Ijara Thumma Al Bai
What is Ijara Thumma Al Bai
The various modes of Islamic financing are grounded in the rules of the Sharia. Sharia is a body of Islamic laws that not only governs the way of life for Muslims all over the world but also dictates how financial transactions should be carried out. For instance, Sharia decrees that every party who has entered into a financial contract must benefit from the arrangement. The soundness and the integrity of the rules of the Sharia find expression in the various modes of Islamic financing, and particularly in ijara, a type of lease agreement entered into by a lessor and lessee. There are various kinds of ijara contracts; ijara thumma al bai is a financial lease contract.
The Essence of Ijara Thumma Al Bai
A basic idea about the essence of ijara thumma al bai can be had by analyzing the words that make up the name. The word “ijara” means renting, hiring, or leasing. “Thumma” means to be followed by or thereafter, whilst the phrase “al bai” refers to sales. So, essentially, this mode of Islamic financing refers to a financial arrangement where the leasing of an asset is followed by its purchase. It is thus a lease-sale contract and has striking similarities with the conventional financial lease contract. This basic idea of ijara thumma al bai will aid a detailed discussion of the working principles that drive this contract.
Businesses often have to buy expensive machinery, a piece of equipment, or some fixed asset like land or a building to aid their production process. Those who do not have the funds to buy the asset or the property approach a bank or any other Islamic financial institution and this need leads to the creation of an ijara thumma al bai contract.
The bank or the financial institution funds the purchase of the asset or the property as the two parties—the lessor and the lessee—enter into a leasing agreement whereby the lessee is bound to pay for the use of the asset some fixed amount of rent at pre-determined intervals of time. The lessor retains the right of ownership of the asset and as per the rules of ijara thumma al bai, is legally bound to bear the risks and responsibilities associated with the ownership.
A notable characteristic of an ijara thumma al bai contract is that the entire cost of the asset or the property specified in the contract is amortized during the lease tenure. For this reason, this contract is also referred to as a “full payment lease” contract.
Expounding a Myth Associated with Ijara Thumma Al Bai
While the essence of an ijara thumma al bai financial agreement is easy to understand and transparent, many people make the mistake of assuming that it is actually a combination of two contracts—lease and sale, that is, a leasing contract bound by the condition to sell. Nothing can be further from the truth.
An ijara thumma al bai is actually two separate contracts, undertaken independent of each other and executed at two different stages of the leasing period. At first, a leasing contract or an ijara is entered into by the lessor and the lessee. There is a “unilateral promise” specified in this contact—to sell the asset or the property to the lessee at a pre-determined price. This promise is an additional agreement in the contract and is to be strictly read as an “option” for the lessee, and definitely not an obligation on his part, to buy the asset or the property at the termination of the leasing contract.
The lessor is obliged to fulfill the afore-mentioned promise at the end of the leasing period, after the lessee has made all the rental payments, and has expressed his desire to exercise the option to buy the asset. A sale contract (bai) thus comes into play at this point and as can be gauged, it is independent to the ijara contract. This sale contract confers the right of ownership of the asset to the lessee.
Application of Ijara Thumma Al Bai
Ijara thumma al bai finds widespread application in the financing of expensive consumer goods such as vehicles or in business scenarios where the lessee does not have the funds to buy a costly piece of production equipment, anything from a tractor to a computer server. The money would have to be gathered from all available sources to buy the large scale product to then enjoy the benefits from its use.
The above practical applications of ijara thumma al bai make it clear how this mode of Islamic financing aids both cash-strapped start-ups find their footing and establish themselves in an increasingly competitive business environment and individuals fulfill their cherished dreams of owning a vehicle to move to and from.