IJARAH FINANCING DEFINITION: Ijarah is a contract whereby the owner of an asset, other than consumable, transfers its usufruct

to another person for an agreed period at an agreed consideration. In Islamic Finance Ijarah is a lease contract under which financial institution leases equipment or building to its clients against agreed rentals or installments equal to the value of the assets. The financier is Rab-al-Maal also known as Lessor who finance equipment or building to the Sarif (user or tenant) also called Lessee.

Explanation: Ijarah is a financing facility in which Rab-ul-Maal finance the asset of any nature to the Sarif on his request. In Ijarah the ownership of the assets remains with lessor (institution) and only its right of usage is transferred to the lessee. Until the assets to be leased are delivered to the lessee, no lease rental becomes due and payable. (i.e. Ijarah cannot be recorded until the subjected asset is delivered to the lessee.) The title of the assets remains with the Lessor during the entire lease term. ThelLessor bears all the risk and reward associated with the ownership to the asset. All cost associated with the asset to bring it into usable form and condition should be borne by the lessor. In Ijarah contract the user pays the rentals for its usage to a certain period then return the asset upon the maturity back to the financier. Ijarah can also be formed on the basis that the lessee will pay the price of the asset in installments over a certain period of time and the asset will be given to the lessee for use and in return, he will pay rentals to the lessor for the usage. The rental and installment payments by the lessee lead to ownership of the asset to the lessee. Early payment of the installments by the lessee will reduce the rentals he pays and thus less is the expense on him. Financing amount is determined on the basis of users affordability part of his gross income that he can pay for rentals and installments. The equity part of the user is called Arboon which is the part of the total amount of the financing amount. Installments are the saving part of the user and rentals are the expense that user bears for the use of the asset.

In Ijarah Working, Sarif or lessee; Mr Hammads gross monthly income is Rs75,000/who wants to buy a car and for that he approaches to a car financing institution (Rab-ul-Maal or lessor). Mr Hammad explains to the institution that he can afford 30% of his income for acquiring the car. Mr Hammad needs a car whose market price is Rs600,000/- with insurance cost of 3% per year that is equals to Rs 18000 per year and tax cost of 1% that is equals to

Rs 6000. Thus total (600,000+54,000+6,000).

cost

of

vehicle

reaches

to

Rs

660,000/-

Mr Hammad and car financing Institution reach to an agreement that Hammad will contribute 20% of the market price of the asset i.e. Rs. 120,000/- that is termed as Arboon which is exclusive of all costs and the institution will invest 80% and all the costs i.e. insurance cost and tax cost which is the total Ijarah financing amount which is Rs. 540,000/-. The agreement is made for 3 years period of 36 equal monthly installments. On the basis of total 36 installments, monthly installment for ownership is Rs 15000 per month. As stated above, the monthly affordability is 30% of the gross income of Rs 75000 which is equals to 22500. This monthly affordable amount is the monthly repayment amount of each installment. In this way, monthly rental profit will be 7500 (22500-15000). Thus after 3 years, total payment paid by the lessee to the lessor is Rs.810,000/(540000+270000) which is 50% excess to financing facility or we can say that the institution earned the 50% profit on its financing amount. On the basis of that financiers monthly profit is 1.4% and the yearly profit is 16.7%. As per this Ijarah contract, 20% of Mr Hammads gross monthly income is his saving and 10% is expense out of total 30% of his saving income. In example 1, if the car financing institution doesnt want to invest its own capital or it doesnt have the required capital to invest, it can get the required capital for ijarah financing by entering into sukuk subcription. Thus the institution enters into the Sukuk Subcription by taking a sukuk price as Rs.100 and selling these sukuks to Ghulam Mohammad =1000, Ayesha=100, Seema=200, Saboor=300, Abdul Malik=400, Abdul Wakeel=500, Bank Islami=600, Bank Muslim=700, Bank Pakistan=400 and Scan Industries=1200. The total capital is invested for 3 years. The cost for managing the Ijarah contract is estimated to 30% of Gross Profit and net realized profit is divided among total sukuk issued given the net profit on each sukuk. As per the above Ijarah contract, the sales proceed is Rs 810,000 which is the total payment received by the institution against the ijarah financing amount and gross profit is Rs 270,000 which is the total rental profit received during the Ijarah contract period. After deducting the cost of 81000 which is the 30% of the gross profit, net profit is realized that is amounting to Rs 189,000/- which is then distributed among the sukuk holders according to the capital invested by each sukuk holder as mentioned in Sukuk Subcription Working. Profit earned on each sukuk is Rs.35/- and the ROI is 35%.