Hire Purchase Shirkatul Melk: How it functions

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Among rental based finance the common ones are Lease and Hire Purchase. Arabic terms of them are 'Ijara' and 'Ijara - bil - bai' respectively. Although both of these mechanisms of financing have been allowable in Islamic Banking, in Bangladesh a new hybrid product has been designed with features of more than a single mechanism. This is Hire Purchase Shirkatul Melk (HPSM), evolved from two concepts. These two terms are: (i) Hire-Purchase, and (ii) Shirkatul Melk. Hire-Purchase denotes an arrangement involving two common terms: (a) Hire, and (b) Purchase. Such a contract also gets a general indication that this arrangement involves these two things simultaneously. Here a party at a point of time gets a thing on hire and at another point of time, he owns it. It is, therefore, hire first and purchase next. Many conventional organizations including banks and financial institutions have been practicing such business since long. Under such an arrangement, an initial hirer of an asset attains full ownership of the same at the end of the deal. Shirkat means partnership. Melk means ownership. So "Shirkatul Melk" means share in ownership i.e. when more parties than one jointly own a thing, it evolves Shirkatul Melk. It is a concept of co-ownership. All the terms (Hire, Purchase and Shirkatul Melk) in a single arrangement is known as HPSM (Hire Purchase Shirkatul Melk). At the beginning, under this mode, both the bank and the client supply equity in an agreed proportion to procure an asset like land, building, machinery, and transport or the like; purchase the asset with that equity money, own the same jointly; share the benefit as per agreement. The share, part or portion of the asset owned by the bank is hired out to the client partner for a fixed rent per unit of time for a fixed period. Bank sells the ownership of its portion to the client against gradual payment of price for that part in addition to due rent. In fact HPSM stipulates an additional condition of co-ownership from the beginning of acquisition of the asset over and above a Hire Purchase agreement. Co-ownership to culminate in sole ownership Under HPSM arrangement, installments paid by the client include rentals as well as principal as price of asset on piecemeal basis. By virtue of payment of portion of the principal, the client gets the ownership of the corresponding share in that asset. This contract indicates that the hiree bank will gradually sell and transfer its part of ownership to the client hirer in proportion to the amount paid as principal price. Thus, the hirer paves the way to acquire the full title of the entire asset on payment of the total price at the end of the hire period. It should be noted that acquisition of each share of asset to be sold to the hirer increases gradually and the amount of rent should be decreased proportionately. In other words, decrease of Hiree's ownership is marked by increase of Hirer's ownership on the asset. Rent is, therefore, charged according to diminishing balance method. Key features and some general rules l In case of hire purchase under Shirkatul Melk, the asset is jointly purchased by the hiree (bank) and the hirer (client). However, if the partners agree and wish the asset purchased may be registered in the name of any one of them clearly mentioning the same in the HPSM agreement. The whole of the purchased asset including the share owned by the hiree bank is put at the possession of the hirer. The client partner shall thereafter purchase the bank's share gradually through the process as detailed in the HPSM agreement. l Ownership risk is borne by both the hiree and the hirer in proportion to their retained equity. Under this arrangement the role of hirer is one that of a trustee. l If the hire contract is revoked for any reason prior to the payment transfer of full title to the hirer, the hirer will share that part of the hired property which has been sold to him against payment made by him, and the remaining part will belong to the hiree bank. l It is a condition that the subject (benefitservice) of the contract and the object (asset) should be known comprehensively. l It is imperative that the asset to be hired must be a non-fungible one. For example a car (non-fungible) may be hired, but a barrel of oil (fungible) cannot. Fixation and payment of rental The rental of the asset will be fixed keeping in view the demand and supply condition in the market. It is worth mentioning that default in the payment by the hirer client shall cause increase of the total rent as the rental is fixed on pre-determined rate applied on diminishing balance assuming timely repayment according to the schedule. Such extra rent may, however, be realized at the conclusion of the transaction. But it is not permissible to charge anything extra on the accrued rent. The client partner shall pay the rent as per agreement usually from the date he takes delivery of the asset. Moratorium gestation period In HPSM investment sometimes there evolves a gap period between investment (disbursement) and building (creation acquisition) of the asset which is essential to cause the same to generate revenue. Charging rent by the bank for such a period is highly objectionable under Shariah because such investment does not enable to generate any cash-flow during that period. The period from the date of disbursement for acquisition of the asset to the date of handing over of the asset to the hirer in good order to derive the desired benefit is called "Gestation Moratorium Grace Interim period." During the gestation period, the asset remains under construction installation making form. So the asset can not yield the desired benefits, and as such no rent should be charged for that period. But to cover the loss of gestation period, rent may be charged at a higher rate for the remaining period to adjust expected rate of return for the entire period including the moratorium. On the other hand, rent may be allowed to be charged during the gestation period, if the delivery of the asset is completed in usable condition. In that case gestation may be allowed if the hirer client needs more time for commencement of operation. Deferring repayment up to start of revenue generation would facilitate matching of the client's periodical expenditure and corresponding revenue vis-à-vis the concerned HPSM asset. In the cases where rent cannot be charged during moratorium, traditionally, in Islamic banking arena of Bangladesh, there is a practice of revaluation of HPSM asset, at a prefixed rate on completion of the gestation period. Under this system bank sells its share in the asset at a higher price to cover the expected return of the gestation period. Such a system of overvaluation of asset at a pre-fixed rate irrespective of market price and to sell the same under Murabaha or 'cost + profit' base, in addition to original HPSM agreement raises question among the stakeholders as well as Shariah scholars. The writer is the First Vice President and Head of Islamic Banking of Bank Asia Ltd. He can be reached at email afzal@bankasia.com.bd Opinions expressed in the article are of the writer's own and not necessarily of the organization he is working for