Specialised Financial Institutions: Pakistan
Besides commercial banks, the financial system of Pakistan consists of a number of specialised financial institutions. The Council has already submitted its recommendations in respect of elimination of interest from the operations of National Investment (Unit) Trust, Investment Corporation of Pakistan and House Building Finance Corporation. The Council’s recommendations relating to other specialised financial institutions are contained in this Section.
Pakistan Industrial Credit and Investment Corporation (PICIC)
The Pakistan Industrial Credit and Investment Corporation (PICIC) was established in October, 1957 to provide finance to the private industrial sector in the form of long- and medium-term loans in local or foreign currencies, equity participation, purchase of debentures or underwriting of public issue of shares and debentures. It guarantees and counter-guarantees loans and obligations, arranges participation of local and external finance from private and institutional investors, helps facilitate creation, issue or conversion of capital in any form and acts as a trustee in this regard.
PICIC is a public limited company, with a paid-up capital of Rs. 79.68 million. Of this, 65 per cent is currently held by private investors and financial institutions in Pakistan and 35 per cent by foreign investors. Foreign shareholders consist mostly of financial institutions belonging to various industrialised countries. The International Finance Corporation (IFC), a member of the World Bank Group, also holds 3.5 per cent of the total paid-up capital.
On the assets side, PICIC’s operations involving interest consist of: (a) debentures purchased; (b) loans in foreign currency as well as in local currency; and (c) deposits held with banks. On the liabilities side, interest is involved in: (a) debentures issued; (b) long-term Rupee borrowings; (c) line of credit in foreign currency; (d) borrowings from banks; and (e) borrowings from the State Bank of Pakistan.
The Council’s recommendations for elimination of interest from PICIC’s operations and its substitution by feasible arrangements consistent with the Shari'ah are given below. A noteworthy feature of PICIC which is distinct compared to other specialised financial insti- tutions is that a portion of its share capital is also held by foreign investors. It is, therefore, necessary that the foreign shareholders be taken in confidence and requested to give their assent to the new arrangements. In case they are not agreeable, they may be given the- option to disinvest their shares.
PICIC purchases and holds debentures of joint stock companies. After the cut-off date for the elimination of interest from the operations of PICIC, no new interest-bearing debentures may be purchased. Instead^, it may purchase the Participation Term Certificates (PTCs) which have been proposed as a substitute for debentures in this Report. The existing holdings of debentures may also be converted into PTCs or equity participation with mutual consent of the parties concerned. In cases where the parties are not agreeable to such a conversion, the debentures may continue on interest-bearing basis till maturity.
The PICIC provides loans both in local currency and foreign currencies for periods of 10 to 15 years for acquisition of fixed assets. No loans are provided for meeting working capital requirements. The interest rate margins over its own borrowing rates in respect of both foreign currency and local currency lines of credit are fixed by the Government. After the cut-off date for the elimination of interest, PICIC may switch-over completely to interest-free forms of financing discussed in Section I. It may make use of the methods of PLS, investment auctioning, leasing, hire-purchase or Bai Muajjal as considered advisable. Foreign currency loans obtained by PICIC on the basis of interest would be guaranteed by the Government of Pakistan both in respect of principal and interest liability and it is hoped that on account of this guarantee foreign lenders would not insist that relending transactions pertaining to foreign loans should continue to be on the basis of interest.
A large proportion of PICIC’s balances with banks consists of time deposits, while a small proportion is maintained in current accounts. After the elimination of interest from the deposits side of commercial banking, PICIC may hold its time deposits with banks on PLS basis.
Under its underwriting arrangements, PICIC provides bridge finance for periods between the establishment of companies and floatation of their shares for public subscription. Bridge financing, which carries interest, may be replaced by the system of “firm commitment” underwriting which is compatible with Shari‘ah.
P1CIC issues debentures to raise local currency resources for its Rupee loans. After the elimination of interest, PICIC may issue the proposed PTCs. The debentures already issued by PICIC may also be replaced by PTCs, to the extent possible, with the consent of the holders of such debentures, and the rest may be allowed to run their course.
PICIC has been securing long-term Rupee loans at concessional rates of interest from the Government of Pakistan. These loans are subordinated to the share capital of PICIC so as to broaden its equity base for borrowing purposes. After the elimination of interest, these loans may be converted into Government investment on PLS basis or replaced by PTCs to be issued by PICIC to the Government. In future, the Government may provide assistance to PICIC either under PLS arrangements or through purchase of its PTCs.
PICIC received a long-term loan of Rs. 30 million from the U.S. Government in 1967 through the Agency for International Development. The loan is repayable in twenty-one equal half-yearly instalments commencing from December, 1976. It carries interest at the rate of 5 x/i per cent of which 3A per cent is payable to the USAID and 4% per cent to the Government of Pakistan. The outstanding amount as on December 31, 1978 was Rs. 22.9 million. The Government of Pakistan may forego the interest payment due to it from PICIC on this loan and instead share in PICIC’s profit/loss related to the daily product of the amount of the loan. In the case of interest payment to USAID, the USAID may be approached to make the loan interest- free. If they do not agree, the existing arrangement may continue till the liability is fully discharged.
PICIC’s foreign currency borrowings consist of loans from the World Bank, Asian Development Bank and other agencies. Since it does not appear possible at present to obtain such assistance on a basis other than interest, the Corporation may continue to obtain it on the basis of interest until viable alternative conforming to Shari‘ah is available.
PICIC’s borrowings from State Bank consist of cash credit, on which interest is payable at the bank rate, and loans under the State Bank’s refinance scheme designed to promote local sale of Pakistani machinery on which interest is payable at 2 per cent below the rate charged to sub-borrowers by the Corporation. After the introduction of interest-free system, State Bank’s assistance to PICIC may be provided on PLS basis. The profit-sharing ratio in respect of finance provided by the State Bank to PICIC under its refinance scheme for locally manufactured machinery may be kept suitably lower.
PiCIC’s other operations involving commission, project examination fee, fee for undertaking feasibility studies and charges for technical and managerial advice may continue on the existing basis.
Industrial Development Bank of Pakistan (IDBP)
The Industrial Development Bank of Pakistan was established in August, 1961 to meet the long- and medium-term credit needs, in foreign as well as local currency, in the private industrial sector, particularly for the development of small- and medium-sized new industrial units. The Bank provides medium- and long-term loans for the acquisition of fixed assets and short-term loans for meeting the working capital requirements. It also provides guarantees for loans raised by industrial concerns from other sources and invests in equity and debentures of industrial companies.
The Bank has a paid-up capital of Rs. 50 million held entirely by the Federal Government. Apart from share capital and reserves, the Bank’s resources consist of deposits held by the public with it, borrowings from State Bank of Pakistan, loans from the Federal Government and foreign credits from institutions like Asian Development Bank, the World Bank, etc. The nature of IDBP’s functions and operations is similar to that of PICIC. For elimination of interest from its operations, therefore, the changes required would also be similar to those suggested in the case of PICIC. It, however, differs from PICIC in so far as it also provides finance for working capital and accepts deposits from the public. In these respects, therefore, the recommendations made by the Council in regard to commercial banks would also apply to IDBP. To offer competitive return to depositors, IDBP should be free to determine its own profit-sharing ratios.
National Development Finance Corporation (NDFC)
The National Development Finance Corporation was established in 1973 to provide financial and technical assistance for the establishment of new enterprises and for balancing, modernisation and expansion of existing enterprises in the public sector. The functions and activities of the Corporation include: (a) provision of medium- and long-term loans in foreign and local currencies; (b) provision of loans for working capital requirements; (c) equity participation; (d) purchase of debentures; (e) underwriting; (f) issue of guarantee for local and foreign currency loans; (g) participation in loan syndication both in local and foreign currencies; (h) financing sale of locally fabricated machinery; and (i) mobilisation of savings through various deposit schemes.
The share capital of the Corporation is Rs. 120 million which is held entirely by the Government of Pakistan. Apart from the share capital and reserves, the resources of the Corporation consist of deposits of fixed maturities held with it, assistance from State Bank of Pakistan and foreign credits.
On the assets side, NDFC’s operations involving interest pertain to loans advanced, debentures purchased and deposits held with commercial banks. On the liabilities side, interest is involved in its borrowings and deposits accepted by it. The functions and operations of NDFC are very similar to those of PICIC and, therefore, the changes required for elimination of interest from its operations would broadly be the same as those suggested in the case of PICIC. As regards deposits accepted by it, the required changes would be similar to those suggested in respect of deposits held by commercial banks. The specific recommendations of the Council for eliminating interest from NDFC’s operations are as follows:
- Cash credit from the State Bank, which is currently available at the bank rate, may be provided on PLS basis. The concessionary refinance under the State Bank’s scheme for locally manufactured machinery may also be on PLS basis but at a suitably lower ratio than that applicable to cash credit.
- The deposits accepted for medium- and long-term may continue to be subject to existing terms and conditions during the transitional period of, say, two years, as suggested in the case of commercial banks. Thereafter, fresh deposits may be accepted only on PLS basis and the Corporation may determine its own profit-sharing ratios. Deposits outstanding at the cut-off date may continue on interest basis but depositors may be given option for conversion of these deposits into PLS deposits.
- After the elimination of interest from the deposits side of commercial banks, NDFC’s fixed deposits with commercial banks would also be on PLS basis.
- All foreign currency borrowings by NDFC would continue to be subject to the terms and conditions agreed with the foreign suppliers of credit till such time as alternative arrangements permissible under the Shari‘ah are evolved. This means that interest would continue to be paid on foreign borrowings. However, in providing finance with the help of foreign currency loans, the Corporation may use PLS or other alternative methods, as suggested in the case of PICIC and IDBP.
Local currency loans provided by the Corporation include long- anu medium-term loans, loans for meeting working capital requirements and suppliers’ credit. In addition, it participates in syndicate loans in conjunction with other financial institutions. Under the new system, term loans would be substituted by PLS and other methods as suggested above, while finance for working capital including opening of L/Cs may be provided under PLS arrangements or Bai Muajjal.
Agricultural Development Bank of Pakistan (ADBP)
The Agricultural Development Bank of Pakistan was established in 1961 by merging the Agricultural Development Finance Corporation (ADFC) and the Agricultural Bank of Pakistan (ABP). The Bank provides credit to individuals as well as corporate bodies engaged in agriculture and for development of agriculture which, according to the Bank’s Charter, includes raising of crops, horticulture, fisheries, forestry, animal husbandry, poultry farming, dairy farming, bee-keeping and sericulture. Loans may also be granted for the cottage industries in rural areas. The Bank advances loans for short, medium and long terms. The short-term loans are given for financing the cost of seasonal inputs and thus cover items like seeds, fertilizers, labour charges, hire of bullock carts and small agricultural implements etc. Medium-term loans are given for periods exceeding 18 months but not exceeding five years. These are usually granted for purchase of agricultural implements, means of transport and light machinery, cattle and sheep breeding, dairy farming, poultry farming and reclamation of land. Long-term loans are given for periods exceeding five years and are meant for development purposes, like construction of ware-houses and cold storages, purchase of tractors and other heavy machinery, agro- industries, installation of tubewells and plantation of orchards etc.
The Bank’s financial resources consist of its capital and reserves, different types of deposits and borrowings from domestic as well as foreign sources. ADBP’s loaning operations pertain largely to loans in local currency and most of these are for long term. In 1978-79, for instance, 80 per cent of the loans disbursed were for long term, 11 per cent for short term and 9 per cent for medium term. The bulk of ADBP’s loans (74.4% of the total) was for financing purchase of tractors. The shares of other categories were: seasonal inputs, such as seeds, fertilizer etc., (10.5%); draught animals (4.4%); tubewells (2.6%); poultry, dairy and marine fisheries (0.5% each); and miscellaneous (7.6%).
During 1978-79, 98.7 per cent of ADBP’s total income and 68 per cent of its total expenditure was accounted for by interest receipts and payments. ADBP’s interest payments are on account of deposits accepted by it, borrowings from State Bank of Pakistan and loans from international institutions. After the elimination of interest, deposits accepted by the Bank should be subject to the same arrangements as those suggested for commercial banks and the Bank should be free to determine its own profit-sharing ratios. Loans received from the State Bank of Pakistan may be on PLS basis or even free of any charge if considered necessary. Borrowing from international agencies may continue to be interest-bearing until alternative arrangements compatible with Shari‘ah become feasible. For its financing operations, the ADBP may adopt the same methods as suggested in the case of agricultural financing by commercial banks.
Small Business Finance Corporation (SBFC)
The Small Business Finance Corporation, previously known as the People’s Finance Corporation (PFC), was established in 1972 to provide financial assistance to persons of small means. The Corporation provides finance on interest basis to all types of small business owned or sponsored by individuals or firms. These include shopkeepers and traders; owners of small scale and cottage industries; artisans; taxi/ rickshaw/bus/truck owners; owners of power-driven fishing boats; professionals, such as physicians, surgeons, engineers, architects, chartered accountants, advocates etc., interested in setting up their business; small exporters and importers; and new entrants in business. The Corporation is authorised by law to provide loans up to a maximum limit of Rs. 50,000 to individuals and firms and up to Rs. 150,000 to cottage and small scale industries. To be eligible for borrowing from the Corporation, the net assets of such individuals and firms should not exceed Rs. 50,000. Cottage and small scale industries eligible for borrowing from the Corporation are defined as those the value of fixed assets of which, excluding the cost of land but including the amount of any loan advanced by the Corporation, does not exceed Rs. 300,000. The Corporation also provides loans for purchase of cycles and motor cycles.
The paid-up capital of the Corporation is Rs. 70 million, which is held as follows: Federal Government: Rs. 30 million; State Bank of Pakistan: Rs. 9.60 million; and nationalised commercial banks: Rs. 30.40 million.
Although the bulk of financing by SBFC is for productive purposes, financing of a few consumer durables such as motor cycles and cycles may technically be categorised as consumption loans even though loans for purchase of cycles or motor cycles help in increasing production by increasing mobility and efficiency of workers.
It is suggested that the Corporation may provide finance for purchase of trucks, wagons, taxis etc. on the basis of hire-purchase of Bai Muajjal while cycle advances may be provided free of cost. Financing of small industries, small business and for professions may be on the basis of “normal rate of return”.
Other transactions of the Corporation involving interest include its deposits with banks and borrowings from the Government and commercial banks. After the elimination of interest, the Corporation’s deposits maintained with banks would be treated in the same manner as other private sector deposits. Borrowings by the Corporation from the Government may be either free of cost or on PLS basis while those from commercial banks should be on PLS basis.
Equity Participation Fund
The Equity Participation Fund was created in 1970 by a special legislation to foster and accelerate the growth of small- and medium-sized industrial enterprises in the private sector in the less developed areas of the country. The Fund, which is administered by the Industrial Development Bank of Pakistan, is empowered to provide equity support in the form of direct pruchase of shares and underwriting of public issues of shares and offers bridge finance facilities for projects set up in less developed areas. The resources of the Fund consist of paid-up capital of Rs. 50 million of which Rs. 20 million is held by the Federal Government and Rs. 10 million each by the State Bank of Pakistan, Provincial Governments and institutional investors.
Except for bridge finance, interest is not involved on the assets side of the Fund. The Council, therefore, recommends that after the cut-off date, the Fund may adopt the system of “firm commitment” underwriting, as suggested in the case of commercial banks so as to avoid the bridge financing on interest-bearing basis. In case any interest element is involved on its liabilities side, it may be eliminated on similar lines as those suggested in respect of IDBP. The deposits held by the Fund with banks may continue to be interest-bearing until interest is eliminated from the deposits side of commercial banks, after which such deposits would be on PLS basis.
Federal Bank for Co-operatives (FBC) and Other Co-operative Credit Institutions
The co-operative credit structure in the country consists ol three tiers. At the apex is the Federal Bank for Co-operatives which provides credit to the Provincial Co-operative Banks which form the middle tier of the system. The third tier consists of the primary cooperative credit societies.
The Federal Bank for Co-operatives was established in December, 1976 to improve the flow of credit to agriculture through the co-operatives and to assist the Federal and Provincial Governments in the development and revitalisation of the co-operative movement. It has a paid-up capital of Rs. 200 million of which the State Bank of Pakistan has subscribed Rs. 150 million, while the Federal Government and the four provincial governments together have subscribed Rs. 20 million and Rs. 30 million respectively. The Bank is the principal financial institution for meeting the credit needs of Provincial Cooperative Banks and multi-unit co-operative societies. It is authorised to: (i) accept money on deposit; (ii) borrow funds from the Federal Government, specified financial institutions and such other financial institutions in or out-side Pakistan as are approved by the Government; (iii) raise funds through issue and sale of bonds and debentures; (iv) make secured loans and advances to Provincial Co-operative Banks and multi-unit co-operative societies; and (v) invest its funds in Government securities and other approved securities and in the share capital of a Provincial Co-operative Bank and a multi-unit co-operative society up to specified limits.
There is one Provincial Co-operative Bank in each of the provinces with branches in different areas. It is the main agency for providing credit to primary co-operative credit societies. Agricultural co-operative credit societies represent the bulk of all types of co-operative societies. In 1977-78 the total number of agricultural cooperative credit societies in the country was 16,609 with a membership of 0.81 million.
The main source of funds for the co-operative credit institutions is the State Bank of Pakistan which provides loans to the Federal Bank for Co-operatives at a rate of interest which is 3 per cent below the bank rate. The Federal Bank for Co-operatives, in turn, provides loans to Provincial Co-operative Banks at 2 per cent below the bank rate while the latter provide loans to primary co-operative credit societies at 1 per cent below the bank rate. The ultimate borrowers receive loans from the primary co-operative credit societies at rates of interest which are 2—3 per cent above the bank rate.
The Council recommends that in general the financing operations of the co-operatives may be re-organised on the same lines as proposed in regard to the agricultural financing operations of the commercial banks viz., wherever PLS on actual basis is feasible, this method may be adopted while in other cases, normal rate of return, hire-purchase of Bai Muajjal may be made use of. In the case of farmers cultivating holdings up to subsistence level, the co-operatives may also provide interest-free loans for input financing. To the extent of these loans they may receive interest-free financial assistance from the provincial co-operative banks and this chain of interest-free loaning should extend back to State-.Bank’s financial assistance to the Federal Bank for Co-operatives. However, in the case of financing carrying return under the various methods suggested, the provision of finance at all the consecutive stages may be on PLS basis with profit-sharing ratios rising at each lower tier. For instance, the State Bank may provide funds to the Federal Bank for Co-operatives with a profit-sharing ratio of 10:90, F.B.C. may provide to Provincial Co-operative Banks with a profit-sharing ratio of 20:80, while the Provincial Co-operative Banks may provide their assistance to co-operative credit societies with a profit-sharing ratio of 30:70.
Deposits of the co-operative banks and co-operative credit societies may be governed by the same stipulations as suggested in the casQ of deposits held by commercial banks.
The Council considers it necessary to stress that in view of the prevalent situation in the co-operative sector there is a great danger of misuse of the new system of financing in the form of undue pre-emption of funds by influential persons, concealment of profit, showing of fictitious losses and delays and defaults in repayments. It would, therefore, be necessary to bring about an improvement in the quality of management of the societies, tighten their supervision by the Provincial Co-operative Banks, expand the system of supervised financing and provide for deterrent penalties and punishments against malpractices of the kinds mentioned above.
Insurance business consists of Life Insurance and General Insurance. While the former pertains to life insurance of individuals, including group-term insurance, the latter covers fire, marine and some other types of insurance. Essentially, insurance is a means for covering risks collectively through creation of a common fund with the help of the premium paid by each member. The funds built up by insurance companies are presently invested mainly in interest-bearing securities and the benefit of these earn. This is the classical “Without Profits” business.
A good deal of insurance business is written on the assumption of a certain expected rate of return from premia received. The insurance company takes the profit if the rate of return on investment exceeds the premium assumption and assumes the loss if the rate falls below the premium assumption. This is the classical “Without Profits” business.
For many classes of business, the only practical way is to proceed on a “without-profits” basis. For example, temporary or “Term” insurances, where the policy covers a relatively short period, do not develop any substantial reserves, and it would be extremely expensive administratively to share out the meagre investment returns to the customers. Here the only practical way is either to assume no investment return and the insurance company keeps as a profit whatever little is earned or to assume some rate of investment return and make a corresponding reduction in the premium.
There is another category of business where substantial reserves are developed and where it is perfectly feasible to share out the investment income as and when earned to the policy-holders in one way or the other. This is the so-called “With Profits” business where the dividends or bonuses to policy-holders fluctuate upward or downward depending on the performance of the fund. However, even in “With- Profits” business it is not customary to assume a zero rate of return on investment. Instead usually a low rate of return is assumed and a specific bonus loading added to the premium. This is the procedure generally followed by insurance companies in Pakistan.
The Council is of the view that the existing system of insurance involves not only the element of interest but also tnat of gambling. It is necessary, therefore, that the insurance business should be organised on co-operative basis and its benefits should be confined to those people who are prepared to offer financial sacrifice for the sake of common good. Towards this end, the following measures are recommended:
- Insurance, both life and general, should be organised on cooperative lines. Every person desiring to take insurance should pay to the company its specified premium. The income from these premia should be invested in profitable business and a portion of the annual profit so earned should be reserved for the distribution among the members. Distribution of profits may either be apportioned annually or adjusted toward payment of premium during the next year or allowed to accumulate and paid in lump sum at the time of maturity of the policy. Undistributed profits may be applied to building a reserve fund which may be utilised for payment of claims.
At the time of maturity of the life insurance policy the insured will be entitled to receive the principal along with the profit to his credit if any. However, if a person stops paying instalment before the maturity he will not be deprived of the principal amount paid by him although a condition may be imposed that payment will be made on a specified future date. For example, if a person had agreed to pay instalments for 15 years but stopped paying after one year, a condition can be imposed that'he cannot withdraw the amount paid by him, say, before five years. However, if he has paid instalments for a fairly long period he may be paid the principal as also some part of the profit that may be due to him.
This procedure can be adopted in all those situations in which insurance is spread over a long period, such as life insurance, or those instances where one and the same insured keeps on renewing the contract as for example the third party insurance of vehicles or insurance of buildings, machines and ships. Some contracts of insurance are of an extremely short duration, related to a temporary phenomenon such as air travel or goods on high seas etc. For these types of insurance the Government may establish a separate trust whose function should be to invest the premia payment made by policy-holders and create a reserve fund. The money so invested and profit accruing therefrom would be the property of the trust. These should be used to meet the obligations on account of claims. Any other policy holder should neither be paid the principal nor profit from this fund, but the instalments paid should be treated as a subscription in favour of the trust.
Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan. Republished with permission.