The main purpose of this report is to examine the different features of Islamic banking and broadly looks at the Ijara concept of Islamic Banking/ finance. The report introduces Islamic Finance highlighting the tremendous expansion of the Islamic financial industry across the world, particularly the banking sector. It shows the reason behind the establishment of the first Islamic banks and its continued growth over the years especially in the Muslim nations involved in oil and gas business. One of the distinctive features of Islamic banks and conventional banks as explained in this report is their obligation to carry out its operations as per the Shariah principles. It shows the Ijara as one of the concepts of Islamic banking that refer to the transfer of usufruct (benefit) of a specific asset to a different individual based on periodic rents that are claimed from the person. Different types of Ijara contracts are explained, and the kind of contracts offered by Kuwait Islamic banks are provided
Islamic finance has been increasing in significance in different countries in the last few decades whereby banks have been playing a leading role in the Islamic financial industry. Islamic banks have been established in more than 75 countries comprising of Muslim nations and others where Muslim minority have settled such as the USA, France and the UK. In 2013 (Sobol, 2015). The Kuwait Finance House Research Department estimated that Islamic financial institutions held a total of $ 1.8 trillion in assets, and Islamic banks own approximately 80 percent of these assets (Sobol, 2014). Islamic banking is also known as an interest-free banking system since under the Shariah law the presence of riba is forbidden in all transactions. The banking system has acceptable that do not allow those associated with speculative trading, sale of goods or services considered unlawful among others. The system of banking also has various concepts applied including Wadiah which means safekeeping, Mudarabah that involves sharing of profits and losses, and Bai Bithaman Ajil that allows deferring of sale payment. Others are the Musharakahj or Joint venture businesses, Ijarah Thumma Bai or hire purchase transactions, Wakalah (Agency), Qard (Rate- free finance), Hibah (gift) (Botis, 2013).
The establishment of Islamic banks in various countries in the world is associated with the increase of wealth in some Middle East countries on one hand and the neo-revivalist movements among Muslim societies on the other. One of influential movements is the Hassan al-Banna Muslim Brotherhood in Egypt, whose establishment in 1928 was due to the lack of support for the financial systems that were based on interest in Egypt and in other areas of the Muslim nations. Hassan had the argument that Islam offers a comprehensive ideological framework that provides guidance on all life’s aspects to all its followers and economic affairs is one of the things that should be included in this framework. The growing wealth of the nations in the Gulf region due to the oil crisis in the world and the huge rise in the oil prices also played a critical role in the quick development of Islamic finance (Sobol, 2014).
Islamic banks most distinctive feature is their obligation to carry out their operations following the principles of Shariah, the Muslims religious laws. The ruling out of usury or riba in all transactions is a fundamental standard employed by Islamic financial institutions. The Koran, the holy book of the Muslims provides the origins of the prohibition of riba and the hadiths that illustrate the life and actions of Muhammad that explain about the condemnation of riba (Aktan, Masood & Ashraf, 2014). The avoidance of excessive risk (gharar) in contracts is another principle applied by Islamic banks whereby transactions involving significant elements of uncertainty are avoided. The economic transactions of the banks should be associated with products or practices that are not considered haram, implying unlawful according to Islam. Due to the prohibition of riba by Islamic finance, different types of products from those used by conventional banks are used by Islamic banks. These are the financial tools divided into PLS instruments that share profit and loss as well as the cost plus instruments. The PSL contracts include the Mudaraba and Musharaka while the cost plus instruments include the istisna, salam and ijara (AlKulaib, Almudhaf, & Al-Jassar, 2013).
Islamic and Conventional banks act as financial intermediaries to investors providing them with the support they need in the capitalizing their projects or investments. However, there are critical differences in the products and processes used by the Islamic and conventional banking systems as explained in the table below (Aktan et al., 2014).
|Islamic banking system||Conventional Banking System|
|The objective of Islamic banks to maximize profit should be as per the Sharia law, and its products and processes of the system are designed according to this law.||The principles used in designing the products and operations of conventional banks are manmade, and their main purpose is to maximize profits without any restrictions (Belal, Abdelsalam & Nizamee, 2015).|
|The relationship that exists between Islamic banks and their clients is that of partners, traders or investors as well as buyers and sellers. Thus, banks are more careful in ensuring the projects undertaken are viable, and they take more time in the preparation of the activities for evaluating and managing projects.||One of the two types of relations, creditor or debtor, exists between conventional banks and their clients. For this reason, banks are less concerned about the creditworthiness and the weight of projects. The banks also have little significance in the development of expertise in the evaluation of projects (Al Ali, H & Naysary, 2014).|
|Islamic banks consider money to be a tool and utility that is used in the facilitation of operations and trading activities.||Conventional banks use money as a commodity, a medium of exchange and a store of value (Shah, Asif, Tahir, & Ali, 2015).|
|Profits are earned from the partnership relationships with customers, and the activity of exchanging goods or services. There is a contract that states how the profits and risks are shared. Therefore, the banks may be required to comprehend the businesses of their customers very well and may at times be involved in the management of the businesses.||The fundamental function of the conventional banks is to lend and borrow money at a compounding interest rate. Here, investors are offered a predetermined rate of interest that is based on the time value of money, and the banks do not share losses with the investors (Ali, 2011).|
|In the case of failure to repay the money, no extra charges are allowed.||In the case of failure to repay loans, additional charges are not allowed.|
|Interest based commercial banks allow investors to borrow money easily.||Approval of transactions is complicated in Islamic banking systems|
|Deposits are not guaranteed due to the profit loss concept and only the deposits based on the principles of wadi’ah (safekeeping) can be guaranteed.||In conventional banks, all deposits are guaranteed to ensure their safety.|
|If a project fails, both the bank and investor still own the project and carry out management restructuring to have better resource utilization.||If a project fails, a loan is taken as a non-performing loan (Belal et al., 2015).|
Ijara is an expression in Arabic that refers to the act of offering a particular item with the expectation of receiving rental payments. It involves the transfer of usufruct (benefit) of a specific asset to a different individual based on periodic rents that are claimed from the person. Unlike in conventional banking, Islamic finance does not allow interest based transactions such the financial derivatives. Instead, it adopts a different type of instruments are under the Shariah law that prohibits riba. The Ijara has three key elements; one of the elements is the wording that expresses the desires of each contracting party, secondly, the contracting parties that involve the lessor and lessee and thirdly the subject matter, which relates to the consideration or rent and the Usufructs (benefits) (Shah, 2015).
In islamic financing, Ijara involves the presence of a leasing contract between a customer and a bank whereby assets such as equipment of buildings are leased for a given time period and predetermined rentals. The customer is required to pay the value of the asset as well as a calculated fixed amount, and the customer is given the opportunity to buy the property within the period of the contract. A wide range of Ijara financing arrangements are used in the Islamic finance systems that have been explained in the table below (Shah, 2015).
|Types of Ijara||Features|
|Simple ijara – operating lease, service lease or a true lease||The lease is a short-term deal that excludes an arrangement to purchase the asset at the end of the contract. The contractual transactions in this kind of lease involve highly priced assets including equipments used in industries, expensive agricultural equipments, ships and aeroplanes. The full cost of the leased property is not amortized over the primary lease period, and the lessee is allowed to cancel the lease any time he wishes to do so as long as there is a prior notice as per the contract. The lessor remains with the title of the property no matter how much has been paid out by the lessee as lease installments, so the bank also suffers the risks and responsibilities of ownership at all times. At the end of the lease period, the asset is reverted to the bank, which can lease it out to another customer depending on whether the asset is in good shape (Swartz, 2013). Simple ijara can further be subdivided in three diverse formats. The uncomplicated format is whereby the asset is under the ownership of the bank, and it is leased out to a customer at predetermined rentals for an agreed term. In this case, the bank is considered as the vendor of the leased property. This is the best kind of ijara financing deal, as its features are similar to that of traditional ijara. However, it is also the least popular and common structure as it does not allow Islamic banks to deal with different types of physical assets (Raza, 2015). The second kind of format involves a different vendor in the contractual process. This structure has two distinct phases, in the first phase, a vendor sells to the bank the asset required by the customer and in the second phase, the customer is leased the asset by the bank as its owner of the asset (Mansour, Ben Jedidia & Majdoub, 2015). In the third structure, the bank does not wish to deal directly with the first phase of purchasing the asset from a vendor. Therefore, the bank appoints the customer as its agent resulting in two different categories of relationships between the customer and the bank. In the first category, the customer acts an agent of the bank because she or he purchases the asset on behalf of the bank. The second set starts from the date when the supplier delivers the asset to the customer, and the lessor and lessee relationship comes into existence (Swartz, 2013).|
|Ijara-thumma-al-bay or Ijara-wa-Iqtina’a or Ijara muntahiea bitamleek (financial lease or lease-sale) arrangement||This type of ijara contract can be loosely compared to the financial lease under the conventional banking system. The lease provides the customers with the opportunity to buy the asset at a predetermined price at the end the contractual period. In this case, the main idea is that the bank funds the acquisition of the asset through a leasing agreement and when the lease period ends, the asset ownership is conveyed to the customer. It is known as a full payment lease because the full cost of the property is amortized during the period of the lease. The lessee is also not allowed to terminate the lease unless if he rewards the bank for any losses suffered. Therefore, the Ijara-thumma-al-Bay is considered to have two diverse agreements that are implemented at two different stages. The first contract is an ijar that has a one-sided promise (wa’ad) to sell the property at a predetermined price to the customer. After the lease expires and the lessee has cleared the payments, the bank has an obligation to fulfill its promise of selling the asset by executing the contract of sale (bay’) (Raza, 2015). The pledge to sell the asset is considered an additional agreement to the main ijara deal and customer may take it as an option to purchase the asset at the end of the lease period. It is implied that the unilateral promise has to be binding on the bank since an option is a right without obligation. The sale contract is not determined in any way by the terms of the ijara contract (Youssef & Samir, 2015). In this contract, the bank continues to hold the ownership of the assets bearing all of its risks and responsibilities and the lessee makes payments of all the rentals as long as he uses the property. The customer takes the ownership of the asset only if he exercises his option to purchase the asset at the end of the lease period.|
|Ijara with Musharaka or mudharaba||This kind of Ijara ends with the transmission of ownership to the customer that is made possible through the combination of ijara with a partnership, which is based on the terms of musharaka or mudharaba. This is common in housing finance, where the customer and bank engage in a partnership that is particularly established for financing the acquisition of the asset that a customer has an interest in. They both contribute to the capital of the partnership in a given ratio, but the bank continues to act as the manger in the partnership. The asset is then purchased by the partnership and the customer acquires it on, making predetermined periodic rentals. The bank stake in the property is reduced over time by the proportion of rental that accrues to the customer, who becomes the full owner of the property after the bank stake is reduced to zero. This is a recent innovation in the Islamic banking; the Ijara is combined with the mechanism of diminishing musharaka or mudharaba (Swartz, 2013).|
|Sale and Leaseback||In this arrangement, an asset owned by a customer is sold to the bank at a price that is then taken back on lease. The sale price of the asset is an immediate cash flow to the customer who then continues to make periodic ijara rentals while using the assets that is now owned by the bank (Youssef & Samir, 2015).|
The financial and banking sector in Kuwait has been the biggest beneficiary of the steady growth of the economy in the country. The banking sector has been growing strongly over the years due to the significant projects in both the gas and oil sectors. The growth can also be explained by the rising demand for the supply of items used for daily consumption, the supply of building materials, and other household items that led to the growth of the commercial sector (National Bank of Kuwait, 2015). Real estate sector has been expanding too as a result of the development of real estate projects that are being implemented. These developments have resulted in the growth of credit facilities to the Kuwait residents involved in different development projects and trading activities (Wright, 2016). The Islamic banks in Kuwait include the Kuwait Finance House that was established in 1977, laying down the base of Islamic banking in Kuwait. Other major Islamic banks include the Kuwait International Bank, Warba Bank, Boubyan Bank and the Ahli United Bank. These banks offer banking products and services that are sharia-compliant (Mitchell, Rafi, Severe, & Kappen, 2014).
|Kuwait Finance House||The bank offers the Ijarah or simple lease deals and Ijarah Muntahiyah Bi Tamleek that ends in ownership of the asset. The bank purchases an asset for a client, who then pays for the asset through the lease to own method in installments. At the end of the lease, the ownership of the assets transmitted to the customer. The bank has gone further to introduce this Ijara concept to a finance card referred to as a Baytik Ijara Card. The card provides users with a maximum credit limit that can be repaid in a period that ranges from 1-24 months. The credit limit goes up to four times the customers’ salary at a fixed rate of 0.7 percent (Shahzad, Zia, Ahmed, Fareed & Zulfiqar, 2014).|
|Kuwait International Bank||The Kuwait International Bank offers financial assistance to its customers in real estate through the Ijara Muntahania Bittaleek (lease to own) financing. It also offers working capital financing to businesses through Ijara contracts (Al-Shamali, Al-Shamali & El-Shebiny 2012).|
|Warba Bank||Ijara project financing for different sectors and businesses is part of the corporate banking products and solutions provided by this Bank. Since 2012, the bank has been offering Ijara product solutions contracts that are according to individual needs to the client in conducting business in real estate sector (Shahzad et al., 2014).|
|Boubyan Bank||Operating lease Ijara is one of the Islamic financing solutions offered in this bank. These offers of the Ijara products have features that are Sharia compliant. It offers competitive profit rate and after the three months, the profit is charged monthly (Shahzad et al., 2014).|
|Ahli United Bank||The bank operates the Ijara-wa-Iqtina allowing customers to own the assets at the end of the contract period. Under Ijara, the bank purchases and possesses the property that a customer has chosen. It then sells the property to the customer at a similar purchase price with a repayment period that goes for about 25 years. During this time, the customer will continue using the property that is owned by the bank. The profit realized from the bank is from the rentals collected from the customers (Al Ahli Bank of Kuwait K.S.C., 2015). The bank also operates the Ijara sale lease Back whereby it makes an agreement with the customer to acquire an asset from them and lease it back to them. In this case, a different lease contract is entered into with a promise that the bank will sell back the asset to the client at the end of the lease period. The ownership is taken over by the bank while the sale of the asset at the end of the lease period makes the customer the owner of the asset once more (Lateh, Ismail & Ariffin 2009).|
Islamic banking systems that originated from the rise of neo-revivalist movements in the Muslim world and the growth of in different Middle East countries have continued to grow over the years in different nations in the world. Islamic banks apply diverse principle in its operations from the conventional banks, and the ban of usury or riba is one of the fundamental principles and most distinctive characteristic applied by these banks. Other principles of Islamic banking include the avoidance of too much risk (gharar) and practices that are illegal (haram). Instead of the typical instruments used by conventional banks, Islamic banks use the PLS and cost plus instrument as its financial tools since riba is prohibited in Islamic finance. Ijara is one of the cost plus instruments contracts which involves the. The different types of Ijara contracts such as Simple ijara/operating lease, Ijara-thumma-al-Bay/Ijara-wa-Iqtina’a, Ijara with Musharaka or mudharaba and Sale and Leaseback Ijara are also offered by various Islamic banks in Kuwait.
Aktan, B., Masood, O., & Ashraf, M. (2014). Stability estimation of Islamic banks: an empirical analysis. Journal of Academic Studies,16(62).
Al Ahli Bank of Kuwait K.S.C. (2015). Al Ahli Bank of Kuwait K.S.C. MarketLine Company Profile, 1-17.
Al Ali, H., & Naysary, B. (2014). Risk Management Practices in Islamic Banks in Kuwait. Journal of Islamic Banking and Finance, 2(1), 123-148.
Ali, S. S. (2011). Islamic banking in the MENA region. The World Bank and Islamic Development Bank, February.
AlKulaib, Y. A., Almudhaf, F. W., & Al-Jassar, S. A. (2013). The Banking Industry During an Extended Financial Crisis: an Empirical Assessment of Kuwait Banks. Academy of Banking Studies Journal, 12(1/2), 61.
Al-Shamali, S., Al-Shamali, F., & El-Shebiny, M. (2012). The Retail Banking Sector in an Oil-Rich Economy. Middle East Journal of Business, 7(4).
Belal, A. R., Abdelsalam, O., & Nizamee, S. S. (2015). Ethical Reporting in Islami Bank Bangladesh Limited (1983–2010). Journal of Business Ethics,129(4), 769-784.
Botis, S. (2013). Shari’ah Concepts in Islamic Banking. Bulletin of the Transilvania University of Brasov. Economic Sciences. Series V, 6(2), 139.
Lateh, N., Ismail, S., & Ariffin, N. M. (2009). Customers’perceptions On The Objectives, Characteristics And Selection Criteria Of Islamic Bank In Thailand. Gadjah Mada International Journal of Business, 11(2).
Mansour, W., Ben Jedidia, K., & Majdoub, J. (2015). How Ethical is Islamic Banking in the Light of the Objectives of Islamic Law?. Journal of Religious Ethics, 43(1), 51-77.
Mitchell, M. C., Rafi, M. I. M., Severe, S., & Kappen, J. A. (2014). Conventional Vs. Islamic Finance: The Impact Of Ramadan Upon Sharia-Compliant Markets. Organizations and Markets in Emerging Economies,5(1).
National Bank of Kuwait. (2015). National Bank of Kuwait MarketLine Company Profile, 1-21.
Raza, M. (2015). Islamic housing finance. Housing Finance International, (12), 45-47.
Shah, P. Q., Asif, M., Tahir, M., & Ali, A. (2015). Multi-Dimensional Financial Analysis of Islamic and Conventional Banks of Pakistan: A Comparative Study of Meezan and NIB Bank. Journal of Managerial Sciences Volume IX Number, 2, 203.
Shahzad, F., Zia, A., Ahmed, N., Fareed, Z., & Zulfiqar, B. (2014). Growth of Islamic Banking in Middle East and South Asian Countries. International Journal Of Management, Accounting & Economics, 1(3), 215-228.
Sobol, I. (2014). Islamic Banking-The Case Of Malaysia. Research Papers of the Wroclaw University of Economics/Prace Naukowe Uniwersytetu Ekonomicznego we Wroclawiu, (370).
Sobol, I. (2015). Islamic Banking in the European Union countries. European Integration Studies, (9), 184-197.
Swartz, N. P. (2013). The salient characteristics of Islamic finance and banking law. SDMIMD Journal of Management, 4(2), 49-57.
Wright, C. (2016). Kuwait’s banks brace for property crash. Euromoney, 47(562), 37.
Youssef, A., & Samir, O. (2015). A comparative study on the financial performance between Islamic and conventional banks: Egypt case. The Business & Management Review, 6(4), 161.