The Importance of Islamic Financing for Lessees

Analyzing Benefits of Ijara for a Lessee

The ever-increasing popularity of Islamic financing methods has intrigued scholars and analysts alike and there has been no dearth of studies undertaken to unearth the reasons. The consensus-Islamic financing methods per se are simple to understand and execute and the terms and conditions of the contract and transaction processes involved are transparent and adhere to the sound financial principles laid down in Sharia law. Amongst the various methods of Islamic financing, ijara is one of the most popularly used, being practiced in about 500 financial institutions all over the world. In fact, such is the widespread preference for this mode of financing that not only Muslims but also people belonging to other religious orders are customers of ijara.The ijara financing mode has benefits for both the lessor and the lessee. A keener comprehension of the popularity of this mode of Islamic financing can be had, particularly by analyzing the benefits of ijara for a lessee. However, before delving into the benefits of ijara for a lessee, gaining an understanding of the salient working principles of ijara will be helpful.

What is Ijara

Ijara is a form of leasing contract where a bank or any other financial institution transfers the right of use of an asset or a piece of property to a customer for a specified period of time and in return for a rental payment, which may or may not be pre-determined. The bank or the financial institution in the ijara contract is the lessor while the customer is a lessee. During the contractual period, the right of ownership of the asset remains with the lessor. The lessor also has to bear the risks of owning the asset. The lessee can choose to have the right of ownership of the asset transferred to him at the end of the ijara period.

These fundamental working principles lie at the heart of the benefits of ijara for a lessee.

The Benefits of Ijara for a Lessee

A discussion of some of the principal benefits of ijara for a lessee will make clear why this mode of Islamic financing is so popular.

One of the most important benefits of ijara for a lessee is that, by allowing 100% financing, it enables the lessee to conserve his capital and even channel it to other revenue-making ventures. As ijara implies borrowing without interest, the lessee’s capital becomes conserved on another front as well. Another one of the critical benefits of ijara for a lessee stems from the inherent simplicity of the transaction process-the lessee gets to enjoy the right to use the asset specified in the contract and reap its benefits immediately after making the first rental payment.

The benefits of ijara for a lessee become reflected on his balance of payments statement as well. As this mode of financing is not treated as debt financing, it does not get reflected as a “liability” in the lessee’s balance sheet and thus is left out of the debt ratios. So, when bankers or other loan givers are determining financing limits, the lessee can hope to enter into other leasing agreements without harming his overall debt rating. Also all payments made as part of the ijara leasing agreement are considered to be operating expenditure and so are fully exempt from taxation.

One of the other notable benefits of ijara for a lessee is that this financial agreement allows both parties to negotiate the amount of rental payment. In a dynamic business world, this flexibility proves to be immensely beneficial by allowing both the lessee and the lessor to modify the rental arrangement to account for economic fluctuations and changes in fiscal and monetary policies.

There are other practical benefits of ijara for a lessee as well, especially in instances where the lessee is renting a piece of equipment. The ijara mode of financial agreement is the most feasible choice when a lessee wants to rent a piece of equipment only for a short period of time. However, customers have also been known to enter into ijara agreements when although they are leasing a piece of equipment for a long period of time, the equipment has a poor resale value. In such instances, the benefits of ijara for a lessee arise from the fact that the lessee does not have to bear the depreciating costs of the equipment as per normal accounting principles.

Conclusion

The above attributes are only some of the benefits of ijara for a lessee. But these benefits of ijara for a lessee are sufficient to establish the superiority of this form of financial arrangement over many other established practices.