Ijarah in Islamic Financing: Definition, Types & Example

Understand

In Islamic Finance, The ijarah is a type of contract in which a bank (considering the need/choice of a customer) purchases an asset and rent it out to the customer normally for long term period. Upon completion of ijarah contract, the asset is gifted or sold at a token amount to the customer. The main feature of this Islamic kind of lease contract is that it has no interest payments like a conventional lease contract does.

Example

Suppose Subhan Bank is leading Islamic Bank in your country. It offers the car ijarah contract to its customers in which a car according to customer choice is purchased by the bank and rented out to the customer for 5 years.  After the completion of 5 years when the bank has recovered its costs and made a reasonable profit then the car is gifted or sold at a very little amount to the customer.

Types of Ijarah

In operating ijarah (Sale), ownership is not transferred to the customer after completion of ijarah period rather the asset is sale out on consent of the customer to him/her whereas in ijarah muntahia bittamleek (Gift), the asset is transferred in the name of the customer without any payment.

Conventional Lease Contract vs. Ijarah

The main difference between these two contracts lies on these two elements:

  • Risk
  • Interest

In the conventional lease contract, bank do not share risk with a customer and receive interest payments, however, in the ijarah risk is equally shared between both parties and nor interest payments exist.

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