P1: OTA
c01 JWBK501-Kettell May 30, 2011 12:46 Printer: Yet to come
Case Study 1: Ijara Contract 3
Under leasing or lease purchase, the Islamic financial institution buys the financed asset and
retains the title through the life of the contract. The customer makes a series of lease payments
over a specified period of time, and may have the option at the end to buy the item from the
lessor (and owner) at a pre specified residual value.
Leasing was not originally a mode of financing. It was simply a transaction meant to transfer
the usufruct of a property from one person to another for an agreed period and an agreed upon
consideration. Leasing can be used as a mode of financing, in Islamic banks, as an alternative
to conventional car financing. However, the consideration of leasing as a mode of financing
should be based on certain conditions. It should be understood, by all using it as a mode of
financing, that it is not sufficient to substitute the term ‘interest’ with the term ‘rent’, and use
the term ‘mortgage’ instead of the term ‘leased asset’. There must be a significant difference
between leasing and an interest-bearing loan.
It is no secret that an Islamic bank or financial institution will take into consideration the
same factors as a conventional bank when determining the rental payments and residual value.
These would include the rate of inflation, the creditworthiness of the lessee, the opportunity
cost value of the money (as reflected by market interest rates) and so on. An implicit ‘interest
rate’ can trivially be calculated from the price, residual value, term of the lease and the lease
payment. This fact is not hidden. Indeed Muslim customers are encouraged to ‘shop around’
and ensure that the Islamic financial institution is not implicitly charging an interest rate, which
is in line with the conventional market.
In the final analysis, however, the difference is in the form of the contract. If the lease
is structured in accordance with the various conditions within Islamic jurisprudence, it will
contract no riba and ensure that it cannot contain such forbidden riba in the future (e. g., in
terms of late payment fees, etc.).
1.3.4 What is the Difference between a Conventional Lease and an Islamic Lease?
The most important financial difference between Islamic leasing and conventional leasing is
that, with Islamic leasing, the leasing agency must own the leased object for the duration
of the lease. Therefore, although leasing a car from a car manufacturer or car dealership
may in principle be permitted for Muslims (if the contract satisfies the other conditions),
Muslims should investigate further. In many cases, the car dealership may in fact use a
bank or other financial intermediary to provide a loan for the present value of lease pay-
ments, and charge the customer interest on this loan. This would constitute the forbidden
riba.
Scrupulous Islamic financial institutions ensure that the contract abides by all the restrictions
set out in the Sharia’a (e. g., subleasing requires the permission of the lessor; late payment
penalties must be handled very carefully to avoid riba, etc.).
The differences between conventional and Islamic financing schemes are described in the
sections below.
1.3.4.1 Leasing versus Conventional Financing
Conventional Financing
The conventional financing schemes provide financing for purchasing a car; that is, in essence
the financier is giving a loan and charging interest.