LEASE FINANCING-BOON TO FINANCIAL SECTOR

Overview of the Leasing Industry

•Historically, leasing dates back to thousands of years – where the industry has developed from being a manufacturer’s selling technique to a stand-alone specialized financial service industry.

•First leasing firms started in the US in 50’s; then in Europe and Japan in the 60’s; and since the 70’s, leasing has been spreading to many developing nations

•In 2001, over US6 billion of new vehicles, plant, machinery and equipment were financed through leasing.

•Africa region accounted for US.8 bn less than 1% of total volume

•The top four countries in leasing volume are U.S., Japan, Germany, and the U.K.

•South Africa remains the largest leasing market in the Africa region with a volume of US.79 bn.

•Substantial scope for future growth – globally, annual leasing volumes as a percentage of GDP average about 1.5% (U.S. 2.3%).

 Leasing Industry in the Developing Countries:

 Since the late 70’s, many developing nations have been developing their leasing industries. The most spectacular increases being in Asia, led by Korea.In 1994, South Korea’s leasing market was 5th largest in the World – an industry which was started in 1975 with IFC’s investment in Korea’s first leasing firm. Growth of leasing in Africa, Asia and S. America exploded in the early 90’s but stagnated over the last 5 years.

Why has Leasing Grown so Fast.

.Financial Leasing

A contractual arrangement that allows one party (the lessee) to use an asset owned by the leasing company (the lessor) in exchange for specific periodic payments.  This requires:

Separation of legal ownership from economic use. Credit analysis focuses on lessor’s cash generation capacity to finance lease payments rather than relying on credit history.

Security is the asset itself. As such, this product is particularly suitable for new Micro, Small or Medium Sized Enterprises.Leasing has filled the gap for financing the un-met demand for a key sector in any Economy.

For Lessee:

•Fewer requirements about balance sheets.

•Leasing may be the only source of financing

•No outside security/collateral needed

•Low documentation cost

•Leasing can finance a higher % of equipment than bank loans

•Governments allow lessees to deduct full lease payments from their income before tax.

For Lessor:

•Ownership of asset

•Transaction costs lower

•Lighter regulations, because they are not deposit taking institutions.

•Tax incentives, although they are eroding.

•Better control on utilization of funds.

 Importance of Leasing for Medium and small scale industries

•Leasing may be the only source of financing as access to capital markets or bank loans is difficult given the small size of these companies and/or their unproven track record.

•Government support of leasing industry is thus an indirect support of Medium and small scale industries.  Also, increases competition in financial services.

 IFC’s Experience in  the Leasing Sector

•IFC has 25 years experience with 179 leasing projects in 56 countries

•From 1977-2002, IFC approved 1.02 billion financing for leasing companies

•Key success factors for IFC’s leasing companies/transactions have been: strong sponsors, access to competitive local currency financing, stable and good legal and regulatory frameworks, and last but not least, good structuring of the financial transactions on IFC’s part.

•Most of IFC’s leasing projects have had strong positive impacts on private sector development particularly in the MSME sector, where they have pioneered financing for a previously under-served market segment.  In most cases, IFC invested in the first leasing firms in a country.

 

IFC’s Roles in Promoting Leasing Companies

•Impact on Broadening the Financial Sector Development:  Leasing companies have helped develop capital markets by increasing financing options for segments of the market which previously relied on informal financing, supplier credit, and internal cash generation – Filled the gap left by banks

•Impact on Capital Markets:  As leasing firms grow, their needs for diversified funding sources becomes eminent – leading to the use of securitization, issuances of bonds and other capital instruments.

•Increased Competition:  The entry of leasing firms in financing the MSME has encouraged competition in many markets, whereby some of the banks started to go down-market in order to serve the smaller clients.

 Challenges Facing the Leasing Industry

•Funding – Leasing companies are not deposit-taking institutions and access to long-term funding is a critical success factor

•Eroding tax benefits – the tax benefits of leasing are gradually eroding, opening the industry to strong competition from the banking sector.

•Regulatory environment changes – While the leasing industry typically has less stringent regulation, changes in law impact operations substantially.

•Lack of deep pocketed shareholders in the absence of capital markets.

•Too much concentration in a sector

•Lack of a robust secondary market for certain equipments.

•Risk management not managed.

•EnablingEnvironment:

Legal and Regulatory Aspects

•Strengthening Leasing Laws

–Lessor’s ownership over the assets funded must be clearly stipulated with simple, effective and timely procedures for repossession if lessee defaults

–Lessee and possession rights – to ensure uninterrupted use for the length of the lease

–Central Registry of charges

•Supervision and Regulation

–Restrict leasing to Licensed operators

–Prudential Requirements – less strict than for deposit-taking institutions

Enabling Environment
Tax and Accounting

•Lessor – Lessors can typically take the benefit of depreciation expense as a shield against taxes.  This advantage has been eroding in the recent past.

•Lessee – Lessees can offset their full lease payments against income before tax

•Sales Tax – Post contract sale of assets is typically exempt from sales tax

•Accounting – Accounting for Leases is done
 under IAS 17 internationally

•Cross Border Issues

 

Trends in Leasing Industry

•Customers:

–Smarter

–Diverse

–Seek more Alternatives

–Service Conscience

–Understand Asset Management

–Trending to Technology

•Products:

–Assume/Manage more Risk

–Solution Packages

–Leases with Other Financing Packages

–Venture Leasing

•Leasing Companies:

–Specialization

–Diversification

–Consolidation

–Globalization

–Branding, Relationship, Image Building

•Rules and Regulations

–Distinction Between Lease and Loans

–Expanded Public Official Understanding

–Global Harmonization of Accounting

 Conclusion:

Leasing is an important source of funding for Medium and small scale industries, which are key drivers of economic development in developing countries. There is substantial scope for future growth in the industry, particularly in developing countries.However, the industry faces financial and regulatory challenges which must be addressed to promote its growth.IFC’s experience has shown that leasing is instrumental in assisting thedevelopment of the financial sector and of the economy as a whole.