Contracts and Deals in Islamic Finance: A User s Guide to Cash Flows, Balance Sheets, and Capital Structures

Chapter 11Ijarah and Its Variants

Ijarah is a contract of leasing. Bank Negara Malaysia refers to a contract involving “an exchange of usufruct or benefits of an asset or a service for rent or commission for an agreed period.”¹ It involves two parties, a lessor and a lessee, and an asset that is to be leased. As a financial instrument, the contract of ijarah is rather straightforward. A lessor acquires an asset and leases it out to a lessee for a specific duration. The consideration paid by a lessee for enjoying the usufruct of the asset is referred to as ujr or rental payment.

The prerequisites for a contract of lease are similar to contracts of sale and we need not delve into them again. There are, however, some additional features in lease contracts. In conventional finance, there are two types of leases, an operational lease and a financial lease. The two are similar, except that in the latter, the lessee undertakes to purchase the asset leased after the lease duration expires at a pre-agreed price. In an operational lease, there is no such undertaking. The traditional scholars of Islamic finance do not recognize a financial lease as it implies two contracts combined into one.² One is a contract of lease, and the other is a contract of sale. We have mentioned before that the shariah does not recognize one contract being contingent on another.

Another salient distinguishing feature of an operating lease is that the asset remains in the ownership of the lessor. The lessee ...