Is the forward lease contract fair? A Shariah perspective

In-Depth Analysis

Picking up from article 75, the discussion continues on the forward lease. As per Shariah principles, under a forward lease contract used for off-plan (under construction) properties, an Islamic bank can only commence charging the lease rent once it has delivered the property to the lessee. However, on the other hand, an Islamic bank shall continue to make payment to the developer of the property based on an agreed stage payment schedule from its own pocket. This is in contrast with the conventional banking practice of applying interest from the day the bank makes the first payment to the developer by creating a mortgage loan facility in its ledger in the customer's name. Note the difference here: the conventional bank creates the loan in the customer's name to make payment to the developer whereas the Islamic bank does not do so and makes the stage payments to the developer from its own source. The question posed was: while the conventional bank recovers its 'cost of funds' from day one together with the interest margin (profit) from the mortgagee, how does an Islamic bank cover its cost of funds if it waits until the completion and delivery of the property to the lessee which may take two to three years? Islamic banks do not have the cost of funds phenomenon in their operating model. Islamic banks do not borrow money at a fixed interest rate from depositors and hence they immediately incur a cost. On the contrary, Islamic banks do not borrow funds from depositors, but rather accept them as a trustee for investing the funds for and on behalf of depositors. Whatever profit is generated through such deployment of funds is distributed between the Islamic bank and the depositors based on a pre-agreed distribution ratio. Since the forward lease contract includes the rate of the variable lease rent (see article 72), the Islamic bank is able to apply this rate on the stage payment schedule and arrives at an aggregate amount of potential variable lease rent under the forward lease contract. This amount is added as the 'additional rent' in the forward lease contract with a stipulation that it will not be payable unless the property is delivered to the lessee in order to commence the lease. As such, the lessee is aware ahead of the delivery of the property and commencement of the lease that he or she is required to pay the 'additional rent' amount in addition to the fixed and variable rentals in the first lease period. The 2008 UAE financial crisis provides the real test: thousands of units sold under the off-plan schemes were inordinately delayed, some as long as up to six years. While customers of conventional banks continued to pay the interest on their mortgage amounts, the potential lessees under the forward lease contracts with Islamic banks heaved a big sigh of relief since their additional rent amount was locked at the time of entering into the forward lease. Another fair approach is that if the project is abandoned permanently due to any reason, the Islamic bank will never be able to recover the additional rent from the customer since it will not be able to deliver the property to the customer and start the lease.