In the world of Islamic finance, there are a number of specific rules of practice and order that you must adhere to in order to make sure that everyone benefits from a transaction. Whether you are the banker or lender or are a customer or borrower, the best way to make sure that you benefit from a transaction is to follow these Islamic finance rules. Shariah is the Islamic religious law that dictates the way of life for Islamic people, and there are provisions for all parts of day to day life including how financial transactions are carried out.
One of the Islamic finance terms that you are going to want to have a good solid understanding of is Ijarah thumma al bai’. Ijarah thumma al bai’ means “hire purchase.” It refers to how parties will enter into contracts which come into effect in a serial manner in order to form a complete lease or buyback transaction. The first contract in this serial process is known as Ijarah, and its purpose is to outline all of the terms for the leasing or the renting across a fixed period of time. The second contract in the serial process is known as Bai, and its purpose is to trigger the sale or the purchase as soon as the term outlined in the Ijarah has completed.
As an example, at a facility that finances cars, the customer is going to enter into the Ijarah contract, leasing the car from the bank or the owner with an agreed payment price across a specific period of time. Once this lease period has expired, the second contract is going to come into effect which is going to allow the customer to completely purchase the vehicle at a price that has already been agreed to.
The bank in the situation of Ijarah thumma al bai’ is going to generate a profit through determining the cost of the vehicle in advance, as well as the residual value for the item at the end of the leasing term. Combining these figures with the time value or the profit margin of the investment is going to allow the bank to generate a profit, for the customer to benefit from the leasing program and for everyone to be benefited equally depending on what their individual interests are. This is an example of why Islamic law and Shariah exist to make sure that everyone is going to benefit from an Islamic finance transaction.