The Similarities and Differences between Ijarah and Leasing Essay

The Similarities and Differences between Ijarah and Leasing - Essay Example Since the banking crisis around the world, many countries have shifted to an alternate banking system such as the Islamic banking system in which there is a mechanism of sharing profit and loss and using fixed service charges instead of interest charges which eases the pressure on the economy. Some prohibitions and certain guidelines have been drawn by the Shariah law, which makes a clear comparison between the conventional finance system and Islamic finance system. The unlawful charging of the interest, Riba, is the foremost concept that is prohibited by the Islamic Shariah, while it also prohibits gharar, an uncertainty in activities and has made gambling, Maisir, forbidden which makes it to differ from the conventional finance system in which interest is considered to be a common ground. In an Islamic term, Ijarah is an agreement to offer something for a lease, rent, or wage. According to a different meaning in Islamic fiqh, Ijarah is also referred to as a payment offered to a person for the services that were delivered by the same person. However, if the term Ijarah is considered in the setting of Islamic banking, it is referred to as the process of transference of a particular property from one person to another in exchange of a lawful return or rent from the owner. The procedure involves the lawful transference of the asset from the owner to the lessee and ends with the purchase of the leasing object. Ijarah in the context of Islamic banking is known as Ijarah Thumma Al-Bai or Ijarah Muntahia Bittamleek, which is a type of leased contract that can only be ended with the purchase of the leased asset. The paper discusses the two concepts relating to the finance system, the convention form of financing system and the Islamic way of financing. Moreover, the paper will discuss the leased contracts based on Ijarah, which is consistently being used by the Islamic institutions. Furthermore, the study will differentiate between the concept of Ijarah leasing and financial and operating leases. The study will also highlight the accounting systems which have been recommended by the Accounting and Audition Organization for the Islamic Financial Institutions (AAOIFI) and the International Financial Reporting Standards (IFRS). Lastly, the paper will give recommendations to conciliate between these approaches. Lease is defined as a rental agreement between the two parties in which the owner of the asset gives rights to the lessee to use the asset, and it would be the responsibility of the lessee to compensate timely and contractual payments to the lessor (Brealey et al., 2006(. There are many benefits in leasing over obtaining external borrowing or purchasing assets by making full payment, and it can benefit in terms of the saving of the taxes, costs associ ated with the use of assets, and mitigation of risks (Ross, Westerfield and Jaffe, 2005). Leasing can create a positive impact as it reduces the cost of financial distress and minimizes the chances of bankruptcy. Even if the lessee occurs to be a defaulter, the lessee would be given a higher priority than a creditor who just borrows money. Leasing generally helps in the sharing of inflation risk, business risk, and residual value risk. The residual value risk is considered to be the risk associated with the market value of the asset at the maturity date which can be transferred from the lessee to the lessor who has the authority to adjust the lease payments to cover the risk. If the lessor can earn an advantage from the secondary market, the lease payments