The baseline rule in shari’a is that only those assets that have an inherent usufruct can be leased with the condition that the leased asset is used only for shari’a compliant activities. According to jurists, the lessor and lessee must agree on the lessee benefiting from the usufruct and that the leased asset must have that usufruct. According to the Shafi’i school of thought, it is not sufficient to agree upon benefiting from the inherent usufruct of the asset, rather they require further specifications as to what extent and what manner the lessee may benefit.
Imam Abu Yousuf and some later Hanafis are more liberal when it comes to the conditions of a lease. According to them, the two parties can lease an asset as long as it has a usufruct, without having to specify in detail its exact usage. There are two leasing-based contracts under use in contemporary Islamic banking & finance: ijara and ijara wa iqtina’.
It is preferred that the lessor must have the asset to be leased at the time of entering into the lease contract. However, this is only a preference and not a strict requirement, as it is acceptable for someone to enter into a lease agreement with another party before it acquires the asset to be leased. However, it is required of the lessor to acquire the asset before the actual lease period starts and make it available to the lessee.
The issue of possession may follow from ownership but it is possible for someone to legitimately possess an asset. For example, an agent may hold an asset on behalf of a principal who has instructed him to lease the asset to a third party. The baseline rule is that the lessor must possess the asset to be leased before the actual lease period starts, whether as a principal or an agent or even in some other cases.
There are many Western-educated Muslim economists who argue that interest is nothing but rent for renting money to someone for a specified period. As leasing or renting is acceptable in Islam, so should be the lending of money for a return. This reasoning is based on a lack of understanding of the treatment of leasing in Islam.
Applications of leasing in modern Islamic banking and finance are abound. On a retail level, some Islamic banks offer auto financing on the basis of leasing. There are some leasing-based home financing products as well. The most widely practiced use of leasing in capital markets is that of a leasing-based sukuk.
While all these products broadly follow shari’a requirements, there is one area that needs re-thinking and improvement, i.e. with regards to the responsibility of on-going maintenance of the leased asset. In order to understand this point more adequately, we may use an example.
A bank buys a car from the market for the price of £50,000 and leases it to a client for a period of five years for a monthly rental of £1,000. If this lease is part of a hire purchase deal, then the bank must undertakes to sell the leased asset to the lessee for an agreed price once the lease period has lapsed and the lessee has fulfilled all its obligations. The lessee in turn undertakes to purchase the car for a price, from the lessor if the former is in breach of the lease contract during the lease period. The price is normally determined by a formula based on the amount outstanding in favour of the lessor pursuant to the lease agreement and a profit margin.
During the lease period and before the leased asset is sold to the lessee, the responsibility of maintenance remains with the owner. However, in practice this is given to the lessee by way of a service agreement between the lessor and the lessee. The estimated maintenance charges are included in the rental agreed in the lease agreement.
It appears as if the use of ijara wa iqtina’ as a financial lease is problematic from a shari’a viewpoint. It is indeed a complicated structure but the way it is practiced by Islamic banks by and large fulfils the generally acceptable shari’a requirements.
The writer, PhD (Cambridge), is a Shari’a Advisor and Chairman of Edbiz Consulting Limited. He can be contacted at firstname.lastname@example.org