Leasing Finance by Islamic Banks
Leasing Finance by Islamic Banks
Ijarah Financing
Ijarah has huge potential as a financing mode for Islamic banks. It can be used for meeting the needs of retail, corporate and the public sectors and can also play a crucial role in promoting Islamic finance industry. Leasing is an attractive mode of investment for Islamic banks for the following reasons:
a) Assets acquired under these contracts are usually of high quality, marketable, maintain their market value well above book value, are movable and are easily disposable for cash in case of default.
b) Because of the good quality of the asset, the bank, as lessor, does not have to depend so much on the creditworthiness of the lessee, since it always has the recourse of selling the asset in case of default.
c) It is possible for the banks to get variable and floating return on long term investments.
Ijarah can be used directly for plants a machinery, autos, housing and consumer durables and indirectly for sukuk issues by the corporate and the government sectors. It can be used to develop different contracts and sukuk that may suit different purposes of issuers and the sukuk holders. Public and private sector corporations can use the securitisation on the basis of ijarah as alternative tool to interest based borrowing provided they have durable and useable assets. Ijarah is conducive to the formation of fixed assets and medium and long-term investments in an economy. Ijarah Sukuk will be discussed in detail in the Module on Treasury and Capital Market Operations dealing with Islamic Financial Markets.
Leasing and investment
As an asset-based lending is a permitted form of debt-financing in Islam, ijarah provides an alternative to interest-based investment in assets for the Islamic banks.The goods in which the investment is to be made are not purchased by the actualuser, but by the bank or a finance company, and are made available to thecontracting partner for commercial use subject to payment of a lease rental which isthe investment return. This form of financing offers Islamic banks various benefits,such as:
• Secured investment, thus reducing credit risks. Because of the good quality of the asset, the bank does not have to depend so much on the creditworthiness of the lessee client, since it always has the recourse of selling the asset in case of default.
• Assets acquired are usually of high quality, marketable, maintain their market value well above the book value, are moveable and are easily disposable for cash in case of default.
• Although it is a longer-term financing instrument, a leasing contract can be reviewed periodically. The financing party thus not tied down to a fixed return that may not be in its investment goals. The rent can be tied to any type of index agreed to.
• Clear basis of calculation returns over the term of the lease period
• Scope for new investments
• Tax benefits for both parties
Islamic banks are able to offer leasing certificates to their depositor clients as specific investment certificates as a form of declining equity. Lease payments include two elements: capital repayments and profit. If both of these are refunded to the certificate holder, net of bank costs, the depositor client recoups part of the capital (the client’s deposit) as the lease gets closer to the end of its term. But it is possible to design certificates which pay the holder dividends only; so that the bank can reinvest the incoming capital repayments in other lease contracts.
Ijarah Muntahia-bi-tamleek (Ijarah wal Iqtina)
Ijarah Munahia-bi-tamleek (Ijarah-wa-iktana) is variation of the leasing method and similar to ijarah except that, included in the contract, is a promise from the lessee to buy the leased asset at a pre-agreed price; rentals paid during the lease term constitute part of the purchase price and the final sale being for a token sum. Ijarah shares many common features with lease financing and operating lease / hirepurchase arrangements. It involves a lessor (usually a financial institution) purchasing an asset and renting it to a lessee for a specific time period at an agreed rental and at the end of the lease period transferring the ownership of the asset to the lessee.
Islamic banks are using Ijarah Muntahia-bi-tamleek as an alternative to a hire purchase and finance lease. It is an arrangement in which leasing is the real and the major contract that is subject to all rules of an ordinary operating ijarah contract where the standard Shari´ah principles of lease, its terms and essential prerequisites of the contract have to be observed. The transfer of the asset ownership to the lessee at the end of the lease term is kept separate. It does not comprise two contracts in one bargain; rather, the real bargain is only one whereby the lessor leases the asset and fixes the rentals in such a way that during the lease period the repayment of the cost of the asset and the rental for leasing the asset are received.
Both parties agree on this nature of the transaction; and the other part of the deal is only a unilateral promise not binding on the promissee and as such it is not a transaction until actually entered into by the parties. Further, this arrangement is fair and based on justice for both the parties in that the lessee, who has paid the cost along with the rentals, is able to get ownership title of the asset at the end of the lease period, while the lessor recovers cost of the leased asset and also the profit in the form of rentals. However, the lessee is under an obligation to buy the asset at the end of the lease term.
As owner of the asset, the bank should take out takaful cover to insure the leased assets. Islamic banks normally include the takaful expenses in acquisition cost of the asset for determining the rental. Shari´ah scholars allow this on the ground that rentals in leases are subject to mutual consent of the two parties and if the lessee agrees to the amount of rental, the contract would be acceptable from a Shari´ah perspective. As regards the insurable interest, it rightly belongs to the bank as lessor.
However, the AAOIFI recommends that in case the transfer of ownership becomes impossible without any cause attributable to the lessee (the client), the lessee must be protected from the loss by the lessor paying to the lessee (client) the difference between the rent received as per the lease agreement and the market rentals of such assets.
If the asset is destroyed, and there is proof for lack of observance of the conditions of the takaful policy that bars the bank as lessor from recovery of an insurance claim from the takaful company, the lessee client is held liable. In the absence of any fault or negligence on the part of the lessee client, the bank bears all responsibility for damage to or loss of the leased asset. If the claim paid by the takaful company is less than the loss incurred by Islamic bank, the uncovered loss cannot be charged to the lessee and the bank would bear the loss.
In this way, Islamic banks and financial institution have tried to transform the conventional lease structure to make it Shari´ah compliant. The arrangement, broadly speaking, comprises two contracts entered into at different times: One contract is an ordinary lease contract, where the Shari´ah principles of defining the asset to be leased, its terms and essential prerequisites of contracts are observed. The lessee pays, in addition to the rental, a sum which goes towards buying the leased property.
The other subsequent contract is a contract for gift or sale of the leased asset at the end of the lease period and is independent of the earlier lease contract. Although the rentals to be stipulated in the lease agreements have to be clearly known and fixed, but the actual and net rental income of the banks might not be fixed and predetermined. The Shari´ah principle is that risk cannot be separated from ownership; hence, as the leased asset remains in bank’s ownership, the bank must remain liable for the asset. Furthermore, the lease and sale transactions are contracts of two different nature; they must be kept separate and independent of each other to avoid the prohibition of two inter-dependent / conditional contracts that also has the connotation of a sale and buy back arrangement. If the above two aspects are taken care of, the Islamic banks can adopt any procedure for leasing the assets, mitigating the risks and transferring ownership to the lessee through any of the approved methods.
Written by Zia Ahmed
Investment Banker, Islamic Banker
Question by Carina G: Any reserves hlad by a commercial bank in excess of the legal minimum, are called?
a. required reserves
b. legal reserves
c. excess reserves
d. fiat money
e. vault money
My guess would’ve been a. Please verify it for me.
Best answer:
Answer by Royal Horse
Excess Reserves
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Categories: Commercial Bank Tags: Banks, finance, Islamic, islamic banks, Leasing, private sector corporations
Business Leasing
Business Leasing
Having just completed the Canyon Leasing Training program (www.CanyonLeasing.com) I am embarking on building my own Leasing Company. In hopes of developing relationship with small business the acquire equipment I have outlined the benefits of leasing in this article.
While 80% of all US businesses have leased equipment at one time or another, some may not be aware of the benefits, nor of the hidden costs involved with leasing. Sometimes leasing equipment, instead of buying it, can be the best option for your business. However, there are many variables that should be considered, including costs, use restrictions, and legal implications.
Leasing operating equipment, such as computers, vehicles, and machinery, often makes more sense than buying. However, while favorable leases are often good bets, unfavorable ones can easily sink an emerging venture. While doing your legal homework can help prevent bad deals, it’s always a good idea to have a lawyer look over a lease before signing it.
Benefits of Leasing Equipment
1. Leasing is Flexible.
Companies have different needs, different cash flow patterns, and sometimes irregular streams of income. For instance, startup companies typically are characterized by little cash and limited debt lines. Mature companies might have other needs – to keep debt lines free, to comply with debt covenants, and to avoid committing to equipment that may quickly become obsolete. Therefore, your business conditions – cash flow, specific equipment needs, and tax situation may help define the terms of your lease. Moreover, a lease provides the use of equipment for specific periods of time at fixed rental payments. Therefore, leasing allows you to be more flexible in the management of your equipment.
2. Leasing can be Cost-Effective.
Equipment is costly and some of the costs are unexpected. When you lease, your risk of getting caught with obsolete equipment is lower because you can upgrade or add equipment to best meet your needs. Further, your equipment needs can change over time due to changes to your company, such as diversification. Leasing allows you to stay on the cutting edge of technology.
3. Leasing Has Tax Advantages.
Rather than deal with depreciation schedules and Alternative Minimum Tax (AMT) problems, you, the lessee, simply make the lease payment and deduct it as a business expense.
4. Leasing Helps Conserve Your Operating Capital.
Leasing keeps your lines of credit open. You don’t tie up your cash in equity. Also, you avoid costly down payments. With other advantages such as off-balance sheet financing, leasing helps you better manage your balance sheet.
Although leasing does provide benefits to business owners, there are hidden costs to deal with, and business owners need to be aware of such costs.
Hidden Costs of Leasing
1. Non-Cancellable Agreement
When entering into a lease contract, the business owner agrees to make all the lease payments to the end of the term. While there is no penalty for early payoff, the full payments are normally required to pay off the lease early.
2. Document Fees
These fees are administrative costs due upon signing the lease and range from to as much as 0 or more, depending upon the complexity of the lease contract and size of the transaction.
3. UCC-1 Fees
These are fees required by the Secretary of the State where the equipment is being leased. The fee is usually is a one-time percentage that is due upon signing the lease documents.
4. Taxes
In most states, there is a tax on goods purchased. Some states tax at 5 or 6%, or more. The tax is factored into the lease payments, so be prepared to calculate this cost, as it could increase your monthly lease payments or more per month depending upon the total cost of the equipment, and the state of purchase.
5. Insurance
A section in the lease documentation will require that the equipment be covered by insurance. Here the leasing company is protecting their interests. They want to make sure they will be fully compensated for the equipment in the event of fire, theft, flood, etc. Most business owners will already have adequate insurance on their building to cover such equipment (if it is contained and used inside). However other companies using more portable equipment (such as lift trucks, golf carts, hydraulic lifts, bulldozers, etc.) may need to take out additional insurance to assure adequate coverage.
The bottom line is that when you are deciding to lease equipment, be certain you are aware of all costs involved with the transaction. Then balance them against the benefits to choose the appropriate choice for you and your business.
Albert Lindenberg
Canyon Leasing
Al.Lindenberg@CanyonLeasing.com
Experience: 33 years in leasing and banking industry.
Entrepreneur: Started a one man broker leasing company (LeaseComm Financial Services) and, after years of profitable growth, sold LeaseComm to a public company (Advanta Corp.)
Professional Business manager: Grew Advanta Leasing into one of the largest independent small ticket equipment leasing companies in the United States. This included developing a broker network that generated over 0 million of equipment leases per year with over 400 employees.
Educator: Professor in the Finance and Business departments of:
LaSalle University
Cabrini College
Camden County College
Founder and board member of Advanta University
For lease
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More business sorrow from Main Street… quite literally Main St., Mesa, Arizona. Eximus Wide & Slim with Kodak Tri-X 400.
NEW BUSINESS LICENSES: Week of August 23, 2010
NEW BUSINESS LICENSES: Week of August 23, 2010
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Categories: Business Leasing Tags: Business, Leasing
