Feb 04 - 10, 2008

Islamic finance has become a major global industry with over 300 institutions involved in both Muslim countries and international financial markets. Assets managed in accordance with the Islamic laws are worth over $200 billion, including financing facilities made available by banks and investments by mutual funds that have been screened for shariah compliance. Just three decades ago even the strongest advocates of Islamic finance could not have envisaged that such progress would have been possible in the context of an international financial system that was dominated by western interest based methods of financing.

Modaraba, an Islamic profit sharing alternative to interest based finance, had been used throughout the Islamic world between merchants and moneychangers since the time of the Prophet Mohammed (PBUH). When western commercial banks were established in the Middle East, South and South East Asia in the nineteenth century conventional financial instruments were used. European bankers were aware of Muslim views on riba, but much banking business involved the financing of colonial trade, that was usually in the hands of non-Muslims. Leading institutions such as the Ottoman Bank, the Eastern Bank or the National Bank of Egypt were largely British or French owned and managed.


Modaraba has established itself as a well understood Shariah compliant instrument of financing in Pakistan in early eighties. It has been practiced for the last 25 years and has gained a lot of experience in its operations and management. SBP developed an institutional framework which was acceptable to the scholars and also clarified the initial confusion regarding the regulatory responsibilities. It was initially thought that the experience gained from this mode of financing will replicate it throughout the system in Pakistan but unfortunately Modaraba hasn't taken off so far despite such a long standing and their significant contribution in the financial sector.

The overall performance of the Modaraba sector has not been so encouraging. There are few reasons for this, few of which are as follows;

Corporate governance is one of the key issues in managing the Modarabas' which proved to be inadequate and the interests of the investors and certificate holders have not been adequately protected. The concentration of powers is in the hands of managers particularly when the standards of transparency and disclosures are not that rigorous does leave a lot to be desired. The Modaraba Association is examining the whole governance structure in the light of the experience gained during the last two decades and trying to move in a direction which gains the trust and confidence of the investors.

The risk management practices in Modarabas' should be reviewed to find out if the managers are optimizing the returns for the given level of risk. There is an urgent need to determine if the tools and techniques being adopted by them represent the best practice in the industry keeping the constraint of complying with shariah in place. The only credible way to expand this mode of financing is by demonstrating that the reward-risk relationship under Modaraba is not inferior compared to other instruments.


The Modarabas have not been able to diversify their products or differentiate from other market players such as previously leasing companies and now commercial banks through consumer finance. Today more that 80% of their business is concentrated on commercial banks and leasing companies which do not provide any market niche or comparative advantage to them. The leasing portfolio mostly covers traditional industries such as textiles, light engineering, cement etc. It is vital for Modarabas' to develop some other products and services which are in the domain of the Modarabas' and also tailored to the demand of the particular customer base which has so far not been able to access financial sector institutions.

The Modarabas have to become more competitive in their cost of funding. If they continue to rely on the banks they would always remain at a cost disadvantage. As the tax rates on the banks are gradually reduced, the big banks are privatized and the drag of non performing assets is softened the banks will be able to outclass the Modarabas in cost of funding. A Modaraba has to tap other sources which remain unrealized and do not flow to the banking sector. There are many who do not want to use the banking system and are looking for Shariah compliant products. They should try to attract them and thus add to the overall national savings pool of the country.

The Modarabas' have very little geographical dispersion outside the big cities such as Karachi, Lahore and Islamabad. Unless they establish presence in smaller towns and have a distribution network which is extensive, due to this, their asset growth and deposit mobilization remains lackluster. Small and medium enterprises are looking desperately for finances and consumer financing is completely taking over by commercial banks thus leaves less room for Modarabas to operate. This can be an area where focus can be devoted and resultantly can augment profitability.

With the emergence of Islamic banking in Pakistan especially from the foreign banks, Modarabas have to face tough competition from them as they have huge capital base as compared to them. These banks are marketing their products more aggressively whereas one hardly finds any media advertisement from any Modaraba company. It is vital for Modarabas to develop marketing strategy for their products in addition to the development of new competitive products. Obviously this is a competitive world where only fittest can survive therefore it is not entirely correct to say that Islamic banking has hampered the growth of the Modarabas'.


Despite all this, it doesn't mean that Modarabas' have not progressed over the time, significant progress has been made in Pakistan in the establishment of framework, corporate structure and the role played by Modarabas' in the economic development of the country. Most Modarabas' in Pakistan are in the financial sector, whilst few others have been formed for industrial, trading and other specific purposes. In past, a specific purpose Modaraba named Fayzan Manufacturing Modaraba was started with a paid-up capital of Rs 900 million for a period of five-and-a-half years to construct, operate, manage and own a Polyester Staple Fibre (PSF) spinning plant at the premises of ICI Pakistan Limited. Another example can be of First Equity Modaraba's purchase of membership cards at country-wide stock exchanges. The Securities and Exchange Commission of Pakistan (SECP) encourages acquisitions and voluntary mergers for strengthening the sector. So far more than ten mergers and five acquisitions have been seen in this sector. These mergers are indicative of a general strategic shift towards consolidation that is needed to usher in greater financial stability and operational flexibility.

Summing up, While the world economy is passing through a period of transition and transformation, the contemporary state of the economy of Pakistan, especially the market place for financial services, poses enormous challenges and offers profitable opportunities. We are operating in an environment where there is an increasing number of competitors, new products and a changing regulatory environment. To succeed one must display adaptability, assiduity and innovativeness. Modarabas' as a group have played a significant role in providing financial services in Pakistan. This sector can be more efficient with the development of new products in the Islamic financial market. In view the challenges being faced by the Modaraba sector, experts believe that they must emphasize and focus on the four priorities, including research and development of new Islamic financial products, proper marketing of Modaraba models as Islamic financial service provider, liaison with Islamic banks, Takaful companies and Islamic mutual funds and awareness about Islamic finance within the members by organizing workshops and seminars.