Overview

 Introduction and Brief Perspective of Islamic Banking

 Ijarah
 Essentials of Ijarah
 AAOIFI Standard
 Mechanism and Usage
 Risks and Issues
 Comparison with Conventional Leasing
 Documentation
 Ijarat ul Ashkhaas
 Some Common Misconceptions
1
 BRIEF HISTORY OF ISLAMIC
BANKING IN PAKISTAN
 Efforts for economy wide elimination of Riba started
during 1970s and most of the practical steps were taken in
early 1980s, which are considered as pioneering work in
the Muslim world.
 Banking and other relevant laws and regulations were
amended to facilitate interest free banking system.
 Two important areas kept outside the purview of interest
free banking system mainly due to lack of research in
these fields, viz. Government borrowings (both local and
foreign) and foreign exchange.

2
 FAILURE OF PREVIOUS EFFORTS
Reasons
◦ Absence of Shari’ah compliance mechanism in financial
institutions.
◦ Non-availability of Shari’ah compliant government securities.
◦ Ineffective enforcement of contracts and inefficient system for early
recovery.
◦ Ineffective code of conduct for professionals.
◦ Lack of continued research and development in the field of Islamic
finance and economics.
◦ Inadequate training to the staff of SBP and banks.
◦ Disoriented education system devoid of Islamic principles.
◦ Lack of public awareness about Islamic economic system.
◦ Adoption of free market economic (capitalistic) policies.
◦ Social and cultural factors.
◦ Weak Political resolve of successive governments for Islamization
of economy.
3
 CURRENT STRATEGY
Gradualapproach for Transformation of
economy
◦ Full fledged Islamic banks be established in
Private sector
◦ Islamic banking Subsidiaries in existing
banks be allowed
◦ Stand alone branches for Islamic banking be
allowed in existing banks

4
 POLICY OBJECTIVES

 Introduce, promote and implement Islamic Banking in

Pakistan
◦ as a parallel banking system
◦ comparable and compatible to conventional banking system and
◦ Shariah compliant
 In the long run let people “vote through their wallets”

5
 SBP APPROACH
Parallel banking system offering users
similar
◦ Functionality & Profitability
◦ In line with their beliefs
Provide a level playing field to Islamic
Banking
◦ Regulations
◦ Taxation

6
 SBP APPROACH
 Parameter based vs. Straight jacketed system
◦ Model vs. Standard Agreements
◦ Essentials of Islamic Modes
◦ PLS Mechanism
◦ Modes of Finance
 Shariah compliance mechanism
◦ Essentials of Islamic modes
◦ Shariah Advisor
◦ Internal Shariah Review
◦ Report of Shariah Advisor
◦ SBP Shariah Compliance Inspection
◦ SBP Shariah Board

7
 INDUSTRY PROGRESS
 Sept 2003 One full fledge bank and one conventional bank with one
stand alone Islamic banking branch
 Currently six full fledge Islamic banks and 12 conventional banks with
Islamic Branches.
 Islamic banking is available through over 200 branches in 32 cities of
all four provinces and AJK expected to reach over 270 till Dec. 2007.
◦ Meezan Bank – 78 in 23 cities, Al Baraka Islamic Bank with 12
in 6 cities, Dubai Islamic with 17 in 9 cities, BankIslami with 16
in 6 cities, Emirates Global with 9 in 4 cities and Dawood
Islamic with 5 in 2 cities.
◦ 12 Conventional banks (MCB, HBL, Bank of Khyber, Soneri,
Bank Alfalah, Bank Al Habib, Habib Metropolitan, Standard
Chartered Bank, Askari, NBP, UBL and ABN AMRO) with 72
Islamic Banking Branches (IBBs).

8
 Industry Progress and Market Share
Rs. in Billion
Jun Dec Dec- Dec- Dec-
Description
07 06 05 04 03

Total Assets (Rs. in Bn) 159 119 72 44 13

%age of Banking Industry 3.2% 2.8% 2.1% 1.4% 0.5%

Deposits (Rs. in Bn) 108 84 50 30 8

%age of Banking Industry 2.9% 2.6% 1.9% 1.2% 0.4%
Financing. & Invest. (Rs. in Bn) 90 73 48 30 10

%age of Banking Industry 2.5% 2.3% 1.8% 1.3% 0.5%

No. of Branches 167 150 70 48 17
9
 SBP Shariah Board
 A central Shariah Board established at SBP and is fully functional
◦ Current membership consists of five persons
 Two Shariah scholars
 A Chartered accountant
 A lawyer
 A banker representing the industry as well as SBP
◦ A consultant to the Shariah Board, a scholar from Qum.

10
 Global Perspective

 The size of Islamic Financial Industry is around US$ 900 Bln.

and its growing annually @ 15% per anum.
 Over 70 countries have Islamic Banking Institutions
 Muslim countries including Bahrain, UAE, Saudi Arabia,
Malaysia, Brunei, Pakistan, Sudan, Iran, Indonesia, etc.
 Non-Muslim countries including USA, UK, Canada,
Switzerland, Singapore, South Africa, Australia, etc.

11
 Global Perspective

 In Feb 1999, Dow Jones introduced the Dow

Jones Islamic Market Index (DJIM) of 600
companies world wide whose business
complies with Islamic Shariah laws
 At present there are more than 105 Islamic
Funds operational through out the world with
a total fund base of over USD 3.50 billion
12
 Global Perspective

 Governments of Bahrain ,Malaysia and

Pakistan have issued Islamic Bonds
(Sukuk) in order to facilitate Islamic Banks
in managing their liquidity.
 Issuance of these bonds has also paved the
way for Shariah compliant Government
borrowings.
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IJARAH

14
IJARAH (LEASING)

IJARAH AL ASHKAAS

IJARAH AL AI’YAN
Ijarah (Operating Lease)
Ijarah Muntahia Bittamleek

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IJARAH (LEASING)

Ijarah is to offer for a consideration the

usufruct of a thing of value from which
benefit can be derived without consumption,
while retaining the ownership of the leased
assets and assuming risks pertaining thereto.

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Ijarah Muntahia Bittamleek

 Thisis a lease that ends with the ownership of the asset.

 There are several types of Ijarah Muntahia Bittamleek.
These are characterized based on the method by which the
ownership transfers to the user:
◦ For no consideration (through a gift)
◦ For token consideration
◦ For price specified in the lease
◦ For remaining amount (if lease is terminated before period)
◦ Gradual transfer

17
ESSENTIALS OF IJARAH

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IJARAH (LEASING)

The corpus of leased commodity remains in the ownership

of the lessor and only its usufruct is transferred to the lessee.
Any thing which cannot be used without consuming the
same cannot be leased out like money, edibles, fuel, etc.
Only such assets which are owned by the lessor can be
leased out except that a sub-lease is effected by the lessee
with the express permission of the lessor.
Until such time that assets to be leased are delivered to the
lessee, lease rentals do not become due and payable

19
IJARAH (LEASING)

During the entire term of the lease, the lessor must retain
title to the assets, and bear all risks and rewards pertaining to
ownership.

If any damage or loss is caused to the leased assets due to

the fault or negligence of the lessee, the consequences
thereof shall be borne by the lessee.

The consequences arising from non-customary use of the

asset without mutual agreement will also be borne by the
lessee.

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IJARAH (LEASING)

The lessee is also responsible for all risks and consequences

in relation to third party liability, arising from or incidental
to operation or use of the leased assets.

The insurance of the leased asset should be in the name of

lessor and the cost of such insurance borne by him.

A lease can be terminated before expiry of the term of the

lease but only with the mutual consent of the parties.

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IJARAH (LEASING)

Either party can make a unilateral promise to buy/sell the

assets upon expiry of the term of lease, or earlier at a price
and at such terms and conditions as are agreed, provided that
the lease agreement shall not be conditional upon such sale.

Alternatively, the lessor may make a promise to gift the

asset to the lessee upon termination of the lease, provided
the lessee has fulfilled all his obligations.

However, there shall not be any stipulation in the lease

agreement purporting to transfer of ownership of the leased
assets at a future date.

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IJARAH (LEASING)

The amount of rental must be agreed in advance in an

unambiguous manner either for the full term of the lease or
for a specific period in absolute terms.

Assignment of only the lease rentals is not permissible

except at par value.

Contract of lease will be considered terminated if the leased

asset ceases to give the service for which it was rented.
However, if the leased asset is damaged during the period of
the contract but is capable of being repaired, the contract
will remain valid.

23
IJARAH (LEASING)

A penalty can be agreed ab initio in the lease agreement for

delay in payment of rental by the lessee. In that case, lessee
shall be liable to pay penalty calculated at the agreed rate in
percent per day/annum. However, that penalty shall be used
for the purposes of charity.

The banks can also approach competent courts for award of

damages, at discretion of the courts, which shall be
determined on the basis of direct and indirect costs incurred,
other than opportunity cost.

Also, security or collateral can be sold by the bank

(purchaser) without intervention of the court.

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AAOIFI SHARIAH
STANDARD

25
 Ijarah and Ijarah Muntahia Bittamleek

Scope.
This standard is applicable to operating leases of properties or to Ijarah
Muntahia Bittamleek. Whether the institution is the lessor or the lessee.
This standard is not applicable to the employment persons (labor contract).

Promise to lease (an asset).

It is permissible for the institution to require the lease promisor (customer)
to pay a sum of money to the institution to guarantee the customer’s
commitment to accepting a lease on the asset and the subsequent
obligations, provided no amount is to be deducted from this sum except in
proportion to the actual damage suffered by the institution.

26
 Ijarah and Ijarah Muntahia Bittamleek

Acquisition of the asset to be leased.

For the validity of an Ijarah contract concerning a specified asset, the lease
contract should be preceded by acquisition of either the asset to be leased or
the usufruct of that asset.
(a) If the asset or the usufruct thereof is owned by the institution,
which should in principle be the case, an Ijarah contract may be executed as
soon as agreement is reached by the two parties.
(b) however, if the asset is to be acquired from the customer, or from
a third party, the Ijarah contract shall not be executed unless and
until the institution has acquired that asset.

27
 Ijarah and Ijarah Muntahia Bittamleek

Concluding an Ijarah contract.

 The lease contract is a binding contract which neither may terminate or
alter with out the other’s consent.

 The duration of an Ijarah contract must be specified in the contract must be

specified in the contract. The period of Ijarah should commence on the date
of execution of the contract, unless the two parties agree on a specified
future commencement date, resulting in a future Ijarah, that is, an Ijarah
contract to be executed at a future date.

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 Ijarah and Ijarah Muntahia Bittamleek

Subject Matter of Ijarah

 The leased asset must be capable of being used while preserving the asset,
and the benefit from an Ijarah must be lawful in Sharia.

 The lessor may not stipulate that the lessee will undertake the major
maintenance of the asset that is required to keep it in the condition
necessary to provide the contractual benefits under the lease. The lessor
may delegate to the lessee the task of carrying out such maintenance at the
lessor’s cost. The lessee should carry out operating or periodical (ordinary)
maintenance.

29
 Ijarah and Ijarah Muntahia Bittamleek

Rules governing lease rentals.

 In case the rentals is subject to changes (floating rentals), it
is necessary that the amount of the rentals of the first period
of the Ijarah contract be specified. It is then permissible that
the rentals for subsequent periods be determined according
to a certain benchmark.

30
 Ijarah and Ijarah Muntahia Bittamleek

Guarantees and treatment of Ijarah receivables.

 Permissible security, of all kinds, may be taken to secure the
rental payments or as security against misuse or negligence
on the part of lessee.
 It may be provided in the contract of Ijarah or Ijarah
Muntahia Bittamleek that a lessee who delays payment for
no good reason undertakes to donate a certain amount or
percentage of the rentals due in case of late payment. Such
donation should be paid to charitable causes under the co-
ordination of the institution's Sharia supervisory board.

31
 Ijarah and Ijarah Muntahia Bittamleek

Termination of the Ijarah Contract.

 The two parties may terminate the Ijarah contract before it
begins to run.
 It is permissible to terminate the lease contract by mutual
consent but it is not permissible for one party to terminate it
except in case of force majeure or there is a defect in the
leased asset that materially impairs its use. Termination is
also possible when one party secures an option to terminate
the contract in which case the party who holds the option
may exercise it during the specified period.

32
 Ijarah and Ijarah Muntahia Bittamleek

Transfer of the ownership in the leased property in

Ijarah Muntahia Bittamleek.
 In Ijarah Muntahia Bittamleek, the method of transferring the title in the
leased asset to the lessee must be evidenced in a document separate from the
Ijarah contract document, using one of the following methods.
◦ By means of a promise to sell for a token or other consideration,
or by accelerating the payment of the remaining amount of
rental, or by paying the market value of the leased property.
◦ A promise to give it as gift (for no consideration).
◦ A promise to give it as a gift, contingent upon the payment of the
remaining installments.

33
MECHANISM

34
 Leasing (Ijara Wa Iqtina)
Beneficial use
Transfer of asset of asset

Financier Entrepreneur
Vendor (Lessee)
(Lessor)
Payment of Lease rentals
purchase price
 Another popular instrument – 15% of the transactions
 Right available to lessee to purchase
 Asset ownership risk with owner; operational risks with lessee
 Features close to a financial lease
 Used for machinery, equipment, property, vehicles, aircraft etc.
 Ownership usually transferred at the end

35
 Ijarah
Ijarah Muntahia
Muntahia Bittamleek
Bittamleek

GENERAL MECHANICS

. .
VENDOR ISLAMI BANK Agreement CUSTOMER
C

The customer approaches the Bank with the request for financing


The Bank purchases the item required for leasing and receives title

of ownership from the vendor
The Bank makes payment to the vendor


36
 Ijarah Muntahia Bittamleek
GENERAL MECHANICS

. .
VENDOR ISLAMI BANK Agreement CUSTOMER
C

The Bank leases the asset to the customer



The customer makes periodic payments as per the contract



The
 asset title transfers to the customer based on the method
disclosed in the agreement

37
USAGE OF IJARAH

38
IJARAH (LEASING)

Ijarah (Operating Lease) Examples:

Houses
Rent-A-Car
Agricultural Durables
Aircrafts, etc.

Issues
Asset Price Risk
Repair and Maintenance
Running Expenses (depending upon contract)
Credit Risk (Default in rental payment)

39
IJARAH (LEASING)

Ijarah Muntahia Bittamleek Examples:

Vehicles Ijarah Financing
Plant and Machinery
Consumer Durables
House Financing
Project Finance, etc.

40
RISKS AND ISSUES

41
Risks and Practical Issues
Proper documentation
Sequence of Documentation in Sale and
lease Back.
Time of Transferring asset in Sale and
Lease back
Islamic Lease covers the conditions of
Finance Lease as described in IAS 17.
Accounting & Tax Depreciation Issues.

42
 Risks
 Credit Risk
 Rate of Return Risk
 Customer may decline to enter into
Ijarah.
 Damage to Asset
 Overdue Rentals
 Non-Compliance/Violation of contract.
 Early Termination
 Asset Price Risk
43
Risks and Practical Issues
 How to treat insurance cost paid by the
Lessor?
 Treatment of Security deposits received
from customers.
 Treatment of Advance rentals.
 Accounting rule/policy regarding
repairs of Leased assets.
 Securtization of Asset or Receivables?

44
 Leasing/Ijarah Contract

Conventional Leasing Car Ijarah

There are two types of contracts, The Ijarah contract does not contain
Financial lease and loan for car any condition that makes the contract
financing. Both these contracts void under Sharia'h perspective.
contain conditions that are
contravenes with the Islamic
Sharia'h.
Financing lease contains conditions
of hire purchase, which is not
permissible by Sharia'h.
Car financing or loan agreement
contains conditions of interest.
Interest is considered Riba by
Sharia'h
45
 Rights & Liabilities of Lessor and Lessee

Conventional Leasing Car Ijarah

In Conventional Leasing Products, All risks pertaining to ownership

the Customer is responsible for all are borne by Lessor.Customer only
kinds of losses or damages to the bears usage-related risks
Leased asset, irrespective of the
circumstances.

If the insurance company does not Lessor bears the risk of Insurance
compensate the entire outstanding claim settlement.
amount in case of total loss, the
customer is liable to pay the balance.

46
Rentals recovery in case of theft and loss

Conventional Leasing Car Ijarah

If the Leased Asset is stolen or Under the Islamic Ijarah, rent is

completely destroyed, the consideration for usage of the
conventional leasing company or leased asset, and if the asset has
Bank would continue charging the been stolen, destroyed or
lease rent till the settlement of the temporarily out of order and not in
Insurance claim use of Customer, the concept of
rental becomes void. In such
situations rental is not charged
from the lessee.

47
Penalty for late payment

Conventional Leasing Car Ijarah

In most contemporary financial Under Ijarah, the Lessee may be

leases, an extra monetary amount asked to undertake that if he fails
is charged if rent is not paid on to pay rent on its due date, he will
time. This extra amount is the pay a certain amount to a charity
considered Riba and is Haram. Fund, which will be administered
through the Islamic Bank.
This amount is taken by the
leasing institution into their For this purpose the bank
income. maintains a charity fund where
such amounts may be credited and
disbursed for charitable purposes.

48
Insurance premium
Conventional Leasing
Insurance is independent of the
lease contract. The insurance
expense of the asset is directly
borne by the lessee
Car Ijarah
Takaful / Insurance should be at
the expense of the Lessor and not
at the expense of the lessee. The
Lessor may increase the lease rent
to recover any costs incurred by
him in connection with the asset.
However, as a matter of principal,
the cost should be paid for by the
Lessor.
49
Registration Charges

Conventional Leasing Car Ijarah

Lessee is responsible for the The Leased Asset(vehicle) is

Registration of Leased Vehicle. registered in the name of the Bank
and registration charges are paid
by the Bank (Lessor).

The Lessor may increase the lease

rent to recover any costs incurred
by him in connection with the asset

50
 Purchase of asset
Conventional Leasing
Under conventional leasing
contracts, the vehicle is
automatically transferred in the name
of the customer upon completion of
the lease period, whether or not he
wants to purchase it.
Car Ijarah
There is not such clause in the Ijarah
Agreement that Leased Asset will
automatically transfer to Lessee.
Separate sale agreement is required
to execute sale transaction at the end
of lease term.
51
 Commencement of Rentals
Conventional Leasing
In case of Booking of Leased
Asset, recovery of Lease
installment commence after the
payment of cost of Asset to
manufacturer/dealer.
Car Ijarah
In case of Car Ijarah, the recovery
of rentals is associated with
delivery of Leased Asset.
Rental recovery should not be
commenced before the delivery of
Asset.
52
 Signing of Lease Contract
Conventional Leasing
Lease Agreement can be signed by
the Lessee and Lessee any time even
if the Leased Asset is not owned by
the Customer.
Car Ijarah
In case of Ijarah, the Ijarah
Agreement can not be signed by the
Lessor and Lessee unless:
Asset has come in to existence
Assets is in the ownership of the
Lessor
Lessor has taken possession of the
Asset
53
 Termination before delivery
Conventional Leasing
The customer will suffer loss of
interest paid during the booking
period because installment commence
immediately after payment of cost of
asset to the Manufacturer/Dealer.
Car Ijarah
The loss of customer is only limited
to actual loss, if any, suffered by the
Lessor on sale of asset in the open
market.
Since the customer has not paid any
rental during the booking period, no
other cash loss is expected under
Ijarah.
54
DOCUMENTATION OF
IJARAH

55
IJARAH AGREEMENT

Ijarah Agreement is the basic document which

contains all terms and conditions pertinent of Ijarah
of particular Asset(s).

Ijarah Agreement shall be signed after the Lessor

has taken the possession the Asset and not earlier.

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ADDENDUMS TO IJARAH AGREEMENT

Description of the Ijarah Asset

Schedule of of Ijarah Rentals
Receipt of Asset
Demand Promissory Note

57
DESCRIPTION OF IJARAH ASSET

This document contains the detailed

description about the Leased Asset agreed
between the parties e.g Name, Make
,Model,Engine No., Chassis No., Registration
No. etc etc.

This documents shall be signed signed after

Delivery of asset to the Lessee and not earlier.

58
SCHEDULE OF IJARAH RENTALS

This schedule contains a table which shows:

Amount of rental (Monthly/Quarterly/Half Yearly)

Date of Payment of each rental

This schedule will also contain the date on

which first rental is due.

This documents shall be signed signed after

Delivery of asset to the Lessee.
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RECEIPT OF ASSETS

This document confirms that customer has

taken the possession of Leased Asset as
described in the earlier document “Description
of Ijarah Asset”.

This document is only signed by the Lessee on

receipt of Asset, as an acknowledgement of
receipt of described asset under Ijarah Contact.

60
PROMISSORY NOTE

After signing of Ijarah Agreement, the

amount of rentals become Debt (Dyan) to the
Lessee.

Promissory Note is Lessee’s

acknowledgement to Debt amount and its
promise to pay.

61
 UNDERTAKING TO PURCHASE LEASED
ASSET

This documents contains undertaking from

the Lessee that he/it will purchase the Leased
asset on the purchase Price corresponding to
the Purchase Date.

This document contains a schedule which

shows Purchase Price(s) during the Ijarah
term on which the Lessee can purchase the
asset by making lump sum payment.
62
OTHER DOCUMENTS

Undertaking for Personal use of Ijarah

Asset
Trust Receipt
Authorization to Take possession of
Leased Asset
Sale Deed

63
 Shari’ah legitimacy Ijara-tul-Ashkhas

Ijarah delivers legitimacy from the Qura’an and the Sunnah.

On the level of Qur’an, Allah says : “ said one of them ‘o my father engage him
on wages”
(Surah al-Qasas verse 26)

The saying of the Prophet Hazrat Muhammad (Sallallau Alihi Wsallam) that
“whoever hired a worker must inform of his wages”
(Ibn-e-Majah, Sanan Ibn-e-Majah 2/817 )

“Give a worker his wages before his sweet is dried”

(Ibn-e-Majah, Sanan Ibn-e-Majah 2/817 )

64
 Ijara-tul-Ashkhas

According to Shari’ah, Ijarat-ul-ashkhaas which is dealt with hiring the services/

expertise of a person or a party which provides his/her/its expertise.

It depends upon the nature of the transaction that how many parties are
involved in Ijarat-ul-Ashkhaas. For example, there may be three parties, one is
the services provider (the principal lessor), second is Bank (the principal lessee,
which will avail these services on spot/prompt or deferred payment basis) from
the principal lessor and the third is actual services seeker (the sub lessee)

According to the aforesaid Shari’ah principle, Bank can devise consumer as well
as corporate products for its clients from the services providers on either prompt
or deferred payment basis.

If the client fails to make payment on due dates, according to pre-agreed

schedule, then Bank will be entitled to only receive charity from the client for the
defaulted period but this charity will not be taken into Bank income rather Bank
will have to pay this charity amount to some approved charitable institutions.

65
 Common Misconceptions

“Islamic banking looks the same as conventional

banking”
A halal meat and haram meat may look exactly the same
but one is permissible while the other is not

“A fixed rate of return is not permitted under Islamic

Shariah”
Fixed return does not make a transaction halal or haram
For example:
• Profit on trading
• Rent on property
66
 Common Misconceptions

“Murabaha and Ijara are major modes being

practiced”
• Modaraba is major mode
“Only Documents certified by Shariah
Scholars are necessary for Shariah
compliance”
• Execution of documents

67
 ISLAMIC BANKING

SUGGESTED STRATEGY
Take a view
Have the right attitude
Make an active effort to learn
Have a commitment to implement the
change

68
Our Lord let not our hearts
deviate now after You have
guided us but grant us
mercy from Your own
Presence

for You are the Grantor of

bounties without measure.
Surah Ali ‘Imran 8

69
Our Lord! Condemn us not if
we forget or fall into error

Our Lord! Lay not on us a burden

Like that which You put on those
before us
Our Lord! Lay not on us a burden
greater than we have strength to
bear
Blot out our sins, and grant us
forgiveness Have mercy on us You
are our Protector Help us against
those who stand against faith
Surah Al-Baqarah 286 70