Regulatory framework for Modarabas

In order to better monitor and regulate the financial activities of the Modaraba sector, the Securities and Exchange Commission of Pakistan (SECP) has issued draft Modaraba Regulations 2019 aimed at introducing a new regulatory framework by imposing certain conditions for providing finance to their customers, limiting their capital market access and prescribing financial indicators of the borrowers. According to the SECP, a Modaraba shall provide finance to a customer which is equal to or exceeds five hundred thousand rupees after netting-off the liquid assets held as security, and give due weight to the credit report relating to the customer or its group obtained from a credit information bureau. If the report of the credit information bureau indicates overdues, the Modaraba shall maintain a file of such exceptions. Modaraba shall not provide finance to a customer who has defaulted or availed a write-off during the last 3 years. In case the customer is an individual, Modaraba shall obtain documentary evidence of the means of the customer such as wealth statement, statement of assets and liabilities or any other documents considered to be appropriate by the Modaraba. Maximum per party limit in respect of housing finance shall be Rs 20 million.

A lending Modaraba may with the approval of the Commission raise funds through issuance of Certificates of Musharakah (COM) after complying with certain specified requirements and the outstanding exposure by a Modaraba to a person shall not at any time exceed 20 percent of the equity of the Modaraba. A Modaraba's aggregate exposure in listed equity securities (in the ready market) and spread transactions shall not exceed 25 percent of its equity while investment of Modaraba fund in listed equity securities of any company shall not exceed 5 percent of the paid-up capital of the investee company or 10 percent of its own-equity, whichever is less. A Modaraba while taking an exposure shall not provide finance if total exposure availed by the customer from financial institutions exceeds 10 times of the equity of the customer as disclosed in the financial statements of the customers.

A closer look at the draft Modaraba Regulations 2019 would reveal that the proposed regulatory framework is meant primarily to safeguard Modarabas against financial risks arising out of their desire to earn more profits for their equity holders and subject them to certain controls which would be helpful in diversifying their portfolios. A clause has also been added to ensure that defaulters are least able to obtain finances from Modarabas. This has been done by inserting a condition that such borrowers would have to get a clean chit from the credit information bureaus about their status as a good quality borrower. Besides, the Modarabas will be obliged to maintain a file on exceptions and provide the same to the inspection team of the SECP. In order to ensure that the borrower is able to repay the loan, his financial position would be made fully transparent by asking him to provide his wealth statement and statement of assets and liabilities. Housing finance has been restricted to Rs 20 million because it is usually a long-term finance which could be difficult to recover in case of financial emergencies experienced by the Modaraba. The most detailed account in the draft Regulations has been reserved for per party or per group exposure which is clearly meant to ensure diversification of funds disbursed by the Modaraba. The conditions prescribed by the SECP are likely to ensure that a Modaraba does not become too dependent on a single party and credit could be utiliSed by a large number of borrowers. The Guidelines seem to be certainly in good faith and comprehensive and were probably needed in order to save the Modarabas from going under and facing the prospects of bankruptcy.

However, while the Guidelines are meant for improving the financial health of Modarabas, the SECP needs to give enough space and flexibility to Modarabas to innovate and decide about the exposure of their clients. We agree that their soundness is of paramount importance but they should also be enabled to carry out their investment decisions and deposit mobilisation in an environment that is not suffocating to stifle their initiative. We are certain that the Modarabas themselves would come up with certain suggestions which would allow them to work freely but in a way that their solvency and soundness is not threatened.