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IJARAH
Presented by:
MAHMOOD SHAFQAT
Joint Director
Islamic Banking Department
At AlHuda CIBE Workshop
The views expressed in this presentation are those of the author
and do not necessarily represent State Bank of Pakistan
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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
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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.
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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.
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CURRENT STRATEGY
 Gradual approach 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
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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”
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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
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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
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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).
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Industry Progress and Market Share
Rs. in Billion
Description
Jun
07
Dec
06
Dec05
Dec04
Dec03
Total Assets (Rs. in Bn)
159
119
72
44
13
3.2%
2.8%
2.1%
1.4%
0.5%
108
84
50
30
8
2.9%
2.6%
1.9%
1.2%
0.4%
90
73
48
30
10
2.5%
2.3%
1.8%
1.3%
0.5%
167
150
70
48
%age of Banking Industry
Deposits (Rs. in Bn)
%age of Banking Industry
Financing. & Invest. (Rs. in Bn)
%age of Banking Industry
No. of Branches
17
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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.
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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.
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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
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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
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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
 This is 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
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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
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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.
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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MECHANISM
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Leasing (Ijara Wa Iqtina)
Beneficial use
of asset
Transfer of asset
Financier
(Lessor)
Vendor
Payment of
purchase price
Entrepreneur
(Lessee)
Lease rentals

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
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Ijarah Muntahia Bittamleek
GENERAL MECHANICS
.
VENDOR
.
ISLAMIC BANK
Agreement
CUSTOMER
 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
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Ijarah Muntahia Bittamleek
GENERAL MECHANICS
.
VENDOR
ISLAMIC BANK
Agreement
.
CUSTOMER
 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
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USAGE OF IJARAH
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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)
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IJARAH (LEASING)
Ijarah Muntahia Bittamleek Examples:
Vehicles Ijarah Financing
Plant and Machinery
Consumer Durables
House Financing
Project Finance, etc.
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RISKS AND ISSUES
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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.
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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
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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?
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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 contain void under Sharia'h perspective.
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
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Rights & Liabilities of Lessor and Lessee
Conventional Leasing
Car Ijarah
In Conventional Leasing Products, the All risks pertaining to ownership are
Customer is responsible for all kinds borne by Lessor.Customer only
of losses or damages to the Leased bears usage-related risks
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.
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Rentals recovery in case of theft and loss
Conventional Leasing
Car Ijarah
If the Leased Asset is stolen or
completely
destroyed,
the
conventional leasing company or
Bank would continue charging the
lease rent till the settlement of the
Insurance claim
Under the Islamic Ijarah, rent is
consideration for usage of the
leased asset, and if the asset has
been stolen,
destroyed or
temporarily out of order and not in
use of Customer, the concept of
rental becomes void. In such
situations rental is not charged from
the lessee.
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Penalty for late payment
Conventional Leasing
Car Ijarah
In most contemporary financial
leases, an extra monetary amount is
charged if rent is not paid on time.
This extra amount is the considered
Riba and is Haram.
Under Ijarah, the Lessee may be
asked to undertake that if he fails
to pay rent on its due date, he will
pay a certain amount to a charity
Fund, which will be administered
through the Islamic Bank.
This amount is taken by the leasing
institution into their income.
For this purpose the bank
maintains a charity fund where
such amounts may be credited and
disbursed for charitable purposes.
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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.
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Registration Charges
Conventional Leasing
Lessee is responsible for the
Registration of Leased Vehicle.
Car Ijarah
The Leased Asset(vehicle) is
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
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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.
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Commencement of Rentals
Conventional Leasing
Car Ijarah
In case of Booking of Leased Asset, In case of Car Ijarah, the recovery
recovery of Lease installment
of rentals is associated with delivery
commence after the payment of cost of Leased Asset.
of Asset to manufacturer/dealer.
Rental recovery should not be
commenced before the delivery of
Asset.
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Signing of Lease Contract
Conventional Leasing
Car Ijarah
Lease Agreement can be signed by the In case of Ijarah, the Ijarah Agreement
Lessee and Lessee any time even if the can not be signed by the Lessor and
Leased Asset is not owned by the
Lessee unless:
Customer.
Asset has come in to existence
Assets is in the ownership of the
Lessor
Lessor has taken possession of the
Asset
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Termination before delivery
Conventional Leasing
Car Ijarah
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.
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.
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DOCUMENTATION OF
IJARAH
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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
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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.
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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.
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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.
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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.
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OTHER DOCUMENTS
Undertaking for Personal use of
Ijarah Asset
Trust Receipt
Authorization to Take possession of
Leased Asset
Sale Deed
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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 )
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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.
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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
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Common Misconceptions
“Murabaha and Ijara are major modes being
practiced”
• Modaraba is major mode
“Only Documents certified by
Scholars are necessary for
compliance”
Shariah
Shariah
• Execution of documents
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ISLAMIC BANKING
SUGGESTED STRATEGY
 Take a view
 Have the right attitude
 Make an active effort to learn
 Have a commitment to implement the change
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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
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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
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THANK YOU
Ph: 021-9212509, Fax: 021-9212472
Email: [email protected]
http://www.sbp.org.pk/departments/ibd.htm
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