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

.................... 46 Sukuk Trust Certificates ............................................................................................................................. 49 Sample Transaction Structure — Leasing Assets ........................ 57 ISLAMIC FInAnCIAL gLoSSArY ...................................................................................................................................................................ProJECt FInAnCIng uSIng IJArAH .... 48 Sukuk Trading Options ........................................................................................................................................................................................................................................................ 49 StAndArd & Poor’S rAtIngS oF IJArAH SuKuK .. 52 Ijarah Sukuk Ratings............................................................................ 45 IJArAH SuKuK ...................................................... 44 Project Financing Examples ............. 54 ISLAMIC FInAnCIAL SErvICES BoArd IFSB 9................................................................................................................... 63 ......................................................................................................................................................................................... 44 Risks to Avoid in Project Financing ....................................................................................... 57 Guiding Principles on Conduct of Business for Institutions Offering Islamic Financial Services .......................................................................................................................................................................................... 47 Disadvantages of the Ijarah Sukuk Structure ......... 61 gEnErAL BIBLIogrAPHY ................................................................................................................................................................................................................................................................................................... 43 Ijarah with Istisna .... 48 Ijara and Project Finance ..................................... 52 Criteria Guidelines ....................... 46 Sukuk .... 58 rEFErEnCES ................0 .......................................................................................................


norms. 20102 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.” referring to the way Muslims should live. Source: Islamic Finance and Global Financial Stability. which can be translated to mean “the way. in the Muslim world there is no division between religion. 20101 Disclosure & Transparency . These elements limit the extent of leverage and place emphasis on transparency and disclosure in the documentation of contracts. Islamic finance promotes profit sharing and hence risk sharing.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 5 WHAt IS ISLAMIC FInAnCE? “As a form of financial intermediation. The values. Fundamental to Islamic finance is the requirement that financial transactions must be supported by real economic activity. and this carries to the issues of finance. Zeti Akhtar Aziz. non-Muslim world. Bank negara Malaysia 1 Unlike the segregation of duties and responsibilities that exists in the western. intellect and wealth • High ethical values—justice. Governor. business. life. morals. behaviors. honesty and integrity • More equitable distributor of wealth Materiality and Validity of Transactions • Economically productive underlying activities • Avoidance of interest-based transactions • No involvement in illegal and unethical activities • Genuine trade and business transactions • Avoidance of speculative transactions Mutuality of Risk Sharing • Entitlement of profit confident upon risk taking • Honouring both substance and form of contract Embedded Governance source: Islamic Finance and Global Financial Stability.” — dr. Embraced in its entirety. This construct binding the parts to create the whole is referred to as Shariah. Islamic finance promises to enhance the discipline that contributes towards ensuring growth and financial stability. and the state. trust. The way is well represented below in diagrammatic form in terms of its impact on financial issues. Islamic finance incorporates several elements that guide the process of the mobilization and allocation of funds to generate productive economic activity and inclusive development. and ethics applicable in one situation permeate all the others. fairness. lineage. the family. In addition.

where there is the traditionally understood insurer-and-insured relationship. In Islam. The Holy Quran 2. Shariah is best explained as follows:3 Shariah lexically means a way or path. in Takaful all participants are insurers and insured at the same time. the participants jointly contribute to a pooled fund for the purposes of providing mutual indemnity and protection for any of the participants exposed to defined risk under the Takaful policy. If a transaction is done according to the rules of Islamic Shariah. Shariah refers to the divine guidance and laws given by the Holy Quran. Ijma’ (consensus of the Ummah) 4. whether in global markets or in Islamic-based markets. The Sunnah of the Holy Prophet (Peace Be Upon Him) 3. Halal and Haram Again according to the State Bank of Pakistan. Unlike conventional insurance. 3 Please see end notes at the end of this focused toolkit . including beliefs and practices. and Internal Shariah boards or client directives. Qiyas (by analogy) “Shariah compliance” refers to the decision to apply Islamic principles to financial transactions. Shariah embodies all aspects of the Islamic faith. A Takaful company or operator is responsible for managing the Takaful fund. It is the underlying transaction that makes something halal (allowed) or haram (prohibited) and not the result itself. compliance is driven by national legislation generated by the the Accounting and Auditing organization for Islamic Financial Institutions (AAoIFI) standards. the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations by Islamic scholars. takaful (Islamic Insurance) In a Takaful relationship. prudential and regulatory standards. The Islamic Financial Services Board (IFSB). it is halal even if the end result of the product may look similar to a conventional banking product. the terms halal and haram can be explained as follows: The validity of a transaction does not depend on the end result but rather the process and activities executed and the sequence thereof in reaching the end. Islamic Shariah or the divine law of Islam is derived from the following four sources: 1.6 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) Shariah (Islamic Law) According to the State Bank of Pakistan.

money is not a commodity. any transaction leading to injustice or exploitation is prohibited. • Sanctity of contracts. because interest is prohibited. any investment in a business dealing with alcohol or gambling is prohibited. but a medium of exchange. money represents purchasing power and cannot be utilized to increase the purchasing power without any productive activity. rather than creditors. whether in loans or sales. • Shariah approved activities.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 7 BASIC PrInCIPLES oF ISLAMIC FInAnCE • Prohibition of interest (riba). a store of value. this feature is intended to reduce the risk of asymmetric information and moral hazard. • Money as “potential” capital. only those business activities that do not violate the rules of the shariah qualify for investment. islamic finance discourages hoarding and prohibits transactions featuring extreme uncertainties (gharar) or gambling (maysir). suppliers of funds become investors. • Risk sharing. for example. islamic finance advocates the creation of wealth through trade and commerce. • Social justice. and a unit of measurement.” • Prohibition of speculative behavior. . islamic finance upholds contractual obligations and the disclosure of information as a sacred duty. there is a prohibition against riba — a term that literally means “an excess” and is interpreted as “any unjustifiable increase of capital.

and Sudan—and one multilateral institution. established through the collective efforts of five countries—Bahrain. one that encompasses the full array of capital instruments and specialty Islamic financial products. Corporate governance ratings are based on an entity’s practices. regulatory. based in kuala Lumpur. the capital market. established in 2005. IIFM’s principal objective is to establish.8 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) SuPPort InStItutIonS For ISLAMIC FInAnCE The legal. is not related to the solvency or financial capability of the institution or to the credit quality of its securities or financial products. Malaysia. governance. develop. AAoIFI is a member of the International Accounting Standards Board (IASB. Shariah Quality ratings assess the level of compliance with the principles of shariah. International organization of Securities commissions9. and Shariah standards for the international Islamic banking and finance industry. the Islamic Financial Services Board (IFSB)7 The Islamic Financial Services Board (IFSB). which is defined broadly to include banking. the International Islamic Financial Market (IIFM)5 The IIFM is a nonprofit organization. 7 Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit the International Islamic rating Agency (IIrA)6 The International Islamic Rating Agency (IIRA). the IFSB promotes the development of a prudent and transparent industry by introducing new— or adapting existing— international standards consistent with Shariah principles and recommending them for adoption.) AAoIFI standards seek to establish best practices on handling financial reporting issues specific to Islamic institutions. and assess the demarcation of rights and responsibilities among different stakeholders as well as their compliance with prevailing rules and procedures for making decisions. rather. credit Ratings. Accounting and Auditing organization for Islamic Financial Institutions (AAoIFI)4 AAoIFI is an autonomous entity responsible for the formulation and issuance of accounting. Indonesia. It serves as an international standard-setting body for regulatory and supervisory agencies that have a vested interest in ensuring the soundness and stability of the Islamic financial services industry. and accounting frameworks for Islamic finance and its institutions and products are continually evolving. important institutions framing the development of the global industry are as follows: Sovereign ratings and Credit ratings assess the likelihood that an entity will repay its debt obligations in a timely manner. was established in 2002. on the other hand. IIFM’s role is that of a developer and catalyst of the Islamic financial market. 4 5 6 Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit 8 9 10 . and the International Association of Insurance Supervisors10. it represents an independent opinion about the shariah quality of a financial institution or of a security or financial product. In this regard. auditing. ethics. Brunei. and that enhances the level of analytical expertise in those markets. and corporate Governance Ratings. the Islamic development Bank. To this end. and regulate the islamic capital and money market on the principles of Shariah. and insurance. is the sole rating agency that provides capital markets and the banking sector in predominantly Islamic countries with a rating spectrum. a shariah quality rating differs from a credit rating in that the latter is an evaluation of the solvency of a financial institution and its capability and willingness to repay its obligations. the work of the IFSB complements that of the Basel committee on Banking Supervision8. a shariah quality rating. IIRA offers Sovereign Ratings. encompassing both the short-term money market and the long-term capital market. promote. In advancing this mission. Shariah Quality Ratings.

there is no practical guide as to what constitutes an acceptable Islamic financial instrument. The International Association of Islamic Bankers. while the association’s Supreme Religious Board studies the fatwas of the Shariah boards of member banks to determine whether they conform with Shariah. These boards include some of the most respected contemporary scholars of Shariah. has enacted a law known as the Islamic Financial Services Board Act 2002. and 138 market players and professional firms operating in 39 jurisdictions. which gives the IFSB the immunities and privileges that are usually granted to international organizations and diplomatic missions. and Shariah boards often have divergent views on key Shariah issues. the Islamic corporation for the development of the Private Sector. A Shariah board monitors the workings of the Islamic financial institution and has to clear every new transaction from a Shariah standpoint. and the opinions of the boards are expressed in the form of fatwas. Shariah law is open to interpretation. world Bank. A document or structure may be accepted by one Shariah board but rejected by a different Shariah board. Saudi Arabia. Asian development Bank. the 193 members of the IFSB include 49 regulatory and supervisory authorities as well as the International Monetary Fund. Shariah Board one distinct feature of the modern Islamic banking industry is the role of the Shariah board. which forms an integral part of an Islamic financial institution. an independent body. Bank for International Settlements. Malaysia. MArKEt For ISLAMIC FInAnCE ProduCtS  23% of world population is Muslim Significant growth in Islamic Finance  Islamic Finance assets have grown to in excess of £800 bn  The Sukuk bond market has grown to $70 bn  Total wealth of HNWI1 in Middla East is about $1. Islamic development Bank. the host country of the IFSB. In this regard.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 9 As of november 2009. supervises the workings of individual Shariah boards.4 trillion  Growth in total wealth tracks increase in oil price 1 High net-worth Individuals .

since ownership of the asset always remains with the lessor. Ijarah). there is no option for the lessee to acquire the asset at the end of the lease. the lessor rents the assets to benefit from their use without having ownership transferred to the lessor. the transaction is similar to what we know as “leasing” in English. As an introduction to the subject.) In the Ijarah Aina contract.10 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) IJArAH (ISLAMIC LEASIng)— IntroduCtIon The word Ijarah refers to a transaction that involves giving something on a rental basis.” and the price for this use is referred to as “rent. and there is no option for the lessee to gain title to the asset. referred to as Al-Ijarah Thumma Al-Bai (AITAB).” There is no element of interest in the transaction. (Please note that all the Arabic terms used here are transliterations of the Arabic sounds into the Roman alphabet. The legal term for this arrangement in English is “usufruct. It can denote the paying of wages to employees (Ijarah Amal) as well as the renting of an asset (Ijarah Ain). Ijarah Aina. wherein the lessee can acquire the asset at the end of the lease. This second type is addressed in the second part of this paper. . and for simplicity’s sake shall refer to it as Ijarah. In Ijarah Aina (hereafter. However. since they are but approximations of the true sounds of the words in Arabic. there is another type of Ijarah contract. As we shall see. The spellings of the same terms may vary from one text to another as you encounter them. in this part of the paper we will only address the second type of transaction.

It should be noted that the source of funds used by the financial institution to finance Ijarah transactions must be halal. industrial equipment. ships. They purchase the assets and rent them out to customers in return for rental. Here the financial institution purchases the asset based on a promise from a customer. The lessee also benefits from the transaction. The first type of Ijarah is different from IMB in that the former does not offer an option to the customer to buy the leased asset at the end of the lease period while in the latter the option is offered via a secondary contract. At the end of the lease. namely Ijarah and Al-Ijarah Muntahiya Bittamleek. or buy the asset being leased by the time set for its delivery to the lessee. there is no sale of a tangible asset. that is. All the lease rentals previously paid will constitute part of the price. these assets take a longer time to manufacture. provided that the lessor should normally be able to acquire. such as airplanes. In addition. Al-Ijarah Muntahiya Bittamleek (IMB): Similar to a Finance Lease This type of Ijarah is one that ends with ownership. the lessor owns the property and may have the right to renegotiate the lease payments at various intervals agreed to in advance in the contract with the lessee. his forgoing the use of the assets. . types of Ijarah Islamic financial institutions use the lease for the usufruct as an instrument of financing. due to the fact that there is an increasing demand for leasing them.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 11 Since title (ownership) to the asset is not being transferred. manufacture. which is financed based on the amount of profit and the period of financing. purchases and then leases the asset required by the client in exchange for a rental fee that is not related to interest. The financial institution benefits from the transaction by retaining ownership of the asset while at the same time getting a return by leasing it. using Islamic principles. In this structure. The rental is calculated based on the value of the asset. They use two models. Ijarah’s legal characteristics are similar to those of a sale-and-purchase transaction. Ijarah can be contracted on an asset that is yet to be constructed or manufactured. construct. The institution then leases the same asset to a new lessee and at the same time bears the risk of recession or diminishing demand for the asset. only the sale of an intangible asset. This type of Ijarah is suitable for expensive assets. Under the contract. After the termination of that period. the asset will be returned to the financial institution. an Ijarah is a “contract” whereby a financial institution. This right to use or usufruct is known as manfaah in Arabic. If the lessee chooses to buy the asset. a new contract will be concluded. and agricultural machinery. with the exception that the physical asset is not transferred and there is a specific time limit on the use of the asset. namely the right to its use for a specific period of time. The risks of ownership of the asset stay with the lessor. It rents these assets to other parties on terms and conditions agreed upon for a specific time. the financial institution purchases and maintains assets that have a high degree of marketability. as it is in the case of an operational lease. as long as it is fully described in the contract. Ijarah: Similar to an Operational Lease In this type of Ijarah. it may choose to scrap or dispose of the asset. since it meets his immediate need and saves him from buying the asset at a much higher cost. Because the customer promises to own the asset. Unlike the conventional lease. but instead will be bought by the lessee. the asset will not be returned to the financial institution at the end of the lease period. thereby ensuring that the rental payments are equal to the residual balance value of the asset as well as the opportunity cost of the lessor.

The seller delivers the asset to the client of the financial institution according to the terms and conditions agreed to by the institution and submits proof of delivery. needs to be carefully considered depending upon the jurisdiction in which the contract is developed and entered into. The legality of this type of combined structure. under Islamic Shariah law as interpreted by fatwas.12 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) normal steps in the transaction of an Ijarah contract are as follows: 1. required and Prohibited terms and Conditions Lessee and lessor 1. The client pays the agreed rental. The institution pays cash. The seller must be able to deliver the asset to the lessor. The client of the financial institution approaches a seller or vendor of an asset. 6. tErMS And CondItIonS oF tHE IJArAH ContrACt To qualify as meeting Islamic requirements and thus as a true Islamic financial product. 6. to the institution. 3. The risk of ownership of the asset rests with the lessor. 3. 4. 5. or in Islamic terms must have reached puberty (baligh) 3. based on the payment plan in the Ijarah contract. which are detailed below. The lessor (mujir) must be legally sane and able to enter into the contract (“aqil”) 2. 2. The lessee must be intelligent as defined by Sharia Law. the client returns the asset to the financial institution. 5. The financial institution must be the owner of the asset during the life of the lease. The asset must be capable of being described in detail. Upon expiration of the time limit specified in the Ijarah contract. The lessee (mustajir) must be an adult. The client then approaches the financial institution with the asset price and details and negotiates with the institution to use the Ijarah contract. to the financial institution. the Ijarah contract has certain required and certain prohibited characteristics. not a minor. 7. . 4. The client promises the institution to execute the Ijarah contract. and obtains price and product details. It is prohibited for the lessor or lessee to be coerced into entering into a contract. 5. The asset must be useful and valuable to the lessor. The asset being leased must be lawful. and ownership of the asset transfers to it. with the acceptance of the client. 4. Asset Being Leased 1. which contains the terms that will apply after the institution buys the asset. 2. The full details about the asset must be known by both the seller and the buyer. It is prohibited for the lessee or lessor to be bankrupt or to be wasteful or spendthrift. The financial institution buys the asset from the seller based on the information provided by the seller to the client.

The use of the asset and the asset itself must be permissible under Islamic law. 6. The contract needs to be written in clear and definite language using the past or present tense. not in the future tense. The way that the lessor of the asset will use the asset must be known. 4. 2. Rental (Lease) Payments 1. different amounts of rent or lease payments can be set for different parts of the rental agreement. 2. and the offer and acceptance must be made at the same time in the same meeting. whether the lessor is using the asset or not is irrelevant.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 13 Benefits (Usufruct) 1. as well as currency of payment. The lease period begins upon delivery of the asset to the lessor. Contract (Aquad) Issues 1. The acceptance of the offer of the contract must be agreed upon with the offer. It is prohibited for the lessor to unilaterally increase the rent or lease payment. 5. A value to the lessee for the benefits of using the asset can be established. must be clearly stated and known by both lessee and lessor. 3. The lessor must have the legal right to use and lease the asset. The duration of the lease must be clearly defined. benefit may be derived only from its use. It is prohibited for benefit to be derived from the consumption of any material part of the asset. 4. The lease or rental amount. 2. . 3.

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. Transfer of Title to the FI Assets Leased to Customer Title does not pass at end of Lease Term Vendor Islamic Financial Institution (FI) Payment of Purchase Price Customer (Lessee) Ijarah Installments .14 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) StAndArd FEAturES oF IJArAH ContrACtS oFFErEd BY FInAnCIAL InStItutIonS general terms The Ijarah leasing contract transfers the benefits or use of an asset acquired by the financial institution (FI) for the use of the lessee at an agreed price or rental amount payable for an agreed period of time (lease period).

if variable payments are included. The financial institution defines rental payments that may be either fixed or variable. which has the required characteristic noted earlier. Rebates and Penalties 1. . and associations Incidental Fees and Charges Incidental costs borne by the lessor in providing the asset to the lessee are to be paid by the lessee. Rebates on early redemption are not allowed by the Sharia boards. Generally the rental amounts are based on equal installments. which must cover only actual costs incurred by the lessor.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 15 Examples of Leased Assets 1. In the case of late payments. consumer goods. Automotive equipment 4. but the lessor must not “benefit“ from the penalties paid by the lessee. Fixed assets and buildings 5. Sole proprietorships 3. The terms of the lease or rental agreement can be for up to seven years and vary from institution to institution. 2. the payment amount increases by a certain amount at a certain time. and the receipt of the asset by the lessee. societies. 3. the lessor has the right to unilaterally terminate the contract. fees may be charged. the Ijarah contract is for a relatively short period of time with a renewal option that allows the financial institution to re-price the costs and thus adjust the profits of renting the asset to the lessee. In some cases. The Ijarah contract. clubs. normally. 2. Production machinery and equipment 2. Legal Documents Prepared 1. However. Individuals 2. corporations 4. The undertaking to enter into the Ijarah contract whereby the asset is acquired by the financial institution for the use of the lessee. such as description of the Ijarah asset. Termination If the terms of the contract are not met by the lessee. 2. such as computers and furniture 3. if there are no defaults. the schedule of the rentals. Government entities 5. Acceptable Lessees 1. the lessor cannot terminate the lease without mutual agreement. other acceptable assets Rental Payments and Term 1.

is $1.000 3. the financial institutions calculate the rental amounts as follows: Calculations: 1.10 x 5 = $500. The term (T) of the lease is 5 years. The financial institution determines that it wants to have a profit rate (PR) of 10 percent. Total lease rental = Purchase price plus the profit Assumptions: 1. including all costs. The purchase price (PP).000.000 = $1.000/(5 x 12 months) = $25. 3.500.000. 2.16 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) ExAMPLE oF IJArAH FInAnCIng CALCuLAtIonS Generally.000 2.000.000 (cost borne by the financial institution).000 per month .500.000 + $500. $1.000 x 0. Profit (P) = Purchase price x profit rate x period of financing $1. Monthly rental = Total lease rental divided by the term (in months) $1.

In addition. should the customer seek to make claims under those warranties. most lease agreements handle warranties as follows: 1. late payments—The lessor may charge late-payment penalties. the disclaimer of certain implied warranties. 2. especially in a consumer context. The lessor cannot benefit from the late payments. . such disclaimers. These include items such as registration charges. The lessee is not liable for the rental payments during the period of the asset’s delayed delivery to the lessee. In an Ijarah transaction it is generally possible to transfer (contractually) the benefit of the supplier’s warranties from the lessor to the lessee. while the lessee is only responsible for losses to the asset from misuse or negligence. differences cost bearing—In Ijarah. the lessee will want to have the benefit of the supplier’s express and implied warranties relating to the goods or equipment. loss responsibility—The lessor is fully responsible for losses that are beyond the control of the lessee. All warranties issued by the equipment supplier will flow through to the lessee. and the language used must clearly call the customer’s attention to the exclusion. and the insurance used is Islamic insurance or Takaful. The agreement contains language stating that the lessor makes no express or implied warranty as to the suitability or merchantability of the equipment. otherwise the warranties will end up benefitting only the lessor. import expenses. requires specific language to be enforceable. although these costs may be included in the calculation of the rental amount payable by the lessee. and customs duties. This last issue should be addressed during the lessee’s preliminary dealings with the supplier and also in the purchase contract that is eventually signed between the lessor and the supplier.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 17 CoMMEntS on dIFFErEnCES And SIMILArItIES BEtWEEn ConvEntIonAL LEASE ContrACtS And IJArAH Lesson Learned: Warranties (Express or Implied) In a conventional lease. but these may only be amounts that cover the lessor’s costs due to the late payment. such as merchantability and fitness for a particular purpose. and the lessor will want to be sure that his customer is looking to the supplier. are generally not favored and would probably be strictly construed against the lessor. the lessor is required to bear all the costs incurred in the process of purchasing the asset. As we have seen. the financial institution will seek to eliminate any warranty claims that might be made against it by the lessee. Regardless of the lessor’s responsibilities under an Ijarah transaction. rather than to the lessor. in an Ijarah transaction the lessor is responsible for the adequate operation of the equipment. Generally. except for equipment breakdowns resulting from the lessee’s negligence or oversight. any disclaimer of warranties must be conspicuous. Similarity The rental or lease payments under the lease start when the lessee takes possession of the asset being leased. not from the date the lessor purchases the asset for the lessee. Similarly. warranty disclaimers that fail to meet those requirements may be held to be invalid. Although it is generally possible to disclaim warranties. insurance—The costs of insuring the leased asset are borne by the lessor.

for example by selling it to new owners. that is.3 million (=24 x $1.012. and 2. Persons who share the ownership of a leased asset can dispose of their property.500). at a total rent of $24. or buy the leased asset by the time set for its delivery to the lessee. This characteristic of Ijarah is essential for securitization of leased assets. etc. the payment of rent may begin before or after the beginning of a lease.9 million per year beginning from the end of the first year. one may lease an asset that is only described and defined in detail at the time of the contract. an Ijarah contract can be arranged for a bridge whose construction takes three years. The payment of rents may be spread over 27 years at a rate of $0. in this connection. Independence of ownership An asset whose ownership is shared by many people can be leased. that is.18 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) Sale of the Leased Asset11 An Ijarah contract in Shariah does not restrict the right of the lessor to sell the leased asset. or part of it. provided the new owner will honor the existing Ijarah contract. the bond holders make a 9% yearly return on their investment. and allows benefitting from the market conditions with regard to the negotiability of the bonds. are as follows: 1. An asset may be given on lease for 10 years. the lessor should be able to fully carry out the commitment made in the lease contract. The important and necessary conditions.. and which is leased to the government for 24 years after the construction is completed. they could be at the beginning or at the end of each period of the lease. while payment of rent may be spread over a period of 12 years. The asset should be clearly described in a way that does not create any ambiguity or controversy about it. In other words. Ijara of non-existing Assets Shariah does not require that the asset/subject of the Ijarah contract should be in existence at the time of the contract. as per the terms of the agreement. the fact that the asset is leased to somebody else does not restrict the owner’s right to dispose of the asset in any form as long as it does not hinder the delivery of the usufruct to the lessee. an Ijarah contract is flexible regarding the timing of rent or lease payments. or vice versa. The lessor should normally be able to acquire. to a new person independently of the other owners. as they may desire. Payments can be made to coincide with the units of time by which the usufructs of the asset are defined. construct. In other words. at a cost of $10 million. the leased asset can be sold. Since the lessor remains the owner. For example. This characteristic of Ijarah also facilitates the securitization of leased assets. Additionally. For instance. The rent payment may also be unrelated to the periods of usufruct. and rents could be payable monthly. yearly. 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). individually or collectively. timing of Lease Payment Unlike a sale. either individually by each owner leasing his or her owned share of the asset or together by all the owners in one contract and under the same conditions. the owner of a share of an asset can sell that share. 11 Please see end notes at the end of this focused toolkit . 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).

Any maintenance or insurance expenses for which the owners may remain responsible can be undertaken by the lessee on the basis of wakalah. For example. or subtractions. or long term. The rent may also be determined for the first period. Maintenance expenses that fall to the owner are of two kinds. according to Shariah the lessor is required to maintain the leased asset in a condition that allows the lessee to extract from it the contracted usufruct. However. There are many ways to put a known rent into an Ijarah contract. an aircraft) after a certain number of hours of work or operation. and the owner (for example a bondholder) would then be charged by the lessee for his outlays. is known either at the beginning of the renewal period for which the increase or decrease applies or at the time of contract. for land. These and similar expenses that can be predicted in advance may actually be charged to the lessee as a part of the rent. medium. or remain constant as long as the formula for increments. Insurance and Maintenance Expenses In the Ijarah contract. on behalf of the owner. rate of return on capital. plus predetermined maintenance and insurance expenses made by the lessee on behalf of the owner. because the assets are replenished through the amortization funds. all predictable maintenance and insurance expenses can be included in the rent in such a way that rent would then consist of cash payments made by the lessee to the owner. for example regular oil changes in automotive equipment. First. actual rent payable by the lessee may increase. decrease. or any other variable. predictable periodical or quasi-periodical expenses. Shariah permits making the lessee responsible for all predictable maintenance and insurance expenses of the asset. such an overhaul of the leased machine (e. There may also be unpredictable changes in the cost of insurance. as stated earlier. the Ijarah may be for one year renewable on a permanent basis. such as a periodically announced price index.g. and these would be placed on the account of the lessor. renewable permanently. determination of rent In an Ijarah contract. 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. as long as the asset which is its subject remains in existence and renders its usufruct for the duration of the contract. which would also become the responsibility of the lessor. assets for which a suitable amortization schedule could be made may be given on lease for a period of one year.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 19 Period of Ijara An Ijarah contract is not restricted to the short. some maintenance expenses might not be predictable.. For each subsequent period. It can be set to any term. As a result. This implies that maintenance expenditures related to the basic characteristics of the asset are the responsibility of the owner. For instance. while maintenance expenses related to its operation. rent may be related to a variable that will be known before the beginning of the renewal period. are to be taken care of by the lessee. that is. . the rent must be made known. Similarly. In addition. notwithstanding the lessor’s responsibility to maintain the equipment.

asserts that (a) any combination of assets can be represented in a written note or bond. 12 Please see end notes at the end of this focused toolkit . Prepayments in Ijarah security deposit: advance rental: 1 to 3 monthly installments are the norm. 2. the issuance of securities that are financial assets. First rental of the lease. two parts of a lease term: 1. as compared to a minority of cash and interpersonal debts. the decision clearly 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: 1.20 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) Securitization of Assets Subject to the Ijarah Contract12 The idea of an Ijarah bond stems from the ability to transform leased assets into financial assets. 5 of the 4th Annual Plenary Session of the oIc Fiqh Academy. guarantees: margin of financing: Legal Opinion Regarding Securitization decision no. provided that the composition of the group of assets. or a guarantee for. interpersonal debts. Furthermore. a security cannot be considered as totally or completely separable from the assets it represents. buildings. physical assets 2. Islamic banks may use the monthly lease rental to offset against the final rental of the lease. financial rights (such as the usufruct in Ijara) 3. that is. Guarantees that can be taken to support the transaction include both personal or individual guarantees and corporate guarantees. or any other property as collateral. IJArAH—trAnSACtIonAL ISSuES The following is a point-form summary of Ijarah transactional issues: collateral: The financial institution may accept land. represented by the bond. the oIc Fiqh Academy. held in Jeddah 18-23/6/1408H (611/2/1988G). put forward an important and essential rule that clarifies the position of Shariah about securitization. Secondary lease period: This period commences if the lessee decides to exercise the option to continue to lease the asset after the expiration of the primary lease period. while discussing sanadat al muqaradah. as follows. Primary lease period: Period for which the lessee (financing customer) has contracted to lease an asset. The margin may be up to 100% of the current price of an asset or the valuation price of an asset. money. and (b) this bond or note can be sold at a market price. In its 4th Annual Plenary Meeting. A financial asset is always regarded in Shariah in association with the asset(s) it represents. Securitization means using certain income-generating physical assets as a base of. consists of a majority of physical assets and financial rights. and 4.

To achieve this. 2. and together are thus referred to as this third type of contract. used extensively in Malaysia and also referred to as IMB or Ijarah wa Iqtina. The financial institution then enters into the Ijarah contract with the client. The institution pays cash and the ownership of the asset transfers to it. its benefit to the client. To reduce the burden if losses occur. encompasses the idea of leasing ending with an option to buy the asset. 1. different terms are used for the same or similar financial tools. The client of the financial institution approaches a seller or vendor of an asset and gets price and product details. Suitable coverage is a comprehensive ‘All Risks’ type. such as the constant rate of return (cRR) and Rule of 78’s (sum of digits). Ijarah first and then Al Bai. AITAB. the rental amount. 4. 2. Total lease rental is determined using available methods of calculation. with the exchange of goods for money. to the institution. In this hybrid mechanism. in which title to the asset is passed to the lessee when the contract terminated. As in many jurisdictions. normal steps in the transaction of an Ijarah contract are as follows: 1. The client pays the agreed rental. with the acceptance of the client. It was essentially created by combining two Islamic contracts: the Al-Ijarah (leasing contract) and the Al-Bai (sale) contract.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 21 Calculation of the total lease rental: AL-IJArAH tHuMMA AL-BAI (AItAB) The instrument known as Al-Ijarah Thumma Al-Bai (AITAB). The contract identifies the asset. use of asset: asset ownership: takaful coverage: Assets leased may not be used for activities that contravene Shariah. the Al Ijarah contract relates to the exchange of the use of the asset (the usufruct) for money. . 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. whereby the possession and right of specified use are given to the client. The financial institution buys the asset from the seller based on the information provided by the seller to the institution’s client. and the period. based on the payment plan in the Ijarah contract. 6. ownership remains with the financial institution. 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. 5. the two contracts are sequential. This construct is also referred to as IMB (translated as leasing ending with ownership) and is sometimes transliterated into English as Ijarah Muntahia Bittamleek. The client approaches the financial institution with the asset price and details and negotiates with the institution to use the AITAB contract structure. to the financial institution. Total lease rental = amount of financing + profit margin.

000 x 0. when the time limit in the Ijarah contract expires. with all costs. therefore it is impossible to apply the “principles of the time value of money. gifted)—or equal to last month’s lease rental.000 per month Sales price = amount agreed. Example of AItAB Financing Calculations In this structure the financial institutions tend to use these calculations: Assumptions: The financial institution determines that it wants to have a profit rate (PR) of 10 percent. Lesson Learned The difference between the profit calculation made under an AITAB contract and the profit calculation under a conventional lease (as described in Section III. or such other amount as agreed. whereupon the institution transfers ownership of the asset to the client as either a gift or a sale.000 + 500.e. Since the earning of interest (riba) is not allowed.000 Total lease rental = Purchase price + profit $1.000 Monthly rental = Total lease rental divided by the term $1. .000/(5 x 12 months) = $25.500.” including net Present Value. of the base toolkit—Leasing Mathematics) is this: The time value of money does not apply. At all stages.000 = $1. the full terms and conditions must be clearly explained and understood by the client and the financial institution. simply an agreement for sale and purchase as added (al-Bai). The essential terms and conditions of the AITAB contract are the same as those of the Al-Ijarah contract.500. executed by both parties. The leasing agreement (Ijarah) between the financial institution and the client. as zero (i. the final payment of the Ijarah contract may be taken as the agreed sale price of the asset under the al-Bai contract. 3. is $1. the use of Internal Rate of Return to express yield does not exist in an Ijarah transaction.000.10 x 5 = $500.000. 2.000. The letter of acceptance (aqad) between the financial institution and the client. There is no return on money in Islam. whichever are the terms of the original agreement. documentation for AItAB It is important to note that to meet Shariah principles the financial institution and its personnel must understand the instrument.000. The purchase price (PP) to the financial institution. to the profit calculation under an AITAB contract.22 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 7. The term (T) of the lease is 5 years. Calculations: Profit (P) = Purchase price x profit rate x period of financing $1. The documentation must be handled in this sequence: 1. The sale and purchase agreement (al-Bai) between the lessor and equipment supplier. the financial institution enters into the al-Bai (sale) contract with the client. Part 1. In some cases.

for example) may be borne by lessee. Interest may be applied (1% per month. without exception. Most Islamic financial institutions have standing religious boards and Shariah advisors for this purpose. lessee. It is essential. Calculation of Profit Charges Related to the Purchase of the Leased Asset Late Payments Acceptance Letter (Aquad) Asset Being Financed Insurance Warranties (Expressed or Implied) Cancellation All charges are borne by lessor. including both a lease contract (Ijarah) and the sale/purchase contract (al-Bai). with respect to lessee’s purchase option at the end of the lease term. Shariah compliance not necessary. and the lessor must rely on Takaful insurance for compensation. Cancellation—Under AITAB. the principal of “arm’s length” does apply. Shariah compliance not necessary. and equipment supplier.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 23 Comments on differences between Conventional Lease contracts and AItAB AITAB CONTRACT Nature of Contract Hybrid instrument. Lessor charges a fixed profit and no interest. Lessee must enter into an acceptance letter. Always for the benefit of the lessee. Same. if the equipment is lost or destroyed the lease may be cancelled. May be transferred from lessor to lessee. any wealth assessment for zakat will not include the asset. Because the client renting or leasing the asset is not its owner. which vary among nations where AITAB is offered. to seek approval from qualified Islamic scholars when implementing such programs. use Acceptance Letters. Principle of “arm’s length” applies between lessor. Lease can be cancelled if equipment is lost or destroyed. Must be Shariah compliant. Lessons Learned Use of Acceptance Letter In both AITAB and conventional lease transactions. therefore. Legal Issues to Consider The need to conform to certain religious principles affects the structure and development of Islamic finance programs. 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) Some charges (shipping & installation. CONVENTIONAL LEASE Same. the lessee is responsible for obtaining property and casualty insurance and naming the lessor as a “loss payee. the “rental” or “Ijarah” payments can be offset against corporate tax by the lessee. Under both types of transactions there is no obligation on the part of the lessee until an Acceptance Letter is executed by the lessee. regardless of whether or not the lessor has property or casualty insurance. particularly before developing new financial instruments. Must be insured using Islamic Takaful insurance. . Under conventional leasing in the west. leases are non-cancellable. for example) to late payments. A fixed charge must be specified in the contract. the lessee is no longer able to generate usufruct from using the equipment. As we have seen (in Part III of the Base Toolkit). when the equipment is lost or destroyed. in this particular case. Therefore.” tax Benefits of AItAB depending on tax laws. Lease is non-cancellable.

takaful business. the Islamic banks are advised and provided guidelines by SAc. 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. as follows. stating that a leasing contract that contained a right of the lessee to purchase the leased asset at the nominal price at the end of the lease term was void insofar as it violated Shariah provisions. It is based on Shariah principles and is supervised and regulated by Bank negara Malaysia. commercial banks do not have a Shariah board for guidance and/or supervision in their day-to-day operations. as the highest Shariah authority on Islamic banking and takaful in Malaysia. Islamic development financial business. recorded in case no. Bank negara Malaysia (BnM) established the national Shariah Advisory council on Islamic Banking and Takaful (nSAc) on May 1. In Malaysia. The court did not take into consideration the fact that the leasing agreement merely pointed out that a separate sale agreement would be entered into and the ownership would not be transferred under the leasing agreement itself. and Indonesia— based on the countries’ regulatory approaches. Malaysia As part of the effort to streamline and harmonize the Shariah interpretations among banks and takaful companies. There must be two contracts.13 Legal Precedent—drafting a Leasing Contract in the republic of maldives. Bahrain. a lease and a sale. Iran Products that can be offered by banks have been defined in regulations issued by the council of Ministers under the Usury Free Banking Act 1983. or any other business. 1997. Islamic financial business. 1997. the court ruled against a leasing company (maldives finance leasing company. as the authority for ascertaining Islamic law for the purposes of Islamic banking business.24 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) A case in point is that the contractual structuring and the wording of the contracts must be such as to comply with Shariah law and with associated fatwas in the country of jurisdiction and operation. in accordance with which one contract shall not contain two elements at the same time. As the reference body and advisor to Bank 13 14 Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit . The Shariah Advisory council (SAc)14 of BnM was established on May 1. ExAMPLES oF tHE IMPACt oF SHArIAH ruLIngS In Four CountrIES Four different approaches are being followed in Shariah rulings in different countries—Iran. 893/mc/2008 (MFLc v Mohamed naeem)). Malaysia. The council of Guardians performs the function of a central Shariah board and provides guidelines to the central bank and commercial banks. and the process of presenting the documents and executing them is as important as the contracts themselves.

it advises BnM on the Shariah aspects of the operations of these institutions. however. A Shariah committee plays a complementary role 15 Please see end notes at the end of this focused toolkit to that of SAc. the Shariah Advisory council is the ultimate arbiter. takaful. The guidelines set out the rules. Shariah committees are formed internally by Islamic banking institutions. in addition to creating and expanding the pool of competent Shariah personnel in Islamic banking and takaful. duties and responsibilities of a Shariah committee are as follows: . Its duty is to advise the banking institution on the Shariah compliance of its banking operations. as well as the relationship and working arrangement between the committee and SAc. The requirement to establish the committee covers all Islamic banks and all banking institutions that participate in Islamic banking schemes. The Guidelines on the Governance of Shariah committees for Islamic Financial Institutions were issued by BnM in december 2004. regulations. and Islamic finance. and development financial institutions that provide Islamic banking facilities. and procedures for establishing a Shariah committee and the role and scope of duties and responsibilities of the committee. These aimed at achieving uniformity of Shariah decisions. which was accorded the status of a sole authoritative body on Shariah matters pertaining to Islamic banking. To preserve its independence. SAc is also responsible for validating all Islamic banking and takaful products to ensure their compatibility with the Shariah principles. The central Bank of Malaysia Act of 1958 was amended in 2003 to enhance the role and functions of SAc. members of SAc are not allowed to participate in any Shariah committee of any financial institution. as well as on their products and services. The Malaysian Judiciary and the Regional center for Arbitration kuala Lumpur15 uses SAc as the reference point in the event of disputes involving Shariah issues on Islamic banking and finance.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 25 negara Malaysia on Shariah matters. takaful operators. In addition.

the committee prepares written Shariah opinions in the circumstances (1) where the Islamic financial institution makes reference to SAc for advice. or (2) where the Islamic financial institution submits applications to Bank negara Malaysia for new product approval in accordance with guidelines on product approval issued by Banknegara Malaysia. Upon any Shariah matters that have not already been resolved or endorsed by SAc. upon request • To advise the Islamic financial institution to consult it on In particular. and . tion • To endorse Shariah compliance manuals • To assist related parties on Shariah matters for advice.26 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) • To advise the Board on Shariah matters in its business opera- • To record any opinion given. The Shariah committee is also expected to assist SAc on any matters referred by the Islamic financial institution.

the Board of commissioners. The national Sharia council (dSn) possess the power of positive law. each Shariah supervisor is obligated to submit a report every six months on the finding of Shariah supervision to the Board of directors. and the Bank of Indonesia. Each bank must have a separate Shariah review function to verify compliance. which may be located in the bank’s internal audit function. Each Islamic banking institution is required to appoint a Shariah advisor. dSn also takes a role in the Shariah Supervisory Board selection process. salam. the rulings of the Shariah Supervisory Boards of Islamic financial institutions are binding on the respective institutions. have adopted Shariah standards issued by the AAoIFI. There is no difference of opinion among the world’s Shariah scholars about the permissibility of these modes. In 2005. The regulatory authorities of some countries. the Bank of Indonesia also issued a regulation on Standards of contract. So far. In other countries. and Salam contracts. SHArIAH SuPErvISorY BoArd (dPS) Every Islamic bank (or window) is obliged to have a Shariah Supervisory Board (SSB). the ruling of SBP’s Shariah Board is final. the regulations (released in 2006) are concerned with Ijarah.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 27 obtaining any advice from SAc. Islamic financial institutions all over the world are generally using similar modes of Islamic finance and products. is an independent body duly recognized by the Bank of Indonesia and is responsible for issuing Shariah rulings on the products of Islamic banks. There are differences of opinion among Shariah scholars on 16 Please see end notes at the end of this focused toolkit Bahrain The central Bank of Bahrain requires all banks to establish an independent Shariah Supervision committee complying with AAoIFI’s governance standards for Islamic financial institutions. Sudan. The Shariah Board of the State Bank of Pakistan (SBP)16 has approved Essentials of Islamic Modes of Finance and Model Agreements. and regulatory authorities do not intervene in these affairs. The Bank of Indonesia has set up “fit and proper” criteria. . All banks must comply with all accounting standards issued by AAoIFI as well as the Shariah pronouncements issued by the Shariah Board of AAoIFI. There is no restriction that the members of the national Shariah Board must serve any financial institution. with minor differences of nomenclature according to their regional. This reporting structure reflects the status of the Shariah committee as an body that is independent of the Islamic financial institution. the commonly used modes are murabaha. However. and no limitation requiring them to serve only one institution. Apart from coordinating with the Bank of Indonesia. the Shariah committee shall ensure that all of SAc’s decisions are properly implemented by the Islamic financial institution. while some others use them as guidelines. responsible to give approval regarding the Shariah compliance of all of the institution’s products and to issue Shariah rulings. which is periodically evaluated to stay relevant with the Islamic banking industry. like Bahrain. there are certain differences in application and modus operandi of the transactions among different countries. to upgrade SSB’s roles. SBP’s Shariah Board advises the bank in forming its regulations on Islamic banking. the Shariah committee reports functionally to the board of directors of the institution. In case of any difference of opinion between SBP’s Shariah Board and the Shariah advisor of an Islamic bank. and other conditions. the banks are authorized to offer products based on Islamic modes under the Banking companies ordinance of 1962. musharaka. diminishing musharaka. The national Shariah Board of the central Bank of Bahrain serves and verifies the Shariah compliance of its own products only. The SSB also plays a critical role as partner of the Bank of Indonesia in Islamic banking supervision. with regard to the reporting structure. mudaraba. istisna. In addition to Ijara. which were previously issued as guidelines to all Islamic banking institutions and have now been made part of the recently issued instructions for Shariah compliance in Islamic banking institutions. In Pakistan. Furthermore. Istisna’a. Indonesia In Indonesia. The Bank of Indonesia issues regulations for Islamic banking products based on a fatwa issued by national Shariah Board. and Syria. the national Shariah Board formed by the Indonesian council of Ulemas in 1999. wakala and kafalah. the national Shariah council. legal. which include a test for new SSB members that cover their understanding of Shariah principles and knowledge of Islamic banking and finance in general.

bai al inah. 4Wd. Who can apply • Individuals ages 18 and above • Sole proprietorships • Partnerships IJArAH trAnSACtIon ExAMPLES • Private limited and public limited companies Example of Car Leasing Shariah-Compliant Car Financing Based on the Principles of Ijarah Thuman Al-Bai (AITAB)17 margin of finance Up to 90% financing period Up to 9 years Terms of financing Titled Vehicles—Margin of finance / Repayment period new passenger car. and commodity murabaha. mpV and suV (cbu and cKd units): Maximum of 90% of seller’s invoice Maximum 108 months second-hand passenger car. online • Renewal of road tax and motor insurance Types of goods financed • new motor vehicles • Second-hand motor vehicles • Reconditioned motor vehicles 17 Please see end notes at the end of this focused toolkit . tawatruq. ATMs. 4Wd. like bai al dain (debt trading). hibah on current accounts. mpV and suV: Maximum of 85% of seller’s invoice Maximum 108 months unregistered reconditioned (imported) vehicle: Maximum of 90% of seller’s invoice Maximum 108 months *All terms and conditions are subject to the financing guidelines by Bank negara Malaysia and Maybank.28 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) the permissibility of certain modes and practices. Malaysia Benefits • Based on the principles of the Ijarah contract (leasing/ renting) and the bai contract (purchase) • Extensive network of dealers nationwide • Easy payment of installment via branches.

(second-hand cars only) • Photocopy of registration card (second-hand cars only) • Pro-forma invoice from seller For non-individual applications.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 29 Required documents • Photocopy of national Id • Photocopy of driving license • copies of last 2 years’ income tax returns (J form or EA) • 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 Repayments Payments must be made for the complete installment amount. Partial payments or incomplete installment payments are not be accepted. other documents may be deemed necessary. .

000 and the customer makes a $40. until the final ownership payment of $1.00. The major difference between a traditional mortgage amortization and an Ijarah transaction is that the Ijarah transaction is based on a reverse amortization calculation. this amount decreases.30 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) IJArAH HoME FInAnCE18 How the Monthly Ijarah rent Payments Are Calculated The initial Ijarah amount that is financed by the customer earns a profit for the investor through monthly rental payments. Traditional amortization calculations are utilized to determine the exact monthly payment. then the initial amount the customer has to pay the investor for 100 percent ownership is $160. These mathematical formulas are acceptable since there are no Sharia issues connected with mathematical calculations. For example. if the value of the property is $200.001.00 18 Please see end notes at the end of this focused toolkit .000 down payment. How the Purchase Price of the Ijarah transaction Is determined The purchase price that is agreed to in the Promise to Purchase is equal to the original purchase price less the down payment made by the customer plus $1. As the customer’s ownership increases.

4. The Ijarah transaction is structured in such a way that 100 percent of the gain is rightfully the customer’s. the sale to the new buyer and the original promise to purchase agreement with the Trust. The procedural steps above create a situation where the customer holds 100 percent title. tenant or Homeowner? In an Ijarah transaction.000 in rent. Furthermore. From a procedural perspective. now let’s look at a traditional mortgage interest transaction: 1. landscape. it is acceptable to describe the profit on an Islamic Ijarah transaction as a percentage. That $6. Is that 6 percent to be regarded as rent or as riba? clearly it is rent. They proceed to purchase the same home with those funds. You sign a lease that obligates you to a rent payment over a period of time. 4. The first example was rent on property. In this case. 5. They pay you the same $500 per month. and by doing so they entitle the customer to be the beneficiary of the difference between the two agreements. or 6% a year for use of the money. at the time of sale 1. is the 6 percent riba? Yes.000 in cash. it is also a requirement under the Truth in Lending Act/consumer Protection Act.000 in rent is a 6% return on your $100. the gain or loss is shared by the parties in a transaction according to their percentages of ownership. 3. sublet. and 4. 3. or basically utilize the property for any legal purpose that it is zoned for. 2. it is in fact acceptable to describe the profit on an Islamic transaction as a percentage. You rent the home to a tenant for $500 per month. the customer will then transfer the title to the new buyer. you are responsible for all the maintenance of the property and you have all the rights and duties of a homeowner. unlike in a typical rental property lease. The only exception may be if you engage in an activity that could harm the value of the property. that any profit earned on a residential real estate finance transaction should be described as a percentage so that a customer can clearly understand what the overall cost of the financial transaction is. since it is rent on money.000 investment. You purchase a home and pay cash for the home. . the Trust will transfer the title of the property to the customer. Suppose you have $100.000 cash. you have collected $500 x 12 or $6. 2. because once your have fulfilled your obligations under the lease or promise to purchase. Under Shariah. you can remodel. The Ijarah transaction abides by this principle. and that is the customer.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 31 the Basis of using a Percentage while it may appear contrary to Sharia. you are technically a tenant. your role is the same as that of a homeowner. The following example should clear up any confusion regarding the acceptability of quoting the profit as a percentage in an Ijarah transaction: 1. albeit for a short time. since it is based upon a business transaction. So it should be clear that from a Sharia perspective. Starting with the same $100. you become the owner of the property. 3. there is only one owner of the property. For all practical purposes. Sharing of a gain or Loss one of the basic Sharia compliance principles is that there should be a sharing of either a gain or loss in a financial transaction. in that when the gain or loss is realized. 2. then the customer will settle with the Trust according to the agreement between the customer and the Trust (the Ijarah documents). At the end of the year. it is. You can sell the property any time you wish. such as demolishing a garage without rebuilding it. However. You give someone the money. the new buyer will then settle the transaction according to the agreement with the customer. decorate.

However. comprehensive feasibility study prepared by reputed consultant. Sharjah Islamic Bank Forward Ijarah is a form of lease which ends by transferring ownership of the asset (the subject of the contract) to the client upon maturity and upon the client meeting all its obligations under the contract. will lease the asset (or its share in the asset) to the client and the client will receive agreed rentals. 10.32 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) ForWArd IJArAH (rEAL EStAtE FInAnCIng)19 terms of Financing: • Type of property: Freehold. copy of title deed. • Mode of Repayment: Monthly. the client may be a partner in a project (the property) contributing its share in the form of land and cash. the bank will have a common share of the property. Qualified Assets: Residential. • Insurance: Insurance policy covering the property under construction to be assigned to the bank. • Security: First-degree registered mortgage on the plot and the building. and based on the client’s request and promise to lease the asset. in addition to the other terms of approval. semiannual. 5.. 6. including up to 2 years for the construction period. 7. copy of approval of electricity connection date. 3. on completion of the construction. 9. Payment of the applicable fees for the project’s technical assessment by the bank’s in-house engineers. which will form the subject of the Forward Ijarah contract. while the bank’s share is putting financing at the project’s disposal for construction. Project specification and approved drawings. whether it is a full share or a common share of a property. • cash contribution: Minimum of 40% to 50% of total project cost. In any case. the bank will transfer the ownership of the property to the client for a nominal sale price under a separate sale contract. Secondary: other incomes. copies of the consultant / contractor agreements. office Buildings & Villa complexes documentary Requirements: 1. copy of valid passport. or annual terms available • Sources of repayment: Primary: Rental income of the project. Full details of personal financial information supported with documents. details of the terms under which this product is offered are outlined below: • Finance tenor: 10 years. 4. the bank. In such as case. If the subject of a contract. Personal bank statements for the last six months. 2. At the end of the lease period (i. does not exist when the Forward Ijarah contract is signed. which has accepted the offer according to the terms and conditions set out in the Forward Ijarah. • Floating rentals: Relevant EIBoR + bank’s margin with a minimum of certain rate. completed finance application form. 8.e. 19 Please see end notes at the end of this focused toolkit . it may be acquired by the bank under an Istisna sale contract or any other Shariah-compliant mode of finance. 11. quarterly. on maturity) and upon meeting all its obligations under the Forward Ijarah contract. copy of site plan.


especially those in need of assets or equipment. taxis to transport people. a property specified in the promise and then leases it to the client on terms of financial lease. • Age of property: Should not exceed 20 years. • Qualified assets: Residential. Microleasing or micro-Ijara serves as a mode of microfinance. 21 20 Please see end notes at the end of this focused toolkit 22 Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit . principally for its noncompliance with Islamic principles. • Advance rent: Minimum of 40% to 50% of the purchase price. details of the terms under which this product is offered are outlined below: ISLAMIC LEASIng For MICro. the bank’s purchasing cost and profit are recovered and the bank can then transfer the ownership of the property to the client for a nominal sale price or as a gift. has been rejected. in addition to the other terms of approval. As a result. And MEdIuM EntErPrISES (MSME) In some Muslim communities. All kinds of income-generating equipment and physical assets may be financed through this mode for the poor. conventional interest-based microleasing. quarterly. and villa complexes. it is estimated that up to 72 percent of people living in Muslim-majority countries do not use formal financial services at all (Honohon 2007)21.34 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) IJArAH (EndIng WItH tItLE dEEd) MuntAHIA BIttAMLEEK20: Ijarah is a form of leasing where a property (commercial building / complex of villas) is leased by the lessor to the lessee in such a way that at the end of an agreed lease period. the bank purchases. semiannual. • Security: First-degree registered mortgage on the plot and the building. shops to sell merchandize. the lessee becomes the owner of the property by purchasing it from the lessor either during or at the end of the lease period at an agreed sale price. for itself and in its own name. Applying the above. The extent of the market opportunity is evident when one realizes that Islamic microfinance represents less than 1 percent of total global microfinance outreach (karim et al 2008)22. and tools and machines to manufacture or produce products. office buildings. Al-Ijarah Muntahia Bittamleek is thought to be more suitable for MSMEs. terms of Financing: • Type of property: Freehold. includ- ing the repayment tenor. • Sources of repayment: Primary: Rental income of the project. SMALL. The lease rent is structured so that at the end of the lease period. They include carts. Products used by these institutions include Ijarah and Al-Ijarah Muntahiya Bittamleek. provide the base for Islamic Ijarah for MSMEs. low-cost houses. • Floating rentals: Relevant EIBoR + bank’s margin with a minimum of a certain rate. An important Shariah rule governing Ijarah as a tool of microfinance is that the risk and liabilities emerging from the ownership of the asset substantially remain with the lessor. or microfinance. or annual terms are available. These Muslim clients. at the end of the lease period. Secondary: other incomes. particularly on the issue of paying interest or riba. who demand products consistent with Islamic financial principles. upon the client’s promise to lease from the bank. which is forbidden under Shariah. The structures and terms of the Ijarah instruments are as outlined above. • Mode of payment: Monthly. • Financing tenor: Up to 8 years. by either a separate sale or gift contract. This has contributed to the failure of government initiatives using conventional microleasing in these communities to overcome poverty and promote economic development.

Sudan. on transfer of the payment of the balance rentals 2. for the transfer to be effective a contract distinct from the Ijarah contract should be executed. . According to IAS 17. Qatar. is an agreement whereby the lessor conveys to the lessee. Thus IMB/AITAB would have the characteristics or the substance of a conventional lease only if the lessee exercises the option. it is referred to as Ijarah Muntahia Bittamleek (IMB) or ITAB. which he may or may not exercise. Lebanon. Since IAS looks at substance over form for accounting purposes. Ijarah and a conventional lease differ in this respect: regarding the requirement to comply with Shariah rules. and Syria. according to the International Accounting Standard. If the contract refers to a promise that the legal title would ultimately pass on to the lessee (mustajir) at its expiration. nor for unlawful transactions. In the Islamic version. as a gift 3. maintenance. the dubai International Financial centre (dIFc) in the UAE. Shariah does not permit Ijarah for use of an asset for payment of interest or involving merchandise considered as haram.” However. Major repairs. a lease is classified as a finance lease if it “transfers substantially the risks and rewards incidental to ownership. they have been officially adopted only by Bahrain. the risks remain with the lessor (mujir).” A lease is classified as an operating lease if it does not transfer substantially all risks and rewards incidental to ownership (see Base Toolkit. Following AAoIFI’s Juristic Rules on the fulfillment of a promise. otherwise. formulated by the Accounting & Auditing organization for Islamic Financial Institutions (AAoIFI). The passing of the risk to the lessee is a prerequisite for a lease to be classified as a finance lease under International Accounting Standards.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 35 AAoFI Although AAoIFI standards are widely followed (without obligation) across many countries. 8. provides an accounting treatment for Ijara. Part V. IntErnAtIonAL FInAnCIAL rEPortIng StAndArdS (IFrS) vS AAoIFI And tHE MALAYSIAn ACCountIngS StAndArdS BoArd (MASB) Comparison With the Conventional Lease Financial Accounting Standard (FAS) no. Thus. whereas these costs are passed on to the lessee in a conventional lease. Jordan. In IMB/ITAB. Accounting). on payment of a token or for an amount specified in the contract. which is loosely considered as equivalent to the conventional finance lease. The key distinction between the IMB/AITAB and the conventional finance lease is that in the Islamic version the lessor undertakes the full ownership risks of the corpus of the leased asset. A ‘lease’. the AAoIFI definition includes the additional condition that the benefit should be Shariah-compliant. on the gradual transfer of the title. This AAoIFI-recommended standard for Ijarah differs in many respects from the standard formulated for conventional leasing. known as International Accounting Standard 17 (IAS 17). AAoIFI FAS 8 also embodies a classification of the instrument into two categories. at the expiration of the term the passing of the legal title to the lessee could occur either 1. and insurance remain on the account of the lessor in an Ijarah contract. or 4. Ijara is defined as “ownership of the right to the benefit of using an asset in return for consideration. IMB/ITAB for all intents and purposes is an operating lease. when passing the risks and rewards of the asset to the lessee the asset is recorded in the books of the lessee coupled with the right to claim depreciation. The lessee has an option. in return for a payment or series of payments. the right to use an asset for an agreed period of time. Hence in both legal form and concept IMB/AITAB and a conventional finance lease are not identical. the risk follows the legal title unless damage is caused by the negligence or misconduct of the lessor. one might view it this way: In Ijarah.

the revenue decreases progressively. at cost on initial recognition and at book value thereafter. The Ijarah installment paid is presented in the lessee’s income statement as “Ijara Expense. the depreciation entitlement for both forms is vested in the lessor. nevertheless under the presumption that the leased assets are deemed to be used in the lessor’s business of leasing. value Added tax (vAt) The exposure of the Ijarah rentals to VAT. in calculating the depreciation of Ijarah Bitamleek assets the residual value will be taken as zero if the lessee’s acquisition of ownership at the end of the period is made through gift. “Investments in Ijarah Assets” and “Ijara Munthia Bitamleek Assets. should be presented in the income statement of the lessor as “Ijara Revenue” on an accrual basis and allocated proportionately according to the term of the lease recognized in the period in which they are due. like Sri Lanka. The right to claim depreciation follows the recording of the asset in the books of the lessor. the lessor enjoys the right to claim capital allowances. under the headings. the same status quo ought to prevail for Ijarah and IMB regarding capital allowances. the lessor (mujir) should also be cautious about possibily creating a permanent establishment in the lessee’s (mustajir’s) jurisdiction. In a scenario involving a cross-border Ijara. The legal / notary fees and stamp duty involved in the dual transfer of title (in IMB) and the property transfer tax may increase the cost of the entire structure in many jurisdictions. depreciation Allowance In certain countries. Unlike in a conventional finance lease under IAS. as opposed to the VAT exemption enjoyed by interest. Ujrah does not consist of a capital component and an interest element. specifically the recording of ‘lease rentals receivable’ and ‘interest in suspense’ in the books of the lessor. Hence the application of accounting methodology adopted for conventional lease rentals under International Accounting Standards. The two categories of assets should be shown in the Statement of Financial position.36 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) ACCountIng undEr AAoIFI The nature of Ijarah rental (or ujrah) is that it represents consideration for the right to use an asset. though the local tax statutes do not explicitly allow the lessor to claim capital allowances under operating and finance leases.” allocated over the lease period recognized when due under both forms of Islamic leases. In these countries. source: © islamic finance today—pioneer publications (pvt) ltd 23 23 Please see end notes at the end of this focused toolkit . if the transfer to the lessee is at a token amount specified in the contract. LESSonS LEArnEd—tAx ISSuES InvoLvIng IJArA Application of Stamp duties/notary Fees The cost of Ijarah in comparison to a loan may be high due to the associated transactional taxes on additional steps involved. on the other hand. is another factor that may have an impact on the pricing. Ijarah and IMB. Installments of both forms. where the lessee acquires title through gradual sale. the said amount should be subtracted in determining the depreciable cost. Ijarah rental would be exposed to withholding tax. while the depreciation of Ijarah assets will be based on the depreciation policy of the lessor. The FAS 8 rule formulated by AAoIFI stipulates that assets rented on the basis of both Ijarah and IMB should be recorded in the books of the lessor (mujir). would pose an issue in accounting for ujrah.” respectively. Though interest paid on a loan from a bank does not attract any withholding tax under most of the tax systems found in the world.

FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 37 MALAYSIAn ACCountIngS StAndArdS BoArd (MASB) Malaysian Accounting Standards Board (MASB) has come out with Financial Reporting Standards 1. plays. Any entity that applies FRS 117 for a period before the commencement date should disclose that fact. the accounting treatment for Islamic hire-purchase. on Ijarah and IMB. 8. Unlike the MASB or FRS standards. FRS 117 is applicable to all leases except the following: Lease agreement for exploration of natural resources. the AAoIFI standard is merely a voluntary action for Islamic financial institutions to follow. early adoption is encouraged. FRS 117 is also not applicable to the measurement issue in relation to the following: Lease agreements for investment property (which are to be covered under FRS 140. However. and copyrights. Investment Property). MASB is actively looking for the best practice of accounting methods to suit all Islamic banking operations. This became effective in January 2004. Agriculture) 24 Please see end notes at the end of this focused toolkit . the accounting standard that prescribes accounting treatments for leases is FRS 117. and lease agreements for such items as motion pictures. will be similar and follow the general guidelines of FRS 117. It discussed the treatment of an Ijarah transaction on the books of the lessor as well as the lessee. In addition. a rule for the Presentation of Financial Statements of Islamic Financial Institutions. which are mandatory to follow. Financial Accounting Standard no. However. or AITAB. 2006. currently. and lease agreements for biological assets (covered under IAS 41. the treatment of Leases under FrS 11724 In Malaysia.11 FRS 117 should be applied for annual periods beginning on or after october 1. AAoIFI has also issued an accounting standard. conventional methods of accounting should be followed in the absence of any specific standards in the Islamic Accounting Standards. which states that all companies practicing Islamic banking must disclose their Islamic banking activities separately from their conventional activities.

FRS 117 does not detail the concept of “transfer of substantially all risks and rewards incident to ownership. Finance leases. regardless of its legal form. 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 rent. into two broad categories: 1. p. operating leases. Rewards incident to ownership may be represented by the exception in value.38 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) Classification and recognition of Leases under FrS 117 FRS 117 classifies all leases. • where the lease contains a bargain purchase option. Para 2. FRS 117 Leases. • If gains or losses from the fluctuation in the fair value of the residual value fall to the lessee. FRS 117 further lists indicators of situations which individually or in combination could lead to a lease being classified as a finance lease. A Practical Guide to Financial Reporting Standards (Malaysia). for accounting purposes. as follows: . as follows: • where the lease transfers ownership of the asset to the lessee • If the lessee can cancel the lease. Under FRS 117. • where the lease term is for the major part of the useful life of the asset. and 2. 307. The criterion used in the classification is the extent to which risks and rewards incidental to the ownership of a leased asset lie with the lessor or the lessee. Malaysian Accounting Standards Board 2005. The journal entries to record the lease in the lessee book for the period would be as follows: Beginning of the transactions: dR Leased equipment cR Lease payable (Record the finance lease) At the End of The Accounting Period: dR Lease payable dR Interest expense cR cash (Record lease payment) dR depreciation expense cR Accumulated depreciation (Record depreciation expense) by the end of the lease term. Para 8. • where the present value of the minimum lease payments (excluding execution costs) is greater than or equal to substantially all of the fair value of the asset. a lease is classified as a finance lease if.” However. Risks incident to ownership include the possibility of losses from idle capacity or technological obsolescence and variations in return due to changing economic conditions. it transfers substantially all the risks and rewards incident to ownership from the lessor to the lessee. and • where the leased assets are not of a specialized nature such that only the lessee can use them without major modification being made. Malaysian Accounting Standards Board 2005. FRS 117. FRS 117. A lease that does not transfer substantially all the risks and rewards in this way is classified as an operating lease. it does provide examples of situations where a lease would normally be classified as a finance lease. the lessee’s losses associated with the cancellation are borne by the lessee.

3. At the end of the accounting period: dR cash cR Executory expenses payable (Record receipt of executory costs) dR cash cR Lease receivable (Record receipt of lease payment) dR Unearned interest income cR Interest income (Recognize interest income) .FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 39 The journal entries to record the lease in the lessor book for the period would be as follows: ACCountIng trEAtMEnt undEr AAoIFI The Accounting Standards committee has reviewed a number of alternatives. FRS 117. Ijarah Muntahiah Bitamleek through transfer of legal title (sale) prior to the end of the lease term for a price that is equivalent to the remaining Ijarah installments. Para 8. Para 10. Malaysian Accounting Standards Board 2005. Para 10. Malaysian Accounting Standards Board 2005. FRS 117. in particular the alternatives proposed in the preliminary study for adoption in the accounting treatments of Ijarah and IMB. dR Lease receivable cR Unearned interest income cR Machinery (Record the finance lease) Classification and recognition of Ijarah under AAoIFI 20 An “operating Ijarah” is an operating lease that does not include a promise that the legal title in the leased asset will pass to the lessee at the end of the lease. IMB allows different kinds of asset transfer. 1 (Statement of objectives) and no 2 (Statement of concepts). 2. Beginning of the transactions: Para 7. whereas IMB (also known as Ijarah wa Iqtina) is a lease that concludes with the legal title in the leased asset passing to the lessee at the end of the contract period. FRS 117. which it considered to be in compliance with the provisions of both Statements of Financial Accounting no. The committee recommended the adoption of the alternatives. 4. including these: 1. FRS 117. Ijarah Muntahiah Bitamleek through transfer of legal title (sale) at the end of a lease for a token consideration or other amount as specified in the lease. Ijarah Muntahiah Bitamleek through gradual transfer of legal title (sale) of the leased asset. Malaysian Accounting Standards Board 2005. Ijarah Muntahiah Bitamleek through gift (transfer of legal title for no consideration. Malaysian Accounting Standards Board 2005.

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. each determined at the inception of the lease. FRS 117 clarifies that the financial statements of lessees. the financial statements of lessors. .40 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) The journal entries to record the lease in the lessor book in the AAoIFI for the period would be as follows: dR Equipment cR cash (cash purchase of equipment for Ijarah financing) dR Ijarah Financing Asset cR Equipment (Provides Ijarah financing to lessee) dR cash cR Profit & Loss (Repayment received from lessee and income recognition) dR Profit & Loss cR depreciation (depreciation cost of Ijarah financing asset) Under the AAoIFI. Materiality in Islamic accounting must disclose even small or insignificant amounts received or related to non-halal income or expenditure. However. A finance lease gives rise to depreciation expenses for depreciable assets as well as finance expense for each accounting period. in the initial recognition. the entire amount would be charged to the period in which it occurred. which is stated in the Statement of concepts. if lower. Any initial direct cost to the lessee is added to the amount recognized as an asset. in the case of initial direct cost. because it is consistent with the concept of matching revenues and expenses. the materiality concept in Islamic accounting is not subject to any minimum amount that can materially affect the company transaction. or 2. costs incurred by manufacturers or dealers in connection with negotiating and arranging leases shall be recognized as expenses when the selling profit is recognized. shall recognize finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or. Recording these costs as deferred costs to be allocated (equally) over the lease term. Unlike the materiality concept in conventional accounting. 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. Alternative (2) has been chosen. if the initial direct costs were immaterial. This is consistent with the materiality concept. the present value of the minimum lease payments. By contrast. two alternative treatments were proposed for the Islamic bank’s share of the initial direct cost (as a lessor or a lessee): 1. charging these costs as a period expense to the period in which they occur.

were developed largely in order to provide rigor. while there are few major theological or ideological differences remaining between the four schools today. and Hanbali. Shafie. predictability. Syria. Egypt. Maliki. with the chief exception being constitutional and inheritance law. named after their main contributing thinkers. Iraq. Lebanon. . Maliki has governed the Muslim populations of north. and hierarchical structure to Islamic lawmaking (or fiqh) at an early point in the Islamic empire’s history. marriage and family law. Jordan. The Hanafi school prevails in Turkey. Shafie has prevailed in East Africa. Malaysia. and central Africa. The main school of thought in the Shi’a school is the Ja’fari school.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 41 Four MAIn SCHooLS oF ISLAMIC tHougHt25 HAnAFI/JA’FArI . and some criminal punishments. and the Sudan. SHAFIE. The schools. they continue to hold geographic 25 Please see end notes at the end of this focused toolkit dominance in particular parts of the Muslim world and do create subtle differences in codified texts. And HAnBALI There are four main schools in classical Sunni Islamic legal thought: Hanafi/Ja’fari. west. and the southern part of the Arabian Peninsula. MALIKI. Legal doctrinal differences between the Ja’fari and Hanafi schools are mostly of the same order as those between the Hanafi school and other Sunni schools.

’Umar. That conflict was ultimately settled by the assassination of ’Ali. or successor. a lease is “an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. As the result of the assassination of the third caliph. the first generation of Muslims established the order of succession by caliphs (caliph meant deputy. it is agreed among them that Ijarah is a contract on the use of benefits or services in return for compensation. of Muhammad. his successor as the secular leader of the community). Hanafi School—Ijarah is defined as a contract that enables possession of a particular intended usufruct of the leased asset (ayn) for a consideration. Hanbali is the basis for the codified law of the kingdom of Saudi Arabia. Sunni and Shi’a After the death of the Prophet Muhammad in 632. nascent Islamic polity. a civil war erupted. while others explained that what is meant by it are considered intentions in light of Shariah and reasoning.” while in Financial Reporting Standard 117 (“FRS 117”).” In summarizing all the definitions. 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. created a small. and ’Uthman. Ijarah may be regarded as a leasing of property pursuant to a contract under which a specified permissible benefit in the form of a usufruct is obtained for a specified period in return for a specified permissible consideration. with the consequence that Islam fractured into two components: Sunni and Shi’a (or Shi’i). Although there are various definitions of Ijarah given by the scholars of Islamic jurisprudence via their various schools of thought. ’Uthman. retained the seat of authority in Medina. and the disputed claim of ’Ali to be the fourth caliph (’Ali was both kin and . that is. The latter were the followers of ’Ali. Ijarah under the Four Schools Ijarah comes from the root word ajr. and not merely intentions. at the same time. which means compensation and. Abu Bakr. The definition of Ijarah according to AAoIFI (FAS 8) is “the ownership of the right to the benefit of using an asset in return for consideration. 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. The first three caliphs. 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. and expanded that polity beyond the Arabian Peninsula into the Byzantine territories of the Syrian littoral in the eastern basin of the Mediterranean Sea. Some jurists have stipulated that the usufruct from the leased asset should be intended. means the sale of usufruct.42 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) son-in-law of the Prophet).

In cases where parties are considering choosing a specific national law. in certain circumstances. thus falling under the purview of national law. There are countries where Shariah is (a) a supreme source of law. The rental fee and the duration of the lease are agreed in advance. or (c) not part of the legal system. Thus. The lessor can use this in any manner it wishes in case of a rent default. they must ensure that there is a reciprocal enforcement treaty in place between both countries. and Pakistan. as in Malaysia. and maintenance are the responsibility of the lessor (the financial institution). The English courts have addressed the extent of applicability of Shariah law to certain contracts. The issues arising in relation to Islamic dispute resolution vary depending on the category to which the country belongs.26 ProJECt FInAnCIng uSIng IJArAH27 The most common form of Islamic project finance uses the Ijarah strucure. (b) one of the sources of law. since it contravenes the basic precepts of Shariah. the client purchases the goods from the financial institution at the end of the lease period for a predetermined price. The majority of legal systems are not based first and foremost on Shariah and. submitting an Islamic finance matter to a state court of any jurisdiction may evince various challenging issues. such as aircraft. Banks can also combine Islamic financing instruments. as a way to refinance itself. In one form. adjudication in accordance with Shariah law. To ensure timely payment. in an Ijarah contract a financial institution purchases goods on behalf of a client and leases them to the client for a rental fee while maintaining ownership. every six months. more conservative Shariah boards stipulate that management. and conflicts among laws. even when such arrangements are in place. This can be particularly useful for the financing of expensive assets: 26 Please see end notes at the end of this focused toolkit 27 Please see end notes at the end of this focused toolkit . however. strong undertakings are required in the lease contract. Sudan. Alternatively. There are differences in the way that Ijarah operates from country to country. This raises issues both in relation to the status of Shariah law within the contract and in the court adjudication process and also in relation to the enforcement of overseas judgments. Many Islamic investment funds principally invest in these types transactions. The bank can issue Ijara bonds for placement with Islamic investors. as a result. include challenges in enforcement. For example. As discussed in detail earlier. the legal system of which includes Shariah law.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 43 dISPutE rESoLutIon Islamic finance cases are adjudicated by the state courts of various countries. Ijara can accommodate variable profit margins: the lease payment is made. In addition to retaining ownership over the asset that is financed. For example. unlike in conventional operating leases. and when the payment is made the profit margin for the following period is determined (generally on the basis of a reference such as sixmonth LIBoR. for example. This arrangement leaves the lessee with little incentive to properly manage and maintain the assets. the financial institution builds in additional security through the payment by the lessee of an amount to be mutually agreed upon by the parties as a security deposit. “liquidated damages” are included in the contract. To overcome this problem. However. courts will apply Shariah law in the context of its interplay with the national laws. This is similar to leasing-and-hire purchase arrangements. if the decision of a foreign court involves payment of interest. referred to in this report as AITAB (Al-Ijarah Thumma Al-Bai) but also known as Ijarah wa Iqtina. This instrument has been frequently used for the financing of major assets. In the Middle East. insurance. and UAE. special Islamic funds can be set up to engage in Ijarah financing. lack of competent training of judges. many Islamic finance transactions name the courts of England and wales as the applicable forum and the law of England and wales as the governing law. Iran. plus a fixed fee). kuwait. Much of the recent growth in Islamic finance has been through the creation of such funds. specifying extra payments that need to be made for any day of delay. such a decision will not be enforced in Saudi Arabia. as for example in Saudi Arabia. a successful enforcement may be impossible.

would reimburse the Islamic financial institution. the Islamic financial institution accepts the manufacturer’s performance risk and the buyer’s payment risk. normally. However. normally. The risk of loss or destruction has to be carefully evaluated.44 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) the construction part can be financed through an istisna (see the next section). As in Islamic finance. As an intermediary. Alternatively. tractor). in this mechanism the buyer (or investor) approaches the financial institution. if he wishes the buyer to pay in installments after delivery of the assets. Banks often use back-to-back transactions: • Under the first Istisna. unless when caused by the lessee. electricity projects. this should be paid (in advance) by the lessee. risks to Avoid in Project Financing when engaging in an Ijarah project finance. The buyer. most likely in installments. in order to classify as an Ijara. • Back-to-back with the Istisna with the manufacturer (con- Ijarah with Istisna 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. or over time based on a set of predetermined completion milestones. the risks of loss or destruction have to stay with the bank. risk of Loss/destruction Taking out property insurance may be difficult for Islamic financial institutions. In general. it can contain financing tranches of different maturities and with different profit rates. the Shariah principle is that the purchase price should be the fair market value. The first tranche of the financing consisted of disbursements under an Istisna. longer-term financings (e. • Under the second Istisna (the “hire to produce” contract). or if he delivers non-conforming goods. this structure was used in a deal for $77 million in project financing for the Bakri Group to build two chemical tankers that were to be chartered by Saudi Basic Industries corporation. This is similar to the back-to-back istisna. If the financial institution agrees. a customer agrees to purchase an asset from the Islamic bank upon completion. transport equipment. It should also be noted that under “western” leases. under Islamic finance. If the bank can take out insurance. Then. infrastructure.g. and the buyer can order (as agent for the financial institution) the equipment. this remains a very difficult issue to deal with. including details of the security offered (government. financial institutions have to avoid certain possible problems. the lessee cannot be asked to continue paying under the lease if the property has been destroyed or otherwise loses its economic value. and this value for a destroyed property is not very high. buyer and seller have to deposit security bonds. Still. through his own bank. this is not possible. but with the important difference that the buyer can make his final payments after the asset has been constructed and delivered to him. So in practice. providing all relevant information. the bank can lease it or sell it on deferred payment terms to the company that will operate it. at completion. and this was replaced by an AITAB on delivery of the tankers. the way this is done is by requiring the lessee to purchase the leased property (with all obligations. the financial institution can reimburse the manufacturer for the expenses he already made. As an example. and once the asset/project is finished. to control the actual use of its funds. He also has to assign the insurance for the assets under construction to the financial institution. liabilities and insurance policies attached to the property). ways to deal with such problems have to be built into the contract with the lessee. pipelines). described next. Istisna is often used for large. the bank could also use an Ijarah (lease) contract with the buyer. It is a condition in Istisna that the seller provides either the raw material or the cost of manufacturing the goods. or parent company guarantees). for the regular payments on the work in progress. the lessee has to continue paying even if the assets have been destroyed. and it can also be structured as a securitization. bank. depending on the specific interpretation of the relevant Shariah court. The Islamic financial institution may pay the manufacturer an advance. The purchaser can pay the financial institution in advance. the Islamic financial institution agrees to pay the manufacturer to build the asset in question. the Ijarah contract . The manufacturer has to provide a performance bond as well as a guarantee to refund the progress payments made by the financial institution if he fails to make delivery. Istisna financing can be syndicated. the bank would ask the manufacturer to open a letter of credit in favor of the supplier of the materials that the manufacturer is using.

it should limit its own liability by the indemnities received from the seller.45 billion conventional debt offering. whether or not due to its fault. that only properly trained personnel will use the goods. in the Ijarah contract. Also. Legal Liability As the owner and lessor of the goods. It involved a $1 billion Ijarah and Istisna component alongside a $2. the lessee should agree to indemnify the lessor for all costs. and obligations linked to the goods. liabilities. At least. and that it will return the goods at the end of the lease in good condition. that it will not sublease or hire out the goods. an economically useful part thereof) is effectively transferred to the lessee. that it will ensure that the use of the goods will not vitiate the insurance policy. fair wear and tear excepted. that the goods will be properly operated and maintained. 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. Project Financing Examples The dolphin Gas Project28. 28 Please see end notes at the end of this focused toolkit . timing of Payments Like most western leases. represents one of the largest Islamic financings of a Persian Gulf oil and gas project to date. which includes natural gas production in Qatar and a pipeline to the United Arab Emirates. The financial institution should include in the contract a disclaimer. payment under the Ijarah can only start once the good (or at least. to the extent possible. the financial institution is exposed to certain legal risks.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 45 requires detailed undertakings by the lessee that it will use the leased goods for normal business use.

46 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) IJArAH SuKuK What is Sukuk?29 Sukuk30 is the plural of sakk. is Islamic investment certificate. Among them. when translated.32 31 32 Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit Sale undertaking Subscription proceeds Subscription proceeds Originator Title to assets Issuer Rent and redemption proceeds Investors Purchase undertaking Rent Lease Originator as lessee . check. The issuer applies the Sukuk proceeds to purchase the asset from the originator and then leases it back to the originator. with this same meaning. when it was related to the recording of financial and other obligations. after closing subscription. which prohibit the charging or paying of interest. receipt of the value of the certificates and put to use as planned. Another Arabic term for sukuk. though it can also be understood as an Islamic equivalent of bond. They therefore represent common shares and rights in the underlying assets or their usufructs and services5. The originator undertakes to repurchase the asset at maturity or upon early settlement at the original purchase price. hence sukuk are securities that comply with Shariah and its investment principles. The issuer is required under Shariah to undertake the major maintenance of the asset. interest-bearing bonds are not permissible in Islam.” In modern Islamic financial terms. sukuk is defined as an Islamic or Shariah-compliant bond.” so sukuk is the Arabic name for a financial certificate. investment sukuk are certificates of equal value representing. AAoIFI has classified sukuk into 14 types. The word sakuk. but it will often appoint the obligor to carry out such activity on its behalf (see diagram below). This concept was used during the medieval period of Islam. fixed-income. deed. Introduction to Ijarah Sukuk31 Sukuk al-Ijarah are issued on a sale and lease-back arrangement (Ijara) of an asset. was also used in western Europe during the period. depending on the contracts used. However. and later evolved to what is presently known by the English words “cheque” and “check. 17. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and nontradability in the secondary markets. which means “legal instrument. 29 30 Please see end notes at the end of this focused toolkit Please see end notes at the end of this focused toolkit According to AAoIFI Standard no. Sukuk Al-Ijarah (lease-based certificate) is the most widely used type of sukuk.

and the Sukuks were listed on the Luxembourg Stock Exchange. MGS then leased those parcels of land to the Federation of Malaysia. The lease payments are determined based on a spread over LIBoR. As trading in debt above or below par would obviously breach the Islamic finance principle of not charging interest and the ability to trade freely in capital market instruments is critical to investors. MGS issued Sukuks to investors and used the funds thus raised to purchase parcels of land in and around kuala Lumpur from another Malaysian state entity. Pursuant to a declaration of Trust.) MGS is owned by a Malaysian state entity. since landlords and tenants (in the traditional sense) can agree on raising or lowering lease payments on land over the period of a tenancy. A floating lease price has been considered acceptable by Islamic scholars. the Malaysian government has agreed to purchase the parcels of land from MGS at the face value of the initial issue amount of the Sukuks. (MGS). the land parcels are held by MGS in favor of the Sukuk holders. 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. All returns made on the land parcels are conveyed to the Sukuk holders. In this instance. However. At the expiry of the term of the lease. including lease payments and the final repurchase proceeds to be paid by the Federation of Malaysia. (See illustration below. Islamic scholars are comfortable with the use of LIBoR as a lease pricing reference mechanism but not as a means of calculating interest. since the Ijarah Sukuks represent an interest in the underlying assets and not debts. The cash flow produced is similar to any bond cash flow. The structure used for the transaction was clean and simple in order to appeal to the broadest possible base of investors. Ijara Sukuks are freely tradable. 33 Please see end notes at the end of this focused toolkit Malaysia will purchase the land parcels at the end of the term Purchase price for land parcels Lease Payments Malaysian Federal Lands Commisioner Land parcels Malaysian Global Sukuk Inc. they can be traded above or below par freely without breaching any Islamic principles. Lease of Land Federation of Malaysia & Sukuks Sukuk holders . a special purpose company was incorporated in Labuan called the Malaysian Global Sukuk Inc. there is a potential further problem.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 47 Sukuk trust Certificates A good example of successfully adopting the Ijarah structure for a truly global capital market issue was the Malaysian government’s issue of Sukuk Trust certificates in August 2002. The MGS issue was rated by Moody’s and by Standard and Poor’s33.

This can be time consuming and costly for the issuer. this SPV issues Sukuk to the investors. • Even if a potential issuer does have access to an appropriate underlying asset. The asset is then leased to a third party for its use. a special purpose vehicle (SPV) or company is created to purchase the asset(s). • Since the asset is tied up for the term of the transaction. Sukuk Manfaa Ijarah—The owner of leasehold rights of existing leased assets may sell the usufruct of such assets through Sukuk issues. The instruments created in this Ijarah Sukuk are completely negotiable and can be traded in the secondary markets. as follows. The lessee makes periodic rental payments to the SPV. 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. despite its simplicity and broad acceptance. depending on the jurisdiction where the asset is located. enabling them to make payments for purchasing the asset. ing asset for such a transaction. which then distributes the payments to the Sukuk holders. Islamic scholars have broadly accepted the Ijarah structure. the Sukuk Al-Ijarah—The owner of an existing tangible leased asset may sell such assets through Sukuk. stamp duty and taxation costs associated with introducing the asset into the structure could make such a transaction unviable. owner of the asset cannot divest it freely and there could be negative pledge implications in putting the asset into the transaction. In turn. • There could be ongoing Shariah audits in connection with the asset.48 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) disadvantages of the Ijarah Sukuk Structure As the preceding makes abundantly clear. namely: • not all potential issuers have access to the necessary underly- Sukuk trading options A simple diagram of the sukuk structure is shown below. Ijarah sukuk suffers from some major commercial disadvantages for the issuer. Sukuk Ijarah Mowsufa Bithima—The owner of a tangible asset to be acquired and subject to a lease contract may mobilize the acquisition cost of such an asset through Sukuk issues. In the issuance of Ijarah Sukuk. nevertheless. Sukuk holders (2) Leased the assets to obligator (1) Sell certain titles of land to SPV (8) Obligator make periodic lease payment to SPV (9) SPV pays coupon to Investors (4) Trust Certificate issued to Investors Originator as seller (7) Payments made by SPV to Obligator SPV (3) Issued Trust Certificate (6) Payments received from investors by SPV Trust Certificate Issue (5) Investors made payments .



Stage 1: Contract for cash sale (Bay’ Mutlakah)
• SPV purchases property (e.g. hospitals) from obligator

Islamic financing structures are increasingly used in the project finance domain, particularly in projects in the Middle East. In most Islamic financing, incorporated within a multi-sourced project financing, the Islamic financing element of the project is provided pari passu with the other senior debt. Istisna and Ijarah elements are frequently used. The following is an example of a transaction structure.

(government). (1)
• The assets purchased by the SPV are funded by the issuance

of sukuk (trust certificates) which represents beneficial ownership in the assets and the lease. (3)
• Government receives cash proceeds. (7)

Stage 2: Contract for leasing (Ijarah)
• SPV rents property to the government for specified period. (2) • SPV collects rentals. (6)

Sample transaction Structure: Leasing Assets
The finance providers under the Islamic facility (the Islamic finance providers) have established an Islamic SPV to operate as their financing vehicle to own certain project assets and lease them to the borrower. The Islamic finance providers and the Islamic SPV appointed an Islamic bank as facility agent (the Islamic facility agent) to perform each of their respective obligations under the Islamic financing documents, which included the following:

Stage 3: During the tenure …
• SPV passed the rentals to investors (9) and makes periodic


Stage 4: At maturity …
• SPV sells the property to the government at an agreed price. • Government pays cash to SPV. • SPV simultaneously pays investors cash for sukuk redemp-

Credit Agreement
This credit agreement sets out the terms and conditions precedent, representations and warranties, covenants, events of 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 respective rights and perform their respective obligations under the Islamic finance documents. The Islamic finance providers, the Islamic SPV, and the borrower acknowledged that the payments made by the Islamic facility agent directly to the borrower (sourced from the Islamic finance providers under the Islamic facility agreement) were payments satisfying the Islamic SPV’s obligation to pay consideration for the project assets under the Istisna agreement. The Islamic SPV owned the assets and appointed the borrower as its service agent to operate and maintain the leased project assets, keep such assets fully insured, and pay any applicable ownership taxes, thereby restoring certain of the risks of asset ownership to the borrower. The Islamic SPV undertook to sell the leased assets to the borrower upon payment of a lease termination payment (a discharge of all outstanding amounts owed, effectively allowing prepayment of the Islamic facility and release of the rights of the Islamic finance providers upon discharge of the Islamic financing). The borrower undertook to purchase the leased project assets from the Islamic SPV upon payment of a lease termination payment (effectively an acceleration of the Islamic facility). Given the principles behind Islamic financing outlined above, the Islamic finance providers were not party to the other finance documents. However, each of the Islamic finance providers was, through the Islamic facility agent, bound by the inter-creditor agreement with the non-Islamic lenders and was

The Ijarah would also not come into effect. This operated after completion of the construction. Following delivery of the project assets under the terms of the Istisna, the Islamic SPV agreed to lease the project assets to the borrower for the period of the lease and the borrower agreed to pay lease payments (equivalent to debt service) to the Islamic SPV. As owner of the assets, the SPV had de facto security over them. Akin to the restrictions and covenants placed upon the borrower according to conventional debt facilities, the borrower undertook to use the leased project assets solely for the purposes contemplated in the Islamic facility agreement. Furthermore, The Islamic SPV and the Islamic facility agent made no representation or warranty as to the project assets so that risk of title, defects, and so on all rested with the borrower, who waived any claim caused by the project assets. The Islamic SPV’s rights to take any enforcement action (e.g., remedies following events of default) were governed by the terms of the inter-creditor agreement. The borrower was entitled to terminate the Ijarah voluntarily by giving notice. Upon termination, including payment of the final lease payment (i.e., maturity), the Islamic SPV was to sell the project assets to the borrower according to the sale undertaking (see below) and the Islamic facility agreement. Subject to the terms of the inter-creditor agreement and the other non-Islamic documents, the Ijarah could be terminated following certain events of default. during the term of this Ijara, the ownership of the project assets remained with the Islamic SPV. The borrower could require the



therefore subject to the inter-creditor provisions governing the relationship between the lenders. These provisions included the method of voting and decision-making; arrangements for joint consultation and actions regarding approval rights and waivers; limitation of the parties’ rights of enforcement upon default; and the application of proceeds upon enforcement. This Islamic facility agreement contained various representation and warranties, covenants and events of default by the borrower. Unlike conventional financing, the Islamic facility agreement did not provide a guaranteed interest rate of return, as the prohibition of interest is a significant principle of Islamic financing. As an alternative, the Islamic finance documents provided for advance amount payments (providing an effect similar to interest calculated on the outstanding principal on or before the lease began) and a lease variable element (providing an effect similar to interest calculated at any time after the lease began). while the Islamic finance documents did not contain any 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

to make a payment connected to the delay. If an Islamic finance provider received a payment that was solely attributable to the borrower’s delay in payment, that participant was required to hand over the net amount (after deducting the actual costs and expenses suffered or incurred by it as a consequence of the borrower’s failure to comply with the applicable Islamic finance document) to such charitable foundation or scientific or medical institution as it selected. The diagram below illustrates a typical project finance transaction that incorporates an Islamic financing structure. construction phase 1—The borrower develops, constructs, and sells project assets to the Islamic SPV. As consideration, the Islamic SPV makes phased payments to the borrower (equivalent to loan advances). Post-construction phase 2—The Islamic SPV leases project assets to the borrower. The borrower makes lease payments (equivalent to debt service).

Islamic finance providers
nt me est ncy t Inv ge en a em re ag

Islamic facility agent

Intercreditor agreement

Non-Islamic lenders

Purchase undertaking

Islamic SPV
Sale undertaking

Islamic facility agreement

Service agency agreement Istisna’a Construction phase1 Ijara Post-construction phase2


Project assets

sale and purchase agreements. Ijarah Sukuk transactions work by passing a lease stream through to the holder of the Ijarah Sukuk. corporations. rather than being structured as an interest-bearing loan secured by a pledge of assets. Ijarah Sukuk ratings Background This section describes ratings of Ijarah Sukuk. irrevocable nature of the lease. Ijarah Sukuk are financial obligations issued by a lessor and backed primarily by a lease stream from a credit lessee. Since Shariah frowns on the payment of interest. including sovereign governments. Higher ratings are unlikely without additional risk-mitigating features. any third-party lease guarantees. its commitment to such transactions as an important and continuing source of financing. in the case of sovereigns. and. although for corporates Ijarah Sukuk may resemble certain characteristics of secured loans and be notched up accordingly. typical transaction configurations. This practice reflects the unconditional. or other factors supporting such a distinction. regional governments.52 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) StAndArd & Poor’S rAtIngS oF IJArAH SuKuK As the above makes clear. It should be noted that only an appropriate Islamic body may recognize the compliance of the terms of any Sukuk issuance with Shariah and that individual investors should make adequate inquiries as to Shariah compliance. Ijarah Sukuk are one of many forms of Sukuk (notes) compliant with Shariah on the provision and use of financial products and services. greater risks associated with lease payments. Standard & Poor’s has rated Ijarah Sukuk transactions backed by various types of underlying credit lessees. Standard & Poor’s also rates financial institutions that provide Islamic banking and insurance services. Standard & Poor’s rating process does not address Shariah compliance. . and/or financial hedges that are found in the transaction. Standard & Poor’s has assigned Ijarah Sukuk the same ratings as it assigns to the lessees creating the payment stream. where the underlying obligor is a government. These factors include the status and responsibilities of the special purpose entity (SPE) typically found in Ijarah Sukuk. and factors affecting the ratings. and multilateral lending institutions. In most cases. the adequacy of the lease payment stream that will service the rated Ijarah Sukuk. Ratings lower than those given to the lessee are assigned where there are diminished recovery prospects.

For example. 3. where there is a material risk of government appropriation. At maturity. to a special purpose vehicle (the SPV) that may be affiliated or unaffiliated with the seller (depending on the degree of compliance with Shariah) Do Standard & Poor’s ratings address Shariah compliance? Standard & Poor’s bases its credit rating opinion on the compliance of an Ijarah Sukuk transaction with applicable commercial law. either legally or for political reasons (for example.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 53 How do Ijarah Sukuk ratings compare with those of the lessee? Ijarah Sukuk should receive the same rating as the underlying lessee if the transaction cash flows survive reasonable stress scenarios short of a payment default by the lessee. prior to maturity the lessee may have the right to call for the assets upon certain amounts due under the Ijarah Sukuk as well as other expenses. where the whole transaction. the SPE sells the assets back to the seller at a predetermined value. That value should be equal to any amounts still owed under the terms of the Ijarah Sukuk. 4. the rating of the Ijarah Sukuk may be below that of the lessee. How are most rated Islamic financings configured? Standard & Poor’s has rated two broad types of Islamic financing: (1) Ijarah Sukuk. land. were a transaction to be governed solely by Shariah. is Shariah-compliant. The seller sells certain assets. The lease may also be supported by affiliate guarantees. combined with a put/tender feature. Most Ijarah Sukuk that Standard & Poor’s has rated are set up in the following manner: 1. In this second configuration. depending on the extent of Shariah compliance. including the ownership structure as well as the notes. in exchange for periodic lease payments. and the SPE might have the right to tender the assets back to the lessee. such a transaction might be difficult to rate because of the lack of predictability . The SPV raises financing to purchase the assets by issuing Ijarah Sukuk to investors in an amount equal to the purchase price. if the lessee views Ijarah (leasing) financing as indistinguishable in terms of priority with conventional debt-based financing. or on a dissolution event. the head lease has a longer maturity than the sublease. The SPV then leases the assets to the lessee. the securities themselves may not necessarily be Shariah-compliant. Such configurations do not include the sale of assets and may be preferred when the sale of an asset is difficult. the SPE may sublease back to the lessee the assets that have been first leased to the SPE by the same lessee. or directly back to the seller itself. currency or other hedges may also play a part in transaction dynamics. for a determined price (the purchase price). which may be indirect or direct depending on the type of SPE. In such an instance. Standard & Poor’s does not exclude the possibility of rating Ijarah Sukuk above the rating of the lessee. new York State law. To notch up the rating where the lessee is a sovereign entity (or where the lessee seeks a rating above that of the sovereign of domicile). English law. including the risk of the sovereign restricting access by the issuer to foreign exchange needed for payments to the holders of the Ijarah Sukuk. Various scholars charged with interpreting the Holy Qur’an and other fundamental Islamic writings offer opinions on the conformity of transactions with the principles of Shariah. an affiliate of the seller. 2. This is most likely to occur when the lessee has a ratable corporate credit profile and the credit characteristics of the Ijarah Sukuk resemble. or other financial or operating risk. Additionally. such as an office building. and if recovery prospects are similar to those in a debt-based transaction. allowing the rating to be notched up above that of the lessee. where the bonds are issued by an unaffiliated SPE with the proceeds used to acquire the assets from the lessee/ seller. governed transactions rated by Standard & Poor’s. Typically. in part. an offshore mechanism for collecting cash flows generated by the assets is likely to be necessary for the Ijarah Sukuk to achieve a rating higher than that of the sovereign of domicile. and the rating therefore does not reflect the compliance of the transaction with Shariah. and (2) the ‘ownership’ Shariah-compliant structure. depending on the strength of the security. a sovereign may not wish to sell the country’s main airport). These lease payments should match the obligations of the SPE under the Ijarah Sukuk. as is the case for government leases in a variety of jurisdictions. The Ijarah Sukuk represent an equity interest in the SPE’s assets. and the commercial codes of the countries where the assets are located have. or an airport. some features of the transaction would have to mitigate the risks posed by a potential sovereign default. other transaction configurations are possible. those of secured debt. for credit purposes.

which can be expressed in the form of questions. subject to commercial law. with the possibility of Shariah principles overriding otherwise valid commercial contractual obligations. the enforceability of the transaction in a commercial court should not be affected by any adverse determination by a Shariah court. However. What are the rating implications if Islamic authorities do not recognize a transaction as Shariah-compliant? If a sovereign or an Islamic legal authority declares (at the time of issuance or during the life of the Sukuk) that Ijarah Sukuk do not comply with Shariah. these would be taken into account in the analysis. for example. Furthermore. and unconditional. if the issuer maintains a sinking fund. although such a result could influence market liquidity. Most. yet this has not curtailed their bond issuance. Should the lease obligation be subject to budgetary appropriation or other risks that. ownership and management of the issuer is also evaluated. irrevocable. the credit exposures of the SPE will be considered. other factors that suggest lower credit quality include these: • Situations under which the lessee may not have to redeem of outcomes in a Shariah court. conventional debt structures from Islamic nations do not comply with Shariah. and any other conditions that allow exceptions for timely payment or for lower recovery prospects. certain Shariah-compliant transactions have specifically disavowed Shariah jurisdiction as a matter of form.54 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) Criteria guidelines Standard & Poor’s criteria for rating Ijarah Sukuk take into consideration four main elements. especially if the third parties could interfere with the lease payment stream destined for the Ijarah Sukuk. if the lessee owns the issuer and there are potential conflicts of interest. • The essentiality of the asset to the lessee is also considered when assessing the lessee’s repurchase commitment. weigh less heavily in issuances of conventional debt. 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. Finally. although they may satisfy Shariah requirements as a matter of substance. or if it has purposes other than engaging in the bare necessities for implementing the transaction. Standard & Poor’s might notch the Ijarah Sukuk down from the credit rating of the lessee. . by comparison. outstanding principal by repurchasing the assets at maturity or in a dissolution event. 1. then a declaration by such a court that the Ijarah Sukuk do not comply with Islamic law could render the Ijarah Sukuk void and unenforceable. as follows. to the extent that Ijarah Sukuk are governed by Shariah and are subject to the jurisdiction of the Shariah courts (which is not the case with any Ijarah Sukuk currently rated by Standard & Poor’s). Loans to the issuer from parties other than the holders of the Ijarah Sukuk are of particular concern. Most Ijarah Sukuk transactions involve contractual agreements. 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. there might not necessarily be any credit implications. Is the SPE a single-purpose pass-through vehicle between the lessee and the holders of Ijarah Sukuk? creditworthiness might be impaired relative to the lessee’s rating if the issuer is not an SPE. 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). Indeed. if not all. 2.

or other encumbrance. is still a fraction of conventional banking and finance activities. 20 percent of the customers in the Gulf region and Southeast Asia would choose an Islamic banking product over a similar conventional product. is a cost that is accrued irrespective of the outcome of business operations. predetermined rate tied to the maturity and the amount of principal. levies. indistinguishable in terms of priority from conventional debt. For example. shortfalls that might arise from foreign currency exposure can be covered by the lease (as supplemental rent). charge. It is within this context that one should consider the development of new Ijarah products. not the least of which is the attraction of “reverse engineering” traditional financial products to become Islamic financial products. Essentially. Additionally. and must train them to comply with Sharia as they serve their Islamic customer population. . whereas interest. outside of the religious and political allure of Islamic banks. fees. This prohibition is not to be confused with a rate of return or profit on capital. estimated annual growth rates of 10 to 15 percent seen in recent years emphasize the potential market for such activities. profit. Another important credit consideration is whether the sold assets are free of any lien. mortgage. is its commitment to its Ijarah Sukuk similar to its commitment to other types of debt financing? ‘willingness-to-pay’ considerations are of particular importance for sovereign lessees. Islamic financial institutions must educate their personnel to understand the tenets of Islamic law that pertain to finance. The most well-known aspect of an Islamic financial system is the prohibition against paying or receiving interest (riba) on capital. Moreover. and charges. in order for Islamic financial institutions to be competitive with conventional products and attractive to customers. by a lease guarantee from another creditworthy entity. Amidst this growing market opportunity there are several inherent risks. making Islamic banking one of the fastest growing segments of the financial industry. which is guaranteed irrespective of the performance of the investment. or by a hedge. must be examined carefully. rather than to create a new stratum of obligation. while fulfilling the tenets of Sharia and remaining sufficiently cost-effective. Islamic financial products must meet the risk/ reward profiles of investors and issuers. ‘willingness’ considerations are supported by Ijarah Sukuk financing being designed to target investors interested in Shariah-compliant instruments. security interest. deed of trust. However. determined ex post. government lessees agree to cover. and therefore present ripe opportunities for Islamic banks. as well as risk of insurer’s default.0. is that people are choosing their services for the safety they are perceived to offer. financially distressed sovereign lessees have occasionally discriminated among their pari passu financial obligations. If this is done by personnel not well versed in the Islamic financial system. then risks abound. whenever they arise. estimated to range from $500 billion to $1 trillion. is considered riba and is therefore prohibited. pledge. fixed. To provide further clarity in terms of development of new products as well as new institutions to market Ijarah products one should take into consideration IFSB 9.61 billion Muslims worldwide. though the terms and exceptions. Most important to note.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 55 3. on a timely basis. 4. There are significant middle-class urban and suburban populations that already use conventional banking. analysing how potential shortfalls are covered in the transaction. and may create wealth even if there are business losses. duties. since earning and sharing profit is very much encouraged within Islam. Do the transaction’s cash flows provide for the full and timely payment of the obligations to holders of Ijarah Sukuk? Standard & Poor’s compares the terms and conditions of the asset lease and those of the Ijarah Sukuk. Historically. Risks to the leased assets from loss or damage can be mitigated by insurance. determined ex ante. According to Standard and Poor’s surveys. Usually. while the size of Islamic finance and banking activities. any additional expenses related to taxes. ConCLuSIon—nEW ProduCt dEvELoPMEnt There are an estimated 1. symbolizes the creation of additional wealth through successful entrepreneurship. any positive. Standard & Poor’s examines the extent to which the government includes Ijarah Sukuk in government accounts as debt obligations. If the lessee is a government.


as well as offering financing only for Shariah-compliant projects. Principle 7: Shariah Compliance An IIFS must be able to demonstrate that its operations are governed by an effective system of Shariah governance and that it conducts its business in a socially responsible manner. and must treat its customers fairly. Principles of business conduct are defined as those principles that are intended to govern the activities of financial services firms with regard to (a) the protection of the interests of their customers. and capital market segments. Honesty and Fairness An IIFS shall aspire to the highest standards of truthfulness. the Guiding Principles will not reinvent the wheel but will instead. and either avoid them or disclose and manage them. both during the sales process and in subsequent communications and reports. with particular regard to Shariah compliance and to the thoroughness of research and risk management. wherever appropriate. . including windows of conventional firms. the guiding Principles Principle 1: Truthfulness. to comply with these principles and other IFSB standards. bearing in mind its fiduciary duties to investment account holders as well as shareholders. Principle 2: Due Care and Diligence An IIFS shall exercise due care and diligence in all its operations. Principle 5: Information to Clients An IIFS shall provide clear and truthful information both in any public document issued and to its actual and prospective clients. including the way it structures and offers its products and provides financing. reinforce the existing internationally recognized frameworks or standards for the conduct of business. so that it offers those products most suitable for their needs. and (b) the integrity of the market. Principle 3: Capabilities An IIFS shall ensure that it has in place the necessary systems and procedures. For IIFS. In accordance with the objectives of the IFSB. guiding Principles on Conduct of Business for Institutions offering Islamic Financial Services The Guiding Principles on conduct of Business for Institutions offering Islamic Financial Services (hereafter Guiding Principles) are applicable to all institutions offering Islamic financial services (IIFS) in the banking. honesty.0 contains a model self-assessment questionnaire to ensure the institutions and its products are Shariah complaint. Principle 6: Conflicts of Interest and of Duty An IIFS shall recognize the conflicts of interest between it and its clients that arise from the type of products it offers.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 57 ISLAMIC FInAnCIAL SErvICES BoArd IFSB 9. IFSB 9. and that its employees have the necessary knowledge and skills. and fairness in all its statements and dealings.0 Principle 4: Information About Clients An IIFS shall take steps to ensure that it understands the nature and circumstances of its clients. Takaful (Islamic insurance). a code of ethical business conduct derives from principles of the Shariah as set out in the Holy Qur’an.

loyalty and honesty. hawala: Bill of exchange. cheque or draft. A debtor passes on the responsibility of payment of his debt to a third party who owes the former a debt. ijarah/ijara: Lease. contracts and transactions that are explicitly prohibited by the Qur’an or the Sunnah. al-Hanafi. al fatawa): An authoritative legal opinion based on the Shariah. is borne by the owner of the capital. An activity may be economically sound but may not be allowed in Islamic society if it is not permitted by the Shariah. lawful. bai al-salam: Advance payment for goods. It also refers to deposits in trust. exertion. professions. unless the loss has been caused by negligence or violation of the terms of the contract by the mudarib. Thus. but the loss. fiqh: Practical Islamic jurisprudence. halal: Permissible. diligence. contracts and transactions that are explicitly prohibited (haram) by the Qur’an or the Sunnah. gharar: Uncertainty in a contract or sale in which the goods may or may not be available or exist. There are four Islamic schools of jurisprudence: al-Shafie.58 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) ISLAMIC FInAnCIAL gLoSSArY al adl: A trusted and honourable person. doings and implicit approval or disapproval of the Prophet. sometimes on a contractual basis. quality. and is an important value of Islamic society in mutual dealings. A trustee. the contract would not be valid. promissory note. 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 mechanism agreed between both of them. ambiguity in the consideration or terms of a contract—as such. sale and purchase. allowed. describes activities. professions. ijarah muntahla bittamleek/ ijarah wa iqtina: A leasing contract used by Islamic financial institutions that includes a promise by the lessor to transfer the ownership of the leased property to the lessee. This is an arrangement under which an Islamic financial institution leases equipment. workmanship) and the date of delivery fixed. the responsibility of payment is ultimately shifted to a third party. al-Maliki and al-Hanbali. trustworthiness. Barring these. if any. As a legal term. hire or the transfer of ownership of a service for a specified period for an agreed lawful consideration. mudaraba/mudarabah: A form of contract in which one party (the rab-al-maal) brings capital and the other (the mudarib) personal effort. Istisna/istisna’a: A contract of sale of specified goods to be manufactured with an obligation on the manufacturer to deliver them on completion. The proportionate share in profit is determined by mutual consent. either at the end of the lease or by stages during the term of the contract. industry. manfa’a: A form of contract in which one party gains the right to use or benefit from the use of an asset. all others are halal. a building or other facility to a client for an agreed rental. hadith: The narrative record of the sayings. can be regarded as the jurists’ understanding of the Shariah. in this case the goods are defined (such as quantity. it means the effort of a qualified Islamic jurist to interpret or reinterpret sources of Islamic law in cases where no clear directives exist. there are activities. ijtihad: Literally effort. maisir/maysir: The forbidden act of gambling or playing games of chance with the intention of making an easy or unearned profit. It is a condition in istisna that the seller provides either the raw material or the cost of manufacturing the goods. commonly applied in the agricultural sector where money is advanced for inputs to receive a share in the crop. haram: Unlawful. Also. Hawala is used in developing countries as a mechanism for settling international transactions by book transfers. amana/amanah: Literally means reliability. while normally the goods need to exist before a sale can be completed. forbidden (see halal). al Maqasid al Shariah: The objective of Shariah. A mudaraba is typically conducted between . fatwa (pl. In Islam. selected by both parties to a transaction. bai/bay: contract of sale.

It is not permitted to stipulate otherwise. see also rab almal.FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) 59 an Islamic financial institution or fund as mudarib and investment account holders as providers of funds. musharaka/musharakah: An agreement under which the Islamic financial institution provides funds that are mingled with the funds of the business enterprise and possibly others. but this is not an essential element. rahn: A mortgage or pledge. riba: Interest. there is a pre-agreed selling price that includes the pre-agreed profit mark-up. qard al hasan/qard hassan: A virtuous loan in which there is no interest or mark-up. sadaqa: Voluntary charity. The profit is distributed among the partners in a pre-determined manner. The second type involves a promise from a customer to purchase the item from the financial institution. The borrower must return the principal sum in the future without any increase. All providers of capital are entitled to participate in management but are not necessarily obliged to do so. the Islamic financial institution purchases the goods and makes them available for sale without any prior promise from a customer to purchase them. . are borne by the partners in proportion to their capital contribution. normally. salam: A contract for the purchase of a commodity for deferred delivery in exchange for immediate payment. but the losses. or the excess over what is justified by the countervalue in an exchange/business transaction. and this is termed a normal or spot murabaha. There are two types of murabaha sale: in the first type. rab-al-maal: The investor or owner of capital in a mudaraba contract (see above). it involves the financial institution granting the customer a murabaha credit facility with deferred payment terms. riba al-buyu: A sale transaction in which a commodity is exchanged for the same commodity but unequal in amount or quality. The literal meaning is an excess or increase. and its prohibition is meant to distinguish between an unlawful exchange in which there is a clear advantage to one party in contrast to a mutually beneficial and lawful exchange. murabaha: A contract of sale with an agreed profit mark-up on the cost. In this latter case. if any. mudarib: The managing partner or entrepreneur in a mudaraba contract (see above). and this is called murabaha to the purchase order. but its meaning is broader. Sometimes equated with usury.

a single Shariah Scholar) evidence their opinion on compliance by issuing a fatwa (an Islamic legal opinion). sukuk: Plural of saak (see above). Shariah Supervisory Boards (or. for smaller operations. an agency contract that generally includes in its terms a fee for the agent. zakah/zakat: A tax that is prescribed by Islam on all persons having wealth above an exemption limit at a rate fixed by the Shariah. Shariah rules do not always function as rules of law as they incorporate “obligations. Recently. so becoming “monetised”. waqf: A charitable endowment. tawarruq: Literally monetisation. investment certificates. wakeel al-Istithamr: An investment agent. Shariah compliance The Islamic finance industry has adopted the practice of appointing Shariah scholars to determine compliance with Shariah. such as Islamic funds or Sukuk (see section 7.” shirkat al-aqad: A joint-venture partnership. the law as extracted from the sources of law (the Qur’an and the Sunnah). Since Shariah can in certain areas be general and implicit. These scholars are appointed to the Shariah Supervisory Boards of financial institutions and investment funds to approve Islamic product lines and individual transactions as well as to audit these institutions and funds to ensure continuing compliance. wakala: Agency. where the commodity sold is not required by the borrower but is bought on deferred terms and then sold to a third party for a lower amount of cash. appropriately qualified scholars are relied upon to determine the relevant rules for financial transactions. wa’d: A promise or unilateral undertaking. However. Fatwas are important documents and are often a condition precedent to the effectiveness of a transaction. shirkat al-milk: A co-ownership partnership. The term is used to describe a mode of financing. duties and moral considerations that serve to foster obedience to the Almighty. The way it is distributed is set out in the Qur’an. deeds. Takaful: A Shariah-compliant system of insurance based on the principle of mutual support. Used to refer to the worldwide community of Muslims. ummah: The community or nation. .5) sometimes append the fatwa issued to the relevant offering documents. saak: Participation securities. urf: The customs of a community. coupons. approvals. Sunnah: The way of the Prophet Muhammad including his sayings. The company’s role is limited to managing the operations and investing the contributions. wadiah: A deposit. but otherwise it is down to each individual to distribute the zakat. The reverse of murabaha.60 FocUSEd TooLkIT: ISLAMIc LEASInG (“IJARAH”) Shariah /Shari’a/Shari’ah: In legal terms. Its objective is to collect a portion of the wealth of the well-to-do and distribute it to the needy. Shariah consultancies have been established to provide a similar service. It is the second source of revelation after the Qur’an. and disapprovals as preserved in the hadith literature. many offerings. It may be collected by the state. Indeed.

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