A conventional financial lease vs. Ijarah Muntahiya Bil Tamleek: what sets them apart

In-Depth Analysis

The author draws on his experience working in a leading UK-headquartered conventional bank over two decades ago, where he handled large corporate finance transactions as part of the risk management team. He always demanded the insertion of a particular clause in the documentation for the financial lease transactions of immovable and movable assets, such as real estate and marine vessels. The gist of the clause was that in case of partial or total loss of the leased asset due to any reason whatsoever, the lessee shall continue to pay the rental until such time that the insurance claim is received by the bank. Should the insurance amount suffice to recover the outstanding amount of the bank's term loan to the customer, together with up-to-date interest and any charges, the surplus, if any, would be released to the customer. However, if the amount paid by the insurance company is less than the outstanding term loan in the bank's books plus the accrued interest and such, the customer would be liable to pay the difference, irrespective of whether the customer was responsible for the damage to the leased asset or not. When the author joined the Islamic bank, he was assigned to deal with the function of risk management within the corporate banking unit. He demanded the insertion of the same clause to 'protect' the Islamic bank's interest but stood corrected on the principles of Islamic financial leasing. It dawned on him that what he had been practicing in the conventional financial leasing transactions had an element of unfairness to the bank's customers. Conventional bank customers had no choice but to accept whatever conditions were imposed by the bank, being in need of the term loan for the growth of their business. Under Islamic financial leasing, which is termed as Ijarah Muntahiya Bil Tamleek or Ijarah Wa Iqtina (literally meaning a lease that ends with the ownership transferred to the lessee), the following parameters must be adhered to. The abbreviated term is IMBT. As explained in the introductory article (No 62) on leasing, the client provides the Islamic bank with a unilaterally signed 'promise to lease' document while submitting the request for leasing an asset from the Islamic bank. The purpose of this document is the same as discussed in the Murabahah contract — to protect the Islamic bank from a situation where the bank purchases the asset but the client may not come forward to start the lease. It is not permissible to eliminate risks in an Islamic financial transaction. However, it is permissible in Shariah to adopt various means to mitigate the risks. Hence, obtaining a 'promise to lease' document from the customer at the outset is a tool to mitigate the risk by the Islamic bank while retaining it in the lease transaction. Another aspect applied to mitigate the risk further is to obtain the security deposit from the customer to be used as a contribution in purchasing the asset. The customer may have already made a downpayment to the third-party seller (which could be a developer), in which case it will be required that such a payment is legally assigned to the Islamic bank through a tripartite agreement between the Islamic bank, its customer, and the seller. Once the Islamic bank receives the 'promise to lease' and completes all due diligence, including the customary know-your-customer process on the applicant, and upon getting the necessary head office approval, the Islamic bank proceeds to purchase the relevant asset in its own name from a third-party seller by way of entering into an asset purchase agreement. If it is an immovable property, the title deed shall be obtained by the Islamic bank in its own name. In case of a movable asset such as an aircraft, a marine vessel, a crane or a car, all official formalities shall be completed and the asset registered in the Islamic bank's name as the owner.