Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
Between
Ijara And
Convention
al Lease
NUST Business
School
Mehwish Shams BBA2K8-A
Table of Contents
INTRODUCTION........................................................................................................... 1
Objective................................................................................................................. 2
Methodology:........................................................................................................... 2
Research limitations/implications............................................................................ 2
Literature Review....................................................................................................... 3
Ijara............................................................................................................................ 5
Ijara contract:.......................................................................................................... 5
Conventional lease..................................................................................................... 6
Conventional lease contract.................................................................................... 6
COMPARISON BETWEEN IJARA AND CONVENTIONAL LEASE.......................................7
FINDINGS.................................................................................................................... 8
ABSTRACT
Financial institutions all over the world are constantly under evolution and continue to strive for
better services for their customers and clients. After a century of growing under capitalist
theories, now it is interacting with the Islamic theology of finance and banking to bring about
new products which are more Sharia compliant so that the huge market of Islamic communities
can be captured. This includes International players as well as local banking institutions. This
study looks at two characteristics of the Islamic and conventional banking that are Ijara and
conventional lease. The paper discusses in detail the concept of Ijara, similarities in Ijara and
conventional leasing, differences between the two, various options and applications of Ijara as
well as conventional leasing and other issues related to both.
INTRODUCTION
A healthy banking system is the heart of every successful economy. It helps to strengthen the
economy of the country, the stronger the financial system the stronger the country is. There are
two types of banking systems, one is Islamic banking and the other is Conventional banking.
Islamic banking differs from conventional banking in several important ways; some of them will
be discussed in this report. The report discusses an important characteristic of the banking system
that is lease.
Leasing can be traced back to before 2000 BC. Sumerians used leasing for agricultural
equipment and hand tools. There were detailed guidelines first drawn up in Roman for operation
of lease. Modern day leasing dates back to 1840s when the rolling stocks were leased and the
leasing companies were known as wagon companies. The worlds first registered leasing
company, the Birmingham Wagon Company, was registered in 1855 1. Over the centuries, leases
have served many purposes and the nature of legal regulation has varied according to those
purposes and the social and economic conditions of the times.
In Islamic bank the lease is called Ijara and in conventional banks it is referred as conventional
lease. Ijara is a Shariah compliant alternative to Conventional lease. In both type of lease Bank
acts as a Lessor and the person to whom the asset is leased acts as a Lessee. The Bank requires
the lessee to pay a monthly rent for the use of the asset. The ownership of the asset remains with
the Bank, only the rights of use is transferred to lessee.
Objective
The objective of the report is to develop a better understanding of Ijara banking and find the
differences and similarities between Ijara and conventional lease.
Methodology:
The report is prepared by studying various characteristic of Ijara and conventional lease
contracts. Various sources of information and review of literature were used to collect
information including internet, research papers of various researchers, online journals and
websites of different banks. Websites of the different Islamic and conventional bank also
provided information related to Ijara and conventional lease.
Research limitations/implications
The paper deals with concepts, information and other facts on Islamic banking that are not
supported by any statistical analysis and empirical evidence. Thus this paper may be regarded as
being subjective in its real essence.
Literature Review
In the process of research and analysis the literature on Islamic and conventional banking was
reviewed and evaluated to find about both types of banking with special focus on leasing. The
study takes into account from the available literature some specific aspects of leasing and Ijara
draws a comparison of both highlighting similarities and differences. The paper drew its main
source of information from websites of various Pakistani financial institutions and the studies
undertaken by various economists
Khalid (2008) found out that Ijara i.e. Islamic lease is a classical concept in Syariah financing
based on Islamic principles. Ijara has emerged as an increasingly popular financial structure in
asset financing and has found its way into transportation financing. It is one of the most easily
recognizable Islamic asset financing techniques which are commonly used in a singular leasing
transaction and, increasingly, as a building block in larger and more complex transactions. Being
one of the simplest asset-based Islamic financial instruments, Ijara has steadily gained
prominence as an alternative financing tool to conventional financing structures.
M. Ishaq Bhatti and M. Mansoor Khan found out that Islamic banking is one of the latest
instruments of financial management which is gaining foothold. Islamic banking refers to
Shariah-compliant tools and mechanisms to replace interest-based financial intermediation with
the risk-sharing and interest-free paradigm. It primarily relies on equity modes to conduct its
affairs. This ensures the most efficient, ethical and equitable use of economic resources of the
polity. Islamic banking relies on PLS modes, namely, mudarabah and musharakah as major, and
murrabah, ijarah, bai salam, bai istisna as secondary instruments to perform lending, borrowing
and investment functions.
Llewellyn, D.T. (2001) found out that the main difference between Islamic banks and
conventional banks is the exclusion of interest. While the operations of Islamic banks seem
similar to those of conventional banks, there are major differences. He lists these as; the mix of
contracts on the liabilities side of the balance sheet, the quasi-equity nature of investment
deposits implying that some depositors share in the risk of the bank, a wider variety of modes of
financing and asset mix of banks, and the risk sharing characteristics of the contracts issued and
who bears risk.
Gafoor A.L.M (1996) found that Islamic jurists are only concerned that the element of risk
should not be excluded from the financial transactions. Otherwise, it would no longer be one of
business and trade, but of usury. The depositors have to be mentally prepared for risk of money
diminishing as a result of losses incurred by the bank in its efforts to generate income. Gafoor
further argued that the profits would have accrued from one year to another according to the
performance of the bank, not according to changes in interest rates.
Zineldine (1990) found out that leasing is a financing technique which is allowed under Islamic
law. It is a contract based on profit sharing between the bank and the client. The leasing is done
for an agreed upon sum by installments and for a mutually agreed upon limited period of time
into a savings account held with the same bank.
Ijara
Ijara in Arabic literally mean 'to give something on rent'. The term Ijara has two meanings in
Islamic perspective
One meaning of Ijara is to employ the services of a person on wages given to him as a
consideration for his hired services." The employer is called 'mustajir' while the
Ijara contract:
Ijara is a lease agreement under which a certain asset is leased out by the lessor to a lessee
against specific rent or rental for a fixed period. Ijara contract is used to finance lease for items
such as real estates, buildings, equipments, machineries, computers, motor vehicles, and other
goods; except the things that are haram or prohibited in Islam. Also the things that cannot be
used without consuming cannot be leased out e.g. money, edibles, fuel, etc. Two fundamental
principles of Islamic finance are:
It has to be asset-based financing: The first fundamental principle of Shariah is that
as opposed to conventional financial dealing, profit is generated when something
having intrinsic utility is sold or offered for use. Money has no intrinsic value. As
such dealing in money cannot generate profit unless converted into real assets.
There has to be an element of risk: The second basic element of Shariah is that one
cannot claim a profit or fee for a property/transaction, the risk of which was never
borne by him.
Conventional lease
It is a process by which a firm can obtain the use of a certain fixed assets for which it must pay
a series of contractual, periodic, tax deductable payments. The lessee is the receiver of the
services or the assets under the lease contract and the lessor is the owner of the assets.
Risk bearer: After the agreement on lease contract, the risk of ownership lies with
whom?
Starting time for rental obligation: When would the rental obligation start, after the
agreement on lease contract?
Asset has value upon completion of leased period: Does asset hold value upon
completion of leased period?
Effect of premature termination: Are all the obligations that are still executory on
both sides considered discharged as a result of premature termination?
Sale and lease back as one transaction: Could sale and lease back be completed
under one transaction?
FINDINGS
After comprehensive review of the collected article and analysis of literature the findings are as
follows:
Ownership:
Ijara: Muajjir (lessor) is the owner of the leased property.
Conventional Lease: In conventional leasing the creditor institution (banks, leasing
companies etc) retains the ownership of the asset throughout the term of
the contracts.
Risk bearer:
Ijara: As Ijara is an asset based contract, and lessor or mu`jir has the ownership of the asset,
therefore all the ownership related rights and liabilities lie with the mu`jir and mustajir is
responsible for all the usage related rights and liabilities. Any loss or harm caused by factors
beyond the control of the Mustajir lessee shall be borne by the Muajjir.
Conventional lease: The lessor assumes and manages the risk of the asset.
Valuable use:
Ijara: Asset to be leased should have valuable use.
Conventional lease: Asset to be leased must have a valuable use; things having no usufruct
cannot be leased.
10
Financing for:
Ijara: It provides financing for tangible assets such as property, machinery, vehicles etc.
Conventional lease: It also provides financing for tangible assets.
Time period:
Ijara: Ijara is commonly used for long and medium term fixed asset financing, project
financing and for retail products such as homes and automobiles.
Conventional lease: Conventional leasing is also applicable to long and medium term assets
like vehicles, houses and land.
lessees commitment :
11
Ijara: Basic rule for Ijara financing is that the leased asset be used productively and in ways
permitted by Islamic law.
Conventional lease: It does not require any such commitment.
Securitization of asset:
Ijara: The mu`jir can sell the asset to a third party, as he is the owner of the asset.
And all
the rights and obligations will then be on part of the third party with regard to the purchased
part of the asset.
Conventional lease: Leased item cannot be sold to another person by the lessor but lessee
can do it after meeting the lease obligations.
Repossession of an asset:
Ijara: There cant be two contracts in one contract. Since the purpose of purchase bargain
option is entirely different than the purpose of transferring the usufructs of an asset.
Inserting the clause of purchase bargain option serves the purpose of another tract. On the
one hand it allows the lessee to avail the usufructs of the leased asset and on the other hand it
also gives the right to the lessee to purchase the same leased asset, which is not allowed in
Shariah.
Conventional Lease: The lease must not contain an option to purchase the asset at a bargain
price.
12
Conventional Lease: The asset must have secondary value after the expiry of the primary
lease term.
Ijara: A leased asset must have a value upon completion of the agreed leased period.
Conventional lease: Same is the case with conventional lease, however, some of the
13
Conventional lease: The lessor can upgrade the asset as new equipment becomes available
payment and shall be adjusted towards the rent after its being due.
Conventional Lease: similar situation prevails in conventional leasing.
Compensation:
Ijara: If the leased asset has totally lost the function for which it was leased, and no repair is
possible, the lease shall terminate on the day on which such loss has been caused. However,
if the loss is caused by the misuse or by the negligence of the lessee, he will be liable to
compensate the lessor for the depreciated value of the asset as it was immediately before the
loss.
Conventional Lease: The loss or any other damage to asset is lessees responsibility
14
Conventional Lease: This transaction involves the sale of the property by one company to
another which in turn leases the same property back to the original seller.
Determinant of rent:
Ijara: Rent is determined by market given forces. In practice, the market rate of interest is
used to determine the rental rate, although this is not explicitly stated.
Conventional Lease: Lessors consider market related forces while scheduling lease
payments. The market rate of interest provides a basis for lease determination.
Equivalent to a sale:
Ijara: Leasing differs from sale in the way that it does not transfer the corpus or ownership
of the property, which remains with the transferor.
Conventional Lease: A manufacturer or dealer doesnt recognize any selling profit on
entering into an operating lease because it is not the equivalent of a sale.
15
REFERENCES
www.ijaraloans.com
www.meezanbank.com
http://www.darululoomkhi.edu.pk
http://staff.uob.bh
M. Mansoor Khan and M. Ishaq Bhatti, Development in Islamic banking: a financial riskallocation approach, Journal of Strategic Studies
Mohamed Ariff (September 1988) ,Islamic Banking, Asian-Pacific Economic Literature, Vol. 2,
No. 2, 46-62
Dr. Zeinab Mohamed El-Gawady, Monash Business Review Volume 3 Issue 1 April 2007
Llewellyn, D.T., A Regulatory Regime for Conventional and Islamic Banks. Regulation and
Supervision of Islamic Banks: Current Status and Prospective Developments Seminar, IRTI, The
High Institute for Banking and Financial Studies, April 24, 2001, Khartoum
Gafoor A.L.M (1996), Interest Free Commercial Banking, A S Noordeen, Kuala Lumpur.