essentials of islamic finance 1. 2 ijarah finance lease is mostly used to raise long term capital to...
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ESSENTIALS OF ISLAMIC FINANCE
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IJARAH
Ijarah derives from the
root word ajara “to
recompense,
compensate or
give consider
ation and
return”. Ajr
refers to a
worker’s wage, and
ujrah to rental
payment. In its juristic usage, Ijarah
primarily refers to both a rental as well
as a hire contract
that engages
the services
of persons.
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TYPES OF IJARAH
IJARAH
Finance lease is mostly used to
raise long term
capital to pay for
assets. It enables
the lessor to earn
reasonable profit along
with full recovery
of the cost of
the asset.
operational lease it is also called as a “non-full
payout” leases, because the amount of the rental
does not cover the lessor full cost of asset and the period of lease is always less than the useful life of the asset.
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IJARAH IN QURAN AND SUNNAH Ijarah is also validated by the Quran,
Sunnah, and ijmah.
QURAN•Several verses are found in the Quran (al-Kahf, 77: al-Qasas, 26: al-Talaq, 65-6) on the worker’s entitlement to a wage
SUNNAH•References also occur in hadith to ijarah and the employer-employee relations“pay the employee his wages before the sweat of his brow dries up”.
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IJARAH AS A MODE OF FINANCING
In Islamic finance Ijarah is a very popular sharyah way to asset finance without
involving interest.
It enables the customer to use durable inconsumable goods, equipment and
heavy machinery
The amount of rent can be re-priced by the Islamic banks
Leasing allows a logical way to separate ownership and the use of asset.
The decision of Islamic banks to provide Ijarah financing depends upon the amount of cash flows from the leased asset and the financial position of
the customer but without interest.
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PROCESS OF IJARAH
The client” Lessee” contact the bank “Lessor” with the request for ijarah leasing and enters into a promise for lease contract. It includes the offer and acceptance by the client.
The bank buys the asset required for ijarah and gets title of ownership from the manufacturer.
The bank makes payment to the manufacturer.
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The bank leases the asset to the client after execution of the ijarah contract which takes place after the client gets the delivery of the asset.
The lessee makes periodic fixed rental payments according to the contract of ijarah
At the end of contract period the lessee can purchase the asset from the bank under a separate sale agreement at a nominal price
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FOUR SCHOOLS
Hanafi School• Defines as a
contract that enables possession of a particular usufruct of the leased asset (ayn) for a consideration.
Maliki School• Defines
Ijarah as a contract that relates to permissible usufructs for a particular period.
Shafie School• Defines
Ijarah as a contract for a defined usufruct liable to utilization and accessibility for a particular recompense.
Hanbali School• Hambali
definition is that the benefit or services of ijarah appear in the future
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IJARAH BONDS AND SUKUK
Ijarah sukuk or bonds are the securities that shows the ownership of clearly specified existed and known asset
For example, An air craft on ijarah leased can be represented in bonds Less risk as compare to common stocks
Ijarah Sukkuk are completely transferable and can be traded in the secondary markets
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SECURITIZATION OF BONDS
•The arrangement of Ijarah has a good potential of securitization which may help create a secondary market for the financiers on the basis of Ijarah.
•The lessor in Ijarah owns the leased assets, he can sell the asset, in whole or in part, to a third party who may purchase it and may replace the seller in the rights and obligations of the lessor with regard to the purchased part of the asset.
•In the case of total destruction of the asset, he will suffer the loss to the extent of his ownership.
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IJARAH SUKUK STRUCTURE
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SALES AND LEASE BACK
There should be at least one year lease period
There should be separate contracts for sale and
lease
The agreement to sell at the end of the lease must be separate
The intention of the client is to avoid interest
related transactions
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LIABILITY FOR LOSS
Lessor in a financial lease, bears ownership responsibilities, in the
event the asset is destroyed during the lease period, he alone
stands to suffer the loss.
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RULES OF IJARAH
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REVOCATION OF IJARAH contract of ijarah can only be revoked
where the asset lost its utility or function
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EXAMPLE OF IJARAH FINANCING CALCULATIONS Generally, the financial institutions
calculate the rental amounts as follows:The financial institution determines that it wants to have a profit rate (PR) of 10 percent.
The purchase price (PP), including all costs, is $1,000,000 (cost borne by the financial institution).
The term (T) of the lease is 5 years.
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ECONOMIC BENEFITS
Islamic leasing is especially suitable for some sectors of the economy
Lease finance is easier to practice
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CONCLUSION As method of financing ijarah is still in its
early stage of development and there is a lot more opportunities to expand its application.
In majority of the countries the contribution of Ijarah financing is low and the Muslim countries are also not utilizing Ijarah bonds as a mode of financing.
The research on Ijarah also shows that there is basically no major deviation to sharyah rules in ijarah contract practiced by Islamic banks.
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Some of the issues that should need to be addressed are that, there is very less information on Ijarah contract is available.
The other issue that should be
addressed in the light of sharyah is the compensation on late payment to the lessor, as penalty on late payment is given to the charity so it does not compensate the lessor.
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