AFMP4
Syllabus B. Advanced Investment Appraisal B3. Impact of financing on investment decisions and APV

B3a. Ijara (leasing) and Murabaha (credit) 6 / 18

Syllabus B3a)

a) Identify and assess the appropriateness of the range of sources of finance available to an organisation including Islamic finance.

Trade credit (murabaha)

Let’s say that you, a small businessperson, wish to go into business selling cars.

A conventional bank would examine your credit history and, if all was acceptable, grant you a cash loan.

You would have to pay back funds on a specific maturity date, paying interest each month along the way.

You would use the proceeds to buy the car—and meet other expenses—yourself.

Murabaha

  • But in a murabaha transaction, instead of just giving you the cash, the bank itself would buy the cars. 

    You promise to buy them from the bank at a higher price on a future date. 

    The markup is justified by the fact that, for a period, the bank owns the property, thus assuming liability. 

    At no point in the transaction is money treated as a commodity, as it is in a normal loan.

  • A murabaha must be asset-based however, so it can’t help a small businessman who needs a working-capital loan to meet payroll and other expenses.

    To get such capital from an Islamic financial institution, an entrepreneur would have to sell the bank an equity interest in his business. 

    This is far riskier for the bank and thus much harder to obtain.

Lease finance (ijara)

  • A transaction where a benefit arising from an asset is transferred in return for a payment, but the ownership of the asset itself is not transferred.

    Most often the lessee returns the asset (and its benefits) to the lessor. 

    Basically an operating lease.

  • An alternative is for the lessee to buy the asset at the end. 

    However some jurists do not permit this latter arrangement on the basis that it represents more or less a guaranteed financial return at the outset to the lessor, in much the same way as a modern interest-based finance lease.

  • The terms of ijara are flexible enough to be applied to the hiring of an employee by an employer in return for a rent that is actually a fixed wage.

Some generally agreed conditions for ijara are as follows :

  1. The leased asset must continue to exist throughout the term of the lease. 

    Items which are consumed in the process of usage, ammunition for instance, cannot be leased

  2. In contrast with most conventional finance leases, the responsibility for maintenance and insurance of the leased item under ijara remains that of the lessor throughout

  3. A price cannot be pre-determined for the sale of the asset at the expiry of the lease. 

    However, lessor and lessee may agree the continuation of the lease or the sale of the leased asset to the lessee under a new agreement at the end of the initial lease period.