How 'purchase and leaseback' transaction work

In-Depth Analysis

The purchase and leaseback transaction utilizes the Ijarah contract to provide liquidity relief to customers in need through a Shariah compliant mechanism. This type of transaction is not the norm in the consumer banking segment of an Islamic bank but is frequently used in the wholesale banking sector where liquidity is a daily challenge for corporate customers. The first and foremost aspect to know is whether the customer owns any clean-titled movable or immovable asset. By clean-titled, it means the asset must not be charged or 'liened' or mortgaged to any conventional lender or Islamic financier or any third party for that matter. Also, at times corporate entities obtain certain credit facilities and provide a negative pledge as a covenant. The negative pledge clause in the credit facility documentation is inserted to prevent a customer from pledging any assets in a way that compromises the lender's existing security position. If such a clause appears in an already executed credit facility agreement between the corporate entity and a bank or financial institution, the entity shall not be able to offer any of its assets to the Islamic bank for undertaking a purchase and leaseback transaction. In such a situation, the existing banks may allow a one-time exemption. Then comes the juncture of ascertaining the funding need of the client vis-a-vis the current value of the offered asset. The value could be determined in various ways including relying on the value of the offered asset appearing in the latest audited balance sheet after taking into consideration the depreciation for the period from the last audited balance sheet and the time of the application. Another approach could be to seek professional valuation of the asset, carried out by a reputable surveyor. However, depending on the Islamic bank's level of trust on the customer, there may be no need to obtain independent valuation and it should be in order to rely on the amount appearing in the entity's latest audited or in-house financials. The Shariah scholars forming the board of the institution thoroughly reviewed the situation based on the documents provided and came up with the solution to carve out the non-Shariah compliant units from the overall property block and conduct the transaction based on the available units not violating any Shariah principles. The guidance provided by the Shariah scholars reduced the amount of the transaction, albeit no compromise was made on the Shariah principles. Similarly, the same principle shall be applied if the offered property holds some units where Shariah-repugnant activities are carried out — the Islamic bank shall purchase the customer's fully Shariah compliant property by way of signing the property purchase agreement. When the Islamic bank signs the property purchase agreement, it assumes the ownership of the property from the customer and is now able to lease it to the customer. A question arises whether the transaction remains cost-efficient for the customer compared to conventional bank lending after taking into consideration the land registry fee and the other relevant charges upon the bank assuming ownership.