University of Nairobi Fundamental of Islamic Finance 2022

UNIVERSITY OF NAIROBI
SCHOOL OF BUSINESS
DEPARTMENT OF FINANCE AND ACCOUNTING
BACHELOR OF SCIENCE IN FINANCE DEGREE PROGRAMME

FUNDAMENTALS OF ISLAMIC FINANCE

DFI 212

Saturday, Nov 2022

DFI 212 IJARA

University of Nairobi Fundamental of Islamic Finance 2022

IJARA

IJARA

Ijarah means ‘to give something on rent’. ajara. To recompense, compensate or to give a
consideration or return In Islamic jurisprudence, it 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 second type is relates to the usufructs of assets and properties, and not to the
services of human beings. In this sense it means “to transfer the usufruct of a particular
property to another person in exchange for a rent claimed from him.’

It is a contract for the transfer of ownership of usufruct for compensation. Some scholars
say that, “it is a sale of a known usufruct for a known compensation. Thus, the contract of
lease is a kind of contact of financial exchange.

The difference between ijarah and bay is that ijarah is a sale but only of the usufruct,
whereas a normal bay (sale) contract is a transfer of the corpus. A lease contract may be
carried out immediately or at a future date, whereas a sale contract must be carried out
immediately. Consumables may be the subject matter of a sale but not of a lease.

The key elements in leasing contracts which must fulfill the conditions of its validity are

1. Contracting parties: both lessor and lessee must be of sound mind, attain the age of
maturity and not restricted from dealing with business transaction

2. Object of contract: the asset or equipment must be tangible, owned by the Lessor at
the time of contract, can be delivered to the lessee for usage and remain with the
lessee throughout the lease period

3. Rent : it must be determined and agreed by both parties at the time of the contract,
must be specified in terms of currency and can be collected in advance

4. Term or Period: period of lease must be determined and agreed by both parties at the
time of the contract

5. Offer and acceptance: it must be concluded in a definite and decisive language,

acceptance must be consistent with the offer made and that the offer and acceptance
must be made at the same meeting

In ijarah contract, the financial institution as the Lessor maintains ownership in the leased
asset whilst the lessee owns the rights to use the asset for an agreed period at agreed
rentals. All liabilities and risks pertaining to the leased asset are borne by the Islamic

DFI 212 IJARA

University of Nairobi Fundamental of Islamic Finance 2022

financial institution including obligations to restore any impairment and damage to the
leased asset arising from wear and tear and natural causes which are not due to the
lessee’s misconduct or negligence.

LEASE AS A MODE OF FINANCING

Lease was NOT originally a mode of financing. It is simply a transaction meant to transfer
the usufruct of a property from one person to another for an agreed period against an
agreed consideration. However, certain financial institutions have adopted leasing as a
mode of financing instead of long term lending on the basis of interest. This kind of lease is
generally known as the ‘financial lease’ as distinguished from the ‘operating lease’ and
many basic features of actual leasing transaction have been dispensed with therein.

THE APPLICATION OF IJARAH IN THE BANKING SYSTEM

The common mechanism of ijarah as applicable in Islamic banking contracts is as follows

1. The client identifies and approaches the vendor or supplier of the asset that he or she
needs and collects all the relevant information

2. The client approaches a bank for ijarah of the asset and promises to take the asset on
lease from the bank upon purchase

3. The bank makes payment of price to the vendor

4. The vendor transfers ownership of the asset to the bank

5. The bank leases the asset, transfers possession and specific right of use to the client

6. The client pays ijarah rentals over future (known) time periods(s)

7. The assets reverts to the bank in the operating lease or is transferred to the client in
the financing lease

1. Ijarah Mawsufah fi Al Dhimmah (Forward Lease)

Ijarah Mawsufah fi Al Dhimmah, is a forward lease contract where the lessee will use an asset
or equipment that will only be available in the future. Although the asset is not available at the
time of the contract, the Lessor must describe in detail and must deliver at an agreed date in
the future

The key elements in forward sale contract which must fulfill the conditions of its validity are

a) The rental payable may be fixed or varied according to an agreed benchmark for a
specified period and shall be determined at the time of the contract

DFI 212 IJARA

University of Nairobi Fundamental of Islamic Finance 2022

b) The rental can be paid in advance but the amount received by the Lessor shall be
earned only upon effective delivery of the usufruct of the leased asset to the lessee

c) The rental amount received by Lessor shall be refunded to the lessee if the asset
cannot be effectively delivered to the lessee for the agreed period.

d) Upon the completion of the leased asset under a forward lease and prior to enjoyment
of the usufruct, the lessee may purchase the leased asset and the forward rentals
amount may be treated as part of the selling price.

2. Ijarah Muntahiya Bil- Tamlik

It refers to a lease contract with the transfer of the legal title of the leased to the lessee at
the conclusion of the lease arrangement. The transfer can be in the form of a sale or a gift
of the asset to the lessee.

3. Ijarah Thumma Al- Bay’

It is a form of ijarah where the sale contract is executed at the lease period to effectively
transfer the asset ownership from the competition of the Islamic financial institution
(Lessor/seller) to the customer (lessee/buyer)

It comprises of two separate contracts that are executed in sequence i.e. ijarah (leasing)
and Bay’ (sale)

Through the lease period, the lessee pays a total sum of monthly rentals comprising of an
actual cost of the asset paid by the Islamic financial institutions (lessor) after deducting any
down payment paid by the lessee and the lessor’s profit margin

At the end of the lease period or upon early settlement, the Islamic financial institution
(seller) transfers the title of the asset to the customer (buyer) for a token sum by executing
a sale contract.

Silent Shari’a Issues in Ijarah Contract

1. Combination of Contracts

Muslim jurists ruled that it is not permissible to tie up one transaction with another so as to
make the former a pre-condition for the other. However, they allow the combination of
more than one contract in one transaction without imposing one contract as a condition in
the other, provided that it does not go against the restriction of the Shari’a that prohibits it
on exceptional basis. Therefore, the Lessor may enter into a unilateral undertaking to sell
the leased asset to the lessee at the end of the lease period. This undertaking shall be
binding on the Lessor only.

DFI 212 IJARA

University of Nairobi Fundamental of Islamic Finance 2022

2. Linked Rentals in Long-term Lease with Interest Rate Benchmark

Muslim jurists agree that the Lessor in a long-term may either stipulate a condition may
also tie the rent amount with other well-defined benchmarks such as linking the increment
or decrease in rent to the rate of government taxes or the inflation rate. They, however,
disagree on tying the rental with an interest rate benchmark like LIBOR.

DFI 212 IJARA