Hire-Purchase (Leasing) in Islamic Finance

A hire-purchase agreement provides the hirer with the option to become the owner of the item at the end of the tenure of the hire provided that the hirer has fulfilled all the conditions in the agreement. Under its terms, a business entity or individual may request the bank to purchase capital goods such as equipment, tools or machinery and rent them to him or her. The rent is charged from the date the lessee takes delivery of the goods and the duration of the lease is determined. In cases of non-payment of installments, the bank (lessor) has recourse to the leased asset. Under the contract, the lessee is obliged to pay a periodical rental charge, which normally exceeds the depreciation value of the asset. This can be a fixed amount for the whole period of the lease or a variable amount, depending on the specific terms of the agreement. Provisions for such things as insurance, repair costs and protection of the leased item can also be tailored to the respective needs of the parties. The duration of the hire purchase period must not exceed the useful life of the item in question and the lessee has no right to transfer the property to any other party without the bank’s written permission.

For the lessee, hire-purchase (leasing) has many advantages over direct purchase in that it is the use of the asset that is most important, not who has the title to it. There are many reasons, good and bad, for leasing. In general, though, it has gained momentum in the banking system largely as a result of the tax advantage it has to offer.

Source: Prof. Iraj Toutounchian, Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Narrated by Camille Paldi. Republished with permission.