Leading players in financial sector

Feb 21 - 27, 2005

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 interest rates.

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 financing business.

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 sector.

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 policy."

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 capacities.

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 unprecedented rate.

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 consumer finance.

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 raising funds.

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 also.

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.