Reference: Contracts & the Products of Islamic Banking by Zaharuddin Abd Rahman
36
______________________________________________________________________ _______________ DEFINITION “A contract pertaining to usufruct transfer, with compensation” It differs with sale and purchase of goods concept. Lease is selling and purchasing of usufructs of the goods. However, the goods are still subjected to the ownership of the lessor. The right to use the usufructs of the asset is switched from the owner to the lessee. For consideration, the lessee has to pay an amount of rental payment to the owner of the asset. RULING ON IJARAH (At-Tahrim:6) “And if they suckle your offspring, give them their recompense”. Hadith: “Pay the hired worker his wages before his sweat dries off”. IJARAH (LEASING)
“A contract pertaining to usufruct transfer, with compensation”
It differs with sale and purchase of goods concept. Lease is selling and purchasing of
usufructs of the goods. However, the goods are still subjected to the ownership of the lessor.
The right to use the usufructs of the asset is switched from the owner to the lessee. For
consideration, the lessee has to pay an amount of rental payment to the owner of the asset.
RULING ON IJARAH
(At-Tahrim:6) “And if they suckle your offspring, give them their recompense”.
Hadith: “Pay the hired worker his wages before his sweat dries off”.
It is also known that the Muslim nation during the time of the Companions of the Prophet
reached a consensus on the permissibility of leasing. In this regard, the observable usufruct of
goods is clear benefit to the people, thus rendering leasing such usufruct, valid, based on the
validity of selling the objects themselves.
IJARAH (LEASING)
TYPES OF IJARAH
The majority of jurists have classified lease according to various perspectives, the following are two main
perspectives:
a) SUBJECT MATTER OF THE LEASED ASSET
Ijarah ‘Ain: to lease the usufruct from the specific goods or asset.
This first type of lease has invited no difference in opinion among the scholars and jurists as to its
permissibility. The rental payment can be fixed and paid at the initial lease contract or on the
basis of deferred payment.
Eg: Mr Ahmad leases out his house to Mr Karim for the payment of RM700 per month for a period of one
year.
Ijarah ‘Amal: to lease out the works or self-skills
In this type of contract, the work itself will be the subject matter of the contract. Hence, for the
consideration of the work and the skills in performing the job, the workers, such as consultants, lawyers,
company’s staffs, etc., will be paid a certain amount of wages
Ijarah Mawsufah Fi Az-Zimmah or Ijarah Az-Zimmah
This is a form of Ijarah where the asset needs to be described in detail in advance but it is not available at
the time of contract. The asset must be delivered on a future agreed date.
Eg: Mr Ahmad leases out his double storey terrace house in Bandar Baru Bangi measuring 100×30 square
feet to Mr Karim, but the stipulated house will only be fully completed in 2 months time. However, Mr
Karim has leased the house for the period of 3 years with the payment of RM1000 per month prior to its
completion
This is a type of liability lease contract. It is due to the benefit of usufruct leased out which forms the
monetary liability or debt owed by Mr Karim to Mr Ahmad. According to this concept, Mr Ahmad can
claim the rental payment from the conclusion date though his house is not yet occupied by Mr Karim. In
this concept, obligation and responsibility on Mr Karim to Mr Ahmad is a specific usufruct for the terrace
house and not the house itself.
The ruling among jurists and scholars in determining the status of this type of lease contract is briefly
stated as follows:-
Majority of mazhab (Maliki, Syafie, Hanbali) and AAOIFI: the arrangement is
permissible with conditions. However, they differ among themselves as to the time of rental
payment, whether it can be paid when the contract is concluded, or not.
Syafie and Maliki: it has to be paid at the time of contract conclusion because it is
analogous to salam contract rules and regulations. If the parties separate before the rental
payment is paid, the contract is invalid and void. This condition is also important in order to
avoid the case of purchasing debt by debt which is forbidden in Islam. However, Mazhab Maliki
gives up th three days delay, which is line with their opinion bai’ as-salam.
Hanbali and AAOIFI: the price is only to be paid at the conclusion of the contract if the
contract used the pronounciation of as-salam or as-salaf (ie the pronouncement whereby, it can
be made in the future time). Therefore, when the contract is concluded using the pronounciation
of lease, rent or ijarah, other than as-salam and as-salaf, the rental payment is not required to be
paid at the conclusion of the contract.
Hanafi: it is illegal and invalid because the subject matter of lease contract must be of a
specific item. In this type of lease contract, the subject matter is not specific on the asset per se
and it only specific on its usufruct. It means, the lessee can find another house that enables him to
get same specific usufruct of the house if the construction of the house is not completed.
b) USAGE AND ITS NEW STRUCTURE
If ijarah is to be viewed from the perspective of its utilization and its new structure, it can be divided into
2 types of lease as follows:-
i. Operating Lease
ii. Financial Lease
It is worthwhile to comprehend the basic distinction between the two:
ASPECT OPERATING LEASE FINANCIAL LEASE
OWNERSHIP
OF THE ASSET
The legal and beneficial ownership of both types of
contract are within the ownership of the lessor
The lessor only possessed the beneficial
ownership of the asset
MAINTENANCE
OBLIGATIONS
The lessor is still fully obligated in administrative
affairs and basic maintenance of his asset, whereby
the lessee will only be liable on the daily
The lessor will transfer almost his entire
original obligation on the asset to the
lessee. Thus, responsibility on the asset
maintenance of the asset which is directly affected
by his usage of the asset. He then has to pay rental
payment as agreed in the agreement.
insurance, quit rent etc is on the shoulder
of the lessee.
RISKS Any risks such as small damage (which is not
caused by the lessee’s negligence on the asset will
be under the responsibility and liability of the
lessor and not the lessee, for that reason, the lessor
will insure the asset through the Takaful scheme.
All types of risks whether it is caused by
the negligence of the lessee or otherwise,
is under the responsibility of the lessor.
TERMINATION Can be terminated anytime with the consent of
both parties without having to pay any indemnity
or compensation or the sum of arrears of the rent
(depending upon the terms of the contract); after
the termination of the contract, the asset will be
reverted back to the owner of the asset as usual.
Can be terminated but the lessee must pay
all the arrears of the rent in one lump
sum. Then, the asset will be reverted back
to the lessor fully. This is the motive and
the objective of this type of lease.
i. Operating Lease
It is deemed as the original form of ijarah ‘ain, thus the contents and terms of the contract are similar to a
normal lease. This type of lease will normally occur between the original owner of the asset and the
lessee. This lease is hardly found in Islamic banking practice due to its high risk.
However, there are several Islamic Finance Institutions which are not banks, offering the products based
on this concept, such as, in purchasing airplanes, factory machines and leasing them out from time to time
to the identified lessee for a specified period. At the end of the period, the institution will find new
lessees, and they will gain profit from the revenue of the rental payment.
Illustration: Operating lease as financing product
Explanations:
Lease Agreement- the client approaches the Islamic Financial Institution and uncovers his plan to
use certain assets such as 5 buses for the period of 5 years. After the Institution’s credit approval,
the customer submits an undertaking to lease the document to the bank.
Purchase the asset- the Institution purchases the asset (5 buses) from the seller
Lease contract- the Institution leases out the buses to the customer for the period as per agreed.
After the contract ends, the institution will either find new customers or sell the assets.
The above is the flow of contract for the operating lease of an Islamic financing product. However, as per
mentioned, it is rare to find such product being offered by Islamic banks due to its high risk.
BANK
ASSET VENDOR(SELLER)ASSET
CLIENT
2
Promise to take asset on lease
1
3 Lease
Buy asset
ii. Financial Lease
It is a type of lease which is normally used and offered by Islamic banks as Financial Intermediaries, in
order to help their customers in:
Obtaining their desired asset
Obtaining cash money for various purposes
Basically, it can be said that it differs from the type of common lease but it has the same attributes as
found in operating lease. Financial lease in the light of its process and its name as the product in Islamic
banking practice are:
Al-Ijarah Thumma Al-Bai’-AITAB
Al-Ijarah Thumma Al-Iqtina
Al-Ijarah Al-Muntahiyah bit Tamleek
The following are several structures of financing lease, based on its aims and objectives.
a. Financial Lease for the Customer to Obtain Desired Asset
In order for the customer to purchase the desired asset, he will then approach the bank asking for
financing product, then the following process will take place:
Illustration: Financial Lease for the Customer to obtain desired asset
Explanations:
There are two possibilities;
Deposit- in several occasions before seeking the bank’s approval, the customer has already paid
the deposit to the seller. If this happens, there will be Shari’ahissues regarding its flow and the
product at large. This is due to the conflict of ownership between the customer and the bank.
Therefore, any sale and purchase agreement between the customer and the seller of the asset, at
the initial stage, must be avoided, if this concept is to be applied.
BANK
CUSTOMER
ASSET VENDOR(SELLER)ASSET
Buy asset 2
4
3
1
1
Deposit?
Sell @ Ownership Transfer
Lease
Promise Undertaking
Promise undertaking- the customer undertakes to lease the asset from the bank. This process will
take place after the customer has identified the desired asset. As an alternative to the normal
deposit, the customer will have to pay a security deposit (hamisyh jiddiyah1) and the sale and
purchase agreementbetween them should not be concluded. If not, it will be regarded as urbun2.
Purchase the asset- the bank will buy the asset from the seller for cash
Leasing contract- after having the beneficial ownership on the asset, the bank will lease it out to
the customer. In Malaysia, the legal ownership will still be retained by the lessor who is the end
owner of the asset, as for the bank, it will hold the the beneficial ownership in order to enable the
leasing process to be carried out. Undoubtedly, this will trigger several disputed Shari’ah issues.
Full transfer of Ownership- it is done after the end of the last period of the lease, the bank will
transfer its full ownership to the customer, either in the form of gift (Al-Ijarah Al-Muntahiyah bit
Tamleek) or selling at the minimum price (AITAB).
1 Sum of money payable to the seller of the asset to show the intention or determination to buy the stipulated asset either through the
bank or directly from him. This is to be paid by the customer at the request of the institution, both as an indication of the financial
capacity of the customer and to ensure the compensation of any damage to the institution arising from a breach by the customer of his
binding promise. Having taken his hamisyhjiddiyah, the institution need not demand compensation for damage as this may be charged
against the hamisyhjiddiyah. It is being done before the conclusion of any sale and purchase agreement, in other word; it outside the main
agreement of sale and purchase.
2 Amount of money that the customer as purchase orderer or lessee pays to the institution after concluding a Murabahah or sale contract,
with the provision that if the sale or lease is completed during the prescribed period, the amount will be counted as part of the price or
rental. If the customer fails to execute the Murabahah or lease contract, the institution may retain the whole amount.
b. Financial Lease for the Customer to Get Cash
In certain situation, the customer is in need of enormous amount of cash in order to extend its
business premises etc. for the company which possesses its own high valuable asset, it can use
financial lease product to obtain the desired fund.
Illustration: Financial Lease for the Customer to Get Cash
Explanations:
The customer, who is a gigantic company and possesses its own asset, sells its asset to the bank
for the cash needed by it. However, the value of the asset must be priced according to the market
value, or it can be slightly lower or higher according to the market accepted level. In this case,
say RM5 millions. As mentioned before, only the beneficial ownership is transferred to the bank,
whereby the legal ownership is still retained by the customer. Subsequently, the bank pays the
purchase price to the customer on a cash basis.
After having the ownership on the asset, the bank will then leases out the asset to the customer for
the value of rent, for example, RM7 millions, as the total accumulated rental amount, for the
period of 4 years.
BANK
CUSTOMER
Sell @ Ownership transfer3
1
2Lease
Sell
After the 4 years period end and the customer successfully settles out his rental payment as per
agreed, the bank will give its beneficial ownership as a gift to the customer or to sell it at a
minimum price.
Thus,
The customer obtains the desired cash money ie RM5 millions
The bank gains profit amounting to RM2 million from the rental payment
Both of them are able to stay away from the interest based loan and their business is permissible
and valid
ISSUES IN FINANCIAL LEASE
Financial lease causes the lessee to be fully responsible on the asset risk; this situation is
considered as non-compliant with the Shari’ah principle as stated by AAOIFI. Many Islamic
banks which practice this concept seem to have failed in finding the best way out for this matter.
Notwithstanding the fact, majority of Shari’ah Advisory Council of Islamic Banks in Malaysia
take the lenient view which approves that the basic maintenance of the asset is to be shouldered
by the lessee with his/her consent.
Insurance on the asset, tax, etc. are also borne by the customer; in fact it is supposedly under the
responsibility of the owner, not the lessee. However, several Islamic banks endeavor to find the
way out by taking the risk responsibility. Nevertheless, the rental payment will be higher to
accommodate this cost.
In Malaysia, currently all AITAB products, particularly in purchasing cars, are placed under the
Hire Purchase Act 1967. As a result, if any dispute arises, it will be dealt in the court under the
act which is not complying with the Islamic principle. In fact, the basic product of AITAB is the
same as conventional lease under the Act and several clauses in the Act clearly show that the
nature of the contract is loan with fixed interest. Besides, it is also the obligation of the bank to
conclude the contract from the very beginning, thus making it clearly in contradict to the real
concept of AITAB. The conventional Act also requires both parties to amalgamate all the lease
and sale and purchase contract in a basket, which is considered by Shari’ah as repugnant.
The issue also arises if the customer is unable to pay the rental payment for several months (event
of default). When the situation occurs, the product usually gives the choice to the bank whether to
terminate the lease and fully take over the asset or the customer is asked to buy the asset with the
price, equivalent to the outstanding balance. Apparently, such condition will trigger Shari’ah
repercussion which needs to be observed in depth by the Scholars.
Furthermore, Shari’ah issues also arise in the issue of Takaful beneficiaries on the asset should
anything happen to the asset, such as the asset is being stolen, burned, damaged by nature etc.
Typically, the lessee will be made responsible to pay the insurance, but in the event of
destruction, the bank will be benefited from the insurance company/Takaful.
SUKUK IJARAH
Sukuk Ijarah, rental Islamic bonds that are embraced by Shari’ah scholars worldwide, are the most
popular form of Islamic bonds, last year, according to a rating by Mood’s Agency. The report also said
Standard & Poor’s estimated that more than 45% of Islamic bonds issued in 2008 were structured
according to the ijarah principle. Ijarah is a lease where a bank buys an asset and rentals it to its client for
a fee that includes the purchase price and the profit rate, to be earned by the bank during the rental period.
Ijarah sukuk is the securities representing ownership of well-defined existing and known assets tied up to
a lease contract, rental of which is the return payable to sukuk holders. Payment of ijarah rentals can be
unrelated to the period of taking usufruct by the lessee. It can be made before the beginning of the lease
period, during the period or after the period, as the parties may mutually decide. This flexibility can be
used to evolve different forms of contract and sukuk that may serve different purposes of issues and the
holders.
Illustration: The Basic Structure of Sukuk Ijarah applicable worldwide
Explanations:
CUSTOMERSIME DARBY COMPANY
INVESTORSUKUK HOLDERS
SPVISSUER
1
Buy Sime’s asset
2
1Leasing Contract
3
Rental ProceedIssue IjarahSukuk
Scenario- Sime Darby Company needs RM500 millions to expand its business. In order to get sufficient
capital, with the approval of the bank, they will issue an ijarah sukuk. For the purpose, they will establish
a special company which called as Special Purpose Vehicle (SPV) or Special Purpose Company (SPC) or
entity (SPE).
SPV will purchase Sime Darby asset worth RM500 millions on the basis of deferred payment.
However, according to the practice, only beneficial ownership of the assets is transferred to SPV
and not the Legal Ownership.
Having the ownership of the asset, SPV issues sukuk ijarah to represent the beneficial ownership
of the asset bought from Sime Darby. This sukuk is then bought by several investors from banks,
net worth individuals and corporate companies where the total amount targeted will be amounted
to RM500 million. SPV will then pay Sime Darby either in bullet payment or any agreed payment
method.
Subsequently, Sime Darby needs the asset to run its business, hence they agreed to rent out the
asset that was sold in the period of 7 years for instance, with the total sum of the rental payment
for RM600 millions.
The accumulative sum ie RM600 millions will from time to time to be divided among the Sukuk
holders in that period of 7 years.
At the end of 7 years time, as per sukuk agreement, SPV will redeem all the sukuk certificates from
the investors with a pre agreed formula. Lastly, the assets will be returned to Sime Darby
Company.
Thus,
Sime Darby Company is able to obtain the cash money which they require for their business
expansion.
Investors will potentially gain profits amounting to RM100 millions from the rental payment.
In December 2000, Kumpulan Guthrie Berhad (Guthrie) was granted a RM1.5 billion (US$400
million) al-Ijarah al-Muntahiyah bit-Tamlik by a consortium of banks. The original facility was
raised to re-finance Guthrie’s acquisition of a palm oil plantation in Indonesia. The consortium was
then invited to participate as the underwriter/primary subscriber of the sukuk transaction.
US$350million Sukuk Trust Certificates by Sarawak Corporate Sukuk Inc. (SCSI) Sarawak
Economic Development Corporation (SEDC) raised financing, amounting to US$350 milion by way
of issuance of series of trust certificates issued on the principle of ijarah sukuk. The certificates were
issued with a maturity of 5 years and under the proposed structure, the proceeds will be used by the
issuer to purchase certain assets from 1st Silicon (Malaysia) Sdn. Bhd. Thereafter, the issuer will lease
assets procured from 1st Silicon to SEDC at an agreed rental price for an agreed lease period of 5
years.
Sukuk Ijarah Rating
Standard & Poor's has rated Ijarah Sukuk transactions backed by various types of underlying credit
lessees including sovereign governments, regional governments, corporations and multilateral lending
institutions. Standard & Poor's also rates financial institutions that provide Islamic banking and insurance
services.
In most cases, Standard & Poor's has assigned Ijarah Sukuk the same ratings as it assigns to the lessees
creating the payment stream. This practice reflects the unconditional, irrevocable nature of the lease, any
third-party lease guarantees, sale and purchase agreements, and/or financial hedges that are found in the
transaction. Ratings lower than those given to the lessee are assigned where there are diminished recovery
prospects, greater risks associated with lease payments or other factors supporting such a distinction.
Higher ratings are unlikely without additional risk-mitigating features in the case of sovereigns, although
for corporates, Ijarah Sukuk may resemble certain characteristics of secured loans and be notched up
accordingly.
Standard & Poor’s has rated two ‘broad types’ of Islamic financing:-
Ijarah Sukuk where the whole transaction, including the ownership structure as well as the notes,
is Shari'ah-compliant
and the 'ownership' Shari'ah-compliant structure, where the bonds are issued by an unaffiliated SPE
with the proceeds used to acquire the assets from the lessee/seller, combined with a put/tender
feature. In this configuration, the securities themselves may not necessarily be Shari'ah-compliant.
Most Ijarah Sukuk that Standard & Poor's has rated are set up in the following manner:-
(i) The seller sells certain assets (such as an office building, land, or an airport) to a special
purpose entity (the SPE) that may be affiliated or unaffiliated with the seller (depending on
the degree of compliance with Shari'ah) for a determined price (the purchase price).
(ii) The SPE raises financing to purchase the assets by issuing Ijarah Sukuk to investors in an
amount equal to the purchase price. The Ijarah Sukuk represents an equity interest in the
SPE's assets, which may be indirect or direct depending on the type of SPE.
(iii) The SPE then leases the assets to the lessee - an affiliate of the seller, or directly back to
the seller itself - in exchange for periodic lease payments. These lease payments should
match the obligations of the SPE under the Ijarah Sukuk.
(iv) At maturity, or on a dissolution event, the SPE sells the assets back to the seller at a
predetermined value. That value should be equal to any amounts still owed under the terms
of the Ijarah Sukuk.
Other transaction configurations are possible. For example, the SPE may sub-lease back to the lessee the
assets that have been first leased to the SPE by the same lessee. Typically, the headlease has a longer
maturity than the sub-lease. Such configurations do not include the sale of assets and may be preferred
when the sale of an asset is difficult, either legally or for political reasons (for example, a sovereign may
not wish to sell the country's main airport).
Additionally, depending on the extent of Shari'ah compliance, prior to maturity the lessee may have the
right to call for the assets upon certain amounts due under the Ijarah Sukuk as well as other expenses, and
the SPE might have the right to tender the assets back to the lessee. The lease may also be supported by
affiliate guarantees. Currency or other hedges may also play a part in transaction dynamics.
PRODUCT SAMPLE (AITAB)
On last 20th March, we made a visit at AmIslamic Bank to see what they have in hand with
regards to Ijarah. Mr Haris, the manager, introduced to us ARIF HIRE PURCHASE-i. This is a
convenient package provided by AmIslamic Bank that is based on Al-Ijarah Thumma Al-Bai
(AITAB) Principle which refers to two contracts undertaken separately: the Ijarah
(leasing/renting) contract followed by Bai’ (purchasing) contract after a certain period of
payment. Individuals aged 18 and above are eligible to apply for ARIF PURCHASE-i. It’s open
to individuals, sole proprietorships, partnerships, private limited and public listed companies, and
other commercial organizations.
MODUS OPERANDI
Under this scheme, AmIslamic Bank will purchase the vehicle that had been chosen by a
customer and subsequently hire the vehicle to him/her at a pre-agreed rental amount and hiring
period. Upon the expiry of hiring period and full settlement of all rentals, the vehicle will
automatically be his/hers. Should the customer fully settle the financing before its maturity,
he/she would be entitled to statutory rebate on the unexpired rental period. The rebate shall be
calculated in accordance with the following formula:
Rebate = Term Charges (Profit Charges) X n (n+1) N (N + 1)
Where,n = remaining rental periodN = original rental periodTerm Charges (Profit Charges) = total profit chargeShould the customer fail to fulfill his/her obligations under this scheme, the compensation
charges (Ta’widh) are as follow:
During financing period 1% p.a is chargeable on overdue payment
Upon expiry of financing period Charged based on Islamic Interbank Money
Market (IIMM) Rate and calculated on
outstanding
principal only
The Bank has the right to utilize any credit balance in his customer’s account (s) maintained with
them to settle any outstanding balance in this financing account. However, notice should be
made to customer.
The Bank also has the right to repossess the vehicle if there had been two successive defaults.
A VISIT TO INCEIF
On March 4, 2011, we went to visit INCEIF (International Centre for Education in Islamic
Finance) in order to gain more information on the application of Ijarah in today’s business
world. INCEIF is a dedicated university set up by Bank Negara Malaysia, focused on Islamic
finance at the postgraduate level and is delivered solely in English. It combines the study of
Shariah, theories of finance & practical issues in its curriculum and modules - developed
together between industry, Shariah experts and academia. At INCEIF, students are encouraged to
spend time in the industry to gain practical knowledge. Furthermore, International Shariah
Research Academy in Islamic finance is part of INCEIF – it is an institution which promotes
dialogues among Shariah scholars to push the boundaries of knowledge and to achieve
congruence in many areas.
Upon arrival, we were warmly greeted by Mr. Zainal Abidin Mohd Tahir, a teaching fellow at
the Islamic Banking Department, INCEIF, who gave us his opinions about the application of
Shariah contracts in products and services of various financial institutions in Malaysia.
The visit was indeed insightful as we were exposed to the operation of Ijarah in the realm of
Islamic banking as well as conventional banking.
Mr. Zainal Abidin Mohd Tahir of INCEIF and us.
REFERENCE
Al-Ijarah, Dr Abd Sattar Abu Ghuddah, Dallah Al Bakarah, 1998
Contracts &the Products of Islamic Banking, Zaharuddin Abd Rahman, Cert Publications, Kuala
Lumpur, 2010
Islamic Banking A Practical Perspective, Dr Kamal, Prof Bala Shanmugam, Pearson, Kuala
Lumpur, 2008
Islamic Banking and Finance (4th edition), Mohd Nasir, M.Y., and Amirul Hafiz, M.N., Pearson-
Prentice Hall, 2007
Financial Transactions in Islamic Jurisprudence, Dr Wahbah Al-Zuhayli (Translated by Mahmoud
Gamal), Dar al-Fikr, Dimash, 2007
Understanding Islamic Finance, Muhammad Ayub, Wiley Finance Ltd, England, 2007
