Islamic Leasing Ijarah

Focused toolkit
Islamic Leasing
(“Ijarah”)
Table of Contents
WHAT IS ISLAMIC FINANCE?................................................................................................... 5
Shariah (Islamic Law)................................................................................................................. 6
Halal and Haram........................................................................................................................ 6
Takaful (Islamic Insurance)........................................................................................................ 6
Basic Principles of Islamic Finance............................................................................................ 7
Support Institutions for Islamic Finance................................................................................. 8
IJARAH (ISLAMIC LEASING)................................................................................................... 10

Introduction............................................................................................................................. 10
Terms and conditions of the Ijarah Contract.........................................................................12
Standard Features of Ijarah Contracts Offered by Financial Institutions.......................... 14
Example of Ijarah Financing Calculations............................................................................. 16
Comments on Differences and Similarities between Conventional
Lease contracts and Ijarah.......................................................................................................17
Sale of the Leased Asset......................................................................................................... 18
Independence of Ownership................................................................................................. 18
Timing of Lease Payment........................................................................................ 18
Ijara of Non-existing Assets..................................................................................... 18
Period of Ijara........................................................................................................... 19
Determination of Rent............................................................................................. 19
Insurance and Maintenance Expenses................................................................... 19
Securitization of Assets Subject to Ijarah Contract............................................... 20
Legal Opinion Regarding Securitization................................................................ 20
Ijarah — Transactional Issues................................................................................................. 20
AL-IJARAH THUMMA AL-BAI (AITAB).................................................................................. 21

Example of AITAB Financing Calculations............................................................................ 22
Documentation for AITAB...................................................................................................... 22
Comments on Differences Between Conventional Lease Contracts and AITAB.............. 23
Tax Benefits of AITAB............................................................................................................. 23
Legal Issues to Consider.......................................................................................................... 23
Examples of the Impact of Shariah Rulings in Four Countries .......................................... 24
Shariah Supervisory Board (DPS)........................................................................................... 27
Ijarah Transaction Examples................................................................................................... 28
Example of Car Leasing.......................................................................................................... 28
Ijarah Home Finance............................................................................................................... 30
Forward Ijarah (Real Estate Financing)................................................................................. 32
Islamic Leasing for Micro, Small, and Medium Enterprises (MSMEs)................................. 34
AAOFI....................................................................................................................................... 35
IFRS vs AAOIFI and the Malaysian Accountings Standards Board (MASB)........................ 35
Accounting under AAOIFI...................................................................................................... 36
Malaysian Accountings Standards Board (MASB)................................................................ 37
Accounting Treatment under AAOIFI................................................................................... 39
Classification and Recognition of Ijarah under AAOIFI20...................................... 39
FOUR MAIN SCHOOLS OF ISLAMIC THOUGHT: HANAFI/JA’FARI,

MALIKI, SHAFIE, AND HANBALI............................................................................................ 41
Sunni and Shi’a........................................................................................................................ 42
Ijarah Under the Four Schools................................................................................................ 42
Dispute Resolution.................................................................................................................. 43
PROJECT FINANCING USING IJARAH.................................................................................... 43
Ijarah with Istisna.................................................................................................................... 44
Risks to Avoid in Project Financing........................................................................................ 44
Project Financing Examples.................................................................................................... 45
IJARAH SUKUK........................................................................................................................ 46
Sukuk........................................................................................................................................ 46
Sukuk Trust Certificates............................................................................................. 47
Disadvantages of the Ijarah Sukuk Structure....................................................................... 48
Sukuk Trading Options .......................................................................................................... 48
Ijara and Project Finance........................................................................................... 49
Sample Transaction Structure — Leasing Assets..................................................... 49
STANDARD & POOR’S RATINGS OF IJARAH SUKUK........................................................... 52

Ijarah Sukuk Ratings.................................................................................................. 52
Criteria Guidelines...................................................................................................... 54
ISLAMIC FINANCIAL SERVICES BOARD IFSB 9.0.................................................................. 57

Guiding Principles on Conduct of Business for Institutions Offering
Islamic Financial Services........................................................................................................ 57
ISLAMIC FINANCIAL GLOSSARY........................................................................................... 58
References............................................................................................................................. 61
General Bibliography...................................................................................................... 63
4 Focused toolkit: Islamic Leasing (“Ijarah”)
Focused toolkit: Islamic Leasing (“Ijarah”) 5
WHAT IS ISLAMIC FINANCE? Unlike the segregation of duties and responsibilities that exists
in the western, non-Muslim world, in the Muslim world there is
“As a form of financial intermediation, Islamic finance no division between religion, business, the family, and the state.
incorporates several elements that guide the process of the The values, morals, norms, behaviors, and ethics applicable in
mobilization and allocation of funds to generate productive one situation permeate all the others, and this carries to the
economic activity and inclusive development. Fundamental to issues of finance. This construct binding the parts to create the
Islamic finance is the requirement that financial transactions whole is referred to as Shariah, which can be translated to mean
must be supported by real economic activity. In addition, “the way,” referring to the way Muslims should live. The way
Islamic finance promotes profit sharing and hence risk sharing. is well represented below in diagrammatic form in terms of its
These elements limit the extent of leverage and place emphasis impact on financial issues.
on transparency and disclosure in the documentation of
contracts. Embraced in its entirety, Islamic finance promises Source: Islamic Finance and Global Financial Stability, 20102
to enhance the discipline that contributes towards ensuring
growth and financial stability.” — Dr. Zeti Akhtar Aziz,
Governor, Bank Negara Malaysia 1
1 Please see end notes at the end of this focused toolkit 2 Please see end notes at the end of this focused toolkit
Overarching Principles
•• Towards achieving the objectives of Shari’ah (Maqasid al-Shari’ah)
•• Protection of religion, life, lineage, intellect and wealth
•• High ethical values—justice, fairness, trust, honesty and integrity
•• More equitable distributor of wealth
Materiality and Validity of Transactions Mutuality of Risk Sharing

•• Economically productive underlying activities •• Entitlement of profit confident upon risk
•• Avoidance of interest-based transactions taking
•• No involvement in illegal and unethical •• Honouring both substance and form of
activities contract
•• Genuine trade and business transactions
•• Avoidance of speculative transactions
Embedded Governance Disclosure & Transparency

Source: Islamic Finance and Global Financial Stability, 20101
Shariah (Islamic Law) Halal and Haram

According to the State Bank of Pakistan, Shariah is best Again according to the State Bank of Pakistan, the terms halal
explained as follows:3 and haram can be explained as follows:
Shariah lexically means a way or path. In Islam, Shariah refers The validity of a transaction does not depend on the end result
to the divine guidance and laws given by the Holy Quran, the but rather the process and activities executed and the sequence
Hadith (sayings) of the Prophet Muhammad (Peace Be Upon thereof in reaching the end. If a transaction is done according
Him) and supplemented by the juristic interpretations by to the rules of Islamic Shariah, it is halal even if the end result
Islamic scholars. Shariah embodies all aspects of the Islamic of the product may look similar to a conventional banking
faith, including beliefs and practices. Islamic Shariah or the product.
divine law of Islam is derived from the following four sources:
It is the underlying transaction that makes something halal
1. The Holy Quran (allowed) or haram (prohibited) and not the result itself.
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)

Takaful (Islamic Insurance)
4. Qiyas (by analogy)
In a Takaful relationship, the participants jointly contribute to
“Shariah compliance” refers to the decision to apply Islamic a pooled fund for the purposes of providing mutual indemnity
principles to financial transactions, whether in global markets and protection for any of the participants exposed to defined
or in Islamic-based markets. Compliance is driven by national risk under the Takaful policy. Unlike conventional insurance,
legislation generated by the the Accounting and Auditing where there is the traditionally understood insurer-and-insured
Organization for Islamic Financial Institutions (AAOIFI) relationship, in Takaful all participants are insurers and insured
standards, The Islamic Financial Services Board (IFSB), at the same time.
prudential and regulatory standards, and Internal Shariah
A Takaful company or operator is responsible for managing the
boards or client directives.
Takaful fund.
3 Please see end notes at the end of this focused toolkit

Basic Principles of Islamic Finance • Prohibition of speculative behavior.

Islamic finance discourages hoarding and prohibits
• Prohibition of interest (riba). transactions featuring extreme uncertainties (gharar) or
There is a prohibition against riba — a term that literally gambling (maysir).
means “an excess” and is interpreted as “any unjustifiable
increase of capital, whether in loans or sales.” • Sanctity of contracts.
Islamic finance upholds contractual obligations and the
• Money as “potential” capital. disclosure of information as a sacred duty. This feature is
Money is not a commodity, but a medium of exchange, intended to reduce the risk of asymmetric information and
a store of value, and a unit of measurement. Money moral hazard.
represents purchasing power and cannot be utilized to
increase the purchasing power without any productive • Shariah approved activities.
activity. Islamic finance advocates the creation of wealth Only those business activities that do not violate the rules
through trade and commerce. of the Shariah qualify for investment. For example, any
investment in a business dealing with alcohol or gambling
• Risk sharing. is prohibited.
Because interest is prohibited, suppliers of funds become
investors, rather than creditors. • Social justice.
Any transaction leading to injustice or exploitation is
prohibited.
Support Institutions for Islamic Sovereign Ratings and Credit Ratings assess
the likelihood that an entity will repay its debt obligations in
Finance a timely manner.
The legal, regulatory, and accounting frameworks for Islamic
finance and its institutions and products are continually
evolving. In this regard, important institutions framing the
development of the global industry are as follows:
Shariah Quality Ratings assess the level of compli-
ance with the principles of Shariah.
Accounting and Auditing Organization for

Corporate Governance Ratings are based on an
Islamic Financial Institutions (AAOIFI)4
entity’s practices, and assess the demarcation of rights and
AAOIFI is an autonomous entity responsible for the formulation responsibilities among different stakeholders as well as their
and issuance of accounting, auditing, ethics, governance, and compliance with prevailing rules and procedures for making
Shariah standards for the international Islamic banking and decisions.
finance industry. AAOIFI is a member of the International
A Shariah Quality Rating differs from a Credit Rating in
Accounting Standards Board (IASB.) AAOIFI standards seek
that the latter is an evaluation of the solvency of a financial
to establish best practices on handling financial reporting
institution and its capability and willingness to repay its
issues specific to Islamic institutions.
obligations. A Shariah Quality Rating, on the other hand,
is not related to the solvency or financial capability of the
institution or to the credit quality of its securities or financial
The International Islamic Financial Market products. Rather, it represents an independent opinion about
(IIFM)5 the Shariah Quality of a financial institution or of a security
or financial product.
The IIFM is a nonprofit organization, established through the
collective efforts of five countries—Bahrain, Brunei, Indonesia,
Malaysia, and Sudan—and one multilateral institution, the Islamic
Development Bank. IIFM’s principal objective is to establish, The Islamic Financial Services Board (IFSB)7
develop, promote, and regulate the islamic capital and money The Islamic Financial Services Board (IFSB), based in Kuala
market on the principles of Shariah. IIFM’s role is that of a developer Lumpur, was established in 2002. It serves as an international
and catalyst of the Islamic financial market, encompassing both the standard-setting body for regulatory and supervisory agencies
short-term money market and the long-term capital market. that have a vested interest in ensuring the soundness and stability
of the Islamic financial services industry, which is defined
broadly to include banking, the capital market, and insurance.
The International Islamic Rating Agency (IIRA)6 In advancing this mission, the IFSB promotes the development
of a prudent and transparent industry by introducing new—
The International Islamic Rating Agency (IIRA), established in or adapting existing— international standards consistent with
2005, is the sole rating agency that provides capital markets and Shariah principles and recommending them for adoption.
the banking sector in predominantly Islamic countries with a
rating spectrum, one that encompasses the full array of capital To this end, the work of the IFSB complements that of the
instruments and specialty Islamic financial products, and that Basel Committee on Banking Supervision8, International
enhances the level of analytical expertise in those markets. Organization of Securities Commissions9, and the International
IIRA offers Sovereign Ratings, Credit Ratings, Shariah Quality Association of Insurance Supervisors10.
Ratings, and Corporate Governance Ratings.
As of November 2009, the 193 members of the IFSB include 49 Shariah Board
regulatory and supervisory authorities as well as the International
Monetary Fund, World Bank, Bank for International One distinct feature of the modern Islamic banking industry is
Settlements, Islamic Development Bank, Asian Development the role of the Shariah board, which forms an integral part of
Bank, the Islamic Corporation for the Development of the an Islamic financial institution. A Shariah board monitors the
Private Sector, Saudi Arabia, and 138 market players and workings of the Islamic financial institution and has to clear
professional firms operating in 39 jurisdictions. every new transaction from a Shariah standpoint. These boards
include some of the most respected contemporary scholars
Malaysia, the host country of the IFSB, has enacted a law known of Shariah, and the opinions of the boards are expressed in
as the Islamic Financial Services Board Act 2002, which gives the form of fatwas. The International Association of Islamic
the IFSB the immunities and privileges that are usually granted Bankers, an independent body, supervises the workings of
to international organizations and diplomatic missions. individual Shariah boards, while the association’s Supreme
Religious Board studies the fatwas of the Shariah boards
of member banks to determine whether they conform with
Shariah.
Shariah law is open to interpretation, and Shariah boards often

have divergent views on key Shariah issues. In this regard, there
is no practical guide as to what constitutes an acceptable Islamic
financial instrument. A document or structure may be accepted
by one Shariah board but rejected by a different Shariah board.
Market for Islamic Finance Products
23% of world population is Muslim

Islamic Finance assets have grown to in excess of £800 bn
Significant The Sukuk bond market has grown to $70 bn
growth Total wealth of HNWI1 in Middla East is about $1.4 trillion
in Islamic Growth in total wealth tracks increase in oil price
Finance
1 High Net-Worth Individuals
IJARAH (ISLAMIC LEASING)— In the Ijarah Aina contract, there is no option for the lessee
to acquire the asset at the end of the lease. However, there
Introduction is another type of Ijarah contract, referred to as Al-Ijarah
The word Ijarah refers to a transaction that involves giving Thumma Al-Bai (AITAB), wherein the lessee can acquire the
something on a rental basis. It can denote the paying of wages asset at the end of the lease. This second type is addressed in the
to employees (Ijarah Amal) as well as the renting of an asset second part of this paper.
(Ijarah Ain). As an introduction to the subject, in this part of In Ijarah Aina (hereafter, Ijarah), the lessor rents the assets to
the paper we will only address the second type of transaction, benefit from their use without having ownership transferred to
Ijarah Aina, and for simplicity’s sake shall refer to it as Ijarah. the lessor. The legal term for this arrangement in English is
As we shall see, the transaction is similar to what we know as “usufruct,” and the price for this use is referred to as “rent.”
“leasing” in English. (Please note that all the Arabic terms used There is no element of interest in the transaction, since
here are transliterations of the Arabic sounds into the Roman ownership of the asset always remains with the lessor, and there
alphabet. The spellings of the same terms may vary from one is no option for the lessee to gain title to the asset.
text to another as you encounter them, since they are but
approximations of the true sounds of the words in Arabic.)
Since title (ownership) to the asset is not being transferred, Ijarah: Similar to an Operational Lease
there is no sale of a tangible asset, only the sale of an intangible
asset, namely the right to its use for a specific period of time. In this type of Ijarah, the financial institution purchases and
This right to use or usufruct is known as manfaah in Arabic. maintains assets that have a high degree of marketability.
It rents these assets to other parties on terms and conditions
Unlike the conventional lease, an Ijarah is a “contract” whereby agreed upon for a specific time. After the termination of that
a financial institution, using Islamic principles, purchases and period, the asset will be returned to the financial institution.
then leases the asset required by the client in exchange for a The institution then leases the same asset to a new lessee and
rental fee that is not related to interest. Under the contract, the at the same time bears the risk of recession or diminishing
lessor owns the property and may have the right to renegotiate demand for the asset. At the end of the lease, it may choose to
the lease payments at various intervals agreed to in advance in scrap or dispose of the asset.
the contract with the lessee, thereby ensuring that the rental
payments are equal to the residual balance value of the asset as This type of Ijarah is suitable for expensive assets, such as
well as the opportunity cost of the lessor, that is, his forgoing airplanes, ships, industrial equipment, and agricultural
the use of the assets. The risks of ownership of the asset stay machinery. In addition, these assets take a longer time to
with the lessor. manufacture, due to the fact that there is an increasing demand
for leasing them. The financial institution benefits from the
In this structure, Ijarah’s legal characteristics are similar to those transaction by retaining ownership of the asset while at the
of a sale-and-purchase transaction, with the exception that the same time getting a return by leasing it. The lessee also benefits
physical asset is not transferred and there is a specific time limit from the transaction, since it meets his immediate need and
on the use of the asset. It should be noted that the source of funds saves him from buying the asset at a much higher cost.
used by the financial institution to finance Ijarah transactions
must be halal. Al-Ijarah Muntahiya Bittamleek (IMB): Similar to
Ijarah can be contracted on an asset that is yet to be constructed a Finance Lease
or manufactured, as long as it is fully described in the contract,
This type of Ijarah is one that ends with ownership. Here the
provided that the lessor should normally be able to acquire,
financial institution purchases the asset based on a promise
construct, manufacture, or buy the asset being leased by the
from a customer. Because the customer promises to own the
time set for its delivery to the lessee.
asset, the asset will not be returned to the financial institution
at the end of the lease period, as it is in the case of an operational
lease, but instead will be bought by the lessee. The rental is
Types of Ijarah calculated based on the value of the asset, which is financed
based on the amount of profit and the period of financing.
Islamic financial institutions use the lease for the usufruct
as an instrument of financing. They purchase the assets and The first type of Ijarah is different from IMB in that the former
rent them out to customers in return for rental. They use two does not offer an option to the customer to buy the leased asset
models, namely Ijarah and Al-Ijarah Muntahiya Bittamleek. at the end of the lease period while in the latter the option is
offered via a secondary contract. If the lessee chooses to buy
the asset, a new contract will be concluded. All the lease rentals
previously paid will constitute part of the price.
Normal steps in the transaction of an Ijarah contract are as Terms and conditions of the
follows:
Ijarah Contract
1. The client of the financial institution approaches a seller
or vendor of an asset, and obtains price and product To qualify as meeting Islamic requirements and thus as a
details. true Islamic financial product, the Ijarah contract has certain
required and certain prohibited characteristics, which are
2. The client then approaches the financial institution detailed below.
with the asset price and details and negotiates with the
institution to use the Ijarah contract. The client promises
the institution to execute the Ijarah contract, which
contains the terms that will apply after the institution Required and Prohibited Terms and
buys the asset. Conditions
3. The financial institution buys the asset from the seller
Lessee and lessor
based on the information provided by the seller to the
client. The institution pays cash, and ownership of the 1. The lessor (mujir) must be legally sane and able to enter
asset transfers to it. into the contract (“aqil”)
4. The seller delivers the asset to the client of the financial 2. The lessee (mustajir) must be an adult, not a minor, or in
institution according to the terms and conditions agreed Islamic terms must have reached puberty (baligh)
to by the institution and submits proof of delivery, with
3. The lessee must be intelligent as defined by Sharia Law.
the acceptance of the client, to the institution.
4. It is prohibited for the lessor or lessee to be coerced into
5. The client pays the agreed rental, based on the payment
entering into a contract.
plan in the Ijarah contract, to the financial institution.
5. It is prohibited for the lessee or lessor to be bankrupt or
6. Upon expiration of the time limit specified in the Ijarah
to be wasteful or spendthrift.
contract, the client returns the asset to the financial
institution.
Asset Being Leased
The legality of this type of combined structure, under Islamic
Shariah law as interpreted by fatwas, needs to be carefully 1. The asset must be capable of being described in detail.
considered depending upon the jurisdiction in which the 2. The financial institution must be the owner of the asset
contract is developed and entered into. during the life of the lease.
3. The asset being leased must be lawful.
4. The seller must be able to deliver the asset to the lessor.
5. The asset must be useful and valuable to the lessor.
6. The full details about the asset must be known by both

the seller and the buyer.
7. The risk of ownership of the asset rests with the lessor.

Benefits (Usufruct) 2. Different amounts of rent or lease payments can be set

for different parts of the rental agreement.
1. A value to the lessee for the benefits of using the asset
can be established. 3. The lease period begins upon delivery of the asset to
the lessor. Whether the lessor is using the asset or not is
2. The lessor must have the legal right to use and lease the irrelevant.
asset.
4. It is prohibited for the lessor to unilaterally increase the
3. The use of the asset and the asset itself must be permis- rent or lease payment.
sible under Islamic law.
4. The way that the lessor of the asset will use the asset Contract (Aquad) Issues
must be known.
1. The contract needs to be written in clear and definite
5. The duration of the lease must be clearly defined. language using the past or present tense, not in the
future tense.
6. It is prohibited for benefit to be derived from the con-
sumption of any material part of the asset; benefit may 2. The acceptance of the offer of the contract must be
be derived only from its use. agreed upon with the offer, and the offer and acceptance
must be made at the same time in the same meeting.
Rental (Lease) Payments
1. The lease or rental amount, as well as currency of pay-
ment, must be clearly stated and known by both lessee
and lessor.
Standard Features of Ijarah General Terms

Contracts Offered by Financial The Ijarah leasing contract transfers the benefits or use of an
asset acquired by the financial institution (FI) for the use of the
Institutions
lessee at an agreed price or rental amount payable for an agreed
period of time (lease period). The total amount of the lease or
rental paid over the life of the contract includes the original cost
of the asset to the financial institution (including all related
costs) and the institution’s “profit margin.” Below is a diagram
that shows the standard Ijarah transaction.
Assets Leased
Transfer of Title to Customer Title
to the FI does not pass at end
of Lease Term
Islamic
Financial Customer
Vendor
Institution (Lessee)
(FI)
Payment
Ijarah Installments
of Purchase Price
Examples of Leased Assets Rental Payments and Term

1. Production machinery and equipment 1. The financial institution defines rental payments that
may be either fixed or variable. Normally, if variable
2. Consumer goods, such as computers and furniture
payments are included, the payment amount increases
3. Automotive equipment by a certain amount at a certain time. In some cases,
the Ijarah contract is for a relatively short period of time
4. Fixed assets and buildings with a renewal option that allows the financial institu-
tion to re-price the costs and thus adjust the profits of
5. Other acceptable assets
renting the asset to the lessee.
Acceptable Lessees 2. Generally the rental amounts are based on equal
installments.
1. Individuals
3. The terms of the lease or rental agreement can be for up
2. Sole proprietorships
to seven years and vary from institution to institution.
3. Corporations
Incidental Fees and Charges
4. Government entities
Incidental costs borne by the lessor in providing the asset to the
5. Clubs, societies, and associations
lessee are to be paid by the lessee.
Legal Documents Prepared

1. The undertaking to enter into the Ijarah contract
Rebates and Penalties
whereby the asset is acquired by the financial institution
for the use of the lessee. 1. In the case of late payments, fees may be charged, but
the lessor must not “benefit“ from the penalties paid by
2. The Ijarah contract, which has the required characteris-
the lessee, which must cover only actual costs incurred
tic noted earlier, such as description of the Ijarah asset,
by the lessor.
the schedule of the rentals, and the receipt of the asset by
the lessee. 2. Rebates on early redemption are not allowed by the
Sharia boards.
Termination
If the terms of the contract are not met by the lessee, the lessor
has the right to unilaterally terminate the contract. However,
if there are no defaults, the lessor cannot terminate the lease
without mutual agreement.
Example of Ijarah Financing Calculations:

Calculations 1. Profit (P) = Purchase price x profit rate x period of
financing
Generally, the financial institutions calculate the rental
amounts as follows: $1,000,000 x 0.10 x 5 = $500,000
2. Total lease rental = Purchase price plus the profit
$1,000,000 + $500,000 = $1,500,000

Assumptions:
3. Monthly rental = Total lease rental divided by the term
1. The financial institution determines that it wants to
(in months)
have a profit rate (PR) of 10 percent.
$1,500,000/(5 x 12 months) = $25,000 per month
2. The purchase price (PP), including all costs, is
$1,000,000 (cost borne by the financial institution).
3. The term (T) of the lease is 5 years.

Comments on Differences
Lesson Learned: Warranties (Express or
and Similarities Between
Implied)
Conventional Lease Contracts
In a conventional lease, most lease agreements handle
and Ijarah warranties as follows:
1. The agreement contains language stating that the

lessor makes no express or implied warranty as to
Differences the suitability or merchantability of the equip-
ment.
Cost bearing—In Ijarah, the lessor is required to bear all the
costs incurred in the process of purchasing the asset, although 2. All warranties issued by the equipment supplier
these costs may be included in the calculation of the rental will flow through to the lessee.
amount payable by the lessee. These include items such as
registration charges, import expenses, and customs duties. As we have seen, in an Ijarah transaction the lessor is
responsible for the adequate operation of the equipment,
Loss responsibility—The lessor is fully responsible for losses except for equipment breakdowns resulting from the
that are beyond the control of the lessee, while the lessee is only lessee’s negligence or oversight.
responsible for losses to the asset from misuse or negligence.
Regardless of the lessor’s responsibilities under an Ijarah
Late payments—The lessor may charge late-payment penalties, transaction, the lessee will want to have the benefit of
but these may only be amounts that cover the lessor’s costs due the supplier’s express and implied warranties relating to
to the late payment. The lessor cannot benefit from the late the goods or equipment, and the lessor will want to be
payments. sure that his customer is looking to the supplier, rather
than to the lessor, should the customer seek to make
Insurance—The costs of insuring the leased asset are borne
claims under those warranties. In an Ijarah transaction
by the lessor, and the insurance used is Islamic insurance or
it is generally possible to transfer (contractually) the
Takaful.
benefit of the supplier’s warranties from the lessor to the
lessee. This last issue should be addressed during the
lessee’s preliminary dealings with the supplier and also in
Similarity the purchase contract that is eventually signed between
the lessor and the supplier; otherwise the warranties will
The rental or lease payments under the lease start when the end up benefitting only the lessor.
lessee takes possession of the asset being leased, not from the
date the lessor purchases the asset for the lessee. The lessee is Similarly, the financial institution will seek to eliminate
not liable any warranty claims that might be made against it by
the lessee. Although it is generally possible to disclaim
for the rental payments during the period of the asset’s delayed warranties, such disclaimers, especially in a consumer
delivery to the lessee. context, are generally not favored and would probably be
strictly construed against the lessor.
Generally, any disclaimer of warranties must be

conspicuous, and the language used must clearly
call the customer’s attention to the exclusion. In
addition, the disclaimer of certain implied warranties,
such as merchantability and fitness for a particular
purpose, requires specific language to be enforceable.
Warranty disclaimers that fail to meet those requirements

may be held to be invalid.
Sale of the Leased Asset11 Timing of Lease Payment

An Ijarah contract in Shariah does not restrict the right of the Unlike a sale, an Ijarah contract is flexible regarding the timing
lessor to sell the leased asset. Since the lessor remains the owner, of rent or lease payments. Payments can be made to coincide
the fact that the asset is leased to somebody else does not restrict with the units of time by which the usufructs of the asset are
the owner’s right to dispose of the asset in any form as long defined. For instance, they could be at the beginning or at
as it does not hinder the delivery of the usufruct to the lessee. the end of each period of the lease, and rents could be payable
In other words, the leased asset can be sold, provided the new monthly, yearly, etc., as per the terms of the agreement.
owner will honor the existing Ijarah contract. This characteristic
The rent payment may also be unrelated to the periods of
of Ijarah is essential for securitization of leased assets.
usufruct. An asset may be given on lease for 10 years, while
payment of rent may be spread over a period of 12 years, or vice
versa. Additionally, the payment of rent may begin before or
Independence of Ownership after the beginning of a lease. For example, an Ijarah contract
can be arranged for a bridge whose construction takes three
An asset whose ownership is shared by many people can be years, at a cost of $10 million, and which is leased to the
leased, either individually by each owner leasing his or her government for 24 years after the construction is completed, at
owned share of the asset or together by all the owners in one a total rent of $24.3 million (=24 x $1,012,500). The payment
contract and under the same conditions. of rents may be spread over 27 years at a rate of $0.9 million per
Persons who share the ownership of a leased asset can dispose year beginning from the end of the first year, that is, the bond
of their property, for example by selling it to new owners, holders make a 9% yearly return on their investment.
individually or collectively, as they may desire. In other words,
the owner of a share of an asset can sell that share, or part of
it, to a new person independently of the other owners. This
Ijara of Non-existing Assets
characteristic of Ijarah also facilitates the securitization of leased
assets, and allows benefitting from the market conditions with Shariah does not require that the asset/subject of the Ijarah
regard to the negotiability of the bonds. contract should be in existence at the time of the contract.
One may lease an asset that is only described and defined in
detail at the time of the contract. Such an asset may exist in
a place that is far away from the place of the contract (such as
a building in another town), or it may be an asset that is only
described and does not exist at all at the time of contract (as
in the case of leased manufacturing equipment that is yet to
be manufactured). The important and necessary conditions, in
this connection, are as follows:
1. The asset should be clearly described in a way that does

not create any ambiguity or controversy about it, and
2. The lessor should normally be able to acquire, construct,

or buy the leased asset by the time set for its delivery to
the lessee, that is, the lessor should be able to fully carry
out the commitment made in the lease contract.

Period of Ijara Insurance and Maintenance Expenses

An Ijarah contract is not restricted to the short, medium, or In the Ijarah contract, according to Shariah the lessor is required
long term. It can be set to any term, as long as the asset which to maintain the leased asset in a condition that allows the lessee
is its subject remains in existence and renders its usufruct for to extract from it the contracted usufruct. This implies that
the duration of the contract. For example, assets for which a maintenance expenditures related to the basic characteristics of
suitable amortization schedule could be made may be given on the asset are the responsibility of the owner, while maintenance
lease for a period of one year, renewable permanently, because expenses related to its operation, for example regular oil
the assets are replenished through the amortization funds. changes in automotive equipment, are to be taken care of by
Similarly, for land, the Ijarah may be for one year renewable on the lessee. In addition, as stated earlier, notwithstanding the
a permanent basis. lessor’s responsibility to maintain the equipment, in an Ijarah
transaction the benefits emanating from expressed or implied
warranties offered by the vendor may be transferred from the
lessor to the lessee.
Determination of Rent
Maintenance expenses that fall to the owner are of two kinds.
In an Ijarah contract, the rent must be made known. There First, predictable periodical or quasi-periodical expenses,
are many ways to put a known rent into an Ijarah contract. such an overhaul of the leased machine (e.g., an aircraft)
For instance, actual rent payable by the lessee may increase, after a certain number of hours of work or operation. These
decrease, or remain constant as long as the formula for and similar expenses that can be predicted in advance may
increments, or subtractions, is known either at the beginning of actually be charged to the lessee as a part of the rent. As a
the renewal period for which the increase or decrease applies or result, all predictable maintenance and insurance expenses
at the time of contract. can be included in the rent in such a way that rent would then
The rent may also be determined for the first period. For each consist of cash payments made by the lessee to the owner, plus
subsequent period, rent may be related to a variable that will predetermined maintenance and insurance expenses made by
be known before the beginning of the renewal period, such as the lessee on behalf of the owner.
a periodically announced price index, rate of return on capital, Shariah permits making the lessee responsible for all predictable
or any other variable. maintenance and insurance expenses of the asset. However,
some maintenance expenses might not be predictable, and
these would be placed on the account of the lessor. There may
also be unpredictable changes in the cost of insurance, which
would also become the responsibility of the lessor.
Any maintenance or insurance expenses for which the owners

may remain responsible can be undertaken by the lessee on the
basis of wakalah, that is, on behalf of the owner, and the owner
(for example a bondholder) would then be charged by the lessee
for his outlays.
Securitization of Assets Subject to the Ijarah Ijarah—Transactional Issues

Contract12
The idea of an Ijarah bond stems from the ability to transform
The following is a point-form summary of Ijarah
leased assets into financial assets. Securitization means using
transactional issues:
certain income-generating physical assets as a base of, or a
guarantee for, the issuance of securities that are financial assets.
Collateral: The financial institution may accept
A financial asset is always regarded in Shariah in association land, buildings, or any other property
with the asset(s) it represents, that is, a security cannot be as collateral.
considered as totally or completely separable from the assets it Guarantees: Guarantees that can be taken to
represents. support the transaction include both
personal or individual guarantees and
In its 4th Annual Plenary Meeting, the OIC Fiqh Academy,
corporate guarantees.
while discussing sanadat al muqaradah, put forward an
important and essential rule that clarifies the position of Margin of The margin may be up to 100% of
Shariah about securitization, as follows. financing: the current price of an asset or the
valuation price of an asset.
Legal Opinion Regarding Securitization

Decision No. 5 of the 4th Annual Plenary Session of the Two parts of a lease term:
OIC Fiqh Academy, held in Jeddah 18-23/6/1408H (6-
11/2/1988G), asserts that (a) any combination of assets
can be represented in a written note or bond, and (b) 1. Primary lease period: Period for which the lessee (fi-
this bond or note can be sold at a market price, provided nancing customer) has contracted to lease an asset.
that the composition of the group of assets, represented 2. Secondary lease period: This period commences
by the bond, consists of a majority of physical assets and if the lessee decides to exercise the option to con-
financial rights, as compared to a minority of cash and tinue to lease the asset after the expiration of the
interpersonal debts. Furthermore, the decision clearly primary lease period.
mentions that assets that can be grouped together for the
purpose of securitization may consist of any combination
of the following four types of assets:
1. physical assets
Prepayments in Ijarah
2. financial rights (such as the usufruct in Ijara)
3. interpersonal debts, and Security 1 to 3 monthly installments are the

deposit: norm.
4. money. Advance First rental of the lease. Islamic banks
rental: may use the monthly lease rental to
offset against the final rental of the lease.


Calculation of the total lease rental: Al-Ijarah Thumma Al-Bai (AITAB)

The instrument known as Al-Ijarah Thumma Al-Bai (AITAB),
used extensively in Malaysia and also referred to as IMB or
1. Total lease rental = amount of financing + profit
Ijarah wa Iqtina, encompasses the idea of leasing ending with
margin.
an option to buy the asset, in which title to the asset is passed
2. Total lease rental is determined using available to the lessee when the contract terminated. It was essentially
methods of calculation, such as the constant rate created by combining two Islamic contracts: the Al-Ijarah
of return (CRR) and Rule of 78’s (sum of digits). (leasing contract) and the Al-Bai (sale) Contract.
Use of asset: Assets leased may not be used for In this hybrid mechanism, the Al Ijarah contract relates to
activities that contravene Shariah. the exchange of the use of the asset (the usufruct) for money,
with the exchange of goods for money. To achieve this, the
Asset Ownership remains with the financial
two contracts are sequential, Ijarah first and then Al Bai, and
ownership: institution.
together are thus referred to as this third type of contract,
Takaful To reduce the burden if losses occur. AITAB. This construct is also referred to as IMB (translated as
coverage: Suitable coverage is a comprehensive leasing ending with ownership) and is sometimes transliterated
‘All Risks’ type. into English as Ijarah Muntahia Bittamleek.
As in many jurisdictions, different terms are used for the same

or similar financial tools.
Normal steps in the transaction of an Ijarah Contract are as

follows:
1. The client of the financial institution approaches a seller

or vendor of an asset and gets price and product details.
2. The client approaches the financial institution with the

asset price and details and negotiates with the institu-
tion to use the AITAB contract structure. The client
promises to execute the AITAB contract structure for an
agreed time period and rental payment as well as buy the
asset from the financial institution.
3. The financial institution buys the asset from the seller

based on the information provided by the seller to the
institution’s client. The institution pays cash and the
ownership of the asset transfers to it.
4. The financial institution then enters into the Ijarah

contract with the client, whereby the possession and
right of specified use are given to the client. The contract
identifies the asset, its benefit to the client, the rental
amount, and the period.
5. The seller delivers the asset to the client of the financial

institution on the terms and conditions agreed with the
financial institution and submits proof of delivery, with
the acceptance of the client, to the institution.
6. The client pays the agreed rental, based on the payment

plan in the Ijarah contract, to the financial institution.
7. When the time limit in the Ijarah contract expires, the

financial institution enters into the al-Bai (sale) contract Lesson Learned
with the client, whereupon the institution transfers
ownership of the asset to the client as either a gift or a The difference between the profit calculation made
sale, whichever are the terms of the original agreement. under an AITAB contract and the profit calculation
In some cases, the final payment of the Ijarah contract under a conventional lease (as described in Section III,
may be taken as the agreed sale price of the asset under Part 1, of the base toolkit—Leasing Mathematics) is this:
the al-Bai contract. The time value of money does not apply.
The essential terms and conditions of the AITAB contract are There is no return on money in Islam, therefore it is
the same as those of the Al-Ijarah contract, simply an agreement impossible to apply the “principles of the time value
for sale and purchase as added (al-Bai). of money,” including Net Present Value, to the profit
calculation under an AITAB contract. Since the earning
of interest (riba) is not allowed, the use of Internal Rate
of Return to express yield does not exist in an Ijarah
Example of AITAB Financing Calculations transaction.
In this structure the financial institutions tend to use

these calculations:
Documentation for AITAB
Assumptions:
It is important to note that to meet Shariah principles the
The financial institution determines that it wants to have financial institution and its personnel must understand the
a profit rate (PR) of 10 percent. instrument. The documentation must be handled in this
sequence:
The purchase price (PP) to the financial institution, with
all costs, is $1,000,000. 1. The letter of acceptance (aqad) between the financial
institution and the client, executed by both parties.
The term (T) of the lease is 5 years.
2. The leasing agreement (Ijarah) between the financial
Calculations: institution and the client.
Profit (P) = Purchase price x profit rate x period of 3. The sale and purchase agreement (al-Bai) between the
financing lessor and equipment supplier.
$1,000,000 x 0.10 x 5 = $500,000 At all stages, the full terms and conditions must be clearly
explained and understood by the client and the financial
Total lease rental = Purchase price + profit institution.
$1,000,000 + 500,000 = $1,500,000
Monthly rental = Total lease rental divided by the term
$1,500,000/(5 x 12 months) = $25,000 per month
Sales price = amount agreed, as zero (i.e. gifted)—or

equal to last month’s lease rental, or such other amount
as agreed.
Comments on Differences between Conventional Lease contracts and AITAB
AITAB CONTRACT CONVENTIONAL LEASE
Nature of Contract Hybrid instrument, including both a lease Same, with respect to lessee’s purchase option
contract (Ijarah) and the sale/purchase contract at the end of the lease term. Principle of “arm’s
(al-Bai). length” applies between lessor, lessee, and
equipment supplier.
Calculation of Profit Lessor charges a fixed profit and no interest. Lessor’s profit is expressed as the difference between
the present value of the lease payments minus cost
of equipment (per Base Toolkit—Lease Math)
Charges Related to the All charges are borne by lessor, without Some charges (shipping & installation, for example)
Purchase of the Leased Asset exception. may be borne by lessee.
Late Payments A fixed charge must be specified in the contract. Interest may be applied (1% per month, for
example) to late payments.
Acceptance Letter (Aquad) Lessee must enter into an acceptance letter. Same.
Asset Being Financed Must be Shariah compliant. Shariah compliance not necessary.
Insurance Must be insured using Islamic Takaful insurance. Shariah compliance not necessary.
Warranties (Expressed or May be transferred from lessor to lessee. Always for the benefit of the lessee.
Implied)
Cancellation Lease can be cancelled if equipment is lost or Lease is non-cancellable.
destroyed.
Tax Benefits of AITAB

Lessons Learned
Depending on tax laws, which vary among nations where
AITAB is offered, the “rental” or “Ijarah” payments can
Use of Acceptance Letter In both AITAB and
be offset against corporate tax by the lessee. Because the
conventional lease transactions, use Acceptance Letters.
client renting or leasing the asset is not its owner, any wealth
Under both types of transactions there is no obligation
assessment for zakat will not include the asset.
on the part of the lessee until an Acceptance Letter is
executed by the lessee. Therefore, in this particular case,
the principal of “arm’s length” does apply.
Legal Issues to Consider
Cancellation—Under AITAB, if the equipment is
lost or destroyed the lease may be cancelled, regardless The need to conform to certain religious principles affects the
of whether or not the lessor has property or casualty structure and development of Islamic finance programs. It is
insurance. When the equipment is lost or destroyed, the essential, therefore, to seek approval from qualified Islamic
lessee is no longer able to generate usufruct from using scholars when implementing such programs, particularly before
the equipment, and the lessor must rely on Takaful developing new financial instruments. Most Islamic financial
insurance for compensation. Under conventional leasing institutions have standing religious boards and Shariah advisors
in the West, leases are non-cancellable. As we have seen for this purpose.
(in Part III of the Base Toolkit), the lessee is responsible
for obtaining property and casualty insurance and
naming the lessor as a “loss payee.”
A case in point is that the contractual structuring and the Examples of the Impact of Shariah
wording of the contracts must be such as to comply with
Shariah law and with associated fatwas in the country of Rulings in Four Countries
jurisdiction and operation. Four different approaches are being followed in Shariah rulings
in different countries—Iran, Malaysia, Bahrain, and Indonesia—
based on the countries’ regulatory approaches, as follows.13
Legal Precedent—Drafting a Leasing
Contract
In the Republic of Maldives, the court ruled against a
Iran
leasing company (Maldives Finance Leasing Company, Products that can be offered by banks have been defined in
recorded in Case No. 893/MC/2008 (MFLC v regulations issued by the Council of Ministers under the Usury
Mohamed Naeem)), stating that a leasing contract that Free Banking Act 1983. The Council of Guardians performs
contained a right of the lessee to purchase the leased asset the function of a central Shariah board and provides guidelines
at the nominal price at the end of the lease term was void to the central bank and commercial banks. Commercial banks
insofar as it violated Shariah provisions, in accordance do not have a Shariah board for guidance and/or supervision in
with which one contract shall not contain two elements their day-to-day operations.
at the same time, a lease and a sale. There must be two
contracts, and the process of presenting the documents
and executing them is as important as the contracts
themselves. Malaysia
The court did not take into consideration the fact that As part of the effort to streamline and harmonize the Shariah
the leasing agreement merely pointed out that a separate interpretations among banks and takaful companies, Bank
sale agreement would be entered into and the ownership Negara Malaysia (BNM) established the National Shariah
would not be transferred under the leasing agreement Advisory Council on Islamic Banking and Takaful (NSAC)
itself. on May 1, 1997, as the highest Shariah authority on Islamic
banking and takaful in Malaysia. Among NSAC’s primary
objectives are these:
•• To act as the sole authoritative body to advise BNM on

Islamic banking and takaful operations
•• To coordinate Shariah issues with respect to Islamic banking

and finance (including takaful)
•• To analyze and evaluate Shariah aspects of new products

and schemes submitted by banking institutions and takaful
companies.
The Shariah Advisory Council (SAC)14 of BNM was established

on May 1, 1997, as the authority for ascertaining Islamic law
for the purposes of Islamic banking business, takaful business,
Islamic financial business, Islamic development financial
business, or any other business. It is based on Shariah principles
and is supervised and regulated by Bank Negara Malaysia.
In Malaysia, the Islamic banks are advised and provided
guidelines by SAC. As the reference body and advisor to Bank

Negara Malaysia on Shariah matters, SAC is also responsible for to that of SAC. Its duty is to advise the banking institution on
validating all Islamic banking and takaful products to ensure the Shariah compliance of its banking operations; however, the
their compatibility with the Shariah principles. In addition, it Shariah Advisory Council is the ultimate arbiter. The Guidelines
advises BNM on the Shariah aspects of the operations of these on the Governance of Shariah Committees for Islamic Financial
institutions, as well as on their products and services. Institutions were issued by BNM in December 2004. These
aimed at achieving uniformity of Shariah decisions, in addition
The Malaysian Judiciary and the Regional Center for Arbitration
to creating and expanding the pool of competent Shariah
Kuala Lumpur15 uses SAC as the reference point in the event of
personnel in Islamic banking and takaful.
disputes involving Shariah issues on Islamic banking and finance.
The Central Bank of Malaysia Act of 1958 was amended in 2003 The guidelines set out the rules, regulations, and procedures for
to enhance the role and functions of SAC, which was accorded the establishing a Shariah committee and the role and scope of duties
status of a sole authoritative body on Shariah matters pertaining and responsibilities of the committee, as well as the relationship
to Islamic banking, takaful, and Islamic finance. To preserve its and working arrangement between the committee and SAC.
independence, members of SAC are not allowed to participate in The requirement to establish the committee covers all Islamic
any Shariah committee of any financial institution. banks and all banking institutions that participate in Islamic
banking schemes, takaful operators, and development financial
Shariah committees are formed internally by Islamic banking
institutions that provide Islamic banking facilities. Duties and
institutions. A Shariah committee plays a complementary role
responsibilities of a Shariah committee are as follows:
•• To advise the Board on Shariah matters in its business opera- •• To record any opinion given.
tion
In particular, the committee prepares written Shariah
•• To endorse Shariah compliance manuals opinions in the circumstances (1) where the Islamic financial
institution makes reference to SAC for advice; or (2) where
•• To assist related parties on Shariah matters for advice, upon
the Islamic financial institution submits applications to Bank
request
Negara Malaysia for new product approval in accordance with
•• To advise the Islamic financial institution to consult it on guidelines on product approval issued by BankNegara Malaysia.
any Shariah matters that have not already been resolved or
The Shariah committee is also expected to assist SAC on any
endorsed by SAC, and
matters referred by the Islamic financial institution. Upon
obtaining any advice from SAC, the Shariah committee shall Shariah Supervisory Board (DPS)
ensure that all of SAC’s decisions are properly implemented by
the Islamic financial institution. With regard to the reporting Every Islamic bank (or window) is obliged to have a Shariah
structure, the Shariah committee reports functionally to the Supervisory Board (SSB). The SSB also plays a critical role as
board of directors of the institution. This reporting structure partner of the Bank of Indonesia in Islamic banking supervision.
reflects the status of the Shariah committee as an body that is The Bank of Indonesia has set up “fit and proper” criteria,
independent of the Islamic financial institution. which include a test for new SSB members that cover their
understanding of Shariah principles and knowledge of Islamic
banking and finance in general. Furthermore, to upgrade SSB’s
roles, each Shariah supervisor is obligated to submit a report
Bahrain every six months on the finding of Shariah supervision to the
Board of Directors, the Board of Commissioners, the National
The Central Bank of Bahrain requires all banks to establish an
Shariah Council, and the Bank of Indonesia.
independent Shariah Supervision Committee complying with
AAOIFI’s governance standards for Islamic financial institutions. The regulatory authorities of some countries, like Bahrain,
All banks must comply with all accounting standards issued Sudan, and Syria, have adopted Shariah standards issued by the
by AAOIFI as well as the Shariah pronouncements issued by AAOIFI, while some others use them as guidelines.
the Shariah Board of AAOIFI. The National Shariah Board
of the Central Bank of Bahrain serves and verifies the Shariah In Pakistan, the banks are authorized to offer products based on
compliance of its own products only. There is no restriction Islamic modes under the Banking Companies Ordinance of
that the members of the National Shariah Board must serve any 1962. The Shariah Board of the State Bank of Pakistan (SBP)16
financial institution, and no limitation requiring them to serve has approved Essentials of Islamic Modes of Finance and Model
only one institution. Each bank must have a separate Shariah Agreements, which were previously issued as guidelines to all
review function to verify compliance, which may be located in Islamic banking institutions and have now been made part of
the bank’s internal audit function. the recently issued instructions for Shariah compliance in Islamic
banking institutions. Each Islamic banking institution is required
to appoint a Shariah advisor, responsible to give approval regarding
the Shariah compliance of all of the institution’s products and to
Indonesia issue Shariah rulings. SBP’s Shariah Board advises the bank in
forming its regulations on Islamic banking. In case of any difference
In Indonesia, the National Shariah Board formed by the of opinion between SBP’s Shariah Board and the Shariah advisor of
Indonesian Council of Ulemas in 1999, is an independent body an Islamic bank, the ruling of SBP’s Shariah Board is final.
duly recognized by the Bank of Indonesia and is responsible
for issuing Shariah rulings on the products of Islamic banks. In other countries, the rulings of the Shariah Supervisory
The Bank of Indonesia issues regulations for Islamic banking Boards of Islamic financial institutions are binding on the
products based on a fatwa issued by National Shariah Board. respective institutions, and regulatory authorities do not
intervene in these affairs.
The National Sharia Council (DSN) possess the power of
positive law. In 2005, the Bank of Indonesia also issued a Islamic financial institutions all over the world are generally
regulation on Standards of Contract, which is periodically using similar modes of Islamic finance and products, with
evaluated to stay relevant with the Islamic banking industry. minor differences of nomenclature according to their regional,
So far, the regulations (released in 2006) are concerned with legal, and other conditions. In addition to Ijara, the commonly
Ijarah, Istisna’a, and Salam contracts. Apart from coordinating used modes are murabaha, musharaka, mudaraba, diminishing
with the Bank of Indonesia, DSN also takes a role in the musharaka, salam, istisna, wakala and kafalah. There is no
Shariah Supervisory Board selection process. difference of opinion among the world’s Shariah scholars
about the permissibility of these modes. However, there are
certain differences in application and modus operandi of the
transactions among different countries.
There are differences of opinion among Shariah scholars on

the permissibility of certain modes and practices, like bai al Who can apply
dain (debt trading), bai al inah, tawatruq, hibah on current
accounts, and commodity murabaha. •• Individuals ages 18 and above
•• Sole proprietorships
•• Partnerships
Ijarah Transaction Examples •• Private limited and public limited companies
Example of Car Leasing

Terms of financing
Shariah-Compliant Car Financing Based on the
Titled Vehicles—Margin of finance / Repayment
Principles of Ijarah Thuman Al-Bai (AITAB)17
period
Margin of Finance
Up to 90% New passenger car, 4WD, MPV and SUV (CBU and
CKD units):
Financing Period
Maximum of 90% of seller’s invoice Maximum 108
Up to 9 years
months
Benefits Second-hand passenger car, 4WD, MPV and SUV:
•• Based on the principles of the Ijarah contract (leasing/
renting) and the bai contract (purchase) Maximum of 85% of seller’s invoice Maximum 108
months
•• Extensive network of dealers nationwide
Unregistered reconditioned (imported) vehicle:
•• Easy payment of installment via branches, ATMs,
online
Maximum of 90% of seller’s invoice Maximum 108
•• Renewal of road tax and motor insurance
months
*All terms and conditions are subject to the financing

guidelines by Bank Negara Malaysia and Maybank.
Types of goods financed Malaysia
•• New motor vehicles
•• Second-hand motor vehicles
•• Reconditioned motor vehicles

Required documents Repayments

•• Photocopy of national ID
•• Photocopy of driving license Payments must be made for the complete installment
amount. Partial payments or incomplete installment
•• Copies of last 2 years’ income tax returns (J form or EA)
payments are not be accepted.
•• Copies of latest 2 months’ salary slips
•• Confirmation of Letter of Employment (latest)
•• Last 3 months’ bank statements (if self-employed)
•• Photocopy of seller’s national ID and driving license

(second-hand cars only)
•• Photocopy of registration card (second-hand cars only)
•• Pro-forma invoice from seller
For non-individual applications, other documents may

be deemed necessary.
Ijarah Home Finance18 How the Monthly Ijarah Rent Payments Are
Calculated
The initial Ijarah amount that is financed by the customer earns a
How the Purchase Price of the Ijarah profit for the investor through monthly rental payments. Traditional
Transaction Is Determined amortization calculations are utilized to determine the exact
monthly payment. These mathematical formulas are acceptable
The purchase price that is agreed to in the Promise to Purchase since there are no Sharia issues connected with mathematical
is equal to the original purchase price less the down payment calculations. The major difference between a traditional mortgage
made by the customer plus $1.00. For example, if the value of amortization and an Ijarah transaction is that the Ijarah transaction
the property is $200,000 and the customer makes a $40,000 is based on a reverse amortization calculation.
down payment, then the initial amount the customer has to
pay the investor for 100 percent ownership is $160,001. As the
customer’s ownership increases, this amount decreases, until
the final ownership payment of $1.00

The Basis of Using a Percentage landscape, sublet, or basically utilize the property for any
legal purpose that it is zoned for. The only exception may be
While it may appear contrary to Sharia, it is in fact acceptable if you engage in an activity that could harm the value of the
to describe the profit on an Islamic transaction as a percentage. property, such as demolishing a garage without rebuilding it.
The following example should clear up any confusion regarding For all practical purposes, your role is the same as that of a
the acceptability of quoting the profit as a percentage in an homeowner, because once your have fulfilled your obligations
Ijarah transaction: under the lease or promise to purchase, you become the owner
1. Suppose you have $100,000 in cash. of the property.
2. You purchase a home and pay cash for the home.
3. You rent the home to a tenant for $500 per month. Sharing of a Gain or Loss
4. At the end of the year, you have collected $500 x 12 or One of the basic Sharia compliance principles is that there
$6,000 in rent. should be a sharing of either a gain or loss in a financial
transaction. The Ijarah transaction is structured in such a
5. That $6,000 in rent is a 6% return on your $100,000
way that 100 percent of the gain is rightfully the customer’s.
investment.
Under Shariah, the gain or loss is shared by the parties in a
Is that 6 percent to be regarded as rent or as riba? Clearly it is transaction according to their percentages of ownership. The
rent, since it is based upon a business transaction. Now let’s Ijarah transaction abides by this principle, in that when the
look at a traditional mortgage interest transaction: gain or loss is realized, there is only one owner of the property,
and that is the customer. From a procedural perspective, at the
1. Starting with the same $100,000 cash. time of sale
2. You give someone the money. 1. the Trust will transfer the title of the property to the
3. They proceed to purchase the same home with those customer,
funds. 2. the customer will then transfer the title to the new buyer,
4. They pay you the same $500 per month, or 6% a year 3. the new buyer will then settle the transaction according
for use of the money. to the agreement with the customer, and
In this case, is the 6 percent riba? Yes, it is, since it is rent on 4. then the customer will settle with the Trust according to
money. The first example was rent on property. So it should be the agreement between the customer and the Trust (the
clear that from a Sharia perspective, it is acceptable to describe Ijarah documents).
the profit on an Islamic Ijarah transaction as a percentage.
Furthermore, it is also a requirement under the Truth in Lending The procedural steps above create a situation where the customer
Act/Consumer Protection Act, that any profit earned on a holds 100 percent title, albeit for a short time, and by doing so
residential real estate finance transaction should be described they entitle the customer to be the beneficiary of the difference
as a percentage so that a customer can clearly understand what between the two agreements, the sale to the new buyer and the
the overall cost of the financial transaction is. original promise to purchase agreement with the Trust.
Tenant or Homeowner?
In an Ijarah transaction, you are technically a tenant. You sign
a lease that obligates you to a rent payment over a period of
time. However, unlike in a typical rental property lease, you
are responsible for all the maintenance of the property and
you have all the rights and duties of a homeowner. You can sell
the property any time you wish, you can remodel, decorate,
Forward Ijarah Terms of Financing:

(Real Estate Financing)19 •• Type of property: Freehold.
•• Cash contribution: Minimum of 40% to 50% of total

project cost.
Sharjah Islamic Bank
•• Finance tenor: 10 years, including up to 2 years for
Forward Ijarah is a form of lease which ends by transferring the construction period.
ownership of the asset (the subject of the contract) to the client
•• Mode of Repayment: Monthly, quarterly, semiannual,
upon maturity and upon the client meeting all its obligations
or annual terms available
under the contract.
•• Sources of repayment: Primary: Rental income of the
If the subject of a contract, whether it is a full share or a
project. Secondary: Other incomes.
common share of a property, does not exist when the Forward
Ijarah contract is signed, it may be acquired by the bank under •• Floating rentals: Relevant EIBOR + bank’s margin
an Istisna sale contract or any other Shariah-compliant mode with a minimum of certain rate.
of finance.
•• Security: First-degree registered mortgage on the plot and
However, the client may be a partner in a project (the property) the building, in addition to the other terms of approval.
contributing its share in the form of land and cash, while the
bank’s share is putting financing at the project’s disposal for •• Insurance: Insurance policy covering the property
construction. In such as case, the bank will have a common under construction to be assigned to the bank.
share of the property, which will form the subject of the
Forward Ijarah Contract.
In any case, on completion of the construction, and based on the Qualified Assets:
client’s request and promise to lease the asset, the bank, which
Residential, Office Buildings & Villa Complexes
has accepted the offer according to the terms and conditions
set out in the Forward Ijarah, will lease the asset (or its share in Documentary Requirements:
the asset) to the client and the client will receive agreed rentals.
1. Copy of valid passport.
At the end of the lease period (i.e., on maturity) and upon
meeting all its obligations under the Forward Ijarah contract, 2. Full details of personal financial information sup-
the bank will transfer the ownership of the property to the ported with documents.
client for a nominal sale price under a separate sale contract. 3. Personal bank statements for the last six months.
Details of the terms under which this product is offered are 4. Completed finance application form.
outlined below:
5. Copy of site plan.
6. Copy of title deed.
7. Comprehensive feasibility study prepared by

reputed consultant.
8. Project specification and approved drawings.
9. Copies of the consultant / contractor agreements.
10. Copy of approval of electricity connection date.
11. Payment of the applicable fees for the project’s tech-

nical assessment by the bank’s in-house engineers.
Ijarah (Ending with Title Deed) Islamic Leasing for Micro, Small,
Muntahia Bittamleek20: and Medium Enterprises (MSME)
Ijarah is a form of leasing where a property (commercial In some Muslim communities, conventional interest-based
building / complex of villas) is leased by the lessor to the lessee microleasing, or microfinance, has been rejected, principally
in such a way that at the end of an agreed lease period, the lessee for its noncompliance with Islamic principles, particularly on
becomes the owner of the property by purchasing it from the the issue of paying interest or riba, which is forbidden under
lessor either during or at the end of the lease period at an agreed Shariah. This has contributed to the failure of government
sale price. initiatives using conventional microleasing in these
communities to overcome poverty and promote economic
Applying the above, upon the client’s promise to lease from
development. As a result, it is estimated that up to 72 percent of
the bank, the bank purchases, for itself and in its own name,
people living in Muslim-majority countries do not use formal
a property specified in the promise and then leases it to the
financial services at all (Honohon 2007)21. The extent of the
client on terms of financial lease. The lease rent is structured
market opportunity is evident when one realizes that Islamic
so that at the end of the lease period, the bank’s purchasing
microfinance represents less than 1 percent of total global
cost and profit are recovered and the bank can then transfer the
microfinance outreach (Karim et al 2008)22.
ownership of the property to the client for a nominal sale price
or as a gift, by either a separate sale or gift contract, at the end These Muslim clients, who demand products consistent with
of the lease period. Islamic financial principles, provide the base for Islamic Ijarah
for MSMEs. Products used by these institutions include Ijarah
Details of the terms under which this product is offered are
and Al-Ijarah Muntahiya Bittamleek. The structures and terms
outlined below:
of the Ijarah instruments are as outlined above.
Al-Ijarah Muntahia Bittamleek is thought to be more suitable

for MSMEs, especially those in need of assets or equipment.
Terms of Financing:
Microleasing or micro-Ijara serves as a mode of microfinance.
•• Type of property: Freehold. All kinds of income-generating equipment and physical assets
•• Advance rent: Minimum of 40% to 50% of the may be financed through this mode for the poor. They include
purchase price. carts, taxis to transport people, low-cost houses, shops to
sell merchandize, and tools and machines to manufacture or
•• Financing tenor: Up to 8 years. produce products.
•• Age of property: Should not exceed 20 years, includ- An important Shariah rule governing Ijarah as a tool of
ing the repayment tenor. microfinance is that the risk and liabilities emerging from the
ownership of the asset substantially remain with the lessor.
•• Mode of payment: Monthly, quarterly, semiannual, or
annual terms are available.
•• Sources of repayment: Primary: Rental income of the

project. Secondary: Other incomes.
•• Floating rentals: Relevant EIBOR + bank’s margin

with a minimum of a certain rate.
•• Security: First-degree registered mortgage on the plot

and the building, in addition to the other terms of
approval.
•• Qualified assets: Residential, office buildings, and

villa complexes.
AAOFI AAOIFI FAS 8 also embodies a classification of the instrument

into two categories. If the contract refers to a promise that the
Although AAOIFI standards are widely followed (without legal title would ultimately pass on to the lessee (mustajir) at its
obligation) across many countries, they have been officially expiration, it is referred to as Ijarah Muntahia Bittamleek (IMB)
adopted only by Bahrain, the Dubai International Financial or ITAB. In IMB/ITAB, which is loosely considered as equivalent
Centre (DIFC) in the UAE, Jordan, Lebanon, Qatar, Sudan, to the conventional finance lease, at the expiration of the term the
and Syria. passing of the legal title to the lessee could occur either
1. on transfer of the payment of the balance rentals

International Financial Reporting 2. as a gift
Standards (IFRS) vs AAOIFI and
3. on payment of a token or for an amount specified in the
the Malaysian Accountings contract, or
Standards Board (MASB) 4. on the gradual transfer of the title.
Following AAOIFI’s Juristic Rules on the fulfillment of a

promise, for the transfer to be effective a contract distinct from
Comparison With the Conventional Lease the Ijarah contract should be executed. The lessee has an option,
which he may or may not exercise. Thus IMB/AITAB would
Financial Accounting Standard (FAS) No. 8, formulated by
have the characteristics or the substance of a conventional lease
the Accounting & Auditing Organization for Islamic Financial
only if the lessee exercises the option. Otherwise, IMB/ITAB
Institutions (AAOIFI), provides an accounting treatment for Ijara.
for all intents and purposes is an operating lease. Hence in
This AAOIFI-recommended standard for Ijarah differs in many
both legal form and concept IMB/AITAB and a conventional
respects from the standard formulated for conventional leasing,
finance lease are not identical.
known as International Accounting Standard 17 (IAS 17).
The key distinction between the IMB/AITAB and the
A ‘lease’, according to the International Accounting Standard,
conventional finance lease is that in the Islamic version the
is an agreement whereby the lessor conveys to the lessee, in
lessor undertakes the full ownership risks of the corpus of
return for a payment or series of payments, the right to use an
the leased asset. In the Islamic version, the risks remain with
asset for an agreed period of time. According to IAS 17, a lease
the lessor (mujir). The passing of the risk to the lessee is a
is classified as a finance lease if it “transfers substantially the
prerequisite for a lease to be classified as a finance lease under
risks and rewards incidental to ownership.” A lease is classified
International Accounting Standards. One might view it this
as an operating lease if it does not transfer substantially all risks
way: In Ijarah, the risk follows the legal title unless damage
and rewards incidental to ownership (see Base Toolkit, Part V,
is caused by the negligence or misconduct of the lessor. Since
Accounting).
IAS looks at substance over form for accounting purposes,
Ijara is defined as “ownership of the right to the benefit of using when passing the risks and rewards of the asset to the lessee
an asset in return for consideration.” However, the AAOIFI the asset is recorded in the books of the lessee coupled with
definition includes the additional condition that the benefit the right to claim depreciation. Major repairs, maintenance,
should be Shariah-compliant. Thus, Ijarah and a conventional and insurance remain on the account of the lessor in an Ijarah
lease differ in this respect: regarding the requirement to comply contract, whereas these costs are passed on to the lessee in a
with Shariah rules. Shariah does not permit Ijarah for use conventional lease.
of an asset for payment of interest or involving merchandise
considered as haram, nor for unlawful transactions.
Accounting Under AAOIFI Lessons Learned—Tax issues

The nature of Ijarah rental (or ujrah) is that it represents involving Ijara
consideration for the right to use an asset. Ujrah does not
consist of a capital component and an interest element.
Hence the application of accounting methodology adopted
for conventional lease rentals under International Accounting
Application of Stamp Duties/Notary Fees
Standards, specifically the recording of ‘lease rentals receivable’ The cost of Ijarah in comparison to a loan may be high
and ‘interest in suspense’ in the books of the lessor, would pose due to the associated transactional taxes on additional
an issue in accounting for ujrah. The FAS 8 rule formulated by steps involved. The legal / notary fees and stamp duty
AAOIFI stipulates that assets rented on the basis of both Ijarah involved in the dual transfer of title (in IMB) and the
and IMB should be recorded in the books of the lessor (mujir). property transfer tax may increase the cost of the entire
The two categories of assets should be shown in the Statement of structure in many jurisdictions.
Financial position, under the headings, “Investments in Ijarah
Assets” and “Ijara Munthia Bitamleek Assets,” respectively, at
cost on initial recognition and at book value thereafter.
Value Added Tax (VAT)
The right to claim depreciation follows the recording of the
asset in the books of the lessor. Unlike in a conventional finance The exposure of the Ijarah rentals to VAT, as opposed to the
lease under IAS, the depreciation entitlement for both forms is VAT exemption enjoyed by interest, is another factor that
vested in the lessor. While the depreciation of Ijarah assets will may have an impact on the pricing. Though interest paid
be based on the depreciation policy of the lessor, in calculating on a loan from a bank does not attract any withholding tax
the depreciation of Ijarah Bitamleek assets the residual value under most of the tax systems found in the world, Ijarah
will be taken as zero if the lessee’s acquisition of ownership at rental would be exposed to withholding tax.
the end of the period is made through gift. On the other hand,
if the transfer to the lessee is at a token amount specified in the
contract, the said amount should be subtracted in determining
the depreciable cost. Depreciation Allowance
Installments of both forms, Ijarah and IMB, should be presented In certain countries, like Sri Lanka, though the local
in the income statement of the lessor as “Ijara Revenue” on an tax statutes do not explicitly allow the lessor to claim
accrual basis and allocated proportionately according to the capital allowances under operating and finance leases,
term of the lease recognized in the period in which they are nevertheless under the presumption that the leased assets
due. Where the lessee acquires title through gradual sale, the are deemed to be used in the lessor’s business of leasing,
revenue decreases progressively. the lessor enjoys the right to claim capital allowances.
In these countries, the same status quo ought to prevail
The Ijarah installment paid is presented in the lessee’s income for Ijarah and IMB regarding capital allowances. In
statement as “Ijara Expense,” allocated over the lease period a scenario involving a cross-border Ijara, the lessor
recognized when due under both forms of Islamic leases. (mujir) should also be cautious about possibily creating
a permanent establishment in the lessee’s (mustajir’s)
jurisdiction.
Source: © Islamic Finance Today—Pioneer Publications (Pvt) Ltd 23

Malaysian Accountings The Treatment of Leases Under FRS 11724

Standards Board (MASB) In Malaysia, the accounting standard that prescribes accounting
treatments for leases is FRS 117.11 FRS 117 should be applied
Malaysian Accounting Standards Board (MASB) has come out
for annual periods beginning on or after October 1, 2006.
with Financial Reporting Standards 1, a rule for the Presentation
However, early adoption is encouraged. Any entity that applies
of Financial Statements of Islamic Financial Institutions,
FRS 117 for a period before the commencement date should
which states that all companies practicing Islamic banking
disclose that fact. In addition, the accounting treatment for
must disclose their Islamic banking activities separately from
Islamic hire-purchase, or AITAB, will be similar and follow the
their conventional activities. This became effective in January
general guidelines of FRS 117.
2004. However, conventional methods of accounting should be
followed in the absence of any specific standards in the Islamic FRS 117 is applicable to all leases except the following: Lease
Accounting Standards. Currently, MASB is actively looking agreement for exploration of natural resources; and lease agreements
for the best practice of accounting methods to suit all Islamic for such items as motion pictures, plays, and copyrights.
banking operations.
FRS 117 is also not applicable to the measurement issue in
AAOIFI has also issued an accounting standard, Financial relation to the following: Lease agreements for investment
Accounting Standard No. 8, on Ijarah and IMB. It discussed property (which are to be covered under FRS 140, Investment
the treatment of an Ijarah transaction on the books of the Property), and lease agreements for biological assets (covered
lessor as well as the lessee. Unlike the MASB or FRS standards, under IAS 41, Agriculture)
which are mandatory to follow, the AAOIFI standard is merely
a voluntary action for Islamic financial institutions to follow. 24 Please see end notes at the end of this focused toolkit
Classification and Recognition of Leases •• If the lessee can cancel the lease, the lessee’s losses associated
Under FRS 117 with the cancellation are borne by the lessee;
FRS 117 classifies all leases, for accounting purposes, into two •• If gains or losses from the fluctuation in the fair value of the
broad categories: residual value fall to the lessee; and
1. Operating leases, and •• If the lessee has the ability to continue the lease for a second-
ary period at a rent which is substantially lower than market
2. Finance leases. rent.
FRS 117 Leases, A Practical Guide to Financial Reporting
Standards (Malaysia), p. 307.
The journal entries to record the lease in the lessee book
Para 2, FRS 117, Malaysian Accounting Standards Board 2005. for the period would be as follows:
Para 8, FRS 117, Malaysian Accounting Standards Board 2005.
The criterion used in the classification is the extent to Beginning of the transactions:
which risks and rewards incidental to the ownership of a DR Leased equipment
leased asset lie with the lessor or the lessee. Risks incident to
ownership include the possibility of losses from idle capacity CR Lease payable
or technological obsolescence and variations in return due to
(Record the finance lease)
changing economic conditions. Rewards incident to ownership
may be represented by the exception in value. At the End of The Accounting Period:
Under FRS 117, a lease is classified as a finance lease if, DR Lease payable
regardless of its legal form, it transfers substantially all the risks
and rewards incident to ownership from the lessor to the lessee. DR Interest expense
A lease that does not transfer substantially all the risks and CR Cash
rewards in this way is classified as an operating lease.
(Record lease payment)
FRS 117 does not detail the concept of “transfer of substantially
all risks and rewards incident to ownership.” However, it does DR Depreciation expense
provide examples of situations where a lease would normally be
CR Accumulated depreciation
classified as a finance lease, as follows:
(Record depreciation expense)
•• Where the lease transfers ownership of the asset to the lessee
by the end of the lease term;
•• Where the lease contains a bargain purchase option;
•• Where the lease term is for the major part of the useful life
of the asset;
•• Where the present value of the minimum lease payments

(excluding execution costs) is greater than or equal to sub-
stantially all of the fair value of the asset; and
•• Where the leased assets are not of a specialized nature such

that only the lessee can use them without major modifica-
tion being made.
FRS 117 further lists indicators of situations which individually

or in combination could lead to a lease being classified as a
finance lease, as follows:
Accounting Treatment under

The journal entries to record the lease in the lessor book
for the period would be as follows: AAOIFI
The Accounting Standards Committee has reviewed a number
Beginning of the transactions: of alternatives, in particular the alternatives proposed in the
preliminary study for adoption in the accounting treatments of
Para 7, FRS 117, Malaysian Accounting Standards Board
Ijarah and IMB. The committee recommended the adoption of
2005.
the alternatives, which it considered to be in compliance with
Para 8, FRS 117, Malaysian Accounting Standards Board the provisions of both Statements of Financial Accounting No. 1
2005. (Statement of Objectives) and No 2 (Statement of Concepts).
Para 10, FRS 117, Malaysian Accounting Standards

Board 2005.
Classification and Recognition of Ijarah
Para 10, FRS 117, Malaysian Accounting Standards
Board 2005.
under AAOIFI 20
An “Operating Ijarah” is an operating lease that does not
DR Lease receivable
include a promise that the legal title in the leased asset will pass
CR Unearned interest income to the lessee at the end of the lease, whereas IMB (also known
as Ijarah Wa Iqtina) is a lease that concludes with the legal title
CR Machinery in the leased asset passing to the lessee at the end of the contract
(Record the finance lease) period. IMB allows different kinds of asset transfer, including
these:
At the end of the accounting period: 1. Ijarah Muntahiah Bitamleek through gift (transfer of
DR Cash legal title for no consideration.
CR Executory expenses payable 2. Ijarah Muntahiah Bitamleek through transfer of legal

title (sale) at the end of a lease for a token consideration
(Record receipt of executory costs) or other amount as specified in the lease.
DR Cash 3. Ijarah Muntahiah Bitamleek through transfer of legal

title (sale) prior to the end of the lease term for a price
CR Lease receivable
that is equivalent to the remaining Ijarah installments.
(Record receipt of lease payment)
4. Ijarah Muntahiah Bitamleek through gradual transfer of
DR Unearned interest income legal title (sale) of the leased asset.
CR Interest income
(Recognize interest income)

Under the AAOIFI, in the case of initial direct cost, two

The journal entries to record the lease in the lessor book alternative treatments were proposed for the Islamic bank’s
in the AAOIFI for the period would be as follows: share of the initial direct cost (as a lessor or a lessee):
DR Equipment 1. Charging these costs as a period expense to the period in

which they occur, or
CR Cash
2. Recording these costs as deferred costs to be allocated
(Cash purchase of equipment for Ijarah financing)
(equally) over the lease term.
DR Ijarah Financing Asset
Alternative (2) has been chosen, because it is consistent with
CR Equipment the concept of matching revenues and expenses, which is
stated in the Statement of Concepts. However, if the initial
(Provides Ijarah financing to lessee) direct costs were immaterial, the entire amount would be
charged to the period in which it occurred. This is consistent
DR Cash
with the materiality concept. Unlike the materiality concept
CR Profit & Loss in conventional accounting, the materiality concept in Islamic
accounting is not subject to any minimum amount that can
(Repayment received from lessee and income recognition)
materially affect the company transaction. Materiality in
DR Profit & Loss Islamic accounting must disclose even small or insignificant
amounts received or related to non-halal income or expenditure.
CR Depreciation
(Depreciation cost of Ijarah financing asset)
The Findings
The differences in the accounting treatment of Ijarah between
the Financial Reporting Standard (FRS) and the Accounting
and Auditing Organization for Islamic Financial Institutions
(AAOIFI) is an interesting topic worth discussing.
FRS 117 clarifies that the financial statements of lessees, in the

initial recognition, shall recognize finance leases as assets and
liabilities in their balance sheets at amounts equal to the fair
value of the leased property or, if lower, the present value of the
minimum lease payments, each determined at the inception of
the lease. Any initial direct cost to the lessee is added to the
amount recognized as an asset. A finance lease gives rise to
depreciation expenses for depreciable assets as well as finance
expense for each accounting period.
By contrast, the financial statements of lessors, during the initial

recognition shall recognize assets held under a finance lease
in their balance sheets and present them as receivables at an
amount equal to the net investment in the lease. Costs incurred
by manufacturers or dealers in connection with negotiating
and arranging leases shall be recognized as expenses when the
selling profit is recognized.
FOUR MAIN SCHOOLS OF ISLAMIC dominance in particular parts of the Muslim world and do
create subtle differences in codified texts, marriage and family
THOUGHT25 law, and some criminal punishments.
The main school of thought in the Shi’a school is the Ja’fari

Hanafi/Ja’fari , Maliki, Shafie, and school. Legal doctrinal differences between the Ja’fari and
Hanafi schools are mostly of the same order as those between
Hanbali the Hanafi school and other Sunni schools, with the chief
There are four main schools in classical Sunni Islamic legal exception being constitutional and inheritance law.
thought: Hanafi/Ja’fari, Maliki, Shafie, and Hanbali. The
The Hanafi school prevails in Turkey, Syria, Lebanon, Iraq,
schools, named after their main contributing thinkers, were
Jordan, Egypt, and the Sudan.
developed largely in order to provide rigor, predictability, and
hierarchical structure to Islamic lawmaking (or fiqh) at an Maliki has governed the Muslim populations of North, West,
early point in the Islamic empire’s history. While there are few and Central Africa.
major theological or ideological differences remaining between
the four schools today, they continue to hold geographic Shafie has prevailed in East Africa, Malaysia, and the southern
part of the Arabian Peninsula.
son-in-law of the Prophet), a civil war erupted. That conflict

was ultimately settled by the assassination of ’Ali, with the
consequence that Islam fractured into two components: Sunni
and Shi’a (or Shi’i). The latter were the followers of ’Ali.
Ijarah Under the Four Schools

Ijarah comes from the root word ajr, which means compensation
and, at the same time, means the sale of usufruct.
Hanafi School—Ijarah is defined as a contract that enables

possession of a particular intended usufruct of the leased asset
(ayn) for a consideration. Some jurists have stipulated that the
usufruct from the leased asset should be intended, while others
explained that what is meant by it are considered intentions in
light of Shariah and reasoning, and not merely intentions.
Maliki School—The Maliki school of fiqh defines Ijarah as

a contract that relates to permissible usufructs for a particular
period and a particular consideration not arising from
usufruct.
Shafie School—The Shafie school of fiqh defines Ijarah as

a contract for a defined intended usufruct liable to utilization
and accessibility for a particular recompense.
Hanbali School—The Hanbali school of fiqh defines

Ijarah as a contract for a particular permissible usufruct that
is taken gradually for a particular period and a particular
consideration.
Hanbali is the basis for the codified law of the Kingdom of Although there are various definitions of Ijarah given by the
Saudi Arabia. scholars of Islamic jurisprudence via their various schools of
thought, it is agreed among them that Ijarah is a contract on
the use of benefits or services in return for compensation.
Sunni and Shi’a The definition of Ijarah according to AAOIFI (FAS 8) is “the
After the death of the Prophet Muhammad in 632, the first ownership of the right to the benefit of using an asset in return
generation of Muslims established the order of succession by for consideration.” While in Financial Reporting Standard 117
caliphs (caliph meant deputy, or successor, of Muhammad, that (“FRS 117”), a lease is “an agreement whereby the lessor conveys
is, his successor as the secular leader of the community). The to the lessee in return for a payment or series of payments the
first three caliphs, Abu Bakr, ’Umar, and ’Uthman, retained right to use an asset for an agreed period of time.”
the seat of authority in Medina, created a small, nascent In summarizing all the definitions, Ijarah may be regarded
Islamic polity, and expanded that polity beyond the Arabian as a leasing of property pursuant to a contract under which
Peninsula into the Byzantine territories of the Syrian littoral in a specified permissible benefit in the form of a usufruct
the eastern basin of the Mediterranean Sea. As the result of the is obtained for a specified period in return for a specified
assassination of the third caliph, ’Uthman, and the disputed permissible consideration.
claim of ’Ali to be the fourth caliph (’Ali was both kin and
Dispute Resolution Project Financing Using Ijarah27

Islamic finance cases are adjudicated by the state courts of The most common form of Islamic project finance uses the
various countries, thus falling under the purview of national Ijarah strucure. This is similar to leasing-and-hire purchase
law. There are countries where Shariah is (a) a supreme source of arrangements. Many Islamic investment funds principally
law, as for example in Saudi Arabia, Iran, Sudan, and Pakistan, invest in these types transactions.
(b) one of the sources of law, as in Malaysia, Kuwait, and UAE,
Ijara can accommodate variable profit margins: the lease
or (c) not part of the legal system.
payment is made, for example, every six months, and when the
The issues arising in relation to Islamic dispute resolution vary payment is made the profit margin for the following period is
depending on the category to which the country belongs. determined (generally on the basis of a reference such as six-
month LIBOR, plus a fixed fee).
The majority of legal systems are not based first and foremost
on Shariah and, as a result, courts will apply Shariah law in the In addition to retaining ownership over the asset that is
context of its interplay with the national laws. This raises issues financed, the financial institution builds in additional security
both in relation to the status of Shariah law within the contract through the payment by the lessee of an amount to be mutually
and in the court adjudication process and also in relation to the agreed upon by the parties as a security deposit. The lessor can
enforcement of overseas judgments. use this in any manner it wishes in case of a rent default. To
ensure timely payment, “liquidated damages” are included in
In the Middle East, many Islamic finance transactions name
the contract, specifying extra payments that need to be made
the courts of England and Wales as the applicable forum and
for any day of delay.
the law of England and Wales as the governing law. The English
courts have addressed the extent of applicability of Shariah law As discussed in detail earlier, in an Ijarah contract a financial
to certain contracts. institution purchases goods on behalf of a client and leases them
to the client for a rental fee while maintaining ownership. The
In cases where parties are considering choosing a specific
rental fee and the duration of the lease are agreed in advance.
national law, the legal system of which includes Shariah law,
In one form, referred to in this report as AITAB (Al-Ijarah
they must ensure that there is a reciprocal enforcement treaty
Thumma Al-Bai) but also known as Ijarah wa Iqtina, the client
in place between both countries.
purchases the goods from the financial institution at the end
However, in certain circumstances, even when such of the lease period for a predetermined price. This instrument
arrangements are in place, a successful enforcement may be has been frequently used for the financing of major assets, such
impossible. For example, if the decision of a foreign court as aircraft.
involves payment of interest, such a decision will not be
The bank can issue Ijara bonds for placement with Islamic
enforced in Saudi Arabia, since it contravenes the basic precepts
investors, as a way to refinance itself. Alternatively, special
of Shariah.
Islamic funds can be set up to engage in Ijarah financing. Much
Thus, submitting an Islamic finance matter to a state court of of the recent growth in Islamic finance has been through the
any jurisdiction may evince various challenging issues, include creation of such funds.
challenges in enforcement, adjudication in accordance with
There are differences in the way that Ijarah operates from
Shariah law, lack of competent training of judges, and conflicts
country to country. For example, more conservative Shariah
among laws.26
boards stipulate that management, insurance, and maintenance
are the responsibility of the lessor (the financial institution),
unlike in conventional operating leases. This arrangement
leaves the lessee with little incentive to properly manage and
maintain the assets, however. To overcome this problem, strong
undertakings are required in the lease contract.
Banks can also combine Islamic financing instruments. This

can be particularly useful for the financing of expensive assets:
the construction part can be financed through an istisna (see and it can also be structured as a securitization.
the next section), and once the asset/project is finished, the
Banks often use back-to-back transactions:
bank can lease it or sell it on deferred payment terms to the
company that will operate it. This is similar to the back-to-back •• Under the first Istisna, a customer agrees to purchase an
istisna, but with the important difference that the buyer can asset from the Islamic bank upon completion. The purchaser
make his final payments after the asset has been constructed can pay the financial institution in advance, at completion,
and delivered to him. or over time based on a set of predetermined completion
milestones.
As an example, this structure was used in a deal for $77 million
in project financing for the Bakri Group to build two chemical •• Under the second Istisna (the “hire to produce” contract),
tankers that were to be chartered by Saudi Basic Industries the Islamic financial institution agrees to pay the manu-
Corporation. The first tranche of the financing consisted of facturer to build the asset in question. As an intermediary,
disbursements under an Istisna, and this was replaced by an the Islamic financial institution accepts the manufacturer’s
AITAB on delivery of the tankers. performance risk and the buyer’s payment risk.
•• Back-to-back with the Istisna with the manufacturer (con-

tractor), the bank could also use an Ijarah (lease) contract
Ijarah with Istisna with the buyer, if he wishes the buyer to pay in installments
after delivery of the assets.
Istisna/Istisna’a is a contract of sale of specified goods to be
manufactured with an obligation on the manufacturer to deliver
them on completion. It is a condition in Istisna that the seller
provides either the raw material or the cost of manufacturing Risks to Avoid in Project Financing
the goods.
When engaging in an Ijarah project finance, financial institutions
Istisna is often used for large, longer-term financings (e.g. have to avoid certain possible problems, described next.
infrastructure, electricity projects, transport equipment,
pipelines). In general, in this mechanism the buyer (or
investor) approaches the financial institution, providing all
relevant information, including details of the security offered Risk of Loss/Destruction
(government, bank, or parent company guarantees). If the
Taking out property insurance may be difficult for Islamic
financial institution agrees, buyer and seller have to deposit
financial institutions, depending on the specific interpretation
security bonds, and the buyer can order (as agent for the
of the relevant Shariah court. Still, in order to classify as an
financial institution) the equipment.
Ijara, the risks of loss or destruction have to stay with the bank,
The Islamic financial institution may pay the manufacturer unless when caused by the lessee. If the bank can take out
an advance. The manufacturer has to provide a performance insurance, this should be paid (in advance) by the lessee.
bond as well as a guarantee to refund the progress payments
The risk of loss or destruction has to be carefully evaluated. It
made by the financial institution if he fails to make delivery,
should also be noted that under “western” leases, the lessee has
or if he delivers non-conforming goods. He also has to assign
to continue paying even if the assets have been destroyed; under
the insurance for the assets under construction to the financial
Islamic finance, this is not possible. As in Islamic finance, the
institution. Then, for the regular payments on the work in
lessee cannot be asked to continue paying under the lease if
progress, the bank would ask the manufacturer to open a
the property has been destroyed or otherwise loses its economic
letter of credit in favor of the supplier of the materials that the
value. Ways to deal with such problems have to be built into
manufacturer is using, to control the actual use of its funds.
the contract with the lessee. Normally, the way this is done is
Alternatively, the financial institution can reimburse the
by requiring the lessee to purchase the leased property (with
manufacturer for the expenses he already made. The buyer,
all obligations, liabilities and insurance policies attached to the
through his own bank, would reimburse the Islamic financial
property). However, the Shariah principle is that the purchase
institution, most likely in installments.
price should be the fair market value, and this value for a
Istisna financing can be syndicated, it can contain financing destroyed property is not very high. So in practice, this remains
tranches of different maturities and with different profit rates, a very difficult issue to deal with. Normally, the Ijarah contract
requires detailed undertakings by the lessee that it will use the At least, it should limit its own liability by the indemnities
leased goods for normal business use, that it will ensure that received from the seller. Also, in the Ijarah contract, the lessee
the use of the goods will not vitiate the insurance policy, that should agree to indemnify the lessor for all costs, liabilities, and
it will not sublease or hire out the goods, that only properly obligations linked to the goods, whether or not due to its fault.
trained personnel will use the goods, that the goods will be
properly operated and maintained, and that it will return the
goods at the end of the lease in good condition, fair wear and
tear excepted. Project Financing Examples
The Dolphin Gas Project28, which includes natural gas
production in Qatar and a pipeline to the United Arab Emirates,
represents one of the largest Islamic financings of a Persian
Timing of Payments
Gulf oil and gas project to date. It involved a $1 billion Ijarah
Like most western leases, payment under the Ijarah can only and Istisna component alongside a $2.45 billion conventional
start once the good (or at least, an economically useful part debt offering.
thereof) is effectively transferred to the lessee.
An example of government-related financing in the Middle
East is the $50 million pipeline financing in Pakistan, which
used a five-year Ijarah facility.
Legal Liability
As the owner and lessor of the goods, the financial institution is
exposed to certain legal risks. The financial institution should
include in the contract a disclaimer, to the extent possible. 28 Please see end notes at the end of this focused toolkit
Ijarah Sukuk According to AAOIFI Standard No. 17, investment sukuk

are certificates of equal value representing, after closing
subscription, receipt of the value of the certificates and put to
use as planned. They therefore represent common shares and
What is Sukuk?29 rights in the underlying assets or their usufructs and services5.
AAOIFI has classified sukuk into 14 types, depending on the
Sukuk30 is the plural of sakk, which means “legal instrument,
contracts used. Among them, Sukuk Al-Ijarah (lease-based
deed, check,” so sukuk is the Arabic name for a financial
certificate) is the most widely used type of sukuk.
certificate, though it can also be understood as an Islamic
equivalent of bond. However, fixed-income, interest-bearing
bonds are not permissible in Islam, hence sukuk are securities
that comply with Shariah and its investment principles, which Introduction to Ijarah Sukuk31
prohibit the charging or paying of interest.
Sukuk al-Ijarah are issued on a sale and lease-back arrangement
Financial assets that comply with the Islamic law can be (Ijara) of an asset. The issuer applies the Sukuk proceeds to
classified in accordance with their tradability and non- purchase the asset from the originator and then leases it back
tradability in the secondary markets. This concept was used to the originator. The originator undertakes to repurchase
during the medieval period of Islam, when it was related to the the asset at maturity or upon early settlement at the original
recording of financial and other obligations. The word sakuk, purchase price.
with this same meaning, was also used in western Europe
during the period, and later evolved to what is presently known The issuer is required under Shariah to undertake the major
by the English words “cheque” and “check.” maintenance of the asset, but it will often appoint the obligor
to carry out such activity on its behalf (see diagram below).32
In modern Islamic financial terms, sukuk is defined as an
Islamic or Shariah-compliant bond. Another Arabic term for
sukuk, when translated, is Islamic investment certificate.
Sale undertaking
Subscription proceeds Subscription proceeds
Originator Issuer Rent and redemption Investors

Title to assets proceeds
Purchase undertaking
Rent Lease
Originator
as lessee
Sukuk Trust Certificates The MGS issue was rated by Moody’s and by Standard and
Poor’s33. and the Sukuks were listed on the Luxembourg Stock
A good example of successfully adopting the Ijarah structure Exchange. The lease payments are determined based on a
for a truly global capital market issue was the Malaysian spread over LIBOR. Islamic scholars are comfortable with the
government’s issue of Sukuk Trust Certificates in August 2002. use of LIBOR as a lease pricing reference mechanism but not
The structure used for the transaction was clean and simple in as a means of calculating interest. A floating lease price has
order to appeal to the broadest possible base of investors. In been considered acceptable by Islamic scholars, since landlords
this instance, a special purpose company was incorporated in and tenants (in the traditional sense) can agree on raising or
Labuan called the Malaysian Global Sukuk Inc. (MGS). (See lowering lease payments on land over the period of a tenancy.
illustration below.)
Ijara Sukuks are freely tradable. As trading in debt above or
MGS is owned by a Malaysian state entity. MGS issued Sukuks below par would obviously breach the Islamic finance principle
to investors and used the funds thus raised to purchase parcels of not charging interest and the ability to trade freely in capital
of land in and around Kuala Lumpur from another Malaysian market instruments is critical to investors, there is a potential
state entity. MGS then leased those parcels of land to the further problem. However, since the Ijarah Sukuks represent
Federation of Malaysia. At the expiry of the term of the lease, an interest in the underlying assets and not debts, they can be
the Malaysian government has agreed to purchase the parcels traded above or below par freely without breaching any Islamic
of land from MGS at the face value of the initial issue amount principles.
of the Sukuks.
Pursuant to a declaration of Trust, the land parcels are held by

MGS in favor of the Sukuk holders. All returns made on the
land parcels are conveyed to the Sukuk holders, including lease
payments and the final repurchase proceeds to be paid by the
Federation of Malaysia. The cash flow produced is similar to
any bond cash flow. The lease payments are like coupons and
the repurchase proceeds paid at the end of the term are like the
principal component of a bond.
Malaysia will purchase the land

parcels at the end of the term
Purchase price
for land parcels Lease Payments
Malaysian Malaysian
Federation
Federal Lands Global Sukuk
of Malaysia
Commisioner Land parcels Inc. Lease of Land
& Sukuks
Sukuk
holders
Disadvantages of the Ijarah Sukuk Structure Sukuk Trading Options

As the preceding makes abundantly clear, Islamic scholars have A simple diagram of the sukuk structure is shown below. In the
broadly accepted the Ijarah structure. Nevertheless, despite issuance of Ijarah Sukuk, a special purpose vehicle (SPV) or
its simplicity and broad acceptance, Ijarah sukuk suffers from company is created to purchase the asset(s). In turn, this SPV
some major commercial disadvantages for the issuer, namely: issues Sukuk to the investors, enabling them to make payments
for purchasing the asset. The asset is then leased to a third party
•• Not all potential issuers have access to the necessary underly-
for its use. The lessee makes periodic rental payments to the SPV,
ing asset for such a transaction.
which then distributes the payments to the Sukuk holders. The
•• Even if a potential issuer does have access to an appropriate instruments created in this Ijarah Sukuk are completely negotiable
underlying asset, depending on the jurisdiction where the as- and can be traded in the secondary markets, as follows.
set is located, stamp duty and taxation costs associated with
introducing the asset into the structure could make such a Sukuk Al-Ijarah—The owner of an existing tangible leased
transaction unviable. asset may sell such assets through Sukuk.
•• Since the asset is tied up for the term of the transaction, the
Sukuk Ijarah Mowsufa Bithima—The owner of a
owner of the asset cannot divest it freely and there could be
tangible asset to be acquired and subject to a lease contract
negative pledge implications in putting the asset into the
may mobilize the acquisition cost of such an asset through
transaction.
Sukuk issues.
•• There could be ongoing Shariah audits in connection with
the asset. This can be time consuming and costly for the Sukuk Manfaa Ijarah—The owner of leasehold rights
issuer. of existing leased assets may sell the usufruct of such assets
through Sukuk issues.
Sukuk Manfaa Ijarah Mowsufa Bithima—The

owner of leasehold rights of an asset to be acquired and subject
to lease contract may sell the usufruct of such an asset through
Sukuk issues.
Sukuk
holders
(2) Leased the assets (8) Obligator make

to obligator periodic lease
payment to SPV
(4) Trust Certificate
(1) Sell certain titles (9) SPV pays coupon issued to Investors
of land to SPV to Investors
(3) Issued Trust Trust
Originator Certificate
(7) Payments made by SPV Certificate
as seller SPV to Obligator Issue
(6) Payments received
from investors by SPV (5) Investors made
payments
Stage 1: Contract for cash sale (Bay’ Mutlakah) Ijara and Project Finance
•• SPV purchases property (e.g. hospitals) from obligator Islamic financing structures are increasingly used in the project
(government). (1) finance domain, particularly in projects in the Middle East. In
most Islamic financing, incorporated within a multi-sourced
•• The assets purchased by the SPV are funded by the issuance
project financing, the Islamic financing element of the project
of sukuk (trust certificates) which represents beneficial own-
is provided pari passu with the other senior debt. Istisna
ership in the assets and the lease. (3)
and Ijarah elements are frequently used. The following is an
•• Government receives cash proceeds. (7) example of a transaction structure.
Stage 2: Contract for leasing (Ijarah)

•• SPV rents property to the government for specified period. (2) Sample Transaction Structure: Leasing Assets
•• SPV collects rentals. (6) The finance providers under the Islamic facility (the Islamic
finance providers) have established an Islamic SPV to operate
Stage 3: During the tenure … as their financing vehicle to own certain project assets and
lease them to the borrower. The Islamic finance providers and
•• SPV passed the rentals to investors (9) and makes periodic the Islamic SPV appointed an Islamic bank as facility agent
distributions/coupons (the Islamic facility agent) to perform each of their respective
obligations under the Islamic financing documents, which
Stage 4: At maturity … included the following:
•• SPV sells the property to the government at an agreed price.

Credit Agreement
•• Government pays cash to SPV.
This credit agreement sets out the terms and conditions
•• SPV simultaneously pays investors cash for sukuk redemp- precedent, representations and warranties, covenants, events of
tion. default, and payment provisions on broadly identical terms to
the obligations in the non-Islamic-compliant documents, other
than for the payment of interest and procurement of insurance.
In the example, this agreement operated during the construction

phase. The borrower agreed to develop, construct, and deliver
the project assets according to certain specifications and to sell
the project assets to the Islamic SPV.
Islamic SPV
The Islamic SPV agreed to pay for the project assets by phased
payments (equivalent to advances of finance) to the borrower. If
the borrower failed to deliver the project assets by the due date,
it was liable to pay liquidated damages.
Subject to the inter-creditor agreement (and therefore the

relationship with the non-Islamic financing documents),
acceleration of the Islamic facility agreement would lead to
termination of the Istisna.
Upon termination, the borrower was to reimburse to the

Islamic SPV all payments received less the amount of any
liquidated damages paid, and the Islamic SPV was to waive
all its rights and claims to ownership and title to the assets.
Islamic SPV to repair, reinstate, or replace project assets that

were damaged or destroyed, save to the extent that such damage
or destruction was caused by the borrower’s willful misconduct
or gross negligence.
The Islamic SPV remained responsible for the major

maintenance (maintenance of a capital nature) of the project
assets so that they continued to provide the service for which
the borrower rented them, although it was acknowledged
that these maintenance obligations (and the procurement of
insurance) would be subcontracted to the borrower under the
service agency agreement (see below).
As with the operational covenants contained in conventional

financing of this nature, the borrower was responsible for
ordinary maintenance, such as inspections of the project assets,
maintenance of the assets in good and serviceable repair, and
maintenance of records.
The Islamic finance providers and the Islamic SPV authorized

the Islamic facility agent to act on their behalf to exercise their
The Ijarah would also not come into effect. This operated after respective rights and perform their respective obligations under
completion of the construction. the Islamic finance documents.
Following delivery of the project assets under the terms of the The Islamic finance providers, the Islamic SPV, and the
Istisna, the Islamic SPV agreed to lease the project assets to the borrower acknowledged that the payments made by the Islamic
borrower for the period of the lease and the borrower agreed to facility agent directly to the borrower (sourced from the
pay lease payments (equivalent to debt service) to the Islamic SPV. Islamic finance providers under the Islamic facility agreement)
As owner of the assets, the SPV had de facto security over them. were payments satisfying the Islamic SPV’s obligation to pay
consideration for the project assets under the Istisna agreement.
Akin to the restrictions and covenants placed upon the borrower
according to conventional debt facilities, the borrower undertook The Islamic SPV owned the assets and appointed the borrower
to use the leased project assets solely for the purposes contemplated as its service agent to operate and maintain the leased project
in the Islamic facility agreement. Furthermore, The Islamic SPV assets, keep such assets fully insured, and pay any applicable
and the Islamic facility agent made no representation or warranty ownership taxes, thereby restoring certain of the risks of asset
as to the project assets so that risk of title, defects, and so on all ownership to the borrower.
rested with the borrower, who waived any claim caused by the
The Islamic SPV undertook to sell the leased assets to the
project assets. The Islamic SPV’s rights to take any enforcement
borrower upon payment of a lease termination payment (a
action (e.g., remedies following events of default) were governed
discharge of all outstanding amounts owed, effectively allowing
by the terms of the inter-creditor agreement.
prepayment of the Islamic facility and release of the rights of
The borrower was entitled to terminate the Ijarah voluntarily the Islamic finance providers upon discharge of the Islamic
by giving notice. Upon termination, including payment of financing).
the final lease payment (i.e., maturity), the Islamic SPV was
The borrower undertook to purchase the leased project assets
to sell the project assets to the borrower according to the sale
from the Islamic SPV upon payment of a lease termination
undertaking (see below) and the Islamic facility agreement.
payment (effectively an acceleration of the Islamic facility).
Subject to the terms of the inter-creditor agreement and the
other non-Islamic documents, the Ijarah could be terminated Given the principles behind Islamic financing outlined above,
following certain events of default. the Islamic finance providers were not party to the other
finance documents. However, each of the Islamic finance
During the term of this Ijara, the ownership of the project assets
providers was, through the Islamic facility agent, bound by the
remained with the Islamic SPV. The borrower could require the
inter-creditor agreement with the non-Islamic lenders and was
therefore subject to the inter-creditor provisions governing the to make a payment connected to the delay. If an Islamic finance
relationship between the lenders. These provisions included the provider received a payment that was solely attributable to the
method of voting and decision-making; arrangements for joint borrower’s delay in payment, that participant was required to
consultation and actions regarding approval rights and waivers; hand over the net amount (after deducting the actual costs
limitation of the parties’ rights of enforcement upon default; and expenses suffered or incurred by it as a consequence of
and the application of proceeds upon enforcement. the borrower’s failure to comply with the applicable Islamic
finance document) to such charitable foundation or scientific
This Islamic facility agreement contained various representation
or medical institution as it selected.
and warranties, covenants and events of default by the borrower.
The diagram below illustrates a typical project finance
Unlike conventional financing, the Islamic facility agreement did
transaction that incorporates an Islamic financing structure.
not provide a guaranteed interest rate of return, as the prohibition
of interest is a significant principle of Islamic financing. As an Construction phase 1—The borrower develops, constructs,
alternative, the Islamic finance documents provided for advance and sells project assets to the Islamic SPV. As consideration,
amount payments (providing an effect similar to interest the Islamic SPV makes phased payments to the borrower
calculated on the outstanding principal on or before the lease (equivalent to loan advances).
began) and a lease variable element (providing an effect similar to
Post-construction phase 2—The Islamic SPV leases project
interest calculated at any time after the lease began).
assets to the borrower. The borrower makes lease payments
While the Islamic finance documents did not contain any (equivalent to debt service).
express provision for the payment of default interest, failure
by the relevant party to pay any amount owing under the
applicable Islamic finance document resulted in an obligation
Intercreditor
Islamic finance Islamic facility agreement Non-Islamic
providers agent lenders
t
en
e s tm y
Inv genc ent
a em
re
ag
Purchase Islamic
undertaking facility
Islamic SPV agreement
Sale
undertaking
Service agency
agreement
Istisna’a
Construction phase1 Borrower
Project assets Ijara
Post-construction phase2
Standard & Poor’s Ratings the adequacy of the lease payment stream that will service
the rated Ijarah Sukuk, and, where the underlying obligor
of Ijarah Sukuk is a government, its commitment to such transactions as an
As the above makes clear, Ijarah Sukuk are financial obligations important and continuing source of financing.
issued by a lessor and backed primarily by a lease stream from a Standard & Poor’s has rated Ijarah Sukuk transactions
credit lessee. Since Shariah frowns on the payment of interest, backed by various types of underlying credit lessees, including
Ijarah Sukuk transactions work by passing a lease stream through sovereign governments, regional governments, corporations,
to the holder of the Ijarah Sukuk, rather than being structured and multilateral lending institutions. Standard & Poor’s also
as an interest-bearing loan secured by a pledge of assets. rates financial institutions that provide Islamic banking and
Ijarah Sukuk are one of many forms of Sukuk (notes) compliant insurance services.
with Shariah on the provision and use of financial products and In most cases, Standard & Poor’s has assigned Ijarah Sukuk the
services. It should be noted that only an appropriate Islamic same ratings as it assigns to the lessees creating the payment
body may recognize the compliance of the terms of any Sukuk stream. This practice reflects the unconditional, irrevocable
issuance with Shariah and that individual investors should nature of the lease, any third-party lease guarantees, sale and
make adequate inquiries as to Shariah compliance. Standard purchase agreements, and/or financial hedges that are found
& Poor’s rating process does not address Shariah compliance. in the transaction. Ratings lower than those given to the lessee
are assigned where there are diminished recovery prospects,
greater risks associated with lease payments, or other factors
supporting such a distinction. Higher ratings are unlikely
Ijarah Sukuk ratings
without additional risk-mitigating features, in the case of
sovereigns, although for corporates Ijarah Sukuk may resemble
Background
certain characteristics of secured loans and be notched up
This section describes ratings of Ijarah Sukuk, typical accordingly.
transaction configurations, and factors affecting the ratings.
These factors include the status and responsibilities of the
special purpose entity (SPE) typically found in Ijarah Sukuk,
How do Ijarah Sukuk ratings compare with for a determined price (the purchase price).
those of the lessee? 2. The SPV raises financing to purchase the assets by issu-
Ijarah Sukuk should receive the same rating as the underlying ing Ijarah Sukuk to investors in an amount equal to the
lessee if the transaction cash flows survive reasonable stress purchase price. The Ijarah Sukuk represent an equity
scenarios short of a payment default by the lessee, if the lessee interest in the SPE’s assets, which may be indirect or
views Ijarah (leasing) financing as indistinguishable in terms of direct depending on the type of SPE.
priority with conventional debt-based financing, and if recovery 3. The SPV then leases the assets to the lessee, an affili-
prospects are similar to those in a debt-based transaction. ate of the seller, or directly back to the seller itself, in
Where there is a material risk of government appropriation, as exchange for periodic lease payments. These lease pay-
is the case for government leases in a variety of jurisdictions, or ments should match the obligations of the SPE under the
other financial or operating risk, the rating of the Ijarah Sukuk Ijarah Sukuk.
may be below that of the lessee.
4. At maturity, or on a dissolution event, the SPE sells the
Standard & Poor’s does not exclude the possibility of rating assets back to the seller at a predetermined value. That
Ijarah Sukuk above the rating of the lessee. This is most likely value should be equal to any amounts still owed under
to occur when the lessee has a ratable corporate credit profile the terms of the Ijarah Sukuk.
and the credit characteristics of the Ijarah Sukuk resemble, for
credit purposes, those of secured debt, allowing the rating to be Other transaction configurations are possible. For example,
notched up above that of the lessee, depending on the strength the SPE may sublease back to the lessee the assets that have
of the security. To notch up the rating where the lessee is a been first leased to the SPE by the same lessee. Typically,
sovereign entity (or where the lessee seeks a rating above that the head lease has a longer maturity than the sublease. Such
of the sovereign of domicile), some features of the transaction configurations do not include the sale of assets and may be
would have to mitigate the risks posed by a potential sovereign preferred when the sale of an asset is difficult, either legally or
default, including the risk of the sovereign restricting access for political reasons (for example, a sovereign may not wish to
by the issuer to foreign exchange needed for payments to the sell the country’s main airport).
holders of the Ijarah Sukuk. In such an instance, an offshore
Additionally, depending on the extent of Shariah compliance,
mechanism for collecting cash flows generated by the assets is
prior to maturity the lessee may have the right to call for the
likely to be necessary for the Ijarah Sukuk to achieve a rating
assets upon certain amounts due under the Ijarah Sukuk as well
higher than that of the sovereign of domicile.
as other expenses, and the SPE might have the right to tender
the assets back to the lessee. The lease may also be supported by
How are most rated Islamic financings affiliate guarantees. Currency or other hedges may also play a
configured? part in transaction dynamics.
Standard & Poor’s has rated two broad types of Islamic
financing: (1) Ijarah Sukuk, where the whole transaction, Do Standard & Poor’s ratings address Shariah
including the ownership structure as well as the notes, is compliance?
Shariah-compliant; and (2) the ‘ownership’ Shariah-compliant
Standard & Poor’s bases its credit rating opinion on the
structure, where the bonds are issued by an unaffiliated SPE
compliance of an Ijarah Sukuk transaction with applicable
with the proceeds used to acquire the assets from the lessee/
commercial law, and the rating therefore does not reflect the
seller, combined with a put/tender feature. In this second
compliance of the transaction with Shariah. English law, New
configuration, the securities themselves may not necessarily be
York State law, and the commercial codes of the countries
Shariah-compliant.
where the assets are located have, in part, governed transactions
Most Ijarah Sukuk that Standard & Poor’s has rated are set up rated by Standard & Poor’s.
in the following manner:
Various scholars charged with interpreting the Holy Qur’an
1. The seller sells certain assets, such as an office build- and other fundamental Islamic writings offer opinions on the
ing, land, or an airport, to a special purpose vehicle (the conformity of transactions with the principles of Shariah. Were
SPV) that may be affiliated or unaffiliated with the seller a transaction to be governed solely by Shariah, such a transaction
(depending on the degree of compliance with Shariah) might be difficult to rate because of the lack of predictability
Criteria Guidelines
Standard & Poor’s criteria for rating Ijarah Sukuk take into
consideration four main elements, which can be expressed in
the form of questions, as follows.
1. Do the lease and repurchase payments from

the lessee to the SPE have the same credit
quality as the lessee’s conventional debt?
Standard & Poor’s analyses the lease and repurchase obligations
to determine whether they are timely, irrevocable, and
unconditional. If a government is the lessee, Standard & Poor’s
also gauges appropriation risk (the risk that the legislature will
allocate funds to meet the lease obligation). An important factor
in determining if the Ijarah Sukuk may be rated the same as the
lessee’s conventional debt is whether the lease and other relevant
obligations rank on an equal basis with the lessee’s conventional
debt. Should the lease obligation be subject to budgetary
appropriation or other risks that, by comparison, weigh less heavily
in issuances of conventional debt, Standard & Poor’s might notch
of outcomes in a Shariah court, with the possibility of Shariah the Ijarah Sukuk down from the credit rating of the lessee. Other
principles overriding otherwise valid commercial contractual factors that suggest lower credit quality include these:
obligations. Indeed, certain Shariah-compliant transactions •• Situations under which the lessee may not have to redeem
have specifically disavowed Shariah jurisdiction as a matter outstanding principal by repurchasing the assets at matu-
of form, although they may satisfy Shariah requirements as a rity or in a dissolution event; and any other conditions that
matter of substance. allow exceptions for timely payment or for lower recovery
prospects.
What are the rating implications if Islamic
authorities do not recognize a transaction as •• The essentiality of the asset to the lessee is also considered
when assessing the lessee’s repurchase commitment.
Shariah-compliant?
If a sovereign or an Islamic legal authority declares (at the 2. Is the SPE a single-purpose pass-through
time of issuance or during the life of the Sukuk) that Ijarah vehicle between the lessee and the holders of
Sukuk do not comply with Shariah, there might not necessarily Ijarah Sukuk?
be any credit implications, although such a result could
influence market liquidity. Most Ijarah Sukuk transactions Creditworthiness might be impaired relative to the lessee’s rating
involve contractual agreements, subject to commercial law; the if the issuer is not an SPE, for example, or if it has purposes
enforceability of the transaction in a commercial court should other than engaging in the bare necessities for implementing
not be affected by any adverse determination by a Shariah the transaction. Loans to the issuer from parties other than the
court. Most, if not all, conventional debt structures from holders of the Ijarah Sukuk are of particular concern, especially
Islamic nations do not comply with Shariah, yet this has not if the third parties could interfere with the lease payment stream
curtailed their bond issuance. destined for the Ijarah Sukuk. Furthermore, if the issuer maintains
a sinking fund, the credit exposures of the SPE will be considered.
However, to the extent that Ijarah Sukuk are governed by
Shariah and are subject to the jurisdiction of the Shariah courts Ownership and management of the issuer is also evaluated.
(which is not the case with any Ijarah Sukuk currently rated by Finally, if the lessee owns the issuer and there are potential
Standard & Poor’s), then a declaration by such a court that the conflicts of interest, these would be taken into account in the
Ijarah Sukuk do not comply with Islamic law could render the analysis.
Ijarah Sukuk void and unenforceable.
3. Do the transaction’s cash flows provide for Most important to note, outside of the religious and political
the full and timely payment of the obligations to allure of Islamic banks, is that people are choosing their services
for the safety they are perceived to offer.
holders of Ijarah Sukuk?
However, in order for Islamic financial institutions to be
Standard & Poor’s compares the terms and conditions of
competitive with conventional products and attractive to
the asset lease and those of the Ijarah Sukuk, analysing how
customers, Islamic financial products must meet the risk/
potential shortfalls are covered in the transaction. For example,
reward profiles of investors and issuers, while fulfilling the
shortfalls that might arise from foreign currency exposure
tenets of Sharia and remaining sufficiently cost-effective.
can be covered by the lease (as supplemental rent), by a lease
Additionally, Islamic financial institutions must educate their
guarantee from another creditworthy entity, or by a hedge.
personnel to understand the tenets of Islamic law that pertain
Usually, government lessees agree to cover, on a timely basis,
to finance, and must train them to comply with Sharia as they
any additional expenses related to taxes, levies, duties, fees,
serve their Islamic customer population.
and charges, whenever they arise. Another important credit
consideration is whether the sold assets are free of any lien, While the size of Islamic finance and banking activities,
pledge, mortgage, security interest, deed of trust, charge, or estimated to range from $500 billion to $1 trillion, is still a
other encumbrance. fraction of conventional banking and finance activities,
estimated annual growth rates of 10 to 15 percent seen in
Risks to the leased assets from loss or damage can be mitigated
recent years emphasize the potential market for such activities.
by insurance, though the terms and exceptions, as well as risk
Amidst this growing market opportunity there are several
of insurer’s default, must be examined carefully.
inherent risks, not the least of which is the attraction of “reverse
engineering” traditional financial products to become Islamic
4. If the lessee is a government, is its financial products. If this is done by personnel not well versed
commitment to its Ijarah Sukuk similar to its in the Islamic financial system, then risks abound.
commitment to other types of debt financing?
The most well-known aspect of an Islamic financial system is
‘Willingness-to-pay’ considerations are of particular importance the prohibition against paying or receiving interest (riba) on
for sovereign lessees. Historically, financially distressed capital. Essentially, any positive, fixed, predetermined rate
sovereign lessees have occasionally discriminated among their tied to the maturity and the amount of principal, which is
pari passu financial obligations. Standard & Poor’s examines guaranteed irrespective of the performance of the investment,
the extent to which the government includes Ijarah Sukuk in is considered riba and is therefore prohibited.
government accounts as debt obligations, indistinguishable
in terms of priority from conventional debt. ‘Willingness’ This prohibition is not to be confused with a rate of return
considerations are supported by Ijarah Sukuk financing being or profit on capital, since earning and sharing profit is very
designed to target investors interested in Shariah-compliant much encouraged within Islam. Moreover, profit, determined
instruments, rather than to create a new stratum of obligation. ex post, symbolizes the creation of additional wealth through
successful entrepreneurship, whereas interest, determined ex
ante, is a cost that is accrued irrespective of the outcome of
Conclusion—New Product business operations, and may create wealth even if there are
business losses.
Development
It is within this context that one should consider the
There are an estimated 1.61 billion Muslims worldwide, development of new Ijarah products.
making Islamic banking one of the fastest growing segments of
the financial industry. To provide further clarity in terms of development of new
products as well as new institutions to market Ijarah products
According to Standard and Poor’s surveys, 20 percent of one should take into consideration IFSB 9.0.
the customers in the Gulf region and Southeast Asia would
choose an Islamic banking product over a similar conventional
product. There are significant middle-class urban and
suburban populations that already use conventional banking,
and therefore present ripe opportunities for Islamic banks.
ISLAMIC FINANCIAL SERVICES BOARD Principle 4: Information About Clients

IFSB 9.0 An IIFS shall take steps to ensure that it understands the nature
and circumstances of its clients, so that it offers those products
most suitable for their needs, as well as offering financing only
for Shariah-compliant projects.
Guiding Principles on Conduct of Business
for Institutions Offering Islamic Financial Principle 5: Information to Clients
Services
An IIFS shall provide clear and truthful information both in
The Guiding Principles on Conduct of Business for Institutions any public document issued and to its actual and prospective
offering Islamic Financial Services (hereafter Guiding Principles) clients, both during the sales process and in subsequent
are applicable to all institutions offering Islamic financial services communications and reports.
(IIFS) in the banking, Takaful (Islamic insurance), and capital
market segments, including windows of conventional firms.
Principle 6: Conflicts of Interest and of Duty
In accordance with the objectives of the IFSB, the Guiding
Principles will not reinvent the wheel but will instead, wherever An IIFS shall recognize the conflicts of interest between it and
appropriate, reinforce the existing internationally recognized its clients that arise from the type of products it offers, and
frameworks or standards for the conduct of business. either avoid them or disclose and manage them, bearing in
mind its fiduciary duties to investment account holders as well
Principles of business conduct are defined as those principles
as shareholders.
that are intended to govern the activities of financial services
firms with regard to (a) the protection of the interests of their
Principle 7: Shariah Compliance
customers, and (b) the integrity of the market. For IIFS, a
code of ethical business conduct derives from principles of the An IIFS must be able to demonstrate that its operations are
Shariah as set out in the Holy Qur’an. governed by an effective system of Shariah governance and that
it conducts its business in a socially responsible manner.
IFSB 9.0 contains a model self-assessment questionnaire to

The Guiding Principles ensure the institutions and its products are Shariah complaint.
Principle 1: Truthfulness, Honesty and Fairness

An IIFS shall aspire to the highest standards of truthfulness,
honesty, and fairness in all its statements and dealings, and
must treat its customers fairly.
Principle 2: Due Care and Diligence

An IIFS shall exercise due care and diligence in all its
operations, including the way it structures and offers its
products and provides financing, with particular regard to
Shariah compliance and to the thoroughness of research and
risk management.
Principle 3: Capabilities
An IIFS shall ensure that it has in place the necessary systems
and procedures, and that its employees have the necessary
knowledge and skills, to comply with these principles and other
IFSB standards.
Islamic Financial Glossary haram: Unlawful, forbidden (see halal). Describes activities,
professions, contracts and transactions that are explicitly
al adl: A trusted and honourable person, selected by both prohibited by the Qur’an or the Sunnah.
parties to a transaction. A trustee.
hawala: Bill of exchange, promissory note, cheque or
al Maqasid al Shariah: The objective of Shariah. draft. A debtor passes on the responsibility of payment of his
debt to a third party who owes the former a debt. Thus, the
amana/amanah: Literally means reliability, responsibility of payment is ultimately shifted to a third party.
trustworthiness, loyalty and honesty, and is an important Hawala is used in developing countries as a mechanism for
value of Islamic society in mutual dealings. It also refers to settling international transactions by book transfers.
deposits in trust, sometimes on a contractual basis.
ijarah/ijara: Lease, hire or the transfer of ownership
bai/bay: Contract of sale, sale and purchase. of a service for a specified period for an agreed lawful
consideration. This is an arrangement under which an Islamic
financial institution leases equipment, a building or other
bai al-salam: Advance payment for goods. While normally
facility to a client for an agreed rental.
the goods need to exist before a sale can be completed, in
this case the goods are defined (such as quantity, quality,
workmanship) and the date of delivery fixed. Commonly ijarah muntahla bittamleek/ ijarah wa iqtina: A
applied in the agricultural sector where money is advanced for leasing contract used by Islamic financial institutions that
inputs to receive a share in the crop. includes a promise by the lessor to transfer the ownership of
the leased property to the lessee, either at the end of the lease
or by stages during the term of the contract.
diminishing musharaka: A form of partnership that
ends with the complete ownership of a partner who purchases
the share of another partner in that project by a redeeming ijtihad: Literally effort, exertion, industry, diligence. As a
mechanism agreed between both of them. legal term, it means the effort of a qualified Islamic jurist to
interpret or reinterpret sources of Islamic law in cases where
no clear directives exist.
fatwa (pl. al fatawa): An authoritative legal opinion
based on the Shariah.
Istisna/istisna’a: A contract of sale of specified goods to
be manufactured with an obligation on the manufacturer
fiqh: Practical Islamic jurisprudence. Can be regarded as the
to deliver them on completion. It is a condition in istisna
jurists’ understanding of the Shariah. There are four Islamic
that the seller provides either the raw material or the cost of
schools of jurisprudence: al-Shafie, al-Hanafi, al-Maliki and
manufacturing the goods.
al-Hanbali.
gharar: Uncertainty in a contract or sale in which the goods maisir/maysir: The forbidden act of gambling or playing
games of chance with the intention of making an easy or
may or may not be available or exist. Also, ambiguity in the
unearned profit.
consideration or terms of a contract—as such, the contract
would not be valid.
manfa’a: A form of contract in which one party gains the
right to use or benefit from the use of an asset.
hadith: The narrative record of the sayings, doings and
implicit approval or disapproval of the Prophet.
mudaraba/mudarabah: A form of contract in which
one party (the rab-al-maal) brings capital and the other (the
halal: Permissible, allowed, lawful. In Islam, there are
mudarib) personal effort. The proportionate share in profit is
activities, professions, contracts and transactions that are
determined by mutual consent, but the loss, if any, is borne
explicitly prohibited (haram) by the Qur’an or the Sunnah.
by the owner of the capital, unless the loss has been caused
Barring these, all others are halal. An activity may be
by negligence or violation of the terms of the contract by
economically sound but may not be allowed in Islamic society
the mudarib. A mudaraba is typically conducted between
if it is not permitted by the Shariah.
an Islamic financial institution or fund as mudarib and qard al hasan/qard hassan: A virtuous loan in which
investment account holders as providers of funds. there is no interest or mark-up. The borrower must return the
principal sum in the future without any increase.
mudarib: The managing partner or entrepreneur in a
mudaraba contract (see above), see also rab almal. rab-al-maal: The investor or owner of capital in a
mudaraba contract (see above).
murabaha: A contract of sale with an agreed profit mark-up
on the cost. There are two types of murabaha sale: in the first rahn: A mortgage or pledge.
type, the Islamic financial institution purchases the goods and
makes them available for sale without any prior promise from a riba: Interest. Sometimes equated with usury, but its
customer to purchase them, and this is termed a normal or spot meaning is broader. The literal meaning is an excess or
murabaha. The second type involves a promise from a customer increase, and its prohibition is meant to distinguish between
to purchase the item from the financial institution, and this is an unlawful exchange in which there is a clear advantage
called murabaha to the purchase order. In this latter case, there to one party in contrast to a mutually beneficial and lawful
is a pre-agreed selling price that includes the pre-agreed profit exchange.
mark-up. Normally, it involves the financial institution granting
the customer a murabaha credit facility with deferred payment
terms, but this is not an essential element.
riba al-buyu: A sale transaction in which a commodity is
musharaka/musharakah: An agreement under which exchanged for the same commodity but unequal in amount
the Islamic financial institution provides funds that are or quality, or the excess over what is justified by the counter-
mingled with the funds of the business enterprise and possibly value in an exchange/business transaction.
others. All providers of capital are entitled to participate in
management but are not necessarily obliged to do so. The sadaqa: Voluntary charity.
profit is distributed among the partners in a pre-determined
manner, but the losses, if any, are borne by the partners in salam: A contract for the purchase of a commodity for
proportion to their capital contribution. It is not permitted to deferred delivery in exchange for immediate payment.
stipulate otherwise.
Shariah /Shari’a/Shari’ah: In legal terms, the law zakah/zakat: A tax that is prescribed by Islam on all
as extracted from the sources of law (the Qur’an and the persons having wealth above an exemption limit at a rate
Sunnah). However, Shariah rules do not always function as fixed by the Shariah. Its objective is to collect a portion of
rules of law as they incorporate “obligations, duties and moral the wealth of the well-to-do and distribute it to the needy.
considerations that serve to foster obedience to the Almighty.” The way it is distributed is set out in the Qur’an. It may
be collected by the state, but otherwise it is down to each
shirkat al-aqad: A joint-venture partnership. individual to distribute the zakat.
shirkat al-milk: A co-ownership partnership.

Shariah compliance
saak: Participation securities, coupons, investment
certificates. The Islamic finance industry has adopted the practice of
appointing Shariah scholars to determine compliance with
sukuk: Plural of saak (see above). Shariah. Since Shariah can in certain areas be general and
implicit, appropriately qualified scholars are relied upon to
Sunnah: The way of the Prophet Muhammad including his determine the relevant rules for financial transactions. These
sayings, deeds, approvals, and disapprovals as preserved in the scholars are appointed to the Shariah Supervisory Boards of
hadith literature. It is the second source of revelation after the financial institutions and investment funds to approve Islamic
Qur’an. product lines and individual transactions as well as to audit
these institutions and funds to ensure continuing compliance.
Takaful: A Shariah-compliant system of insurance based on Recently, Shariah consultancies have been established to
the principle of mutual support. The company’s role is limited provide a similar service.
to managing the operations and investing the contributions. Shariah Supervisory Boards (or, for smaller operations, a
single Shariah Scholar) evidence their opinion on compliance
tawarruq: Literally monetisation. The term is used to by issuing a fatwa (an Islamic legal opinion). Fatwas are
describe a mode of financing, where the commodity sold is important documents and are often a condition precedent to
not required by the borrower but is bought on deferred terms the effectiveness of a transaction. Indeed, many offerings, such
and then sold to a third party for a lower amount of cash, so as Islamic funds or Sukuk (see section 7.5) sometimes append
becoming “monetised”. The reverse of murabaha. the fatwa issued to the relevant offering documents.
ummah: The community or nation. Used to refer to the

worldwide community of Muslims.
urf: The customs of a community.
wa’d: A promise or unilateral undertaking.
wadiah: A deposit.
wakala: Agency, an agency contract that generally includes

in its terms a fee for the agent.
wakeel al-Istithamr: An investment agent.
waqf: A charitable endowment.

References
1) Dr. Zeti Akhtar Aziz, Governor, Bank Negara Malaysia — ’Islamic Finance: An Agenda for Balanced Growth and
Development’ Publication: ENP Newswire Date: Monday, October 18, 2010 http://www.allbusiness.com/trade-development/
trade-development-finance-banks/15205013-1.html
2) Islamic Finance and Global Financial Stability, 2010 http://islamicfinancenews.files.wordpress.com/2011/01/ifsb-irti-idb2010.

pdf Graphic Page 15
3) State Bank of Pakistan, http://www.sbp.org.pk/
4) Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), www.aaoifi.com/keypublications.html
5) The International Islamic Financial Market (IIFM), www.iifm.net
6) The International Islamic Rating Agency (IIRA), www.iirating.com
7) The Islamic Financial Services Board (IFSB), www.ifsb.org
8) Basel Committee on Banking Supervision, http://www.bis.org/bcbs/
9) International Organization of Securities Commissions, http://www.iosco.org/
10) International Association of Insurance Supervisors, www.iaisweb.org
11) Source: Islamic Research and Training Institute, Islamic Development Bank.http://www.irtipms.org/PubDetE.asp?pub=213
&search=ijarah&mode=allwords, http://www.irtipms.org/PubDetE.asp?pub=216&search=ijarah&mode=allwords
12) Miles, Adrian (1993), “An Introduction to Securitization of Lease” in Adrian Hombrook, Studies in Leasing Law and Tax,
London: Euromoney Publications, p.15.
13) Decision No. 5 of the 4th Annual Plenary Session of the OIC Fiqh Academy, held in Jeddah 18-23/6/1408H (6-11/2/1988G) —
International Islamic Fiqh Academy, www.fiqhacademy.org.sa
14) Shariah Advisory Council, Bank Negara Malaysia, http://www.bnm.gov.my/index.php?ch=7&pg=715&ac=802
15) Regional Center for Arbitration Kuala Lumpur, http://www.rcakl.org.my/
16) State Bank of Paksitan, Shariah Rulings, http://www.sbp.org.pk/departments/pdf/StrategicPlanPDF/Appendix-C%20

Shariah%20Compliance.pdf
17) Shariah Compliant Ijarah Car Financing, Maybank Malaysia, http://www.maybank2u.com.my/mbb_info/m2u/public/

personalList04.do?channelId=LOA-Loans&programId=LOA03-CarLoans&chCatId=/mbb/Personal/LOA-Loans, http://
www.maybank2u.com.my/mbb_info/m2u/public/personalDetail04.do?channelId=LOA-Loans&cntTypeId=0&cntKey=
LOA03.02&programId=LOA03-CarLoans&chCatId=/mbb/Personal/LOA-Loans, http://www.maybank-ib.com/services/
islamicproducts.html
18) Shariah Compliant Ijarah Home Financing, Ahli United Bank, http://www.iibu.com/buy_home/ijarahow.aspx
19) Forward Ijarah, Dubai Islamic Bank, http://www.dib.ae/en/personalbanking_home_finance_forward_ijarah.htm
20) Ijarah (Ending with Title Deed) Muntahia Bittamleek, Dubai Islamic Bank, http://www.dib.ae/en/realestate_lease.htm
21) Honohon, Patrick. 2007. “Cross-Country Variations in Household Access to Financial Services.” Presented at the World Bank
Conference on Access to Finance, Washington, D.C., 15 March.
22) Karim, Nimrah, Michael Tarazi, and Xavier Reille. 2008. “Islamic Microfinance: An Emerging Market Niche.” Focus Note
49. Washington, D.C.: CGAP, August.
23) Islamic Finance Today, http://www.sailanmuslim.com/news/ijara-a-more-compassionate-form-of-leasing-suresh-r-i-perera-

llb-attorney-at-law-acma-director-tax-regulatory-kpmg-sri-lanka/
24) 13 Para 8, FRS 117, Malaysian Accounting Standards Board 2005,
a) FRS 117 Leases, A Practical Guide to Financial Reporting Standards (Malaysia), page307,
b) Para 2, FRS 117, Malaysian Accounting Standards Board 2005.
c) Para 8, FRS 117, Malaysian Accounting Standards Board 2005
d) http://www.masb.org.my/
e) http://www.masb.org.my/index.php?option=com_content&view=article&id=321%3Afrs117-pg3&catid=6%3Amasb-exclude-
private&Itemid=32
25) Four Main Schools of Islamic Thought, http://www.islamic-banking.com/islamic-jurisprudence.aspx
26) The law firm of Agha & Shamsi, UAE , http://www.aghashamsi.com/mediacentre-publications.htm
27) Islamic Project Finance, Chadbourne and Parke LLP, Islamic Project Finance: Structures and Challenges, February
2010, http://www.chadbourne.com/files/Publication/c4ae820b-24ba-4e5b-9f7d-186814289e7e/Presentation/
PublicationAttachment/20d7847a-8644-4b0f-b3e7-19a496eebf22/pfn_Intl_0210.pdf
28) Dolfin Gas Project, Khaleej Times, Sept 12, 2005, http://www.khaleejtimes.com/displayarticle.asp?xfile=data/business/2005/
september/business_september257.xml&section=business
29) Sukuk, Islamic Bonds (Sukuk): Its Introduction and Application, By Shariq Nisar, http://www.financeinislam.com/
article/8/1/546
30) Sukuk, http://www.inceif.org/_system/media/pdf/global_forum/speech_badlisyah.pdf
31) Ijarah Sukuk, Operatonal Models for Ijarah, Shariah Board Resolutions, Securities and Exchange Organization, Iran, www.
rdis.ir, http://www.rdis.ir/RDFiles/IslamicFin/Operational_models_for_Ijarah46.pdf
32) Ijarah Sukuk Model Project Finance, Innovation in the Structuring of Islamic Sukuk Securities, Professor Rodney Wilson
Durham University, Institute for Middle Eastern and Islamic Studies, http://www.assaif.org/content/download/586/4393/
file/Innovation%20in%20the%20Structuring%20of%20Islamic%20Sukuk%20securities.%E2%80%A6.pdf
33) Standard and Poors Ratings, http://www.standardandpoors.com/ratings, also How Standard and Poors Rate Ijarah Sukuk,
http://www.zawya.com/Story.cfm?id=ZAWYA20050221073726&pagename=SukukMonitor
General Bibliography Islamic Development Bank.(1999) Financing Trade in an

Islamic Economy, Research Paper No. 51.
Abdel Hamid El-Ghazali. Profit versus Bank Interest in
Economic Analysis and Islamic Law. Islamic Development Kahf, M., and Khan, T., (1992) Principles of Islamic Finance,
Bank. Islamic Research and Training institute. Islamic Jeddah: Islamic Research and Training Institute, Islamic
Economics Translation Series No.2. p. 37. Development Bank.
Ahmad, Ausaf and Tariqullah Khan (eds) (1998), Islamic Kamali, M. Hashim (1999), Principles of Islamic Jurisprudence,
Financial Instruments for Public Sector Resource Mobilization, Reprint, Petaling Jaya, Malaysia: Ilmiah Publishers.
Jeddah: IRTI.
Kamali, M. Hashim (2000), Islamic Commercial Law,
Al-Harran, S.A.S. (1993), Islamic Finance: Partnership Cambridge: Islamic Texts Society.
Financing, Selangor Darul Ehsan, Malaysia: Pelanduk
Khan, M. Fahim (1995), Essays in Islamic Finance, Leicester:
Publications.
The Islamic Foundation.
Ariff, Mohamed (2005). Economics and Ethics in Islam.
Manan M.A (ed.).(1996). Financing Development in Islam,
Readings in the Concept and Methodology of Islamic
Islamic Research and Training Institute, Islamic Development
Economics, CERT Publication Sdn. Bhd. Kuala Lumpur,
Bank.
Malaysia, pg.105.
Masood, Waqar (1984), Towards an Interest-Free Islamic
Ariff, Mohamed, Mannan, M.A. (1990), Developing A System
Economic System, Leicester: The Islamic Foundation.
of Islamic Financial Instruments, Jeddah: Islamic Research and
Training Instittute. Muhamad Umar Chapra. (2005). Objectives of the Islamic
Economic Order, An Introduction to Islamic Economics
Datamonitor (2002), Islamic Mortgages, Datamonitor,
and Finance, CERT Publication Sdn. Bhd. Kuala Lumpur,
London.
Malaysia.
El-Gamal, Mahmoud Amin (2000), A Basic Guide to
Phililp Moore, (1997), Islamic Finance: A Partnership for
Contemporary Islamic Banking and Finance, Indiana: ISNA.
Growth, Euromoney Publications PLC: London
Hammad, Nazih (1990), Studies in Principles of Debts in
Sayed Hassan Amin, 1985. Islamic Law in the Contemporary
Islamic Fiqh, Taif: Saudi Arabia: Dar Al Farooq.
World, Tehran: Vahid Publications.
Haron, Sudin (1996), Principles and Operations of Islamic
Sheikh Abod, Sheikh Ghazali, S. O., Syed Agil, A. Ghazali (eds)
Banking, Selangor, Darul Ehsan, Malaysia: Berita Publishing.
(2005), An Introduction to Islamic Economics and Finance,
Institute of Islamic Banking and Insurance (1992), Encyclopedia CERT Publications: Kuala Lumpur.
of Islamic Banking and Insurance, London: IIBI.
Siddiqui, M. Nejathullah (1985), Partnership and Profit
Islamic Development Bank, Islamic Research and Training Sharing in Islamic Law, Leicester: The Islamic Foundation.
Institute. Regulation and Supervision of Islamic Banks.
Sohail, Jaffer (ed) (2005), Islamic Retail Banking and Finance:
Occasional Paper No.3. Jeddah, Saudi Arabia. 1421H[2000].
Global Challenges and Opportunities, Euromoney Books:
Iqbal, Zamir. (1997), Islamic Financial System, Finance and London
Development, June Issue. World Bank Publications, Oxford
Sundararajan, V. and Errico, L (2002), Islamic Financial
University Press. http://www.worldbank.org
Institutions and Products in the Global Financial System: Key
Iqbal, M. and Llewellyn, D.T., (2002), Islamic Banking and Issues in Risk Management and Challenges Ahead.
Finance: New Perspectives on Profit Sharing and Risk, Edward
IMF Working Paper, WP/02/192. Washington: International
Elgar Publishing Limited, Cheltenham, U.K.
Monetary Fund.
Iqbal, M. and R. Wilson (eds) (2005), Islamic Perspective on
Thani N. A. et al, (2003), Law and Practice of Islamic Banking
Wealth Creation, Edinburgh University: Edinburgh
and Financial System, Sweet & Maxwell: Malaysia
Usmani, Imran (2002), Guide to Islamic Banking, Karachi:

Dar-ul-Ishaat.
Vogal, Frank E. and Samuel L. Hayes (1998), Islamic Law and

Finance: Religion, Risk and Return, The Hague: Kluwer Law
International.
Warde, Ibrahim (2000), Islamic Finance in the Global

Economy, Edinburgh, Edinburgh University Press.
Wilson, R. (1990), Islamic Financial Markets, London:

Routledge.
Zahar Ahmad Khan, (2000), Islamic Banking and Its

Operations, Institute of Islamic Banking and Insurance,London.

Islamic Leasing Ijarah

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Islamic Leasing Ijarah

Uploaded by

Copyright:

Available Formats

Focused toolkit

IJARAH (ISLAMIC LEASING)................................................................................................... 10

AL-IJARAH THUMMA AL-BAI (AITAB).................................................................................. 21

FOUR MAIN SCHOOLS OF ISLAMIC THOUGHT: HANAFI/JA’FARI,

STANDARD & POOR’S RATINGS OF IJARAH SUKUK........................................................... 52

ISLAMIC FINANCIAL SERVICES BOARD IFSB 9.0.................................................................. 57

ISLAMIC FINANCIAL GLOSSARY........................................................................................... 58

Materiality and Validity of Transactions Mutuality of Risk Sharing

Embedded Governance Disclosure & Transparency

Shariah (Islamic Law) Halal and Haram

2. The Sunnah of the Holy Prophet (Peace Be Upon Him)

3. Ijma’ (consensus of the Ummah)

3 Please see end notes at the end of this focused toolkit

Basic Principles of Islamic Finance • Prohibition of speculative behavior.

Accounting and Auditing Organization for

Shariah law is open to interpretation, and Shariah boards often

Market for Islamic Finance Products

 23% of world population is Muslim

3. The asset being leased must be lawful.

4. The seller must be able to deliver the asset to the lessor.

5. The asset must be useful and valuable to the lessor.

6. The full details about the asset must be known by both

7. The risk of ownership of the asset rests with the lessor.

Benefits (Usufruct) 2. Different amounts of rent or lease payments can be set

Standard Features of Ijarah General Terms

Examples of Leased Assets Rental Payments and Term

Legal Documents Prepared

Example of Ijarah Financing Calculations:

2. Total lease rental = Purchase price plus the profit

$1,000,000 + $500,000 = $1,500,000

3. The term (T) of the lease is 5 years.

1. The agreement contains language stating that the

Generally, any disclaimer of warranties must be

Warranty disclaimers that fail to meet those requirements

Sale of the Leased Asset11 Timing of Lease Payment

1. The asset should be clearly described in a way that does

2. The lessor should normally be able to acquire, construct,

11 Please see end notes at the end of this focused toolkit

Period of Ijara Insurance and Maintenance Expenses

Any maintenance or insurance expenses for which the owners

Securitization of Assets Subject to the Ijarah Ijarah—Transactional Issues

Legal Opinion Regarding Securitization

3. interpersonal debts, and Security 1 to 3 monthly installments are the

12 Please see end notes at the end of this focused toolkit

Calculation of the total lease rental: Al-Ijarah Thumma Al-Bai (AITAB)

As in many jurisdictions, different terms are used for the same

Normal steps in the transaction of an Ijarah Contract are as

1. The client of the financial institution approaches a seller

2. The client approaches the financial institution with the

3. The financial institution buys the asset from the seller

4. The financial institution then enters into the Ijarah

5. The seller delivers the asset to the client of the financial

6. The client pays the agreed rental, based on the payment

7. When the time limit in the Ijarah contract expires, the

In this structure the financial institutions tend to use

Monthly rental = Total lease rental divided by the term

$1,500,000/(5 x 12 months) = $25,000 per month

Sales price = amount agreed, as zero (i.e. gifted)—or

Comments on Differences between Conventional Lease contracts and AITAB

AITAB CONTRACT CONVENTIONAL LEASE

Tax Benefits of AITAB

•• To act as the sole authoritative body to advise BNM on

•• To coordinate Shariah issues with respect to Islamic banking

23% of world population is Muslim