Lease-Based Product – Ijarah

Definition of Ijarah: Ijarah is a lease contract in which an Islamic bank purchases capital equipment or property and leases it to an enterprise. The bank may finance the equipment either on operating lease basis or on finance lease basis (lease-to-buy) arrangements.

Issues in an Ijarah Contract: In an Ijarah contract, the usufruct – not the title – of the asset is transferred to the lessee. Consequently anything which cannot be used without consuming cannot be subject matter of a lease contract. During the period of the lease, the asset remains under the ownership of the lessor, but the physical possession of the asset and the right to use it are transferred to the lessee. After the expiry of the lease agreement, the ownership of the asset is passed on to the lessee through a separate contract.

Cont. All the liabilities of the leased property emerging from the ownership shall be borne by the lessor. The period of lease, the rent and other necessary details may be determined by mutual consultations of the parties concerned. The leased asset remains with the lease as a trust. Therefore, the lessee is liable to compensate the lessor for any damage to the leased asset caused by any misuse or negligence.

Cont, Termination of the contract must be by mutual consent of both parties. The rental must be determined at the time of contract for the whole period of lease. However, different amounts of rents can be fixed for different phases during the lease period.

Types of Lease Contract: Operating Lease: The client approached the bank and request for leasing an asset with an undertaking to lease if the bank acquires the same. The bank buys the asset from the supplier and then leases it to the client. The client pays the agreed upon rental during the lease period. At the end of lease period, the customer may continue to lease the asset under the new arrangement or the asset is returned back to the bank to lease the same to a third party or to sell it in the secondary market.

Cont. Lease to Own (Ijarah Muntahia bittamilk): It is a form of leasing in which, at the end of the lease period, ownership of the leased property is transferred to the lease. In such case the rental paid during the period of the lease may constitute part of the price.

Steps in an Ijarah Contract The bank buys the asset from the supplier. The bank then leases the asset to the customer. Periodic rentals are collected by the bank. The title of the asset remains with the bank under an operating Ijarah. Title passes to the customer under Ijarah Muntahia bittamilk, either gradually over the period of the contract, or at the end. Bank transfers ownership of asset to client at the end of Ijarah period either through a gift or sale.

Risks in Ijarah: All the risk and liabilities emerging from the ownership of the asset are to be borne by the lessor i.e. the bank unless the damage is caused by mismanagement or negligence of the lessee. Default Risk and its Mitigation: Ijarah rental becomes a debt on the client after it becomes due. The bank is not allowed to charge an additional amount in case of delays in payment of the rentals. The bank may, however, ask the client-lessee to undertake to contribute a certain sum to a charity fund maintained by the bank, should there be a default or delinquency.

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