Islamic Banking is More Than Just Avoiding Interest

Written by Bernard Gachuri

Islamic banking and finance has in the recent past gained a lot of global traction and offered a preferable alternative to conventional commerce.

This practice has largely been embraced due to the appreciation of its nature of engagement as being on an investment basis, where the relationship between the parties involved is buyer-seller based and yields a profit motive.

This is in comparison with conventional banking and finance where the nature of engagement is on a lending basis with the relationship between parties involved being on a borrower-lender basis, where interest is earned.

Unfortunately, the understanding of Islamic banking and finance is popularly limited to the perception that its participants should only eschew interest.

This is not entirely true because proponents of this school of thought often miss the bigger picture, which is, that the practice is based on Shari‘ah, the religious legal system governing the Islamic faith.

Islamic banking and finance must thus be conducted within the permissible Islamic jurisprudence for it to qualify as being Shari‘ah-compliant.


One of the popular financing models in Shari‘ah is the Ijarah which means “to give something on rent”. Ijarah in Shari‘ah compliant financing refers to the usufruct (i.e. the right to use) transfer of a particular property to another person in exchange for rent claimed from him, noting however that the corpus of the property still remains in the ownership of the transferor during the lease tenure.

For instance, if individual A has leased his house to individual B under the Ijarah financing model, the taxes referable to the property such as land rates and rents payments shall be borne by individual A, the lessor, while the water bills, electricity bills and all expenses referable to the use of the house shall be borne by individual B, the lessee.

In such an arrangement where the term Ijarah is synonymous to “leasing”, the lessor is referred to as a “mu’jir”, while the lessee is referred to as a “musta’jir” and the rent payable to the lessor referred to as “ujrah”.

The process flow in an Ijarah financing model is five-thronged; it begins with the lessee’s (customer) execution of a promise to lease. Based on this, the lessor (financier) procures the property by paying for it, confirming its delivery and assuming its possession. The customer and financier thereafter execute a lease agreement at agreed upon lease rentals and tenure.

The customer then honors a defined rental payment schedule during the lease tenure. Finally upon maturity of the lease, the financier is obliged to sell the property to the customer at an amount that had been agreed upon in the lease agreement.

For a leasing transaction to be used as a mode of financing in Shari‘ah, the terms and conditions of the contract must always be governed by the rules of Shari‘ah prescribed for Ijarah financing.

Among the pertinent rules to be observed in an Ijarah financing model is that the subject of lease must be valuable and limited to something that can be used without consumption. Any leasing of consumables such as money, food and fuel is therefore deemed as a loan, not an investment; as such all charge proceeds derived from this arrangement are treated as interest rather than profit.

The period of the lease must also be defined in clear terms and shall commence from the date on which the leased asset has been delivered to the lessee, regardless of whether or not the lessee has started using it. The periodic rental payable must also be determined at the time of contract execution for the whole period of lease.

It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of effecting a lease agreement.

If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease becomes invalid; in such an instance, the lease becomes void because the rent is uncertain and uncertainty (gharar) is prohibited in Shari‘ah.

The use of the leased asset is also defined beforehand in the lease agreement, with the customer being liable to compensate the financier for all damages to the leased asset caused by any misuse or negligence on the part of the customer.

However, the leased asset remains in the risk of the financier throughout the lease period in the sense that any harm or loss caused by factors beyond the control of the customer shall be borne by the financier.


If the leased asset totally loses the function for which it was leased and no repair is possible, the lease automatically terminates on the day on which such a loss will have been caused.

However, if the loss was caused by the misuse or negligence of the customer, he will be liable to compensate the financier for the depreciated value of the asset back to as it was immediately before the said loss.

The Ijarah model of financing is adoptable to Islamic banking products such as home financing, movable asset financing, financing tradeable Sukuks and project financing.

Given the adverse attention that Shari‘ah-compliant banking and finance has received among the Kenyan citizenry as fueled by misinformed reports and related malpractices perpetuated by rogue banking industry players, the assertion that there indeed exists a knowledge gap both in its application and the governing tenets would suffice.

Only by bridging these gaps shall the full benefits of Shari‘ah compliant banking and financing be appreciated and the same adopted to provide dignified financial services to the unbanked masses.




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About the author

Bernard Gachuri

Bernard Gachuri is a banker and currently a post-graduate student at Warwick Business School.