Ijarah (Leasing) as a Mode of Finance

Leasing is well known in the west as a mode of finance. There are many reasons why an agent will opt for leasing rather than borrowing from the bank to purchase the needed asset. For example:

(a) It is easier to lease then borrow for short term needs since it mostly do not require credit evaluation.

(b) Gives more freedom of changing equipment as technology advances.

(c) Easier to get finance through leasing for companies with lower credit standing. These kind of companies may not be able to borrow from banks or the public and if they do, have to pay high of interest.

(d) In many cases leasing can be advantageous from taxing point of view. These advantages may accrue to lessee and sometimes to the lessor since equipment leased remains the ownership of the lessor and hence can be counted, from tax point of view, an investment

(e) In many countries leasing is an off balance sheet finance. As we are well aware, there are many types of leasing arrangements. These are but few:

1. Operating leases: 

   Short term and cancelable during the contract period at the option of lessee.

2. Capital, financial or full-payment lease:

   Extend over most of the estimated economic life of the asset and cannot be canceled, or can be canceled only if the lessor is reimbursed for any. losses. Financial leases are a source of financing and it is borrowing money. The lessee assumes a binding obligation to make the payment specified in the lease contract. He could have borrowed the full purchase price of the asset by accepting a binding obligation to make interest payment to the lender. Cash flow consequences of leasing and borrowing are similar.

3. Full-service or rental lease:

   The lessor promises to maintain and insure the equipment and to pay any property taxes due on it. In a net lease, the lessee agrees to maintain the asset, insure it and pay property tax. Most financial leases are net leases.

4. Direct lease:

   Where user identifies the asset arranges with leasing company to buy it from manufacturer and lease it.

5. Sale & leaseback arrangement:

   Firm sells an asset it already owns, leases it back from the buyer. Common in real estate.

6. Leveraged leases:

   There are financial leases in which the lessor borrows part of the purchase price of the leased asset using the Lease Contract as security for the loan.

Shari’ah Aspects of Leasing

Operating lease are known in Shari’ah. What Islamic banks did was to develop such leases so as to provide a mode of finance, without violation of basic Shari’ah requirements in such contracts. The most important aspects of Shari’ah in leasing contract are:

It is not permitted to enter into a retail and a sale agreement in one leasing contract. Further, it is not permissible in Shari’ah to forward a sale contract with no payment mode. To avoid this, therefore:

(a) Sale should only be an “option” provided to lessee (while lessor is obliged to sell if lessee exercise such option).

(b) They both commit their sales to sale but at the (then) prevailing market price.

Source: An Introduction To Islamic Banking, Shaykh Dr Mohamed Ali Elgari. Republished with permission.