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Literally, Al-Ijarah Thumma Al-Bai’ means to lease, hire, or rent ending with purchase. It is an Islamic financing feature which is based on the combination of two Shari’ah concepts; Ijarah (leasing) and bay’ (sale).

Since the entire risk is borne by the lessor in a normal lease, there is a danger of misuse of the leased asset by the lessee.  The financial lease helps take care of this problem by making the lease period long enough (usually the entire useful life of the leased asset), to enable the lessor to amortize the cost of the asset with profit.  At the end of the lease period the lessee has the option to purchase (iqtina’) the asset from the lessor at a price specified in advance or at its market value at that time.  The lease is not cancellable before the expiry of the lease period without the consent of both the parties.  There is, therefore, little danger of misuse of the asset.

          A financial lease has other advantages too.  The leased asset serves as security and, in case of default on the part of the lessee; the lessor can take possession of the equipment without court order.  It also helps reduce the lessor’s tax liability due to the high depreciation allowances generally allowed by tax laws in many countries.  The lessor can also sell the equipment during the lease period such that the lease payments accrue to the new buyer.  This enables the lessor to get cash when he needs liquidity.  This is not possible in the case of a debt because, while the Shari‘ah allows the sale of physical assets, it does not allow the sale of monetary debts except at their nominal value.

 

Some of the fuqaha’ have expressed doubts about the permissibility of financial lease.  The rationale they give is that the long-term and non-cancellable nature of the lease contract shifts the entire risk to the lessee, particularly if the ‘residual’ value of the asset is also fixed in advance.  The end result for the lessee may turn out to be worse than the outright purchase of the asset through an interest-bearing loan.  A financial lease has thus the potential of becoming more exploitative than outright purchase. Suppose the lease contract is for five years.  The lessee would have to continue making lease payments even if he does not need the asset, say, after two years.  In the case of a purchase through an interest-bearing loan, the purchaser can sell the asset in the market and repay the loan, thus reducing his loss.  This he cannot do in a financial lease.  If he is unable to make lease payments, he may lose his stake in the asset even though he has paid a part of the asset price beyond the rental charge he would normally pay in an operating lease.

 

However, there are fuqaha’ who consider financial lease to be permissible if certain conditions are satisfied. 

Firstly, the lessor must bear the risks of leasing by being the real owner of the leased asset.  He cannot lease what he does not own and possess, and should be responsible for all the risks and expenses related to ownership. Therefore, a leasing contract where the lessor acts only as an intermediary between the supplier and the lessee and plays the role of only a financier, with ownership of the asset being nothing more than a legal device to provide security for repayment of the loan and legal protection in case of default, is not allowed.  In this case the lessor leases an asset before buying it and taking possession of it, and gets a reward without bearing any risk. 

Secondly, lease payments cannot start until the lessee has actually received possession of the leased asset and can continue only as long as it remains usable by him.

Thirdly, all manufacturing defects and other problems which are beyond the control of the lessee, should be the lessor’s responsibility. The lessee can, however, be made responsible for the proper upkeep and maintenance of the leased asset. 

Fourthly, the lease contract should be separate from, and independent of, the contract for the purchase of the residual asset. The residual value has to be market-related and cannot be fixed in advance. The purchase contract has, therefore,  to be optional and cannot be binding because the quality of the asset at the end of the lease period as well as its market-related price, two of the essential requirements for a valid contract, are unknown when the lease contract is signed.

          All Islamic banks as well the Islamic Development Bank use the financial lease by fulfilling, or at least making an effort to fulfil, the Shari‘ah conditions.  The residual value remains a problem but the banks have tried to overcome it by setting a small nominal value for the residual asset or transferring it as a gift from the lessor to the lessee. This does not, according to some fuqaha’, fulfil the Shari‘ah requirement because the residual value gets automatically predetermined and becomes built into the lease payments.

 

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