ISLAMIC BANKING

The Islamic Bank Auto Financing

Facility

SUBMITTED TO

SUBMITTED BY
MISBAH JAMIL E18MBA048
IRUM MALIK E18MBA017
MBA BANKING & FINANCE
SEMESTER 6TH

DATED 10/15/2021
ISLAMIC AUTO FINANCE
Islamic vehicle finance is the type of financing which is based upon the model of
profit and risk sharing, in which both the bank and customer agree to share the risk as
well. It totally prohibits Riba, which is the base of the conventional banking products.
Is Auto finance allowed in Islam?
In other words, a bank or individual cannot charge interest (known as 'Riba' in Arabic)
when lending money. Renting an asset is permissible, but renting money is strictly
prohibited in Islam. This means that many traditional forms of car finance are not
considered halal and consequently are not allowed.

The Islamic Bank Auto Financing Facility

With the growing demands of everyday life, vehicle ownership has shifted from a mere
luxury to a vital necessity. Purchasing a vehicle is often the second most expensive and
important purchase after purchasing a house. While doing so, we have two options:
either to make a hand on hand (cash) purchase or to go for car financing.
However, such facilities are not adequately provided by many banks in Ethiopia.
Moreover, automobile financing facility based on Sharia Principles was not even started
in banks that provide Interest free banking services in Ethiopia. However, many banks
in the world have started Islamic automobile financing facility by designing innovative
Shariah compliant contracts.  

AITAB/IMBT Automobile Financing

The Shari’ah contracts generally applied in vehicle/auto mobile financing is Al Ijarah
Thuma Al Bay’ (AITAB) (is a contract of leasing ending with sale) or Al-Ijarah Muntahiah
bi al Tamlik (IMBT) (a contract of leasing ending with ownership) which is a leasing
contract with an option to purchase at the end of the leasing period. For the case of
AITAB, the contract is a hybrid contract that put together the Ijarah (Leasing) contract
and Sale (Bay’) contract.

Components in AITAB
There are two types of contracts involved which is Ijarah and Al-Bay’. Let’s first
differentiate their components:

1. Components under Rental (Ijarah) Contract:

· The owner (which will be the lessor)
· The Lessee
· The Goods that is rented out
· "Usufruct" or benefit in use
· The Rental Amount
· The Rental Contract

2. Components under Purchase (Al-Bay') Contract:

· The Seller (formerly the owner of the goods)
· The Buyer (the former lessee)
· Goods for sale (the one rented out)
· The price (i.e. the last instalment or early settlement fig.)
· The Sales Contract (Bank as the Seller and the Hirer as Buyer)
By applying the contract of AITAB/AIMAT, under the Automobile Financing facility, the
bank will first purchase the vehicle from the dealer and pay the price of the car.
AITAB/IMBT Automobile Financing process:

Rental of Lease:

 The rental must be determined at the time of contract.

 It is permissible that different amount of rent are fixed for different phases of rental
period.
 It is permissible to tie up the rental amount with a variable benchmark, the ceiling and
floor should be determined.
 Rental will be charged when the Leased asset is handed over to the lessee and not from
the day the price has been paid.

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

Example
Car Ijarah is Meezan Bank's car financing product and is Pakistan's first Interest-free
car financing. It is based on the Islamic financing mode of Ijarah (leasing). This product
is ideal for individuals who want to get interest-free financing for acquiring locally
manufactured /assembled vehicles.
Car Ijara works through a car rental agreement, under which bank purchases the car
and rent it out to the customer for the period of 1-5 years, agreed at the time of contract.
Upon completion of Ijara period, the vehicle will be sold at token amount or gifted to
customer.

Murabahah Automobile Financing

Besides applying the contract of AITAB or IMBT, in some jurisdiction, Islamic banks also
apply the contract of Murabahah in vehicle financing. Murabahah as previously defined
is the cost plus mark-up profit contract where bank will buy the vehicle and sell to
customer at mark-up price. For this purpose, the Murabahah to Purchase Orderer
(MPO) concept is used.

Murabahah Automobile Financing Process

Concept of DM based Auto Financing:

Diminishing Musharakah (DM) is a partnership transaction in which the partners agree
to terminate Shirkat (partnership) gradually by means of purchase of one partner’s
share by other partner.

Under Diminishing Musharakah financing, the Bank and its client participate in the
ownership of an asset on the basis of ‘Shirkat-ul-Milk’ (i.e. Joint ownership)
A DM based Auto financing transaction comprises of mainly following three steps:

 Participation in the ownership of an asset by Bank and Client (i.e. creation of

Musharakah) and dividing Islamic Bank’s ownership share into a number of
Musharakah units;
 Bank rents out its share of ownership in the asset to the Client (i.e. Ijarah transaction
between Islamic Bank and Client); and
 Gradual sale of Musharakah units by Bank to the client on periodic basis and at the
end of the financing tenure client becomes the sole owner of the asset.
A DM Financing is a combination of Musharakah, Ijarah and Sale transaction. Therefore,
all rules pertaining to Musharakah, Ijarah and Sale transactions are applicable to a DM
transaction.

All the three transactions are independent and are executed through separate contracts.