Ijara as an Operating Lease

All About Ijara as an Operating Lease

In a business world marred by economic uncertainties and rising costs of operations,ijara loans are widely regarded as the easiest, safest, and most effective means to finance production processes. Like all other modes of Islamic financing, ijara too is rooted in the sound financial principles laid down by the Sharia. There are different forms of ijara, each suited to the specific needs of the parties entering into the contract.

The two most popular forms of ijara loans are the Simple Ijara or ijara as an operating lease and ijara thumma al-bai or ijara as a financial lease.

Ijara as an Operating Lease

The distinguishing feature of ijara as an operating lease is that the lease contract is not associated with a purchase agreement. Also known as a service lease or a true lease, ijara as an operating lease is usually entered into for short periods of time.

The following are some characteristic features of ijara as an operating lease:

  • The entire price of the asset or the piece of property specified in the contract is not amortized during the primary leasing tenure.
  • The lessee may opt out of the agreement, that is, cancel the ijara as an operating lease contract anytime he wishes to. However, he must furnish a notice prior to doing so.
  • The right of ownership of the asset or the piece of property as mentioned in the contract is retained by the lessor. This right is irrespective of the amount of payment the lessee has tendered and also specifies the lessor’s obligation to bear all the risks and responsibilities associated with the ownership.
  • In ijara as an operating lease, the asset has to be returned to the lessor at the end of the leasing tenure. The lessor, which may be a bank or any other financial institution, can again lease the asset, if it is functioning, to another individual or business entity.

Variations in the Terms of Contract in Ijara as an Operating Lease

There are various ways in which ijara as an operating lease may be carried out.

In its most basic form, the ijara as an operating lease states that a bank or any other financial institution that owns an asset, leases it to a customer in return for a specified sum of rental payment to be made at pre-determined intervals. The lessee, here is also the vendor of the asset. According to Islamic financial scholars, this type of financial agreementis most closely related to the classical form of ijara. However, this is also the least commonly found financial arrangement simply because, in real life, a bank doesn’t own too many physical assets.

In reality, there is usually a separate vendor along with the bank and the customer in the contract and the arrangement involves two distinct phases. In such a form of financial arrangement, the bank first buys an asset from a vendor. It then leases out the asset to the customer. The ijara contract mentions the amount of rental payment to be made and the frequency of payment.

In another form of ijara as an operating lease, the bank appoints the customer as its agent to deal with the vendor who owns the asset. This form of contract is entered into when the bank does not wish to deal directly with the vendor.

In the above-mentioned form of financial arrangement, the bank and the customer enter into two different kinds of relationship. At first, the customer is an “agent” of the bank. The second form of association begins from the day the customer receives the asset from the vendor and from this date, the conventional ijara-kind of lessee-lessor relationship comes into play. The responsibilities of the bank and the customer as they enact the roles in the two forms of relationship are completely different from each other.

Application of Ijara as an Operating Lease

The ijara as an operating lease form of financial arrangement finds most use in instances involving costly assets like aircrafts, ships, and some kinds of agricultural and industrial equipment. Some such assets, apart from being expensive, may have poor resale value. In such instances, it is immensely beneficial for the lessee to enter into this contract because he is not bound to purchase the asset at the end of the leasing period.

From the above discussion, the reasons for the popularity of ijara as an operating lease as an Islamic financing mode are not hard to guess—the simplicity of its working principles, the transparency in the transaction methods, and the myriad benefits for the parties involved in the contract.