SH5023 Assignment Ijarah Based Financing PDF

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MASTERS IN ISLAMIC FINANCE PRACTICE (MIFP)SHARIAH RULES IN FINANCIAL TRANSACTIONS (SH5023)Name of Lecturer:DR HAFAS FURQANIAcademic Session : September 2015Assignment Title :IJARAH BASED FINANCING WITH REFERENCE TOAL IJARAH THUMMA AL BAI’ (AITAB) AND APPRAISALOF ITS APPLICATION BY MAYBANK ISLAMICNam...

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MASTERS IN ISLAMIC FINANCE PRACTICE (MIFP) SHARIAH RULES IN FINANCIAL TRANSACTIONS (SH5023) Name of Lecturer: DR HAFAS FURQANI Academic Session : September 2015

Assignment Title : IJARAH BASED FINANCING WITH REFERENCE TO AL IJARAH THUMMA AL BAI’ (AITAB) AND APPRAISAL OF ITS APPLICATION BY MAYBANK ISLAMIC

Name of Student : MOHAMMAD KAMAL BIN MOHAMMAD RATHI Student ID :1500178

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IJARAH BASED FINANCING WITH REFERENCE TO AL IJARAH THUMMA AL BAI’ (AITAB) AND APPRAISAL OF ITS APPLICATION BY MAYBANK ISLAMIC TABLE OF CONTENT NO

TITLE

PAGE

1.0

INTRODUCTION

2

2.0

DEFINITION OF IJARAH

2

2.1

Source Of Legitimacy- Evidence From Al Quran & As Sunnah

3

2.2

Classical Jurists Opinions

4

3.0

MECHANISM OF IJARAH

6

3.1

Operating Lease

6

3.2

Ijarah Muntahiah Bit Tamlik (Leasing Ending With Ownership)

6

4.0

APPLICABILITY OF AITAB BY MAYBANK ISLAMIC

7

4.1

Comparison Between Conventional Hire Purchase and AITAB/Islamic

8

Hire Purchase 4.2

Operation of Maybank Islamic’s AITAB

8

5.0

GAPS AND SHORTCOMINGS IN AITAB APPLICATION

9

5.1

Lacking in Shariah Framework

10

5.2

Ownership and Ownership Transfer

11

5.3

Maintenance & Insurance Responsibility

11

5.4

Deposit Payment and Penalty In Case Of Default

11

5.5

Intention and Lack Of Understanding Of Both Parties

12

6.0

CONCLUSION

14

7.0

RECOMMENDATION

14

REFERENCES

16

APPENDICES

17-22

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1.0 INTRODUCTION Ijarah or Leasing is a form of contract allowed by Islam based on the textual evidences of Al-Qur’an and Sunnah. Not everyone has the means to purchase or own certain assets which he needs so as to utilise and benefit from them. Therefore, Islam has permitted the contract of leasing in order to facilitate public needs and to provide facilities in life. Islamic law permits the leasing of certain assets whose benefit can be obtained by the lessee against the payment of some agreed rental. Like any other contract, the ijarah contract has to fulfill all the conditions of a valid contract stipulated by the Shari’ah. Ijarah is emerging as a popular technique of financing among Islamic banks. Some of the products that utilise ijarah concepts include house financing, car financing and even project financing and structured products.

2.0 DEFINITION OF IJARAH “Ijarah” is a term of Islamic fiqh. Lexically, it means ‘to give something on rent’. In the Islamic jurisprudence, the term ‘Ijarah’ is used for two different situations. In the first place, it means ‘to employ the services of a person on wages given to him as a consideration for his hired services.’ The employer is called musta’jir while the employee is called ajir. Therefore, if A has employed B in his office as a manager or as a clerk on a monthly salary, A is musta’jir, and B is an ajir. Similarly, if A has hired the services of a porter to carry his baggage to the airport, A is a musta’jir while the porter is an ajir, and in both cases the transaction between the parties is termed as Ijarah. This type of Ijarah includes every transaction where the services of a person are hired by someone else. He may be a doctor, a lawyer, a teacher, a laborer or any other person who can render some valuable services. Each one of them may be called an ‘ajir’ according to the terminology of Islamic law, and the person who hires their services is called a ‘musta’jir’, while the wages paid to the ajir are called their ‘ujrah’. The second type of ijarah relates to the usufructs of assets and properties, and not to the services of human beings. ‘Ijarah’ in this sense means ‘to transfer the usufruct of a particular property to 2

another person in exchange for a rent claimed from him.’ In this case, the term ‘Ijarah’ is analogous to the English term ‘leasing’. Here the lessor is called ‘mu’jir’, the lessee is called ‘musta’jir’ and the rent payable to the lessor is called ‘ujrah’. Both these kinds of ‘ijarah’ are thoroughly discussed in the literature of Islamic jurisprudence and each one of them has its own set of rules. But for the purpose of the present book, the second type of Ijarah is more relevant, because it is generally used as a form of investment, and as a mode of financing also. The rules of Ijarah, in the sense of leasing, is very much analogous to the rules of sale, because in both cases something is transferred to another person for a valuable consideration. The only difference between Ijarah and sale is that in the latter case the corpus of the property is transferred to the purchaser, while in the case of ijarah, the corpus of the property remains in the ownership of the transferor, but only its usufruct i.e. the right to use it, is transferred to the lessee.1 An Ijārah contract ideally needs to fulfill some basic conditions, which include : 1. Leasing is a contract whereby the owner of something transfers its usufruct(“benefits”) to another person for an agreed period, at an agreed consideration. 2. The subject of lease must have a valuable use. Therefore, things having no usufruct at all cannot be leased. 3. It is necessary for a valid contract of lease that the corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything which cannot be used without consuming cannot be leased out. Therefore, the lease cannot be effected in respect of money, eatables, fuel and ammunition etc. because their use is not possible unless they are consumed. If anything of this nature is leased out, it will be deemed to be a loan and all the rules concerning the transaction of loan shall accordingly apply. Any rent charged on this invalid lease shall be an interest charged on a loan. 4. As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property shall be borne by the lessee. 3

5. The period of lease must be determined in clear terms. 6.

The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement..

7.

The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence on the part of the lessee.

8. The leased asset shall remain in the risk of the lessor throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor.2 2.1 Source Of Legitimacy- Evidence From Al Quran & As Sunnah 2.1.1 The verse in the Al Quran which describes the story of the Prophet Musa (A.S) being hired by his father in-law for a certain period of time is normally quoted to support Ijarah contract. Allah SWT says: “And said one of them (the two women): “O my father! Hire him! Verily, the best of men for you to hire is the strong, trustworthy”. He said: “I intend to wed one of these two daughters of mine to you, on condition that you serve me for eight years, but if you complete ten years, it will be (a favour) from you. But I intend not to place you under a difficulty. If Allah will, you will find me one of the righteous.” (Al-Qasas: 26-27). This verse is a clear indication of ijarah as Musa (A.S). was hired for a specific period of time with specific remuneration. In another verse in the Al Quran, Allah SWT says: “….Then if they give suck to the children for you, give them their due payment …” (Al-Talaq: 6) The above verse indicates the obligation of the father to provide adequate wages for the women who breastfeed his child. This is clearly related to the concept of Ijarah where wages are given as a consideration for hired services. 2.1.2 The evidence from the Sunnah is derived from the various Hadiths as follows:

a. The Prophet (S.A.W.) said: “Pay the hired worker his wages before his sweat dries 4

off”.’ (Narrated by Ibn Majah) The order to pay wages (‘ajr) as instructed by the Prophet in this Hadith is clearly an indication of the validity of hiring the worker’s labour for a specific period of time.

b. The Prophet (S.A.W.) is reported to have said: “He who hires a person should inform him of his fee.” (Narrated by al-Baihaqi)

c. Ibn Abbas (R.A) reports that the Prophet (S.A.W.) had cupping performed on him and gave the cupper his fee.

d. Abu Huraira (R.A) reports that the Prophet (S.A.W) said, “Allah said, ‘I will be an opponent to three types of people on the Day of Resurrection: One who makes a covenant in My Name, but proves treacherous; One who sells a free person and eats his price; and One who employs a labourer and takes full work from him but does not pay him for his labour.”

e. Abdullah Ibn Umar (R.A) narrates, “Allah’s Apostle gave the land of Khaibar to the Jews to work on and cultivate and take half of its yield.” Ibn ‘Umar added, “The land used to be rented for a certain portion (of its yield).” 2.2 Classical Jurists Opinion The classical jurists have given several definitions of Ijarah and the different definitions of the jurists on Ijarah can be observed as follows: a) The Hanafis definition: A contract pertaining to usufruct with compensation. b) The Shafi’es definition: A contract over a desirable, known, permissible, and accessible usufruct, in exchange for a known compensation. c) The Malikis and the Hanbalis definition: The transfer of ownership of a permitted usufruct for a known period in exchange for compensation.

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3.0 MECHANISM OF IJARAH Islamic financial institutions at present usually use two modes of Ijarah which are Operating Lease and Ijarah Muntahia Bi al-Tamlik (Leasing Ending With Ownership). The details of these two forms of Ijarah are as follows : 3.1 Operating Lease According to this mode of leasing, the Islamic bank maintains a number of various assets to respond to the needs of different customers. These assets usually have a high degree of marketability. The bank leases out these assets to any party who wishes to utilise it for a term agreed upon between them. After the termination of the lease period the assets would return to the bank and on its part, the bank would look for a new lessee. The distinguishing feature of this mode is that the assets remain the property of the Islamic bank to put them up for rent every time the lease period terminates so as not to be unutilised for long periods of time. Under this mode, the bank bears the risk of recession or diminishing demand for these assets. The operating lease transactions are suitable for high cost expensive assets, that demand large amounts of money in order to possess and a long duration for its production. For example, aircrafts and ships for which the demand for a operating lease is increasing because of high cost and long period of production. 3.2 Ijarah Muntahiah Bit Tamlik (Leasing Ending With Ownership) There are many types of Ijarah Muntahiah Bit Tamlik, some of which have been developed through practice. In fact, Ijarah Muntahiah Bit Tamlik can be categorised into major and secondary types. It should be noted that all of these types aim at transferring the legal title of the leased asset to the lessee, otherwise they would be considered an operating lease contract. The mode of financing using different types of Ijarah Muntahiah Bit Tamlik is becoming a popular financing tool in many products offered by Islamic banks nowadays. One of the most popular of this type of leasing is called Al Ijarah Thumma Al Bai’ (AITAB) or Sale of the Leased Asset at the End of Lease Period for an Amount Specified in the Lease. 6

This agreement is a contract that includes an Ijarah contract and a promise to enter into a sale contract. The sale contract includes an amount for the sold asset to be paid by the lessee (the buyer) after the expiry of the Ijarah period. Thus, upon the

lessee’s paying the agreed

consideration, the leased asset becomes sold and its title transferred to the lessee (the buyer) who would be entitled to the right of benefit and disposal of the asset in any of the legitimate forms of disposal. As for the juristic character of this contract, there is no doubt that when the agreement becomes effective, it is treated as an Ijarah contract which entails all the Shari’ah rulings and effects of an Ijarah contract. The sale contract would become effective only after the expiry of the Ijarah contract due to the consideration paid by the lessee to the lessor to own the leased asset.

4.0 APPLICABILITY OF AITAB BY MAYBANK ISLAMIC The purpose of this paper is to appraise the applicability of AITAB by Maybank Islamic, in relation to its compliance with the Shariah principles. Maybank Islamic is one of the leading Islamic Financial Institutions(“IFIs”) in Malaysia. The Product Disclosure Sheet(PDS) issued by Maybank Islamic is attached as per Appendix A. Amongst others, it states the following :1.What is this product about? The facility is given to you to part finance the purchase of a motor vehicle. Upon approval of the facility, an AITAB Agreement shall be entered between you as the Hirer and Maybank Islamic Berhad (the Bank) as the Owner of the motor vehicle. The profit rate for the AITAB facility is calculated based on fixed or variable rate over the tenure of the facility. The tenure of the facility shall be up to a maximum period of 9 years only. 2. What is the Shariah contract applicable? The applicable Shariah contract is Al-IjarahThumma Al-Bai’ (AITAB). AITAB is a leasing contract (Ijarah) followed by sale contract (al Bai’). Under the leasing contract the customer leases the asset from the Bank at an agreed rental payment over a specific period. Upon expiry of the leasing period, the customer enters into a sale contract to purchase the asset from the Bank at an agreed price.

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4.1 Comparison Between Conventional Hire Purchase and AITAB/Islamic Hire Purchase In conventional hire-purchase, the product is considered as a loan to which interest rate and hiring charges would be applicable and in case of late payment of installment price, interest would accumulate. But in Islamic hire-purchase, the product is considered as a mode of financing, not a loan and the product would have a profit rate and a markup and for late payment of installment price, only late payment charge pre-agreed would be applicable. Table 1 below illustrates the difference between conventional Hire Purchase and AITAB.3

4.2 Operation of Maybank Islamic’s AITAB

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4.2.1 First Contract : Contract Of Lease (Ijarah) - Car Dealer sells the vehicle ordered by the customer to the Bank. The Bank pays to the Dealer full amount of the vehicle. Therefore, the Bank becomes the OWNER of the vehicle. - The customer pays the deposit payment (mostly 10%) of the full amount of the vehicle to the Dealer. The customer agrees to pay the road tax and insurance coverage. He/She is also responsible for the maintenance. Even though the bank is the owner of the vehicle, the car is registered under the name of the Customer, whilst the Bank registers its claim of ownership on the vehicle registration card. - Car Dealer delivers the vehicle to customer. This is done once the Bank has approved the customer’s application for the purpose of leasing the vehicle. A sample of actual Aqad or Contract for Maybank Islamic’s AITAB (in Bahasa Malaysia) is shown as per Appendix B. 4.2.2 Second Contract : Contract Of Sales (Bai') - Owner hires the car to the customer. The Customer becomes the Hirer. - The Hirer is now responsible to pay the rental or installment to the bank with the agreed amount until the payment fully paid either during the contract or end the contract. This is due to financing he/she has obtained (mostly 90%) from the bank. - At the end of the period, the bank and the customer would sign the sale and purchase agreement.

5.0 GAPS AND SHORTCOMINGS IN AITAB APPLICATION Dual banking system of Malaysia creates competitive environment where an innovative product like AITAB provides advantages for banks. Therefore, it should be closely monitored to ensure its legitimacy. Currently AITAB is having several issues and gaps regarding its operation as follows :-

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5.1 Lacking in Shariah Framework The major problem in implementing AITAB in Malaysia is the lacking of Shariah framework (El Din and Abdullah, 2007). Hanudin Amin (2010) described Shariah as the “centerpiece and backbone of the religion of Islam”. AITAB financing is named according to Arabic word in order to show that the transaction is based on the Islamic principles. In reality, AITAB legislations are based on the HirePurchase Act 1967. The difference between AITAB financing and conventional hire purchase financing is that AITAB financing has an additional agreement which is the sale contract after the leasing period is over. Shiyuti et al. (2012) have further noted that AITAB is growing under the shadow of Hire Purchase Act with some changes to suit the Shariah compliant syndrome. This study also was agreed by Hassan et al. (2012) that AITAB does not have a Shariah compliance to govern it, rather it is determined by the conventional legislation. Moreover, AITAB financing has element of interest in calculation of term charges (Hassan et al., 2012). The above facts are in line with our findings from Central Bank Shariah Resolutions (Shariah Resolutions, 2010).4 An example of such computation, where there is an element of interest, is enclosed in Appendix CSecond Schedule of Hire Purchase Act 1967. 5.2 Ownership and Ownership Transfer According to Shariah principles, the bank must own the asset before renting it out because it shows the rights and liabilities of the parties involved in the hire-purchase contract (El Din and Abdullah, 2007). However, Islamic hire purchase contract in Malaysia differs slightly, bank becomes beneficial owner of the asset (usually a motor vehicle), while the customer becomes the legal registered owner. As researcher Davies (1995) has noted that the banks usually register its ownership claim over the title of the asset and have it endorsed on the registration card which similar to the conventional hire purchase financing. As El Din and Abdullah (2007) agreed that the Islamic hire purchase practice is slightly modified version of the conventional hire purchase. The authors also claimed that if customer and bank officer in charge do not understand the intention and the two different aspects in both lease and sale transactions then, there will be virtually no difference 10

regarding asset ownership between AITAB financing and conventional hire purchase financing (AlNashmi. 2003; Syariah Advisory Board, 2002; El Din and Abdullah, 2007). In Malaysia, the common practice is that the transfer of ownership is affected by sale, the asset is purchased through final payment or last instalment which is considered as purchase price. But it generates an issue of whether bank and customer understand that they are completing a sale contract with the customer final payment, if not then the sale contract may not be valid.4 5.3 Maintenance & Insurance Responsibility In the real practice of leasing, the bank has to be responsible with the maintenance of the hired goods but the current practice of AITAB financing in Malaysia shows that the customer is solely responsible with the maintenance while the bank only act as a financier. This action does not explain any resp...