Mufti Abdul Sattar LaghariShariah Adviser

Mufti Abdul Sattar LaghariShariah Adviser

ISLAMIC FINANCE & ETHICS

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IJARAH• Transferring of usufruct of an asset to

another person for an agreed period, at an agreed consideration.

• It is used to express the sale (bay’) of a known benefit in return for its known equivalent.

• The Asset should be valuable and identified and has a usufruct.

• Anything which cannot be used without consuming cannot be leased out. e.g.. Money, Wheat etc.

• Quran:

IJARAH LEGITIMACY

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IJARAH

BASED ON SUBJECT MATTER

TANGIBLE ASSET

LABOUR

DESCRIPTION OF ASSET

BASED ON CONTRACTUAL RELATIONSHIP

OPERATING IJARAH

FINANCIAL IJARAH

TYPES OF IJARAH

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TYPES OF IJARAH

1. Operating Ijarah

Operating Ijarah is a lease that does not

include a promise that the legal title in the

leased asset will pass to the lessee at the

end of the lease.

BANK

2. Financial Ijarah (Ijarah Muntahia

Bittamleek )

It is a contract that concludes with the legal

title in the asset passing to the lessee after

Ijarah.

IT MAY CONCLUDE:

Through Hiba (Gift).

Through Salvage Value.

Through Pre Decided Price if,

During the Lease Period.

TYPES OF IJARAH

TYPES OF IJARAH

3. IJARAH TUL MUSHA OR JOINT OWNERSHIP

IJARAH

It is a lease where Bank & Customer jointly

owned the leased asset. Bank gives its share

to the customer on lease.

After the term of Ijarah, the treatment is

similar to Ijarah Muntahia Bittamleek.

TYPES OF IJARAH

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BASIC RULES OF IJARA

• Ownership Expenses• All Liabilities of ownership e.g. Takaful,

Registration cost etc are borne by Lessor because corpus of leased property remains in the ownership of the seller.

• Period of LeaseMust be determined in clear terms at the time of contract.

• Lease for Specific Purpose OnlyIf no specific purpose is identified in the agreement, then it can be used for any purpose for which it is used in normal course.

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BASIC RULES OF IJARA

• Lessee as Ameen The lessee is liable to compensate the

Lessor for every harm to the leased asset caused by any misuse or negligence. The leased asset shall remain in the risk of the Lessor throughout the lease period.

• Lease Of Jointly Owned PropertyIt is permitted and rentals shall be distributed between all the joint owners according to the proportion of their respective shares in the property.

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Determination of Rental

• The rentals must be determined at the time of contract for the whole period of lease.

It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that:

1. The amount of rent for each phase is specifically

agreed upon. 2. Floor & Cap is decided to eliminate

Gharar.

The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the Lessor, as normally done in financial leases, is not against the rules of Shariah

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Determination of Rental

The Lessor cannot increase the rent unilaterally, and any agreement to this effect is void.

The rent or any part thereof may be payable in advance after execution of lease agreement.

The lease period shall commence from the date on which the leased asset has been delivered to the lessee.

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Rent Charging

Rent should be charged after the delivery of the leased asset to the lessee

and not from the day the price has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay.

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Charity For Late Payment Of Rent

The Lessor cannot charge an additional amount in case the lessee delays payment of the rent but an amount on account of charity can be charged.

Charity received on late payments is given to charitable institutions by the bank on behalf of the customer.

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Termination of Lease

. If the lessee contravenes any term of the agreement, the Lessor has a right to terminate the lease contract unilaterally.

In normal scenarios Ijarah can be

terminated through mutual consent only. However, in such a case the Lessor cannot charge rentals of remaining period.

Ijarah is also terminated on maturity of the lease period.

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Transfer of Ownership

It is a well-settled rule of Islamic jurisprudence that one transaction cannot be tied up with another transaction so as to make the former a pre-condition for the other. However, 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 will be binding on the Lessor only.

The Lessor can also take “undertaking to purchase” from the customer binding him to purchase the asset during facility period or at maturity.

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Transfer of Ownership

. Ijarah Wa Iqtina

The Lessor may sign a separate promise to gift the leased asset to the lessee at the end of the lease period, subject to his payment of all amounts of rent.

. Sub-Lease

If the leased asset is used differently by different users, the lessee cannot sub-lease the leased asset except with the express permission of the Lessor.

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• The customer approaches the Bank with the request for financing

• The Bank purchases the item required for leasing and receives title of ownership from the vendor

• The Bank makes payment to the vendor

• The customer approaches the Bank with the request for financing

• The Bank purchases the item required for leasing and receives title of ownership from the vendor

• The Bank makes payment to the vendor

GENERAL MECHANICS

CUSTOMERISLAMIC

BANK

VENDOR

. .Agreement

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• The Bank leases the asset to the customer

• The customer makes periodic payments as per the contract

• The asset title transfers to the customer based on the method disclosed in the agreement

• The Bank leases the asset to the customer

• The customer makes periodic payments as per the contract

• The asset title transfers to the customer based on the method disclosed in the agreement

GENERAL MECHANICS

CUSTOMERISLAMIC

BANK

AgreementVENDOR

. .

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Ijarah VS Conventional Lease.

• Rent can only be charged after delivery of leased assets.

• Charity of late payment of rental is given to charity.

• Transfer of asset at the end of lease period to lessee is not included in the lease agreement.

• All risks and rewards of assets will be held with bank.

• Rent charged from the days the price has been paid even if delivery is delayed.

• Penalty of Late payment of rental is taken into Income.

• Transfer of asset at the end of lease period to lessee is a part of the lease agreement.

• All risks and rewards of assets transferred to lessee.

Ijarah Conventional Lease

APPLICATION OF ACCOUNTING STANDARD

The Islamic Financial Accounting Standard (IFAS)-2 “ IJARAH” was issued by the Institute of Chartered Accountants of Pakistan (ICAP) and was adopted by the Securities and Exchange Commission of Pakistan (SECP) vide its notification S.R.O 431 (i)/2007 dated May 22,2007.

Effective Date

IFAS-2 has become operative for financial statements covering periods beginning on or after July 01, 2007.

Sale & Lease BackSale & Lease back is such a transaction in which a

customer sells his already possessed asset to a financier and then enters into a separate lease agreement to get the right of use over a certain period.

• Ideally SLB transactions should be avoided. It should be used in exceptional cases and care should be taken to ensure that the transaction is genuine and not merely a source of liquidity /overdraft facility or a substitute of personal financing.

• Sale and Lease Back may be allowed in following

cases:

A. Financing of Newly Imported Asset

( machinery, equipment etc)

B. Replacement from Conventional to

Islamic Financing

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Ijarah Risks & Its Mitigates

• Theft or Damage of

• Leased Assets

• Delayed in Rental Payment

• Doubtful Customers

• Through Takaful Arrangement

• Charity for Late Payment

• Through Know Your Customer Analysis

RISKS MITIGATES

DIMINISHING MUSHARAKAH

DIMINISHING MUSHARAKAH

MUSHARAKAH

“Shirkah” means “Sharing” and in the

terminology of Islamic Fiqh;

Musharakah is basically a kind of

partnership in which the partners join

together with different contributions

for the common objective of joint

ownership or undertaking business

and trade in accordance with the

principles of Shariah.

What is Diminishing Musharakah?

Diminishing Musharakah is just Musharakah with an additional feature of decreasing ownership of one partner. In this type of Musharakah the ratio of ownership keeps changing.

The closest term in conventional finance for DM is Redeemable Capital.

Types of Diminishing Musharakah

Like the normal Musharakah, this is also distributed into two categories:

I. Shirkat ul AqdFor the purpose of Business

II.Shirkat ul MilkFor the Purpose of Joint

Ownership

Basic features of Diminishing Musharakah●● Creation of partnership.●● Implementing the relevant Rules of Musharakah.●● Renting one Partner’s Share to the Other.●● Redemption of one partner’s share by purchasing from another.

BASIC OPERATION

BANK CUSTOMER

JOINT

OWNERSHIP

RENT

• The customer approaches the Bank with the request for project /

machinery / house finance.• The Bank enters into a Musharakah (Joint Ownership

Agreement) with the Customer and both of them pay their respective shares to the seller of asset.• The Bank gives its share to the client on rent and

client pays the rent to the bank against use of the bank’s Share.• The Client promises to purchase Bank’s share (Units)

over the tenure of the transaction with the help of Undertaking to Purchase.

BASIC OPERATION

»» There should be a real partnership.»» Every partner should enjoy the benefits and bear the responsibilities.»» The promise of sell / buy should be obtained through a separate document.»» In case of Shirkat ul Aqd, redemption will be on market price or negotiated price or on N.A.V bases, not on any pre decided price.»» Proper documentation should be made.

Conditions To Be Fulfilled

Diminishing of Shirkat ul Aqd

A and B invest their capital and create a joint venture.

A separate Musharakah agreement is executed.

B promises to sell his shares to A gradually or Apromises to buy B’s shares.

A and B enjoy their rights as partners as they share the revenue in agreed ratio and bear the loss according to their shares in capital.

A will keep buying B’s shares until he acquires the complete ownership.

Diminishing of Shirkat ul AqdA purchases the Share of B

Gradually 4

Diminishing of Shirkat ul MilkA joint ownership is created between A and B in any property or any asset which is not a subject matter of any business. A promises to buy B’s shares gradually on an agreed price. A may take B’s shares on rent. A will purchase the shares of B at different stages.The rental will be adjusted according the remaining shares of B.

DIMINISHING MUSHARAKAH

Accruing Rentals

Share in capital

Share in capital

Partner Bank

2

3Sell its

share in equity

Pays price of the units of

bank’s equity

1 1

4HMB SIRAT

Uses of Diminishing Musharakah

Project financing of fixed assets

Agriculture Finance

Plant and Machinery Finance

House finance

Car / Transport finance

Shariah Principles• To create joint ownership in property is

called Shirkat-ul-Milk and is expressly allowed by all schools of Islamic Jurisprudence.

•  All Muslim Jurists agree on the permissibility of the Financier leasing his share in property to client and charging him rent i.e. the permissibility of leasing one’s share to his partner.

•  There is difference of opinion among leasing one’s share to a third party But there is no difference on permissibility on leasing to a the co owner.

Shariah Principles• Promise of client to purchase units of share

of financier is also allowed.

•  The Transactions cannot be combined in a single arrangements and they have to be executed independently. This is because it is a well settled rule of Islamic Jurisprudence that one transaction cannot be made a condition for another.

•  Instead of making the transactions a pre-condition for one another there can be one-sided promises from one party to another.

CASE STUDY• MEEZAN EASY HOME

Features:• Flexible Financing Tenure 3 to 20 years.• Highest financing amounts up to PKR 40

Mln.• BIR up to 85% of property value.• Flexibility to make additional unit

purchase.• Minimal processing charges.• Very affordable and competitive monthly

payment plan with a regularly reducing rental amount.

Product Range • Easy Home Offers a Comprehensive

solution with: 

• Easy Buyer - Buying a home is Easy & Halal 

• Easy Builder - Building a home is Easy & Halal

 • Easy Renovate - Renovating a home is

Easy & Halal • Easy Replacement - Replacing your

existing mortgage is Easy & Halal

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