Muhammad Ayub Understanding Islamic Finance phần 7 pptx

298 Understanding Islamic Finance items, provided that the asset and the rent both are clearly known to the parties at the time of the contract. • The Ijarah rate can be fixed or floating, provided a clear formula is mutually agreed with a floor and a cap. Rental has to be stipulated in clear terms for the first term of lease, and for future renewable terms it could be constant, increasing or decreasing by benchmarking. • Holders of Ijarah Sukuk jointly acquire ownership in the asset, bear the price risks and the ownership-related costs and share its rent by leasing it to any user(s). The flexibility described above can be used to develop different contracts and Sukuk that may suit different purposes of issuers and holders. Governments can use this concept as an alternative tool to interest-based borrowing, provided they have durable useable assets. Use of assets is necessary, while it does not matter whether these assets are commercially viable or not. Funds mobilized by issuance of Ijarah Sukuk may be used to purchase assets for leasing and the rentals received from the users distributed among the Sukuk holders. Ijarah Sukuk can be traded in the secondary market on market price; the purchasers replace the sellers in the pro rata ownership of the relevant assets and all rights and obligations of the original subscribers pass on to them. Hence, they may help in solving the problems of liquidity management faced by the Islamic banks and financial institutions. Hence, Ijarah has great potential for financing public sector projects without the involve- ment of interest. Ijarah Sukuk/certificates can be issued to raise funds from the primary financial market for projects to be started afresh, or they can be issued against already existing projects. They can also be sold in the secondary market at a price to be determined by the market. Suppose a government intends to build an airport but is short of funds. It may sign a contract with a contractor to build the airport, but at the same time, it may undertake to lease the airport and sell it to the public by issuance of Ijarah Sukuk. The value of the lease (equal to or greater than the cost of construction) will be divided over a large number of Ijarah Sukuk/certificates of different denominations and maturities. In other words, different investors may participate in the lease contract for different periods. The government will pay the contractor from the proceeds of the Sukuk. The government is not obliged to pay investors anything different from the actual income from the facility. 11.6 SUMMARY OF GUIDELINES FOR ISLAMIC BANKERS ON IJARAH 1. According to Islamic principles of finance, there is no difference between operating and finance leases; if all of the four essential elements relating to contracting parties, subject matter, consideration and the period in Ijarah are taken care of, Ijarah can be used as the mode of modern business by the financial institutions in the form of Ijarah Muntahia-bi- Tamleek. The deciding factor in this regard is the risk relating to ownership that must remain with the lessor and sale should be separate from the lease. 2. The lease of an identified asset cannot commence before the bank takes the possession of the asset to be leased. If the time of possession of the asset to be leased is unknown, the whole arrangement will be provisional. 3. Any arrangement of twocontracts into one contract is not permissible in Shar ¯ ı´ah. Therefore, IFIs cannot have the agreement of hire and purchase built into a single agreement. Ijarah – Leasing 299 4. When the period of lease comes to an end, the bank can transfer the ownership to the client or dispose of it in the open market. If the bank transfers the ownership to the lessee, the proper sale agreement or gift deed should be executed. The promise to transfer the ownership is binding on the promisor only; the other party must have the option not to proceed. The AAOIFI Standard provides for promise by the lessor, while many Islamic banks, as in the case of Pakistan and other jurisdictions, take undertaking from the lessee and deem it binding on him. Abiding by the AAOIFI’s Standard in this regard seems to be justifiable and nearer to the spirit of the Shar ¯ ı´ah. 5. The lessor bears expenses relating to the corpus of the asset, i.e. Takaful, accidental repairs, etc., while operating expenses related to running the asset have to be borne by the lessee. Takaful and other costs incurred by the bank can be recovered in the lease rental, subject to transparency and mutual understanding. If the customer pays the Takaful cost as agent of the bank, it will be reimbursed to the client by the bank. 6. A bank can jointly acquire an asset with a customer who wishes to get the asset on lease; the bank can then lease its share of the asset as per the undertaking of the customer. The rental to be received by the bank should be in proportion to its share in the ownership of the asset. Box 11.1: Risk Mitigation in the Case of Ijarah Nature of risk Mitigating tool 1. The bank has purchased the asset as per the undertaking by the customer, but the latter refuses to take the asset on lease. A binding promise to lease should be obtained from the customer at the time of booking/purchase of the asset by the bank. Hamish Jiddiyah should also be taken from the client. The bank can sell the asset in the open market and the actual loss can be recovered from the Hamish Jiddiyah. 2. The customer may default in payment of the due rental. The bank might not be able to recover even its investment; the asset is taken back, but it does not cover the loss. An undertaking should be obtained from the customer to pay a certain amount to charity in the case of late payment of rental. This amount will go to the Charity Account. Any actual loss can be recovered from Hamish Jiddiyah. Securities/collateral can also be realized. 3. Asset risk of major maintenance/destruction. This risk can be managed through a Takaful facility. 4. Early termination of lease agreement. Keeping in mind the market value, the bank can also take the asset back and sell in the market to redeem its investment. In more risky cases, an undertaking to purchase the asset at a pre-agreed price schedule can be obtained from the customer. 300 Understanding Islamic Finance Box 11.1: (Continued) Nature of risk Mitigating tool 5. The lessee may use the asset carelessly, requiring the bank to bear major maintenance expenditure. A trust receipt should be obtained from the customer to bind him to use the asset as a trustee. It may be mentioned in the trust receipt that loss due to negligence of the customer shall be borne by the customer himself. 6. Rate of return risk due to inflation. This risk can be covered through a benchmarked floating rental rate, which is permissible subject to a floor and a cap. 7. Sale of asset at maturity – the customer may not buy. Only those assets should be leased that have sufficient resale value that the bank could sell them in the market. Alternatively, a separate promise to purchase at the end of the lease term can be obtained from the customer. Box 11.2: Auto Ijarah Compared with Conventional Leasing Products Conventional auto lease products Islamic Ijarah Muntahia-bi-Tamleek Conventional financing leases contain hire–purchase arrangements, which are not permissible by Shar ¯ ı´ah. The Ijarah contract does not contain any condition that makes the contract void under Shar ¯ ı´ah. The lease remains subject to all Ijarah rules; sale is not a part of it. In conventional leasing schemes, the customer is responsible for all kinds of loss or damage to the vehicle, irrespective of circumstances being out of his control. All risks pertaining to ownership are borne by the Islamic bank. The customer only bears usage-related expenses. Insurance is independent of the lease contract. The insurance expense of the asset is borne directly by the lessee. Takaful should be at the expense of the lessor. The lessor, however, may increase, with the consent of the lessee, the lease rent to recover the Takaful cost. If the insurance company does not compensate the entire outstanding amount in the case of loss/damage, the customer is liable to pay the balance. The Islamic bank bears the risk of Takaful claim settlements. Ijarah – Leasing 301 If the leased vehicle is stolen or completely destroyed, the conventional leasing company would continue charging the lease rent until the settlement of the insurance claim. Under the Islamic system, rent is consideration for usage of the leased asset, and if the asset has been stolen or destroyed, the concept of rental becomes void. As such, an Islamic bank cannot charge the rental. In some conventional leases, the lessor is given an unrestricted power to terminate the lease unilaterally at his sole discretion. Ijarah is a binding contract and if there is no contravention on the part of the lessee, the lease cannot be terminated by any one party. It can be provided in the agreement that if the lessee contravenes any terms of the agreement, the lessor has a right to terminate the lease contract unilaterally. In most contemporary financial leases, an extra amount is charged if rent is not paid on time. This extra amount is taken by the leasing institutions into their income. This is prohibited due to being Riba. Under Ijarah, the lessee may be asked to undertake that if he fails to pay rent on its due date, he will pay a certain amount to a charity but the bank cannot charge any further return. Under conventional leasing contracts, the vehicle is automatically transferred to the name of the customer upon completion of the lease period. In Ijarah, the customer is not obliged to purchase the vehicle. He may purchase the asset through a formal sale deed if he considers it beneficial for him. Upfront payment has to be made in the form of downpayment, the first year’s insurance premium and other insurance expenses, first month’s rental, etc. Islamic banks normally take only a security deposit, which is refundable if the lease is not finalized. The bank has the authority to recover only actual expenses not including the cost of funds. Box 11.3: A Hypothetical Case Study on Ijarah ABC Textile Mills (Pvt.) Ltd, one of the customers of Merit Islamic Bank, has requested an Ijarah facility for the following assets. The client will deposit 10 % of the value of the Ijarah asset as a security deposit/earnest money. 1. Company cars 20 Rs. 10 000 000 (L/C has been established with XYZ bank) 2. Trucks 20 Rs. 360 000 000 3. Dyeing plant Rs. 140 000 000 (already owned by the client) 4. Looms 50 Rs. 15 000 000 (operating for about 1 year) The Islamic bank’s employee is required to decide: Issue # 1 Which asset will the bank finance through adirect lease and which through sale and lease- back? What factors will it consider before allowing sale and lease-back transactions? 302 Understanding Islamic Finance Box 11.3: (Continued) Issue # 2 One year after leasing the looms for his factory, ABC reports to the bank that five of the looms have broken down and have to be repaired. The bank asks the evaluator from the Takaful company to calculate the cost of repair and damage. The evaluator reports, after inspection, that the looms broke down due to poor maintenance on the part of the client and will take a month to be repaired at a cost of Rs. 20 000 per loom. How should the bank calculate future rentals and the rental for the time when the looms are being repaired? Issue # 3 ABC has already leased 20 cars from the bank for a tenure of five years and has used them to varying degrees. Two years down the line, ABC requests the bank to sell him ten vehicles at a price of Rs. 400 000 each. Should the bank accept his offer and what consideration should determine the decision? Prepaid expenses, including Takaful outstanding, are Rs. 20 000 per vehicle. The outstanding Ijarah investment is Rs. 350 000 per vehicle. Issue # 4 In the same year, one of the cars is destroyed in an accident without any negligence on the part of the client. The remaining outstanding Ijarah investment is the same as given in Issue # 3 above. The Takaful amount recovered by the bank is Rs. 450 000 and the client deposited a security deposit of Rs. 50 000. What amount is the bank legally bound under the Ijarah agreement to give to the client? In view of the satisfactory payment behaviour, in what ways can the bank accommodate the client without burdening itself? Answers to the above Issues: Answer 1 Direct lease/Ijarah Sale and Lease-back The assets that can be financed under direct lease are trucks, because the bank has to purchase the same from the market. The assets that can be financed under a sale and lease-back arrangement are the dyeing plant, looms and company cars (already owned by the client). Documentation required Documentation required • Agency agreement and letter of agency • Undertaking to Ijarah • Ijarah agreement • Sale deed of cars and plant • Undertaking to Ijarah • Ijarah agreement • Description of Ijarah assets • Ijarah rental schedule • Demand promissory note • Promise to sell/purchase Ijarah assets. — description of the Ijarah asset — schedule of Ijarah rentals — receipt of asset — demand promissory note For sale and lease-back, an IFI must consider the need and willingness of the client to avoid interest and work with an Islamic bank. Further, it will add the condition that ABC Textile will not ask for early retirement before one year. • Ijarah rental schedule • Unilateral promise to sell/purchase Ijarah asset • Sale deed at the end. Ijarah – Leasing 303 Answer 2 As per the inspection report, the asset was not handled with care and proper mainte- nance was not made by the client. Therefore, the bank should ask the client to repair the asset at his cost; the bank will not bear the loss. Apparently, the rental will continue to become due and rescheduling of the Ijarah payment plan should not be needed. However, the Shar ¯ ı´ah advisor should be involved and may decide, on merit, whether the client may be given any relaxation or not. Answer 3 In the given scenario, the bank can accept the offer of the client for the purchase of ten cars with the consideration that the price offered by the client covers the current outstanding liabilities, i.e. 3.7 million, and through this offer the bank can earn a profit of Rs. 300 000, i.e. Rs. 30 000 per car, even after returning the security deposit, with the assumption that the security deposit is included in the offer price. Answer 4 As per the Ijarah agreement, any loss that occurs to the asset without negligence of the client will be borne by the bank. The client has the right to take back the security deposit as the agreement has come to an end due to the destruction of the asset. Therefore, he will be paid Rs. 50 000 of his security deposit. The bank has been paying the Takaful premium as owner of the asset. As such, legally the bank is entitled to receive the Takaful claim. However, the client has been paying rental more than the mere rental of similar assets as prevalent in the market, due to the inclusion of the cost by the bank in the normal rental, and he has paid all the instalments as per agreement. As per clause 8/8 of the AAOIFI Standard on Ijarah, the bank should allow/give the customer Rs. 130 000 that includes Rs. 50 000 of security deposit and the claim recovered from the Takaful company after deducting the liabilities outstanding as per # 3 above, making the amount Rs. 80 000. Box 11.4: Accounting Treatment of Ijarah 1. Operating Ijarah Assets acquired by the bank as lessor • are recognized at historical cost; • depreciate as per normal depreciation policy; • are presented as investments in the Ijarah assets A/c. Ijarah revenue/expense • is allocated proportionately in financial periods over the lease term; • is presented as Ijarah revenue. Initial direct costs • are allocated over the lease term or otherwise charged directly as an expense. 304 Understanding Islamic Finance Box 11.4: (Continued) Repairs of leased assets • a provision for repairs is established if repairs are material and differ in amount from year to year; • repairs undertaken by the lessee with the consent of the lessor are to be recognized as expense. 2. Ijarah Muntahia-bi-Tamleek through gift Assets acquired • are recognized at historical cost; • are presented as Ijarah Muntahia-bi-Tamleek, with assets measured at book value; • depreciate as per normal depreciation policy; • however, no residual value shall be subtracted since it is to be transferred to the lessee through gift. Ijarah revenue/expense • is allocated proportionately in financial periods over the lease term; • is presented as Ijarah revenue. Initial direct costs • material costs are allocated over the lease term or otherwise charged directly as an expense. Repairs of leased assets • a provision for repairs is established if repairs are material and differ in amount from year to year; • repairs undertaken by the lessee with the consent of the lessor are to be recognized as expense. At the end of the financial period/lease term • legal title passes, subject to settlement of Ijarah instalments. Permanent impairment/sale of lease asset • If theIjarah instalmentsexceed the fairrental amountand impairment is not dueto action or omission of the lessee, the difference between the two amounts shall be recognized as liability due and charged to the income statement. 3. Ijarah Muntahia-bi-Tamleek for token consideration or specified amount Assets acquired • are recognized at historical cost; • are presented as Ijarah Muntahia-bi-Tamleek assets and measured at book value; • residual value is subtracted in determining the depreciable cost. Depreciation is charged as per normal depreciation policy. Ijarah revenue/expense • is allocated proportionately in financial periods over the lease term; Ijarah – Leasing 305 • is presented as Ijarah revenue. Initial direct costs • material costs are allocated over the lease term or otherwise charged directly as an expense. Repairs of leased assets • a provision for repairs is established if repairs are material and differ in amount from year to year; • repairs undertaken by the lessee with the consent of the lessor are to be recognized as an expense. At the end of the financial period/lease term • legal title passes, subject to settlement of Ijarah instalments and on purchase of the asset by the lessee; • if the lessee is not obliged to purchase and decides not to do so, the asset shall be presented as assets acquired for Ijarah and valued at the lower of the cash equivalent value or the net book value. If the cash equivalent is less than the net book value, the difference between the two shall be recognized as loss; • if the lessee is obliged to purchase the asset due to his promise but decides not to do so, and the cash equivalent value is lower than the net book value, the difference between the two amounts shall be recognized as a receivable from the lessee. Permanent impairment/sale of lease asset • if the Ijarah instalments exceed the fair rental amount and impairment is not due to action or omission of the lessee, the difference between the two amounts shall be recognized as liability due and charged to the income statement. 4. Ijarah Muntahia-bi-Tamleek through sale prior to the end of the lease term for a price equivalent to the remaining Ijarah instalments Assets acquired • are recognized at historical cost; • are presented as Ijarah Muntahia-bi-Tamleek assets and measured at book value; • depreciate as per normal depreciation policy. Ijarah revenue/expense • is allocated proportionately in financial periods over the lease term; • is presented as Ijarah revenue. Repairs of leased assets • a provision for repairs is established if repairs are material and differ in amount from year to year; • repairs undertaken by the lessee with the consent of the lessor are to be recognized as expense. Permanent impairment/sale of lease asset • as in the above case. 12 Participatory Modes: Shirkah and its Variants 12.1 INTRODUCTION Islamic modes are asset-based and entail real economic activity and undertaking responsi- bility or liability. The modes that form the basis of Islamic finance belong to participatory or profit/loss sharing (PLS) or risk-sharing techniques and as such are considered the most desirable modes by the majority of jurists on Islamic finance. This does not imply that non- participatory modes, as discussed in the previous few chapters, do not involve business risk; taking risk and responsibility is rather a precondition for the legality of profit in any busi- ness. Shirkah-based participatory modes of business, however, involve direct participation in profits and losses by the parties. Two contracts, namely Mudarabah and Musharakah, that lend themselves to the system of profit/loss sharing are based on the concept of Shirkah. A partnership may be in the right of ownership (Shirkatulmilk), wherein a profit motive may not necessarily exist, or it may be contractual (Shirkatul‘aqd), in which the partners enter into a contract to conduct a joint business with the objective of earning profit and agree to share the profit on a pre-agreed ratio and bear the loss, if any, to the extent of the investment of each partner. Another variant may be wherein one partner may provide the capital and the other may manage the business (Mudarabah) for earning profit. These modes are the means of providing risk-based capital and are jointly termed participatory modes of finance. In this chapter we shall discuss variants of Shirkah, namely Musharakah, Mudarabah, modern corporations and Diminishing Musharakah, as modes of business by Islamic financial institutions (IFIs). Partnership-based business was widely practised in the pre-Islamic period. The holy Prophet (pbuh) himself did business on the basis of partnership before his prophethood and many of his Companions did it during his life and later. Islam approved the concept of business partnership. 1 The practice was so commonly prevalent among the Arabs and other Muslims that, perhaps under their influence, the Christians of the areas in Europe where Muslims went also conducted it and introduced it far inside Europe. 2 In the early/conventional books of Fiqh, joint businesses are discussed mainly under the caption of Shirkah, which is a set of broad principles that can accommodate many forms of joint business. According to the majority of the classical jurists, Mudarabah is also a type of Shirkah when used as a broad term. In Fiqh books, discussion on Mudarabah is available both in the chapters on Shirkah and under the separate caption of Mudarabah. 1 Hassan, 1993, p.104. 2 See Postan and Rich, 1952, 2, pp. 173, 267. [...]... Mudarabah and took half of the profits 49 50 51 52 53 54 55 Ibn-Qudama, 13 67 AH, p.33 Ibn-Qudama, 13 67 AH, 5, p 32 Al-Marghinani, 19 57, 3, p 256 Ibn-Qudama, 13 67 AH, p.30 Udovitch, 1 970 , pp 174 – 175 ; AAOIFI, 2004–5a, Standard on Mudarabah, clause 4, p 231 Al-Sarakhsi, n.d., 12, p 18 Al-Sarakhsi, n.d., 12, p 18 322 Understanding Islamic Finance earned by the two brothers, because the public money in their... AAOIFI Standard on Musharakah has defined a stock company as an entity, the capital of which is distributed into equal units of 77 78 79 80 81 82 83 Ibn-Qudama, 13 67 AH, pp 18, 35 Ibn-Qudama, 13 67 AH, pp 5, 64 AlJaziri, 1 973 , 3, p 61 Usmani, 2000b, pp 276 –283 Al-Kasani, 1993, 6, p 77 Usmani, 2000b, pp 313–329 See, for details, AAOIFI, 2004–5a, Standard on Musharakah, pp 208–213 Participatory Modes: Shirkah... the profit for any partner”. 37 31 32 33 34 35 36 37 AAOIFI, 2004–5a, Standard on Musharakah, p 221 Al-Kasani, 1993, 6, p 62 Ibn-Qudama, 13 67 AH, 5, pp 32, 34 Al-Sarakhsi, n.d., 11, p 1 57 Ibn-Qudama, 13 67 AH, pp 33, 62 AAOIFI, 2004–5a, Standard on Musharakah, clauses 3/1/1/4, 3/1/5 AAOIFI, 2004–5a, Standard on Musharakah, clause 3/2, p 2 07 318 12.3.5 Understanding Islamic Finance Guarantees in Shirkah... share the loss according to the ratio of their investment, while in Mudarabah, the loss, if any, is suffered by the Rabbul-m¯ l only However, if a 75 76 AAOIFI, 2004–5a, Standard on Mudarabah, clause 10 Usmani, 2000a, pp 47 49 328 4 5 6 7 Understanding Islamic Finance the Mudarib has conducted business with negligence or has been dishonest, he shall be liable for the loss caused by his negligence or misconduct... Musharakah, clause 4/1/2/3 AAOIFI, 2004–5a, Standard on Musharakah, clause 4/1/2/14 87 AAOIFI, 2004–5a, Standard on Musharakah, clause 4/1/2 /7; also at p 223 88 See Resolution No 63(1 /7) of the International Islamic Fiqh Academy; AAOIFI, 2004–5a, Standard on Musharakah, clause 4/1/2/15, pp 210, 224 85 86 330 Understanding Islamic Finance become void due to the element of interest The case of qualification... expenses) and not in a sum of money or a percentage of the capital or investment by the partners 40 41 42 Al-Atasi, 1403 AH, Section 352, 4: 277 For details see Usmani, 2000b, pp 220–231 AAOIFI, 2004–5a, clause 3/1/6/2, pp 2 07, 222 320 Understanding Islamic Finance Box 12.1: (Continued) 3 It is not necessary that agreement for sharing profit should be proportionate to capital contribution 4 A sleeping... decided accordingly However, contemporary jurists are 15 16 17 18 19 20 21 Hussain, 1964 Ibn Qudama, 13 67 AH, 2, p 168 Al-Marghinani, 3, p 342 Al-Atasi, 1403 AH, Majallah, Article 959 AAOIFI, 2004–5a, clauses 3/1/1/2, 3/1/1/3, p 201 Al-Kasani, 1993, 6, p 63 Ibn-Qudama, 13 67 AH, 5, p 16; Al-Sarakhsi, n.d., 11, pp 156, 159 314 Understanding Islamic Finance unanimous that the value of goods should be assessed... some transactions and profit has been realized in some others, the profit can 71 72 73 74 AAOIFI, 2004–5a, Standard on Mudarabah, clause 8/8 AAOIFI, 2004–5a Standard on Mudarabah, clause 8/4 AAOIFI, 2004–5a, Standard on Mudarabah, clause 8/2 Al Jaziri, 1 973 , 2, pp 862–865 Participatory Modes: Shirkah and its Variants 3 27 be used to offset the loss at the first instance, then the remainder, if any,... allowed to donate Mudarabah funds or waive receivables of the business without explicit permission from the financier. 67 64 65 66 67 AAOIFI, 2004–5a, Standard on Mudarabah, clause 5/1 Al Jaziri, 1 973 , 2, p 815 Al Jaziri, 1 973 , 2, p 851 AAOIFI, 2004–5a, Standard on Mudarabah, clauses 9/5–9 /7, pp 236, 244 Participatory Modes: Shirkah and its Variants 12.4.3 325 Work for the Mudarabah Business According... partner takes a loan ı for the joint business, all partners will be (jointly) liable to pay.12 10 11 12 Al Mudawwanah, 1323 AH, 12, p 5 Al-Kasani, 1993, 6, pp 68, 69 Al-Kasani, 1993, 6, p 72 312 Understanding Islamic Finance A Musharakah (and also Mudarabah) contract may be for any specific project up to its completion or in the form of a redeemable investment by a partner,13 particularly the financial . caption of Mudarabah. 1 Hassan, 1993, p.104. 2 See Postan and Rich, 1952, 2, pp. 173 , 2 67. 308 Understanding Islamic Finance Musharakah is a term used by the contemporary jurists both for broad and. facility. 11.6 SUMMARY OF GUIDELINES FOR ISLAMIC BANKERS ON IJARAH 1. According to Islamic principles of finance, there is no difference between operating and finance leases; if all of the four essential. Mudawwanah, 1323 AH, 12,p.5. 11 Al-Kasani, 1993, 6, pp. 68, 69. 12 Al-Kasani, 1993, 6,p .72 . 312 Understanding Islamic Finance A Musharakah (and also Mudarabah) contract may be for any specific project