Principles of Islamic banking and finance/PIBF201/Fixed income Islamic modes of finance/Ijarah

'''Introduction '''

Ijarah is a term of Islamic fiqh. Lexically, it means ‘to give something on rent’. In the Islamic jurisprudence, the term ‘ijarah’ is used for two different situations. In the first place, it means ‘to employ the services of a person on wages given to him as a consideration for his hired services.’ The employer is called musta’jir while the employee is called ajir.

Therefore, if A has employed B in his office as a manager or as a clerk on a monthly salary, A is musta’jir, and B is an ajir. Similarly, if A has hired the services of a porter to carry his baggage to the airport, A is a musta’jir while the porter is an ajir, and in both cases the transaction between the parties is termed as ijarah. This type of ijarah includes every transaction where the services of a person are hired by someone else. He may be a doctor, a lawyer, a teacher, a labourer or any other person who can render some valuable services. Each one of them may be called an ‘ajir’ according to the terminology of Islamic law, and the person who hires their services is called a ‘musta’jir’, while the wages paid to the ajir are called their ‘ujrah’.

The second type of ijarah relates to the usufructs of assets and properties, and not to the services of human beings. ‘Ijarah’ in this sense means ‘to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him.’ In this case, the term ‘ijarah’ is analogous to the English term ‘leasing’. Here the lessor is called ‘mu’jir’, the lessee is called ‘musta’jir’ and the rent payable to the lessor is called ‘ujrah’.

Both these kinds of ‘ijarah’ are thoroughly discussed in the literature of Islamic jurisprudence and each one of them has its own set of rules. But for the purpose of the present discussion, the second type of ijarah is more relevant, because it is generally used as a form of investment, and as a mode of financing also.

The rules of ijarah, in the sense of leasing, is very much analogous to the rules of sale, because in both cases something is transferred to another person for a valuable consideration. The only difference between ijarah and sale is that in the latter case the corpus of the property is transferred to the purchaser, while in the case of ijarah, the corpus of the property remains in the ownership of the transferor, but only its usufruct i.e. the right to use it, is transferred to the lessee.

Therefore, it can easily be seen that ‘ijarah’ is not a mode of financing in its origin. It is a normal business activity like sale. However, due to certain reasons, and in particular, due to some tax concessions it may carry, this transaction is being used in the Western countries for the purpose of financing also. Instead of giving a simple interest - bearing loan, some financial institutions started leasing some equipment’s to their customers. While fixing the rent of these equipment, they calculate the total cost they have incurred in the purchase of these assets and add the stipulated interest they could have claimed on such an amount during the lease period. The aggregate amount so calculated is divided on the total months of the lease period, and the monthly rent is fixed on that basis.

The question whether or not the transaction of leasing can be used as a mode of financing in Shariah depends on the terms and conditions of the contract. As mentioned earlier, leasing is a normal business transaction and not a mode of financing. Therefore, the lease transaction is always governed by the rules of Shariah prescribed for ijarah. Let us, therefore, discuss the basic rules governing the lease transactions, as enumerated in the Islamic Fiqh. After the study of these rules, you will be able to understand under what conditions the ijarah may be used for the purpose of financing.

Although the principles of ijarah are so numerous that a separate volume is required for their full discussion, we will attempt in this chapter to summarize those basic principles only which are necessary for the proper understanding of the nature of the transaction and are generally needed in the context of modern economic practices.

Basic Rules of Ijarah

1. Leasing is a contract whereby the owner of something 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 contract of lease that the corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything which cannot be used without consuming cannot be leased out. Therefore, the lease cannot be effected in respect of money.

4. As the corpus of 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 period of lease must be determined in clear terms.

6. The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement.

7. The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence on the part of the lessee.

8. The leased asset shall remain in the risk of the lessor throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor.

9. A property jointly owned by two or more persons can be leased out, and the rental shall be distributed between all the joint owners according to the proportion of their respective shares in the property.

10. The rental must be determined at the time of contract for the whole period of lease.

11. The period of lease should not be for the entire life of the asset being leased.

Leasing with the above conditions compels the lessor to take the risk of a business. There is no guarantee that the asset will be necessarily rented throughout its entire life and at reasonable rates so that it would eventually generate a positive income. Primarily this type of lease is called operating lease in conventional finance literature and it is completely acceptable and has been used throughout the Islamic history without any controversy or difference of opinion.

The same is not, however, true about financial leasing or Hire Purchase (in Arabic Ijarah wal-Iqtina. In this case the asset is primarily sold to the lessee but the ownership is not fully transferred to her until she pays the full cost of the asset that was determined by the actual cost of the asset the financier had paid for the asset as well as the total interest charges depending on the rate of interest and the period of payment agreed upon.

Contemporary Islamic scholars who sit at the Shari'ah Boards of different Islamic financial institutions have, however, allowed the use of ijarah wal iqtina under some conditions. These will be discussed in Unit 2 of the course when you will learn the actual practices of Islamic banks and other financial institutions.