The fierce competition is mainly due to uneven playing field, more in favour of commercial banks underwriting leases


July 28 - Aug 03, 2003





In the absence of vibrant developing financial institutions (DFIs) leasing companies and modarabas have emerged as the major source of medium-term funds. They have also gone into consumer financing and providing funds for small and medium enterprises. Due to careful risk evaluation and constant monitoring the defaults have been low. Some of the entities indulging in imprudent practices were in bad shape. However, constant and vigilant monitoring by Securities and Exchange Commission of Pakistan (SECP) has helped in avoiding any serious crisis.

The leasing companies and modarabas have virtually assumed the role of DFIs because now they underwrite big-ticket leases and lease period often touches five-year maturity period. Though, leasing companies and modarabas have survived during the period fresh investment was low, the entry of commercial banks and other NBFCs into leasing business has created uneven playing field. Commercial banks enjoying the edge, due to lower cost of funds, force the leasing companies to work on very lean spread. So far they have faced the challenge successfully mainly due to efficient risk management. However, it is yet to be seen how successful are they in the prevailing situation?

According to some financial sector experts, "Leasing companies and modarabas, undertaking leasing as core business, have the expertise to beat the competition. While cost of funds may be higher for leasing companies, the prudent risk management has kept rental recovery percentage high and mostly in-time." In the recent past bulk of the leasing business originating from underwriting of car leases has prompted commercial banks to enter into auto financing business. However, some sector experts say, "Auto financing facility extended by commercial banks is qualify to be called lease. It is offer of loan for the purchase of a vehicle because the client does not qualify for tax credit for the amount being paid."

It may be worth quoting from the message of Khalid Mirza (the then Chairman of SECP) published in Pakistan Leasing Year Book 2002. It says: "I am aware that one of the most formidable challenge being faced by the leasing companies at present is the growing presence of banks and DFIs in the lease market. Their cost of funds, colossal size and extensive branch network do seem intimidating at the first, but the fact of the matter is that leasing by commercial banks in other countries has not been a success. This is essentially because commercial banking and leasing are two separate fields based on totally different risk management criteria. While leasing inherently entails risk, commercial banking is risk averse. In fact 'genuine' leasing by commercial banks is not really possible and almost invariably leasing by commercial banks results in fully collateralized asset financing in the grab of lease".

The entry of commercial banks and NBFCs into leasing business has proliferated only because of the 'accommodating' attitude of Securities and Exchange Commission of Pakistan (SECP) and State Bank of Pakistan (SBP). As the regulator, the SECP should ensure that the companies should confine themselves to the mandate for which they have been established. Technically, leasing does not come under the purview of NBFCs as the rules provide this mandate to leasing companies and modarabas doing leasing as core business. In the past, it was decided that if banks and NBFCs wished to undertake leasing business, they had to establish separate entities. However, the decision has not been implemented in letter and spirit.

Despite the subdued investment in year 2002 and tough competition from commercial banks the companies doing leasing business expanded their geographical reach and extending facilities to small and medium enterprises (SMEs). Leasing companies issued the largest number of term finance certificates (TFCs) and pioneered the flotation of special purpose vehicle (SPV) for raising term financing. The sector also well responded to the regulator's requirement regarding increase in paid-up capital. This also led to mergers and acquisitions resulting in further consolidation.

The collaboration between Leasing Association of Pakistan (LAP) and Swiss Agency for Development and Co-operation (SDC) has proved very fruitful and beneficial. During the year, five seminars were held in NWFP province under SME Lease Awareness programme. These workshops on micro and small leasing were arranged for the staff of leasing companies. The LAP is also developing a database of potential SMEs with the help of SDC. According to LAP Year-Book 2002, the database contained profiles of more than 6,000 potential lessees. The Innovative Project Fund, which was launched with SDC support, has been further availed by the LAP members.


The number of the LAP members increased to 30 in year 2002. The aggregate paid-up capital increased from Rs 4.3 billion in 1998 to Rs 7.5 billion in 2002. However, bulk of the increase was mainly due to SECP's regulation regarding increase in minimum paid-up capital requirement to Rs 200 million. During this period investment in lease finance increased from Rs 28 billion to Rs 39 billion. The revenue grew from Rs 5.3 billion in 1998 to Rs 7.3 billion in 2002. However net profit exhibits downward trend. The aggregate net profit of LAP members went down from Rs 3.98 billion in 2001 to Rs 1.92 billion in 2002.



Earnings are one of the key determinants in the success or failure. It is the most specific expression of an entity's franchise strength and has the direct impact on the ability of the entity to attract equity and debt in terms of amount and cost. Leasing sector's profitability performance during 2002 was adversely affected due to 7 out of 27 companies posting losses. The sector's reduced profitability can be attributed to some infection in the lease portfolio and fierce competition from other financial institutions. With the persistent and substantial reduction in interest rates, internal rates of return (IRR) for the leasing companies have been on the decline.

The emerging trend of large-ticket lease financing hints towards leasing companies assuming the role of DFIs. This is a major shift in focus, though, not necessarily inappropriate provided the leasing sector assembles the wherewithal that is necessary to enter a market that grows more complex with change in technology and render equipment obsolete faster than many may find affordable. This calls for familiarity with the sourcing, supply, demand, and pricing of a much wider variety of industrial technology, and adopting a more sophisticated approach to risk management. The faulty decision making by the financial institutions is mainly due to lack of credible information regarding technology and emerging trends. This forces the lenders to rely on borrowers choice that may often be rooted in non-commercial considerations. It is most desired that leasing companies develop the technology and price evaluation cells. Setting up such elaborate cells may not be possible in each company due to diversity of plant and equipment being imported into the country. Therefore, it may be appropriate that a centralized database and evaluation cell is established. It is not a far cry because syndication is getting popular to hedge the risk.

Modarabas have been playing an important role in the deepening of the financial sector in the country. They have helped in widening the scope of financial services and provided a successful and tested mode of Islamic financing. Some sector experts believe that the sector comprises of too many small players with insignificant capital base and market share posing a systemic risk. There is a need for the players to consciously follow the policy of mergers and acquisition for consolidation. The players must also develop new products and pursue aggressive marketing of these products and services. It is heartening that players are fully cognizant and making efforts. One major bear through has been the approval of Musharika-based TFCs.

Modaraba Association of Pakistan (MAP) has also prepared a proposal for setting up a SME Modaraba. With an initial paid-up capital of Rs 200 million. About 20 modarabas are expected to participate in the SME Modaraba that will undertake SME business in the smaller towns and distant areas. This will help in resolving the problem of individual modarabas, which do not have an elaborate branch network.



It is also reassuring to note that Pakistani modarabas are actively soliciting funds from other Muslim countries by highlighting the successful role they have been playing in eliminating Riba from financial transactions. One such effort has been made at the 9th Private Sector Meeting of Islamic Countries held in Sharjah in December last year. Waqar Ajmal Chaudhry, Chairman of MAP, made a detailed presentation about the operations of modarabas in Pakistan at the meeting. This presentation helped in creating enormous interest of other Muslim countries for participation in the operations of Pakistani modarabas.

The modaraba sector is the largest sector in Pakistan's financial market, having a paid-up capital of Rs 7.9 billion as at June 30, 2002. There are 45 modarabas listed at Karachi Stock Exchange. Out of these 34 are member of MAP. The performance of modarabas has shown consistent and reasonable performance over the years. During 2002, out of 34 MAP members declared dividend. The aggregate payout was Rs 570 million. While 14 members did not declare dividend another 7 posted losses.

While many people believe that modarabas only undertake leasing business, the diversity of their operations can be gauged from the income earned through various activities. During 2002, the total income of MAP members was Rs 3,930 million. Out of this Rs 2,917 million was earned from leasing business and Rs 340 million was from Musharika and Morabaha products.

The latest entrant is Fayzan Manufacturing Modaraba. It was incorporated pursuant to a joint venture agreement between Faysal Bank, Al Faysal Investment Bank, Meezan Bank and Pak Kuwait Investment Company. This is a specific purpose modaraba for a period of five and half years, commencing March 22, 2001. It has been floated to construct, operate, manage and own a polyester staple fibre plant spinning and processing plant at the premises of ICI Pakistan under the licence agreement with ICI. The plant has commenced commercial operations on April 01, 2002.


With the revival of investors' confidence in Pakistan's economy the private sector demand for funds has registered significant increase. Though, commercial banks are suffering from surplus liquidity, they are reluctant to enter into medium-term financing, particularly for plant and machinery. In such a scenario only leasing companies and modarabas have to meet the demand. They are poised to meet the challenge. The only favour they demand from the government is an even playing field for all the players.