jamaldeen

The Arabic term ijara means “providing services and goods temporarily for a wage.” The ijara contract, as you may guess, involves providing products or services on a lease or rental basis. In the ijara contract, a person or party is given the right to use the object (the usufruct) for a period of time; the owner retains the ownership of the assets.

The ijara contract is similar to a conventional lease in which the owner rents or leases his property or goods to a lessee for a specified number of periods for a fee. For example, the lessee is responsible for normal maintenance, and the lessor is responsible for major maintenance, just as with many conventional lease contracts. However, the following features of ijara differentiate it from a conventional lease:

  • The lessor must own the assets for the full lease period.

  • If the lessee defaults on payments or delays payments, the lessor can’t charge compound interest.

  • The leased asset’s use is specified in the contract.

Three types of ijara arrangements can exist according to sharia principles:

  • Lease-ending ownership/lease with ownership (ijara wa iqtina/ ijara muntahia bitamleek): In this ijara contract, the lessee owns the leased asset at the end of the lease period. This lease contract doesn’t contain any promise to buy or sell the assets, but the bank may offer a (verbal) unilateral promise of transfer of ownership or offer a purchase schedule for the asset.

  • The lessee also is allowed to make a (verbal) unilateral promise to purchase the asset. The purchase price is ultimately decided by the market value of the asset or a negotiated price.

  • Operating lease (operating ijara): This type of ijara contract doesn’t include the promise to purchase the asset at the end of the contract. Basically, this setup is a hire arrangement with the lessor.

  • Forward lease (ijara mawsoofa bil thimma): This contract is a combination of construction finance (istisna) and a redeemable leasing agreement. Because this lease is executed for a future date, it’s called forward leasing. The forward leasing contract buys out the project (generally a construction project) as a whole at its completion or in tranches (portions) of the project.

Many ijara products are on the market with different combinations of contracts. For example, Malaysian-based Maybank offers car financing with a combination of an ijara contract and a bai (purchase) contract. ADCB (Abu Dhabi Commercial Bank) offers ijara home financing, as does SABB (Saudi British Bank) Amanah.