Pakistan: Investing in Modaraba Companies

Most probably Pakistan is the first among the Muslim countries that converted the concept of Modaraba agreement into an entity. The first ever specific purpose Modaraba was created in mid eighties, as an attempt to Islamize financial system in Pakistan. The number proliferated to around 52 but has now reduced to less than half.

Over the years Modarabas have emerged as major non-banking financial institutions (NBFIs) well as dependable source of medium term financing. They also offer opportunity to investors to earn Riba-free income. With the opening up of Islamic banks and designated Islamic banking branches by conventional banks in Pakistan, operations of Modaraba companies have remained subdued because these have not been able to mobilize low cost funds.

Some of the sponsors made attempt to go beyond leasing (Ijarah) by entering into asset rental, equities trading and establishing manufacturing facilities etc. However, it is often felt that the real potential of the sector has not been exploited as yet. May be the time has come to review the business model and strategies of the players but above all soliciting low cost funds.

The concept of Modaraba entity is almost replica of closed-end mutual fund. The Modaraba Management Company (MMC) is equivalent to an Asset Management Company (AMC). The MMCs, like AMCs were expected to float different types of Modarabas but most remained confined to the first one and if a few had floated more than one, these were merged subsequently.

According to the details compiled based on financial results (year ending June 30, 2012) the major highlights are: 1) though, there are 24 listed Modarabas bulk of the sector aggregate equity is contributed by half a dozen companies, 2) largest quantum of profit earned also pertains to these companies and 3) bulk of investment is in lease finance pertaining to two Modarabas.

Three observations demand specific mention: 1) bulk of the total equity is invested in lease finance; 2) operating expenses eat up substantial portion of revenue and 3) borrowing is very high, which also results in higher financial charges.

The way forward could be: 1) preferably arrangement of credit lines from outside Pakistan to bring down financial cost, 2) inviting foreign investors to become stakeholders in MMCs, 3) secondary offer of Modaraba Certificates and 4) reduction in number of MMCs (through mergers and acquisitions) to bring down operating expenses.

Pakistan having a population of 200 million people looks forwards to boosting GDP size as well as growth rate. The country needs fresh capital for the creation of new infrastructure and productive facilities. The prevailing situation offers an opportunity worth exploring to foreign investors, who are keen in earning Riba-free income.