Deep dive into the supplementary element of periodic rent covering major maintenance obligations. Uses the aircraft leasing example to illustrate how the Islamic bank (as owner/lessor) must fund major maintenance, and how the 4-step Shariah-compliant process works when the airline is appointed as the lessor's agent.
In-Depth Analysis
The supplementary element of periodic lease rent (or Ijarah installment) in a financial leasing transaction covers fixed and variable elements, representing the recovery of an Islamic bank's capital investment and the return (profit) on investment respectively. The third component that was left to be elaborated to the readers is called the supplementary element. In simple terms, the supplementary element of periodic rent is comprised of the cost of major maintenance incurred by the owner in providing the leased asset to the lessee in perfect working condition during the course of the entire financial lease. Shariah principles dictate that the primary responsibility for the maintenance of the leased asset lies with the owner of the asset. In Shariah, the asset maintenance is categorized into two parts: major maintenance and minor maintenance. Whilst major maintenance is such in nature that, without which, the leased asset would either cease to function at all or would not be able to provide the normal benefit or lose its effectiveness for the lessee. In this situation, the rent paid by the lessee will become questionable since the lessee is unable to fully enjoy the benefit arising from the asset. Examples of major maintenance are overhauling of an aircraft engine, dry-docking of a marine vessel, or routine service of the centrally air-conditioned plant of a large real estate asset. Minor maintenance includes changing the light bulb in a residential unit taken on lease by the tenant or watering the lawn, upkeeping of the aircraft with regular replenishment of all consumables such as engine fluids, fuel, oxygen, food, etc. To further elaborate on major maintenance, imagine an Islamic bank providing financial lease of an aircraft to an airline: the staff of the Islamic bank would not know how to take care of the aircraft whereas the airline will have in its workforce aircraft engineers and other technical staff fully conversant with the requirements of keeping an airplane in the air. The most logical step would be for the Islamic bank to appoint the airline as its technical agent to service the airplane so as to keep it in perfect working condition. As such, a servicing agency agreement shall be drawn to be signed between the Islamic bank as the principal and the airline as the agent pursuant to which the airline will assume the responsibility of undertaking major maintenance of the airplane while at the same time also performing minor maintenance in the capacity as the lessee. The preferred Shariah position for the 4-step process is defined below: (1) the owner of the aircraft should pay the upcoming major maintenance cost to the agent beforehand; (2) if the owner does not do so, the agent shall have the option to complete the major maintenance by utilizing its own money since it needs the airplane to remain in good working condition to support its operation; (3) the agent should immediately claim the reimbursement of the amount it has spent on major maintenance by submitting the bill to the owner (acting as the principal in the technical agency agreement); (4) the owner (acting as the principal in the technical agency agreement) should immediately reimburse the major maintenance cost to the agent. The Islamic bank as the lessor is faced with a huge deficit upon entering into a financial lease because while the rent on the airplane shall be market-oriented, the payment of the reimbursement amount on the account of major maintenance makes the Islamic financial leasing a disastrous offer. This is because the rent is calculated at market rates, but the bank must also fund all major maintenance — a cost that can run into millions for aircraft.
What You Need to Know
- 1Supplementary rent element covers major maintenance costs incurred by the owner/lessor
- 2Shariah categorizes maintenance into major (owner's responsibility) and minor (lessee's responsibility)
- 3Major maintenance examples: aircraft engine overhaul, marine vessel dry-docking, HVAC servicing
- 4Minor maintenance examples: light bulbs, lawn care, consumables replenishment
- 54-step Shariah process: owner pays upfront, agent may self-fund, agent claims reimbursement, owner reimburses
- 6Aircraft leasing example illustrates the practical challenge of major maintenance funding
- 7Servicing agency agreement appoints the lessee (airline) as the lessor's technical agent
- 8Market-rate rent plus major maintenance reimbursement creates a financial challenge for the lessor
Key Statistics
U.S. Market Relevance
For US Islamic home financing, the concept of owner's maintenance responsibility is significant. Under Ijarah, the Islamic provider bears major maintenance costs — a potential advantage over conventional mortgages where the homeowner bears all costs. Understanding the supplementary rent element helps US consumers appreciate the full cost structure of their Islamic home financing payments.
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