HOW FEASIBLE IS A CONVERTIBLE IJARAH CONTRACT FOR SME FINANCING?: A SIMULATION APPROACH

Abstract

Islamic financial institutions have relied for decades on margin-based contracts to
provide financing for the business sector, despite the basic idea that Islamic finance
is expected to provide an equity-based or a profit and loss sharing (PLS) contract.
This fact raises the need to encourage the use of a margin-based instrument with an
innovative scheme that allows for conversion of the contract into a PLS-based contract.
Moreover, we propose a convertible ijarah contract to fill this need. A convertible ijarah
contract is an ijarah (rent) contract that is convertible to a PLS contract according to
the Islamic financier’s decision. In this study, we simulate three scenarios of project
financing with (a) murabaha as a margin-based contract, (b) musharaka as a PLS
contract and (c) a convertible ijarah contract. The aim is to evaluate whether the
convertible ijarah contract will provide a higher return for the financier compared to the
other contracts. The main input of the simulation is nine sectors of Indonesian SMEs’
financial performance. We found that when the financial performance of Indonesian
SMEs was measured by short-term financial performance, the convertible ijarah
contract outperformed the murabaha contract for all sectors but did not outperform
the musharaka contract, except for low-margin sectors. However, when the financial
performance of Indonesians SMEs was measured by long-term economic performance,
we found that the convertible ijarah contract outperformed the murabaha contract and
musharaka contract for almost all sectors.





Kami menemukan bahwa kontrak ijarah konversi mengungguli kontrak murabahah dan