UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Ijarah in Islamic Finance





“Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipments such as plant, office automation, or motor vehicles for a fixed period and price.” (Wikipedia)

“Ijarah gives the Lessee the right to access the equipment on payment of the first installment. This is important as it is the access and use (and not ownership) of equipment that generates income.” (

Advantages of Ijarah

“Ijarah provides the following advantages to the Lessee:

  • Ijarah conserves the Lessee’ capital since it allows up to 100% financing.
  • Ijarah gives the Lessee the right to access the equipment on payment of the first installment. This is important as it is the access and use (and not ownership) of equipment that generates income.
  • Ijarah arrangements aid corporate planning and budgeting by allowing the negotiation of flexible terms.
  • Ijarah is not considered Debt Financing so it does not appear on the Lessee’ Balance Sheet as a Liability. This method of “off-balance-sheet” financing means that it is not included in the Debt Ratios used by bankers to determine financing limits. This allows the Lessee to enter into other lease financing arrangements without impacting her overall debt rating.
  • All payments towards Ijarah contracts are treated as operating expenses and are therefore fully tax-deductible. Leasing thus offers tax-advantages to for-profit operations.
  • Many types of equipment (i.e computers) become obsolete before the end of their actual economic life. Ijarah contracts allow the transfer of risk from the Lesse to the Lessor in exchange for a higher lease rate. This higher rate can be viewed as insurance against obsolescence.
  • If the equipment is used for a relatively short period of time, it may be more profitable to lease than to buy.
  • If the equipment is used for a long period but has a very poor resale value, leasing avoids having to account for and depreciate the equipment under normal accounting principles.


Ijarah thumma al bai’ (hire purchase)

Parties enter into contracts that come into effect serially, to form a complete lease/ buyback transaction. The first contract is an Ijarah (lease) that outlines the terms for leasing or renting over a fixed period and the second contract is a Bai that triggers a sale or purchase once the term of the Ijarah is complete. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed amount over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed to price.

The bank generates a profit by determining in advance the cost of the item, its residual value at the end of the term and the time value or profit margin for the money being invested in purchasing the product to be leased for the intended term. The combining of these three figures becomes the basis for the contract between the Bank and the client for the initial lease contract.   (wikipedia)

“In cases where a buyer cannot afford to pay the asked price for an item of property as a lump sum but can afford to pay a percentage as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly rent. When a sum equal to the original full price plus interest has been paid in equal installments, the buyer may then exercise an option to buy the goods at a predetermined price (usually a nominal sum) or return the goods to the owner. Hire purchase enables one to eventually secure ownership of the new asset. The cost can be spread over its useful life and paid for from revenue. Payment patterns can be tailored to suit individual needs, generally involving a deposit, followed by a series of monthly or quarterly installments. Hire purchase is suitable for individuals and businesses of all sizes. Funding is on balance sheet and one has a choice of fixed or variable interest rate agreements.” (


Ijarah wal iqtina is a contract under which an Islamic bank provides equipment, building, or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.” (


Refinancing of assets owned by the client in a sale and leaseback arrangement is allowed under certain circumstances. The bank being the owner of the asset is paid rent, fixed or variable as agreed by the parties. The rental amount is often linked to Libor.

This structure involves two different contracts.  (1) Sale of asset by the customer to the financier at cash price.  (2) An option is given to the customer/developer to purchase back the asset after the expiry of the lease period.  Usually the repurchase price is tantamount to the price which the financer bought the asset.  (AMANIE)

Usufruct Financing via Ijarah Contract (Operating Lease)

The lessor is the owner of the asset who has granted the right to use the asset to the lessee.  After the expiry of the lease period, the lease may be extended or may not be renewed following which the leased asset will return back to the lessor.  The lessee has to pay a certain agreed rental during the lease period.  (AMANIE)

 International Accounting Standard (IAS) 17 defined an operating lease as a lease other than a finance lease.  Literally this is an agreement to lease certain items just like a Financial Lease but within a shorter time (usually between 12-24 months).  The lessor or the lessee can terminate the agreement at anytime on the basis that the lessor will be responsible for any damage occurring to the leased item.  This lease type is very similar to a normal rental agreement.

Asset-Financing via Ijarah Muntahhiya bi Tamlek

I.E., The financier purchases the house from the vendor and leases it to the customer with a call option to purchase the house in the following alternative arrangements.  (1) Token payment of purchase price; (2) Last rental payment is deemed to be the purchase price; (3) Gift; (4) Actual price of the house (based on financial modeling).  This structure requires two contracts, one for the lease and one for the sale.  (It is prohibited to have two sales in one.)  A Put Option is used to require the lessee to purchase the leased asset in the case of (1) Pre-payment; (2) Default payment.  (The formula would be the outstanding principle plus takaful cost – unearned profit).  (AMANIE)

Finance Lease

 “According to the International Accounting Standard 17, a finance lease is defined as a lease that transfers substantially all the risks and rewards incidental to ownership of an asset… title may or may not pass.  A finance lease is also defined as an agreement to lease certain equipment with a fixed period of time-mostly medium to long, where the leasing company will not provide any service or maintenance, repair or insurance of the leased item. The lessor will calculate payment, depending on the price of the item, plus interest and benefit.  Neither the Lessor nor the Lessee can terminate the agreement.”



UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

%d bloggers like this: