Financial Institutions are becoming crucial in today’s competitive and uncertain economic environment as it pump the idle funds in various productive channels of the economy. Therefore, it is important for every country to have efficient financial institutions for continuous growth. Financial institutions can improve their efficiency with the production of high outputs or by reducing their input costs. There are various types of efficiency concepts, which explain a range of dimensions such as; technical efficiency determines the ability of financial institutions to maximize their outputs with the utilization of lower inputs. Profit efficiency examines that how profitable a firm to its rivals whereas, the cost efficiency determines, how close a firm’s cost to a best performer’s cost. Leasing and Modaraba companies as the part of financial institutions are also contributing in the economic development of Pakistan as like the other financial institutions. On one hand, Leasing companies by providing the heavy machinery on lease facilitate the small businesses to save their funds since small businesses mostly have constraints on their financial resources. Moreover, small businesses also enjoy various financial benefits associated with the lease finance such as they charge periodic payments on the use of a specific fixed asset, which are allowed to subtract from the taxable profits of the business firm.
In a developing country like Pakistan, it is highly essential to have an efficient leasing sector to support the businesses in the country. On other hand, modarabas provide various Islamic products but within the limits of Sharia law such as; Musharika, Modaraba, Murabaha and leasing activities etc. In Pakistan, leasing and modaraba firms are providing medium to long term financing facilities and contributing a lot towards the development of the financial sector in Pakistan.
If we compare the efficiency trend of the leasing companies than it reveals the fact that the technical efficiency and cost efficiency of the leasing companies have lower variation (2005-2010) while technical efficiency is slightly raised which suggests that the leasing industry have improved its operation which raised their operational efficiency. The profit efficiency suddenly falls in the year 2009 indicating that the financial crisis has negatively affected the profitability of the leasing firms in Pakistan. In comparison the efficiency trend of modarabas suggest that profit efficiency of the modaraba companies has decreased from 2006 to 2008 and after that they have improved their profit efficiency with the raise in their profitability. The technical efficiency and cost efficiency are gradually improved over the period of 2005 to 2010. It indicates that the modaraba companies have raised their efficiency level. The financial crisis has not affected their efficiency since Modarabas has lower participation in the financial sector of Pakistan.
Instead of all efficiency mudarba companies (MCos) confront many challenges including:
- MCos., have found the stock market inevitable for their existence. There has been no example of Modaraba Company, big or small, which may have started operations without being listed. It is unique characteristic of (MCos) to open to stock market competition without any prior experience of business.
- MCos., are almost 100% equity financed. Due to non-availability of appropriate financial instruments, these are incapacitate of mobilizing Modarabas other than the MCs and initial contribution to the paid-up capital by the sponsors.
- Due to the second feature, MCos., have to overwhelming rely on distributing stock bonuses for saving cash.
- Similarly, due to the second feature, for mobilizing Modarabas, MCos., overwhelmingly rely on rights issues.
- Again, due to the second feature, for mobilizing Modarabas, MCos., overwhelmingly rely on rights issues.
- MCos., have to build a cash reserve with the State Bank of Pakistan equivalent to their paid-up capital. This reserve is built by a 20% contribution out of annual profits till the reserve is fully built. Thereafter, they have to contribute 5% of annual profits for the preservation of this Modaraba. According to new regulations, they can issue bonus shares only against this reserve. This regulations is considered to constrain the cash flow as well as dividend distribution by MCos.
- Investors are understood to consider MCos., as a form of nonconventional business. The collapse of finance companies, and cooperatives which were somehow not similar to conventional financial institutions, has created a confidence problem for MCos., too.
- Initially, MCos., were tax exempt provided they paid 90% of profits in dividends; 10% is paid to the management company as mudharib’s share prescribed in the law. This tax benefit prompted many established companies to float MCos. The more novice MCos., are in fact competing with these matured institutions.
- Modaraba firms are intensive in physical capital. MCs are issued against these physical assets. The value of the MCs basically depends on the value of these assets. The assets depreciate overtime. Asset replacement by means of profit retention or borrowing is not common. Naturally, therefore, the price of MCs must depreciate in proportion to depreciation of the assets.
- MCos., have no R&D investments. These investments, e.g., in the chemical and pharmaceutical firms enable them to acquire value and capital gains overtime.
MCos., are unique in the sense that these companies can neither device their financial policy independently nor their dividend policy. Their financing policy is constrained by non-availability of diversified financial instruments for resource mobilization. They are virtually dependent on one instrument: the MC. Reliance on one type of financial instrument could have been fair, provided it was the same for all market participant. All the non-Modaraba sector has the choice to utilize the over 30 instruments available. Obviously, therefore, this constrain is reflected through the market on the depreciating prices of the MCs. Similar is the case with the dividend policy. Compared to other companies, MCos., are not free in deciding between how much to retain and how much to pay in dividends. In fact, the concept of retention of profits in the Modaraba business has not yet been thoroughly discussed. Working together, these two factors impose a severe constrain on the policy of growth ‘financing by the MCos., as compared to other companies. As a matter of fact, it seems that MCos., have no growth financing policies. For ongoing firms growth financing is an important source of continuity and dynamism. But attracting investment in mudarba require special feature and benefits
It is therefore recommended that benefits must be highlighted to catch the investment in mudarbas like,
- Halal Business: Modaraba is the business model in the financial sector which is based on true Islamic practices duly scrutinized and approved by the members of the Religious Board appointed by the Federal Government. It provides profitable investment opportunities to the stakeholders who are looking for Halal profits on their investments according to Islamic Shariah.
- Diversified Business: The diversity of the Modaraba concept provides a unique universe of business opportunities to the sector, including financing, trading, manufacturing, equipment-rental, and participation in property development, project management, portfolio management, imports and exports and distribution business. Such a diverse canvas of activities is not available to any other entity in the Islamic financial regime.
- Tax Benefit: The income earned by the Modarabas, other than the trading modarabas, is fully exempted from income tax provided they distribute 90% of their profits amongst the certificate holders. For trading modarabas, the maximum tax rate is 25 percent.
- Maximum Distribution of Profits: As an investor of a Modaraba one may expect getting maximum dividends as 90% of the income/profits of the Modaraba are distributed to the certificate holders in order to avail the benefit of tax exemption.
- Funding and Financial Facilities under Shariah Compliant: Funding and financial facilities under the Shariah compliant modes are provided by Modarabas, on the pattern similar to Islamic banks to the clients.