Guide to ijarah or leasing in Islamic banking and finance

In-Depth Analysis

Ijarah is the fourth Shariah sales contract used by Islamic banks and financial institutions for various product offerings. It is referred to as Aqd Al Ijar or Ijarah — the agreement to lease. Leasing is common in both conventional and Islamic financial systems, albeit with vast differences in their applications, similar to the differences between Islamic and conventional banking more broadly. The key distinction is that under a lease agreement, the subject matter is the usufruct or right to use an asset for a defined period of time, not the asset itself. In a recent article on Istisna, the author explained the definition of usufruct, which is the right to enjoy the usage and take advantage of someone else's property for an agreed period of time at a cost, in a manner that it remains intact at the end of the period. The question then arises: is the usufruct a commodity that can be bought and sold through an Ijarah agreement? The answer is yes. The Shariah approach is clear that the usufruct fulfills the Shariah criteria of being a commodity and hence it can be freely bought and sold. This kind of sales contract is different in that there is a time limitation (lease tenor) which is not found in Murabahah, Salam, or Istisna sales contracts. Shariah recognizes different kinds of ownership, which can be classified as three kinds. The first kind is complete ownership where the title and possession to a movable or immovable property both are held by a single party. The second kind is incomplete ownership where the title to a property is held with one party but without possession. The third kind is where possession is owned by a party but without the title. All of them are permissible in Shariah and are used for different transactional purposes. Since the act of leasing is captured under a contract, all parameters of the Shariah contract must apply to leasing, including a minimum of two parties, offer and acceptance, contract language being Shariah compliant, delivery of usufruct, payment of agreed leasing price (rent) and the purchaser of the usufruct (lessee) extracting the benefit from the leased asset. Once entered, the lease contract is binding on both parties and cannot be revoked unilaterally nor can the terms of the lease contract be altered. However, any element of the lease contract can be modified with mutual consent either before or after the delivery of the usufruct. An Islamic bank may directly enter into an Ijarah contract with the customer if the leasing asset is readily available in its ownership and possession. However, it will not be possible for an Islamic bank to enter into an Ijarah contract in the case of absence of the asset purported to be leased. In such a situation, the Islamic bank may request the customer to provide a 'promise to lease' before it starts the acquisition of the asset required to be leased or enter into a forward lease contract with the customer. This 'promise to lease' document is analogous to the 'promise to purchase' discussed in the Murabahah topic, serving as a risk mitigation tool for the bank.