At present there is only one development finance
institution in the country. For meeting the medium and long-term
requirement of funds, investors have no option but to approach
Modarabas and leasing companies. Though commercial banks are also in
the business of providing medium and long-term funds, this does not
fall in their mandate. Taking the advantage, a number of banks have
established Modarabas and leasing companies. Therefore, it may not be
wrong to say that currently these entities are the only source of
medium and long-term funds.
However, the entry of commercial banks into
Modaraba and leasing business has created uneven field. By virtue of
these size and branch network, banks have greater outreach and also
have low cost funds available with them. As against this, Modarabas
and leasing companies are dependent on banks for meeting their funds
requirement, to a large extent. Therefore, it is very difficult for
Modarabas and leasing companies to compete with banks on the basis of
Over the years leasing companies have survived
mainly because of their prompt approval and disbursement, tax benefit
available to the borrower and ability to syndicate. However, over the
years banks have developed their own niche market. Considerably long
time car financing has been the strong hold of leasing companies.
However, now banks have also acquired a substantial share of the auto
Interestingly, in the past, leasing companies were
catering to the needs of big ticket clients, but lately they have
changed their strategy. Now, the emphasis seems to be on small and
medium enterprises (SMEs). This strategy is also being supported by
some of the international donors and financial institutions. Since the
pilot projects and subsequent lending turned out very encouraging,
more and more Modarabas and leasing companies seems to be focusing
small and medium enterprises.
Till recently, the regulatory structure was such
that financial institutions were bound to undertake collateral-based
lending. While the banks were not able to extend funds without
collateral, Modarabas and leasing companies had no such restriction.
However, some of the critics strongly believe that banks have not come
out of the collateral-based lending. The State Bank of Pakistan has
already announced the separate set of prudential regulations to ensure
funding for the SMEs but the bank employees have not attained the
mindset required for catering to the needs of those who cannot offer
collaterals. As against this, from the commencement of their business,
Modarabas and leasing companies have been providing funds on the basis
of ability to generate income and future cash flow.
Similarly, Modarabas have grown, both in terms of
market share and variety of financial products. They have come up with
Riba-free financing facility and their endeavor is fully supported by
the government. The biggest incentive being that if they distribute
90% of their profit they are not liable to pay income tax. This
incentive has helped the Modarabas as well as the certificate holders.
As per the requirement, Modarabas are required to
set a side part of their profit as statuary reserve. The tax incentive
provides them to keep higher amount, which adds to their financial
health as well as give them an opportunity to expand their business.
As a result of higher distribution, certificate holders were able to
get higher return. This allows them to buy more certificates.
In the past most of the certificates were quoted
par to the extent of half of the face value. Even a 10% dividend was
attractive. According to the details available from Modaraba
Association of Pakistan some of its members have been distributing
substantial dividend. It is evident that over the years, the daily
trading volume of Modaraba certificates has increased substantially.
The active buying has also pushed the market capitalization of the
However, some of the analysts believe that this
incentive has become a serious obstacle. In order to qualify for the
tax exemption most of the Modarabas distribute bulk of the profit. If
the government is serious in promoting Modarabas, there should not be
any such requirement. This becomes all the more important because
Modarabas have only limited options available for raising funds.
Yet another constraint on Modarabas is requirement
of minimum credit rating for borrowing funds from financial
institutions. If there is no such condition for any other business
entity, why restriction on Modarabas only? This condition should be
withdrawn without further delay.
As result of mergers and acquisitions, the sector
has emerged stronger and its capacity to undertake more business has
increased. One may say that the number of Modarabas has reduced. But
it has come down only because weaker Modarabas were merged into the
stronger ones. Their improved financial health is evident from the
fact that now only a few Modarabas are in red.
The improved financial health has allowed them to
widen their scope of activities. Initially, their activities were
confined to leasing and/or trading. Now some of the players have gone
into establishing CNG stations and retail outlets. Some of the players
also actively invest/trade in equities. Their exposure in SMEs is also
on the increase and experience has been very encouraging.
However, it is worth noting that no new Modaraba
has been floated recently. It may look a little paradoxical that
Islamic banking in Pakistan is on the rise but promoters don't seem to
be interested in floating Modarabas. According to some sector experts,
the situation is only because Religious Board, having the mandate to
approve new product and services, has not been there for a very long
time. And in its absence neither new Modarabas could be floated nor
new products be introduced. Therefore, the government must constitute
the new Religious Board without further delay.
Having pinpointed a deficiency, it is also
important to bring on record the contribution of Securities and
Exchange Commission of Pakistan. It is playing a pro-active role. It
also follows consultative approach. On such example is evolution of
Prudential Regulations for the Modaraba sector. Some of the critics
may say that there still exist some anomalies. But others say these
are only irritants and could be removed in due course of time, the
consultation process continues.
One of the Modarabas took the initiative of issuing
Shariah compliant term finance certificates. The offer got very
encouraging response. However, since then no other Modaraba has tried
to follow the footprints of Al-Zamin Modaraba. A question may arise,
are there any hurdles? According to some of the sector experts,
"Technically speaking there are no hurdles. Apparently, the
reason was that when Al-Zamin floated such certificates, interest
rates in the country were experiencing downward trend. Therefore, most
of the cautious players were not ready to opt this as a tool for
mobilizing funds. However, with the interest rates once again on the
rise some of the players are actively considering this option."
According a cynic, "Modarabas are facing the
current situation only because they deviated from their basic mandate.
Modarabas should have not followed the policy of catering to the needs
of big corporates. All other financial institutions are after the
large borrowers and Modarabas cannot compete with them. There niche
market was, still it is and will always remain the SMEs. It is the
basic concept of Modaraba that one with finance and the other with
expertise join hands and work together for mutual benefit. Therefore,
if the Modarabas are going back to the concept of providing funds to
the SMEs, there is nothing wrong and they should continue this
The leasing sector is also expected to emerge
stronger after the increase in minimum paid-up capital requirement. A
vibrant economy is also expected to contribute to the growth of
leasing sector, due to enhanced credit demand. Till recently, most of
the manufacturing units were suffering from poor rate of capacity
utilization. However, now most of them are busy in expanding their
Two of the sectors, which have emerged to be the
biggest borrowers lately, are textiles and automobile. Automobile
sector needs specific mention. Bulk of the business of leasing
companies is coming from auto financing, which has resulted in
doubling of automobile sale. In order to meet the growing demand, the
assemblers as well as the manufacturers of parts are expanding their
production capacities. Therefore, the demand for fund is growing at an
Another factor adding to the growing business of
leasing companies is the enhanced consumer finance requirement in the
country. Initially, a lot of people were reluctant to acquire consumer
durable on deferred payment basis. The impression was that financing
companies were charging very high interest rate. However, with the
passage of time and growing competition interest rate have come down
significantly. This has encouraged the middle income group to opt for
Some of the critics were of the opinion that
consumer finance, at a large scale, could lead to serious defaults.
They still believe so but the record shows the opposite picture. Most
of the borrowers are prompt in settling their liability. They know
that if they are current they can acquire more products in the future.
They also consider this an important option for improving their life
style and quality of life.
Till lately, leasing companies were extending funds
for cars, but they have also started leasing tractors and other
agricultural implements. Venturing into this, new area has opened new
vistas. The extension in outreach, from urban areas to rural areas, is
expected to increase the business of leasing companies manifold.
However, the companies are still a little cautious. It is expected
that with the passage of time the focus may shift from urban areas to
rural areas, because the market enjoys enormous growth potential.
As regards the higher interest rates being charged
by the leasing companies, an expert says, "The rates are not high
if compared in the light of the benefits driven by the client. The
first and most important being that leasing companies take lesser time
in credit approval, they are prompt in disbursement and often no
frills are attached. One such example is auto lease and auto finance.
Most of the clients are not able to understand the difference and
often opt for an expensive alternative. The other factor is that now
leasing companies have also started offering operating lease. There
are advantages of opting for operating lease, but the ultimate
decision has to be made in consultation with a financial advisor so
that benefits could be maximized.
At one time, leasing companies were issuing term
finance certificates in quick succession. And most of the listed TFCs
were issued by the leasing companies. Then the number of news issued
declined, which was attributed to declining interest rates. However,
keeping in view the growing demand for funds and rising interest
rates, TFCs are expected to once again become a viable option for
There is a common complaint that playing field is
not even. There could be two options: either all other financial
institutions, except Modarabas and leasing companies, should be
stopped from undertaking leasing business or financial institutions
should be required to set up separate business entities to undertake
Modaraba and leasing business. The second option sounds more
appropriate and workable. In a free market no entity should be stopped
from undertaking any business.
For those who complain about severe competition,
Orix Leasing Pakistan should be an example. The company has been not
only coming up with new products and services but has also
establishing joint ventures outside Pakistan. Some of the Modarabas
are also exploring the Middle East market. It is believed that local
Modarabas can capitalize there quarter of a century experience by
opening up business in the Middle East. It can also help in overcoming
the financial crunch. The first step is to let the world know about
the performance and success stories of Modarabas.
With the growing demand for plant and machinery
Modarabas and leasing companies enjoy enormous growth potential.
However, creation of even playing field is a must. It is encouraging
that the State Bank of Pakistan and the SECP are following
consultative approach. There are still some irritants and these can be
removed with an open-mind approach. A lot has been done but a lot more
remains to be done.
The State Bank of Pakistan has also released its
Monetary Policy statement which clearly explains its intensions. It
wants to follow the policy of gradual increase in interest rates
without disrupting the ongoing process of investment in the country.
The critics must also realize that present high inflation rate is
mostly cost pushed. Unless crude oil prices come down inflation could
not be contained by following gradual increase in interest rates.
There is also a piece of advice for the players
that instead of complaining about the growing competition, they should
come up with innovative products, both on the asset side and the
liability side. It is worth noting that some of the Modarabas are
expanding the scope of their services but the potential is enormous
and must be tapped.
The rising interest rates also pave way for the
flotation of TFCs. Interestingly over the years commercial banks have
emerged to be the biggest investors of TFCs. As the banks are
suffering from 'surplus liquidity syndrome' it offers a big potential
However, it is necessary to point out the secondary
market of TFCs has not developed in the country. This needs immediate
attention of stock exchanges. It is worth noting that trading in
government bonds is expected to commence shortly. As a preamble a
number of indices of government bonds have been launched. At present
only a few brokers are allowed to trade in TFCs. This restriction
should be removed immediately.
Lending emerges only from appetite for credit. It
is worth noting that the government is trying to extend maximum
incentives to foreign investors. However, it is often felt that local
investors are being ignored. PAGE has pointed out repeatedly
that capital has no nationality and it only stays in safe heavens. If
the local investors are shy, the policy planners should not expect any
foreign direct investment.
So far the government has been taking the
responsibility of developing infrastructure. It has opened up this
sector for the private sector lately. However, only few projects have
been initiated. It is time to pass on the benefit of improved economic
conditions to the masses. More roads and highways should be built.
Healthcare facilities should be improved and above all construction
industry should be promoted.
There is a complaint that financial institutions do
not give attention to small borrowers. For them there is also a piece
of advice, build your credit profile and opt for documentation. These
are the two basic tools required for soliciting credit from financial
institutions. The tile of properties should also be clean.
Last but not the least, while the auto financing is
on the rise the number of cars being stolen is also skyrocketing.
Unless this problem is resolved people will continue to drive old cars
and spending a lot of money on their maintenance rather than acquiring
car of lease.