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 rents it out to the customer normally for long term period. Upon completion of the 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.
Suppose Subhan Bank is a leading Islamic Bank in your country. It offers the car ijarah contract to its customers, in which a car according to the customer choice is purchased by the bank and rented out to the customer for 5 years. After 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 an operating Ijarah (Sale), ownership is not transferred to the customer after completion of the Ijarah period rather the asset is sale out on consent of the customer to him/her whereas in the 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:
In the conventional lease contract, bank does not share risk with a customer and receives interest payments. However, in the Ijarah, risk is equally shared between both parties and nor interest payments exist.