ISLAMIC FINANCE

IMB: Ijarah Muntahia Bittamleek, a contract which begins with an Ijarah contract for the purpose of renting out a lessor's asset to a lessee. Consequently, at the end of the lease period, the lessee will purchase the asset at an agreed price from the lessor by executing a purchase contract.

Binding PL:  Banding Promise to Lease. The Bank enters into the contract based on specific description of an asset to be leased and acquired in the future before it is delivered to the lessee.

Hamish Jiddiyyah: in the case of a binding LP, the risk of selling at a loss is mitigated by securing a Hamish Jiddiyyah (HJ). It's a security deposit held as collateral upon entering into agreement to purchase or agreement to lease. 

Sharia: is the body of Islamic religious law. It is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on Islamic principles of jurisprudence. Sharia deals with many aspects of day-to-day life, including politics, economics, banking, business, contracts, family, sexuality, hygiene, and social issues.

PSIA: Profit Sharing Investment Account is a financial instrument that is relatively similar to the time deposits of conventional banks. According to the terms and conditions of PSIA, depositors are entitled to receive a share of the bank's profits, but also obliged to bear all potential losses pertaining to their investment in the bank. This profit-sharing principle is core to Islamic finance, according to which investors and entrepreneurs must share the risks and rewards of a given venture.

A PSIA can be further categorised into: Unrestricted PSIA and Restricted PSIA. The Bank has full discretionary power in making investment decisions for unrestricted PSIA, but in the case of the restricted PSIA the placement of funds by the Bank is subject to investment criteria contract or agreed between the investment account holders (IAH) and the Bank at the time of contracting.

2-Ijarah's principle

In this section, some principles which must be respected by an Ijarah & IMB contract are described and an example is presented.

An Ijarah or IMB contract is very similar to a contract of leasing in conventional finance. The basic difference between a Sharia Ijarah process and a conventional lease is that, the Ijarah process obligates the seller to sell the property to the buyer under a Promise to Purchase, and while the same contract entitles the customer to purchase the property, the customer is not enforceable obligated to do so.

Like Murabahah, lease is not originally a mode of financing. It is simply a transaction meant to transfer the usufruct of a property from one person to another for an agreed period against an agreed consideration.

When interest-free financial institutions were established in the near past, they found that leasing is a recognized mode of finance throughout the world. They realized that leasing is a lawful transaction according to Sharia and it can be used as an interest-free mode of financing.

So that a Ijarah & IMB contract complies with Sharia, it is necessary to respect some rules:

§         The subject of lease must have a valuable use. Therefore, things having no usufruct at all cannot be leased.

§         The period of lease must be determined in clear terms.

§         The rental must be determined at the time of contract for the whole period of lease.
It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of effecting a lease. If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease is not valid.

§         The lease period shall commence from the date on which the leased asset has been delivered to the lessee, no matter whether the lessee has started using it or not.

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

§         The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence on the part of the lessee.

§         If the leased asset has totally lost the function for which it was leased, and no repair is possible, the lease shall terminate on the day on which such loss has been caused. However, if the loss is caused by the misuse or by the negligence of the lessee, he will be liable to compensate the lessor for the depreciated value of the asset as, it was immediately before the loss.

Example: (The basis of using percentage)

While it may appear contrary to the Sharia, it is in fact acceptable to describe the profit on an Islamic transaction as a percentage.  The following example should clear up any confusion regarding the acceptability of quoting the profit as a percentage in an Ijarah transaction:

1. Suppose you have a $100,000 in cash.
2. You purchase a home and pay cash for the home.
3. You rent the home to a tenant for $500 per month
4. At the end of the year you have collected $500 x 12 or $6,000 in rent
5. That $6,000 in rent is a 6% return on your $100,000 investment

Is that 6% Rent or Riba?  Well it is clearly it is Rent, as it is based upon a business transaction. Now let's look at a traditional mortgage interest transaction:

1. Starting with the same $100,000 cash.
2. You give someone the money.
3. They proceed to purchase the same home with those funds.
4. They pay you the same $500 per month, or 6% a year for use of the money.
5. This is basically rent on money

In this case is the 6% Riba? Yes, it is rent on money.  The first example was rent on property.  So it should be clear that from a Sharia perspective it is acceptable to describe the profit on an Islamic Ijarah transaction as a percentage. 

3- Ijarah stages  

 An Ijarah & IMB contract can be divided in tree stages:

·         Stage I: the asset is available for lease (prior to signing a lease contract).

·         Stage II: the lessee gets the right to use the asset and the lease rental payments are due from the lessee.

·         Stage III: Maturity of contract term and the asset is returned to the Bank.

The calculation and the type of the risk faced by the Bank are different at the various stages of the contract for the two categories.

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