In this simple guide, we will look at the following:
- What is Ijarah?
- Key requirements of Ijarah
- Applications of Ijarah
1. What is Ijarah?
Ijarah is simply a Shariah lease. Ijarah is almost identical to an operating lease which involves the owner of the asset transferring the Manfa’ah (utility) of the asset to another person to use for an agreed period and for an agreed rent. The ownership of the leased equipment remains in the hand of the lessor.
2. Key requirements of Ijarah
Besides the conditions of sanity, adolescence, freedom and mutual consent of the contracting parties, the following conditions must be met for an Ijarah contract to be valid:
- The goods rented should be present and capable of being handed over to the lessor after the completion of the contract of hire;
- The usufruct of the goods or services being hired should have sufficient economic value in substance at the time of entering into the equipment lease. If the object does not have economic value, then the rent can only be required once the object has economic value. In other words, the progress payment structure may not be available. Further, rent cannot be collected until the equipment is in the lessee’s possession. At times, a variant of Ijarah called Ijarah Mawsufah Fil Dhimma is used to collect early rent.
- The rent must be fixed during the entire lease term; any change in the rent would require entering into a new lease. There is no prohibition against raising or lowering the rent, but any such increase or decrease must be specifically set out under the terms of a new lease. According to the jurists, rent will be due when the following conditions are met:
- Complete acquisition or attainment of the usufruct of the hired goods/capital equipment; or
- Ability of the lessee to use the usufruct of the hired goods (though he may not enjoy it actually);
- The actual term of the lease must be set out in the agreement.
- The usufruct of the hired article must be specified. Specification of the usufruct takes place through:
- The period of the use of usufruct;
- The purpose of the hired goods;
- Rent (its nature and amount);
- The article being hired should be physically fit for hire;
- The lessor should hand the hired article over to the lessee in its complete form and shape;
- The lessor must have full possession and ownership of the article he is hiring out;
- Existence of the hired article should continue throughout the contract period;
- The benefit for an Ijarah must be lawful according to the Shariah.
3. Applications of Ijarah
Ijarah as a standalone product without the additional transfer of ownership is rarely practiced as most Islamic Financial Institutions operate as financial intermediaries looking to finance transactions and not in the business of leasing goods.
This Ijarah is known as an operation lease which refers to an ordinary lease in which the asset is leased for a specified period against an agreed return.
Car Financing or auto financing through Ijarah is probably one of the most common applications of such an Ijarah in Islamic Financial institutions, where the IFI retains ownership and after the lease term, the lessee is within their right to return the car to the Islamic financial institution.
Islamic commercial banks typically offer such an Ijarah for a range of assets which include capital goods and income-generating assets such as aircrafts, ships, industrial equipment and agricultural machines etc.