Feb 04 - 10, 2008

The State Bank governor, in one of her speeches last year asserted, "The Islamic Finance now seems to be a reality and is on its way to be institutionalized, albeit at different levels in different countries, and the western world is now selectively and cautiously positioning to invest in this system".

At work in 70 different countries, Islamic Finance has grown to a dollar one trillion industry. The growth story dates back to early eighties when under geo political compulsion the United States decided to use Islam against the then USSR in Afghanistan. Islamic forces in Pakistan were mobilized and a demand for Islamic financial system was created. Under this system, interest was replaced by mark up which in fact is interest sans compounding. Modaraba institutions emerged as a parallel system to the traditional banking. Long Term Venture Modaraba (LTV) formed under the expert patronage of the then NDLC was the first to make waves in the emerging market of Modarabas. Subsequent changes of management affected its performance and it is now being reported in the default section of KSE daily quotations with a "No Trading" tag. At present 35 Modarabas are listed on Karachi Stock Exchange. After 9/11, the resurgence of demand for shariah based financial system has made Modaraba a potential candidate for long term and stable growth provided that the problems presently being faced by Modarabas are resolved and a level playing field is allowed to them.


Modaraba system works under the pooling concept of management skills and financial resources. The business arrangement between Prophet Muhammad (pbuh) and the affluent lady of that era Hazrat Khadija (pbuh), who subsequently became the first wife of Prophet Muhammad (pbuh) is said to be the first Modaraba. The financial resources of Hazrat Khadija (pbuh) and the business skills of Prophet Muhammad (pbuh) were pooled together with an understanding to share the business profit in an agreed ratio.

Modaraba is managed by an asset management company who is entitled to a fee equal to a certain percentage of Modaraba's net profit. For example, First Habib Bank Modaraba was floated by an asset management company with the name of Habib Bank Financial Services (Pvt) Limited. A Modaraba can be a specific purpose Modaraba or a multi purpose Modaraba. Majority of Modarabas are multi purpose Modarabas authorized by the memorandum and articles of association to undertake such activities as, commodity trading, stock exchange investment, business and industrial financing etc. The usual Modaraba products are Morabaha, Musharika and Leasing. A leasing Modaraba can undertake leasing operations provided that the lease is an operating lease that is the leased asset is reported on the balance sheet of the Modaraba who is entitled to depreciation tax benefits, if any.

Modaraba finance is the commonest form of loan to business and industry. Under Modaraba, the Modaraba either directly finances the purchase of an asset from the market for the use of the borrowing company or purchases an existing asset from the borrowing company with an agreement to sell it back to the borrowing company at the termination of Modaraba. Modaraba's resale price or the borrowing company's repurchase price is composed of the amount financed by the Modaraba and a certain amount of mark up. Musharika is a profit and loss based transaction usually undertaken by the Modaraba to raise funds for operational activities. The initial operational funds are the Modaraba's equity funds raised through public subscription against allotment of Modaraba certificates which are traded on stock exchange in the same manner as shares. Modarabs are allowed to raise funds from the market up to a certain extent prescribed under prudential regulations issued by the Security Exchange Commission of Pakistan (SECP) who is the controlling authority for Modarabas. Modarabas are governed by the Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980. Modaraba certificate holders are entitled to any dividends declared, depending on the profitability of the Modaraba. Unlike shareholders, Modaraba certificate holders have no voting rights.


Out of the 35 Modarabas listed on KSE, 8 are being reported under defaulters' category. These are Crescent Standard Modaraba, Dadabhoy Modaraba, Interfund Modaraba, LTV Modaraba, Schon Modaraba, Tawakkal Modaraba, Unicap Modaraba and Unity Modaraba with none of them having paid any dividend during the last three years. The total paid up capital of 35 Modarabas is Rs.9,926 millions with a market capitalization of Rs.5,548 million showing an aggregate equity erosion of Rs.4,378 million. This equity erosion ensues from the fact that only 4 out of 35 Modarabas are being traded above their par values. These are Allied Rental Modaraba, Habib Modaraba, Imrooz Modaraba and Standard Chartered Modaraba with Imrooz Modaraba being the top performer having got its Rs.10/- share quoted at Rs.40/-.

With the statistics mentioned above, the growth picture doesn't not appear very rosy. The reason for the disappointing performance of Modarabas can be traced to the mushroom growth during the early years when control and vigilance were traded off for the survival of a nascent concept, which was introduced in the market without proper ground work. Most of the business and industrial houses were granted license to float Modarabas with a nominal capital and minimum regulations. Later on these Modarabas were misused to cater to the financing needs of the group business. Some of them unscrupulously engaged in stock exchange trading and passed on the trading losses to the certificate holders. Some failed to develop a quality loan portfolio and their equity was wiped off by default losses. Regulations were introduced with the passage of time but the damage was already caused.

Those Modarabas who really meant business were not provided with a level field as commercial banks were there to outwit them in the field of competition. Modarabas could not expand their business due to the paucity of funds. Unlike commercial banks, Modarabas were not allowed to accept public deposits. To expand, they had to borrow funds from the market at the going rate. This afforded them a stingy spread not enough to carry out a profitable business. Modarabas floated by commercial banks managed to survive as they developed a sort of synergy and somehow got cheaper funds to expand business. Afterwards, Modarabas were allowed to raise business funds by issuing certificates of investment (COIs), but here again only those succeeded who enjoyed the patronage of a commercial bank or a financial institution as the prospective purchasers of COIs looked to the patron institutions for their comfort level. Non availability of cheap business funds for Modarabas, in general, has been the root cause of their failure.

Now, when the Islamic Finance is back into vogue with a huge future potential, the Modarabas (and also the leasing companies) should get a new lease of life and provided by the regulators a level playing field to do business and develop. With a boom in the service sector and a hi-fi commercial banks' performance based on a huge spread, Modarabas' subdued performance is a big question mark on regulators' fair mindedness.