Senior Banker

May 10 - 16, 2004






A mosaic of financial products has emerged out of abundant flow of funds but financial sector is hesitant to enter into agri-based market.

Having reached to an exhausting level after tapping areas such as consumer loans, auto loans, house building loans, credit cards, SMEs and corporate sector financing, (all being urban-based) financial products, market is getting dried up for banks. Overheating and subsequent chaos is imminent. Investment is growing too quickly and will exceed market demand. Very soon they will be compelled to look for new sectors. Whereas, banks are concentrating on products to facilitate urban society, the field is wide open for financial sector to enter into agri-based products and penetrate into rural areas. Modarabas can set up an example as trend setters, instead of price receiver, by entering into agric-based market.

In present scenario, State Bank is very keen to encourage investors to come forward in developing infrastructure to facilitate rural products. road network, warehouses, transportation, hydroelectric works, telephone network, education of artisans as components of infrastructure are due for improvement. However ambitious economic recovery plan may be, extra dependence on industrial plan with present growth of population at the rate of 2.3 percent, we cannot provide employment through industry because of input required. The masses will remain poor unless major improvement plan in agriculture sector is carried out. Forty percent of population is living below poverty line and they have to be fed. It is universal truth that political independence without economic independence can be seldom safeguarded.

If we build industry, which can absorb on million people, goods will be produced, but there can not be a market unless people have purchasing power. Infrastructure changes are bound to come with government planning through even public sector borrowing. There will be multiple projects for poverty alleviation. Portion of income from these projects will go to investors and help in revenue generation for state. Large banks having agriculture financing experience are more hooked up by corporate lending. Agriculture Bank in public sector is havang an extra burden of infected portfolio and lacking cash resources to come forward.

Agri-based economy has multiple of choices for investors and risk managers. Crop loans, seeds farming loans, project loans are few areas of interest. Tractors, bulldozers, combined harvesters, fertilizers, pesticides, modern systems of irrigation, tube wells, lift pumps and varied items of import are part of requirement.

In economy, GDP growth target of 6%, the agriculture is offering multiple of choices to achieve self sufficiency and have export potentials. Modarabas are sharing 90% of profit by distribution amongst investors. They have undertaken activities of trade finance, leasing, stock market and various services. But investors, especially foreign, have shied away from investment in Modarabas and resource mobilization remains weak and costly.

In January 2004, Security and Exchange Commission of Pakistan revised Prudential Regulations to provide Modarabas an impetus and leveled playing field in financial sector. The capabilities of risk management, promoting corporate governance have been aimed at. The four segments revised are: comprehensive set of definitions covering all activities, guidelines of Risk Management, Operation Activities and Know Your Customer (KYC) to cover anti-money laundering issues.

State Bank, earlier in January 2003, provided strategic guidelines for promotion of Islamic Banking. It allowed full fledged Islamic bank in private sector, setting up of subsidiaries of Islamic Banking by existing banks and allowed stand alone branches for Islamic Bank in existing commercial banks. In the Gazette of Pakistan dated November 4, 2002, in terms of Banking Companies Ordinance, 2002 as new clause has now been inserted in Banking Companies Ordinance which reads:



"(aa) The carrying on of banking business strictly in conformity with the injunctions of Islam as laid down in the Holy Quran and Sunnah"

The very origin of Modarabas comes from Islamic social system. An interest-free system has been one of the many aspirations of all and sundries in Islamic Society. It is a partnership, where one partner gives money to other for investing it in a commercial enterprise. Funds provision is the soul responsibility of "Rabbul Mal". Management and work is carried out by other partner "Mudarib", working with due diligence by Mudarib, the liability is limited to investment.

Government is committed to promote Shariat mode of financing and financially strong Modaraba sector will lend a helping hand to the cause. Having set the house in order the Modarabas will be well poised to play proactive role as part of financial sector, contributing for the growth of national economy.

In the words of Governor State Bank, Modarabas have the unique advantage of having tested Islamic mode of financing and experienced business strategies and transactions. The research and development of new products have not been undertaken by Modarabas, may be due to low capital base and fragmentation of sector. The association may develop capabilities and issues of collective concen which can be taken as a collective strategy. The conventional financial system makes it difficult to mobilize resources. But when the Government is taking issue of changes in infrastructure, the Modarabas will be having leveled field as the purpose indicated by Securities and Exchange Commission's new regulations. The Modarabas have the untapped market for their input in taking agriculture sector in their fold as the financial sector is getting dried of products.

One of the challenges for Modarabas is cost of funding. If they would rely on financial institutions for supply of funds, they would be at a disadvantage of competing with an advanced financial sector. They can develop their borrowing through short term and long term certificates from private sector who are looking for investment markets. Modarabas can offer incremental return, since the spread will be better in lending in rural sector. Sharing knowledge and reducing risk will enlarge opportunities and expand horizon of asset portfolio with adequate returns. Modaraba's efficiency will contribute for balance sheet indicators, confidence of potential investors will be increased with improved rating.

So far the financial managers have concentrated in urban sector and market potentials with 60% of population in rural areas have been ignored. Ibne Khaldoon, a 14th century thinker and philosopher has commented on urban and rural divide by saying that the activities of rural areas are dependent on their basic needs, close to nature and away from luxuries of life as compared to urban or city areas. Present products offered by major banks and development at financial institutions are originated in a culture of laxity in city life and products are to facilitate city life norm.

Modarabas may take project financing in rural areas, by mobilizing resources from partners in a commercial enterprise as system permits. The may attract interest of investor due to higher yield and profit sharing system. Their fear of going into interior, not having much experience and unbearable establishment cost, will be outlived by reaching arrangements with network of Post Offices and Saving Centres. Post office branch can service as a point of contact, maintenance of account and provide advantage of KYC. It will be creating employment in interior, education for farmers, personal advisory services by the staff at post offices and statistics for state. On-line banking network link, post office opening of agri-desk in the remote areas will not be as difficult compared to opening of new offices or branches by banks/Modarabas, like banks have opened desks at care dealers' showroom.

Agri-product loans and their securitization can be divided into four categories:-

a) Loan secured by crops
b) Loan secured by live stocks
c) Loan secured by farm equipments
d) Consumer purpose loans - To farmers Ranches.

Crops category belong to goods produced in farming operations or crops in their unmanufactured state; grains, cotton, wool, such goods must be in possession of debtor engaged in raising, grazing or other farming operations if goods are products, they are neither equipment nor inventory. They are harvested and moved into storage, warehouses, they become inventory. They must be in possession of the farmer. If they are in possession of some one selling them, they are considered as inventory. Standard has to be followed, in ordinary course of business inventory procedures.

Loans against inventory (raw material, work in process, finished goods) can be allocated. The inventory advances are usually converted to the receivable portion of line once goods are sold then receivable portion of line should be reduced accordingly. The borrowing base is adjusted up and down in accordance with the amount of inventory constantly in pipeline and the existing receivables category.

A maximum limit of Rs. 10 million per customer can be fixed as upper limit for risk management and higher limit to meet peak seasonal needs or before price increase for goods occur, would be a prudent approach. Loan disbursement through post office account will help to develop fund flow in post office channels. It may cover sectors of retail banking and personal banking. The system can be started from adjacent cities Lahore, Karachi, Peshawar and Quetta. Agency arrangement with Post Offices and Saving Centres link in rural areas may provide a public-private sector partnership. Insurance of these loans can be arranged with insurance companies and may provide incentive for them.

Modaraba Association of Pakistan can reach to an agreement with postal authority's network for providing space with shared cost and facilitate post office banking services with limited man-power. It is in line with present concept of Central Processing Unit (CPU) banking in which branches are reduced to skeleton staff for offering only counter services and customer contact point.

Ten percent of Rs. 8 billion paid up capital of Modarabas comes to Rs. 800 million for initial investment. It will create sizeable goods and services market. The flow of funds will facilitate village improvement, education and with diversification of funds, add colour to the investment landscape.

Building inroad for Modarabas in agri-sector is a food for thought and will be a step forward to food for all.