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There is a need to amend rules of the game to enable the sector to play its due role

Feb 18 - 24, 2002

The payout ratio of modarabas is comparatively higher than many other sectors listed at the Karachi Stock Exchange. Most of the certificates are being traded below par value. Despite a long standing they have not been able to establish their niche market and their contribution in the financial sector has not been significant. A large number of modarabas are involved in leasing as core business. International Finance Corporation (IFC) provided credit lines worth US$ 20 million to some modarabas nearly twenty years ago but since then others could not succeed in soliciting any line.

The key objectives of flotation of modarabas are: 1) to serve the needs of those investors who are keen in earning Riba free income and 2) to ensure availability of funds for small and medium size entrepreneurs. While most of the operating modarabas still offer Riba free income generating prospects, they grossly ignore the second objective by indulging in medium and big-ticket leasing business. Therefore, it may not be wrong to say that by deviating from desired mandate, they are directly competing with those financial institutions who have access to low cost funds. Whereas modarabas are confined to funds raised through flotation of modaraba certificates.

An important factor which has been responsible for nominal growth of modarabas is the inconsistency in GoP policies. On top of this, regulatory environment has not been conducive for the operations and growth of modarabas. Currently more than 70 per cent of modarabas are involved in leasing as core business which does not provide them comparative advantage, at the best they come in 'me too' category. They have been able to compete with leasing companies only due to tax incentive.

According to some analysts modarabas have been able to pay higher dividend only because of tax exemption, if they distribute 90 per cent of their profit among certificate holders. Had this incentive not been there they would have not been able to pay even a modest dividend. They also say that the incentive has become an obstruction in formation of capital as most of the modarabas prefer to distribute profit among certificate holders to avail tax exemption.

It is worth noting that when mandatory/statutory reserve requirement was reduced from 20 per cent to 10 per cent, efforts were made to get it changed. The move by the regulators was possibly aimed at facilitating distribution of a larger sum to certificate holders. The sector resisted this on the pretext that it would curb capital formation and slow down growth rate of modarabas.

Modarabas are victim of twin problems, an incentive has become a hurdle and under the prevailing regulatory environment they are not able to mobilize funds from other traditional means, i.e. musharika certificates. According to some analysts, the biggest disadvantage is that modarabas mostly undertake those activities where they do not enjoy an edge over other financial institutions. Over the years they have neither been able to increase paid-up value of their certificates nor acquire credit lines to increase availability of funds, to increase their operations.

In this context it is important to point out that modarabas were allowed to float Musharika Certificates but only one modaraba succeeded in raising funds through this option. This too was made possible due to support of sponsors and private placement. Sector analysts strongly believe that it is very difficult to operate under the notified rules. Unless rules are amended and made realistic most of modarabas will not be able to exercise the option.

It is interesting to note that IFC was the first international financial institution which provided funds worth US$ 20 million to some modaraba. Since then no such influx of funds could be made possible. Analysts attribute this partly to the weak fundamentals for Pakistan and partly to the inability of modarabas to convince international financial institutions about the viability of modaraba concept. Some analysts even go to the extent of saying that terms and conditions agreed with the IFC were not complied and efforts were made to avoid payment on income certificates.

Whereas some analysts believe that foreign fund managers avoid investing in modaraba certificates despite offering attractive dividend yield. On the basis of financial results for the year 2000, twenty four modarabas paid dividend to their certificate holders. To recognize their performance awards were given to five highest dividend paying modarabas. These were, First Grindlays Modaraba, Imroze Modaraba, First Ibrahim Modaraba, First Habib Modaraba and First Habib Bank Modaraba. The dividend paid by these modarabas ranged from 21.5 per cent to 30 per cent. It is expected that for the year ending June 30, 2001 dividend pay out would be better than that of previous year.

Regulatory environment

The general perception is that modarabas are over-regulated, which is not wrong to a large extent. A question arises, are the regulators performing their duties? The fact is, while modarabas are required to file weekly and monthly reports, regulators hardly read the content. To substantiate their point of view, sector experts refer to a few modarabas which ended up in serious problems only because regulators did not read their weekly reports.

The apathy of regulators was evident from the fact that a modaraba having issued Rs 205 million certificates extended financial assistance to a company to the tune of Rs 150 million. This was a clear violation of the rules but regulators did not respond till the balloon burst. It was a single incident, at least five modarabas indulged in irregularities causing huge losses to certificate holders and regulators were the spectators only.

Sector analysts have another point, regulators do not understand the driving spirit behind operations of modarabas, often rules are contradictory and despite efforts by the players hardly any effort is made to remove these anomalies. One such example is deduction of Zakat on dividend paid by modarabas. While Income Tax Ordinance terms modaraba a company, Zakat and Usher Ordinance does not consider modaraba a company. This raises a basic question, does Zakat being deducted on dividend by modarabas has a legal status?

If one tries to find out the factors causing slow growth of modarabas, one of the factors is the professional background of people occupying key positions in modaraba management companies. Most of them are banker by profession, whereas we need modaraba managers. There is a vast difference in mind set of the two types of professionals. While a banker always look for collateral and work on eleven months credit, the driving force behind modaraba is joining of hands of those who have the expertise and those who have the money.

Let us hear what the modaraba management company people say. Some of them say, "Initially modarabas were not insisting on collateral, but experience taught us to hedge the risk by demanding collateral." Whereas others say, "An easy option was exercised. In fact we should have opted for financial re-engineering rather than demanding collateral." Even the regulators agreed to submission of collateral a must for soliciting funds from modarabas. Therefore, modarabas have virtually become banking operation. Efforts should be made to break this status quo.

Formation of two banks, based on lending with collateral, for providing funds to small and medium enterprises should be an eye opener for those who always said that lending without collateral was too risky. The track record of Khushhali Bank in Pakistan proves that the risk is minimized by funding economically viable projects and not by demanding collateral. Efforts should be made on the similar lines to bring necessary changes in rules governing modarabas.


At a time when government is making efforts to eliminate Riba from society, it is an appropriate opportunity to highlight the potential and problems faced by modarabas sector. A point must be kept in mind that modarabas can play a vital role in revival of Pakistan economy as well as offer Riba free income. Innovative ideas are needed to strengthen and improve performance of modarabas so that they play their due role of organizing business activities in line with Islamic principles.

In this regard all concerned have to play an active role to enable modarabas to play their due rule. The biggest responsibility lies on the shoulders of modaraba management companies. They have to introduce such financial products which are capable of not only delivering modest return but are also acceptable to regulators.

Housing finance is grossly ignored by financial sector. Those who are providing fund also charge very high interest rates. Modarabas can play a vital role in housing finance. If they are given permission, it will be a favour to those who are seeking fund for construction of housing units. At least eighty industries are directly or indirectly associated with construction business. It will also help in revival of cement industry.

Since most of modarabas are involved in leasing business, they should concentrate on consumer leasing rather than indulging in big-ticket leasing. They should also give attention to operating lease. It will not be out of context to mention that regulators demand provisioning even in case of operating lease. Is it not a little absurd?

Religious Board also has an important role to play. The objective of the Board should be to facilitate and not to create hurdles. The experience shows that being over-conscious they are often not willing to approve a financial product where they suspect involvement of Riba .

Though, regulators insist on extensive and intensive reporting, unless these reports are read, scrutinized and prompt actions are taken against erring players, they are not discharging their duty. Laws, rules and regulations are of no consequence unless followed in letter and spirit. Regulators must wake up.

Modaraba vs other sectors


Mutual Funds


Leasing Companies

Investment Banks

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Dividends Declared between

3.50 to 60%

1.50 to 46%

3.5 to 45%

10 to 30%

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Average paid-up capital (Rs in mln)





Aggregate dividend paid (Rs in mln)





Average rate of dividend (%)