Last month, we discussed the fundamental objectives and principles of Islamic Finance which can be summarized as follows:
• Sharing of business risks between financier and business owner
• Prohibition of Riba: interest whether "nominal" or "excessive", simple or compound, fixed or floating
• Removal of Gharar: uncertainty about the terms of the agreement
• Avoiding Maysir: gambling or speculation
. Desisting from hoarding wealth which is harmful to the community
• Taking of security is permitted
Islamic Finance Instruments
Over the next few weeks, we will examine the Islamic alternatives to available conventional financial products.
Ijarah (an Islamic lease) is one of the most commonly used Islamic finance instrument. "Ijarah" is a term of Islamic fiqh, which means 'to give something on rent'. It means 'the transfer of the usufruct of a particular property from one person (the lessor) to another person (the lessee) in exchange for a rent. The lessor is called 'Mujir', the lessee is called musta’jir' and the rent payable to the lessor is called 'ujrah'. The term 'Ijarah' means leasing in English.
Ijarah and the conventional leases share some features; for example, Ijarah leases may be entered into for long, medium or short terms and may be adapted to fulfill the functions of either finance or operating leases. However, there are three main differences between the Ijarah and the conventional leases.
Islamic lease rentals cannot be expressed by reference to interest rates Islamic leases cannot provide for default interest or interest for late payment. Under Ijarah, the responsibility for maintaining and insuring the leased asset must remain with the lessor, rather than be passed to the lessee as is done in conventional leases.
Fundamentals of Ijarah
1. Leasing is a contract whereby the owner of an asset transfers its usufruct to another person for an agreed period, at an agreed consideration.
2. The subject of lease must have a valuable use. Therefore, things having no usufruct at all cannot be leased.
3. It is necessary for a valid lease contract that the leased asset remains in the ownership of the lessor, and only its usufruct is transferred to the lessee. Thus, anything, which cannot be used without consuming, cannot be leased out. Therefore, leases cannot be affected in respect of money, edibles, fuel, water etc because their use is not possible unless they are consumed.
4. As the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property shall be borne by the lessee.
5. The rental must be determined at the time of contract for the whole period of lease. It is permissible for different amounts of lease rentals to be fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of effecting a lease.
For Example: If Brother Musa leases his house to Brother Adams for a 5 year period. The rent of the first year is N100,000 and it is agreed that in the in subsequent years, there will be a 10% increase in rent, the lease is valid.
On the other hand, if Brother Musa says that there will be an increase in the rent in the subsequent years and the increase is not specified, then this lease is not valid.
The Transaction Process of a Typical Ijarah
The financier and the client agree on the terms of the lease. The financier purchases the asset The client leases the asset from the financier, paying a fixed monthly rental The client purchases the asset from the financier at the end of the lease period.
Termination of Lease
If the lessee contravenes any term of the agreement, the lessor has a right to terminate the lease contract unilaterally. However, if there is no contravention on the part of the lessee, the lease cannot be terminated without mutual consent.
Products and Services Structured Using Ijarah
Ijarah can be structured for the provision of various assets as long as they have a usufruct and are halaal:
Household Appliances - Television sets, Cookers, Computers, Generators; etc.
Office Equipments - Printers, Photocopiers, Generators, Office furniture, etc.
Vehicles - Cars, Trucks, Trailers, etc.
Factory Equipment - Machinery, Factory equipments, Production facilities, etc.
So far, we have been able to establish the fact that leasing is a viable solution to a lot of our financial needs as individuals. Ijarah brings a lot of added value to our lives by making the acquisition of assets easy and bearable without having to compromise our values.
Ijarah seeks to minimize the liabilities and burden of the Lessee while not compromising the security of the resources of the Lessor. This is a competitive advantage of Islamic Finance in financial service provision. It also 'reiterates a fundamental principle of Islamic finance, which is justice and fairness to all.