Understanding Islamic Finance - Doha Academy of Tertiary Studies

Ijarah – Leasing 301If the leased vehicle is stolen orcompletely destroyed, the conventionalleasing company would continuecharging the lease rent until thesettlement of the insurance claim.In some conventional leases, the lessoris given an unrestricted power toterminate the lease unilaterally at hissole discretion.In most contemporary financial leases, anextra amount is charged if rent is not paidon time. This extra amount is taken by theleasing institutions into their income.This is prohibited due to being Riba.Under conventional leasing contracts, thevehicle is automatically transferredto the name of the customerupon completion of the lease period.Upfront payment has to be made in theform of downpayment, the first year’sinsurance premium and other insuranceexpenses, first month’s rental, etc.Under the Islamic system, rent isconsideration for usage of the leasedasset, and if the asset has been stolen ordestroyed, the concept of rental becomesvoid. As such, an Islamic bank cannotcharge the rental.Ijarah is a binding contract and if thereis no contravention on the part of thelessee, the lease cannot be terminated byany one party. It can be provided in theagreement that if the lessee contravenesany terms of the agreement, the lessorhas a right to terminate the leasecontract unilaterally.Under Ijarah, the lessee may be asked toundertake that if he fails to pay rent onits due date, he will pay a certainamount to a charity but the bank cannotcharge any further return.In Ijarah, the customer is not obliged topurchase the vehicle. He may purchasethe asset through a formal sale deed ifhe considers it beneficial for him.Islamic banks normally take only asecurity deposit, which is refundable ifthe lease is not finalized. The bank hasthe authority to recover only actualexpenses not including the cost of funds.Box 11.3:A Hypothetical Case Study on IjarahABC Textile Mills (Pvt.) Ltd, one of the customers of Merit Islamic Bank, hasrequested an Ijarah facility for the following assets. The client will deposit 10 % ofthe value of the Ijarah asset as a security deposit/earnest money.1. Company cars 20 Rs. 10 000 000 (L/C has been established with XYZ bank)2. Trucks 20 Rs. 360 000 0003. Dyeing plant Rs. 140 000 000 (already owned by the client)4. Looms 50 Rs. 15 000 000 (operating for about 1 year)The Islamic bank’s employee is required to decide:Issue # 1Which asset will the bank finance through a direct lease and which through sale and leaseback?What factors will it consider before allowing sale and lease-back transactions?