When I was working in my last conventional bank over two decades ago — a leading UK-headquartered financial institution — I handled large corporate finance transactions as part of the risk management team.
It was always my intention to make the transaction as watertight for the bank as possible within the bank’s credit policy guidelines. During my tenure over there, I dealt with several bilateral and syndicated term loan transactions of large amounts and conducted thorough review of the documentation.
I always demanded the insertion of a particular clause in the documentation for the financial lease transactions of immovable and movable assets, such as real estate and marine vessels. The gist of the clause was that in case of partial or total loss of the leased asset due to any reason whatsoever, the lessee shall continue to pay the rental until such time that the insurance claim is received by the bank.
Should the insurance amount suffice to recover the outstanding amount of the bank’s term loan to the customer, together with up-to-date interest and any charges, the surplus, if any, would be released to the customer. However, if the amount paid by the insurance company is less than the outstanding term loan in the bank’s books plus the accrued interest and such, the customer would be liable to pay the difference, irrespective of whether the customer was responsible for the damage to the leased asset or not.
When I joined the Islamic bank, based on my previous experience, I was assigned to deal with the function of risk management within the corporate banking unit — and that included review of documents.
I demanded the insertion of the same aforementioned clause in order to ‘protect’ the Islamic bank’s interest but stood corrected on the principles of Islamic financial leasing. It dawned on me that what I had been practicing in the conventional financial leasing transactions had an element of unfairness to the bank’s customers.
I now believe my conventional bank customers had no choice but to accept whatever conditions were imposed by the bank, being in need of the term loan for the growth of their business.
How did I stand corrected about Islamic financial leasing upon entering the Islamic bank? Let me explain it in the following passages.
Under Islamic financial leasing, which is termed as Ijarah Muntahiya Bil Tamleek or Ijarah Wa Iqtina (literally meaning a lease that ends with the ownership transferred to the lessee), the following parameters must be adhered to. For the sake of convenience, please allow me to use the abbreviated term IMBT:
a. As explained in the introductory article (No 62) on leasing, the client provides the Islamic bank with a unilaterally signed ‘promise to lease’ document while submitting the request for leasing an asset from the Islamic bank.
The purpose of this document is the same as discussed in the Murabahah contract, such as to protect the Islamic bank from a situation where the Islamic bank purchases the asset but the client may not come forward to start the lease.
Readers will remember that I had explained in the starting articles of this series that in an Islamic financial transaction, it is not permissible to eliminate the risks, unlike the conventional financial transactions. However, it is permissible in Shariah to adopt various means to mitigate the risks. There is a difference in eliminating the risks from a transaction versus mitigating them without elimination. Hence, obtaining a ‘promise to lease’ document from the customer at the outset is a tool to mitigate the risk by the Islamic bank while retaining it in the lease transaction.
Another aspect applied to mitigate the risk further is to obtain the security deposit from the customer to be used as a contribution in purchasing the asset. There is a possibility that the customer may have already made a downpayment to the third-party seller (which could be a developer) of the asset, in which case it will be required that such a payment is legally assigned to the Islamic bank through a tripartite agreement between the Islamic bank, its customer and the seller.
b. Once the Islamic bank receives the ‘promise to lease’ and pursuant to the completion of all due diligence, including the customary know-your-customer process on the applicant, and upon getting the necessary head office approval, the Islamic bank proceeds to purchase the relevant asset in its own name from a third-party seller by way of entering into an asset purchase agreement.
If it is an immovable property, the title deed shall be obtained by the Islamic bank in its own name by paying the required land registration fee and any other charges. In case of a movable asset such as an aircraft, a marine vessel, a crane or a car, all official formalities shall be completed and the asset registered in the Islamic bank’s name as the owner.
It is possible that the seller of the immovable or movable asset is not a third party but the applicant itself. So, what is the Shariah position for an Islamic bank to purchase the asset from the customer and lease it back to the same customer? We shall pick up the subject next week from here.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the senior advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: Discussion on a financial lease and other aspects of Ijarah shall continue.