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How Leasing Contributes to Economic and Financial Sector
Development
IFC’s Experiences
Mamta ShahChief Financial OfficerCredit Review Department
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Agenda
• Leasing defined
• Overview of the leasing industry worldwide
• Why has leasing grown so fast
• Impact of leasing
– Economic development
• Micro, Small and Medium Sized Enterprises (MSMEs)
– Financial sector development
– IFC’s experience
• Role of the Regulator / Enabling environment
• Trends in Leasing Industry
• Conclusions
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Leasing defined
Two kinds of leases:– Operating lease or hire-purchase– Financial lease
We will discuss only financial leasing. The difference between the two being that operating lease is not a means of financing equipment purchase – only short-term use of equipment: e.g., car rentals. Maintenance and obsolences risk lie with the leasing company as against the lessee in financial leasing.
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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(MSMEs) without a long credit history offinancial statements.
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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 US$476 billion of new vehicles, plant, machinery and equipment were financedthrough leasing.
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Overview (Cont’d)
• Africa region accounted for US$3.8 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$2.79 bn
• Substantial scope for future growth – globally, annual leasing volumes as a percentage of GDP average about 1.5% (U.S. 2.3%).
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Leasing Industryin 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.
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Why has Leasing Grown so Fast
• Leasing has filled the gap for financing the un-met demand for a key sector in any Economy – MSME
• MSME are mostly shunned out from the formal banking sector due to high transactions costs, and as well as other considerations.
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Why has Leasing Grown so Fast
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.
Beneficial to both lessee and lessor:
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Why has Leasing Grown so Fast
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.
Beneficial to both lessee and lessor:
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Why has Leasing Grown so Fast
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.
Beneficial to both lessee and lessor:
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Economic Contribution of MSMEsin Select African Countries
Country
MSMEs % SME as %
of Total Enterprise
formal employment
Algeria 99 60
Egypt 99 55
Mali 99 45-55
Morocco 93 50-55
Mozambique 90 45-55
Nigeria 96 50-55Source: World Bank Group SME Department
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Importance of Leasingfor MSMEs
• 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 MSMEs. Also, increases competition in financial services.
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IFC’s Experiencein 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.
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IFC’s Roles in Promoting Leasing Companies
• Leasing regulatory framework
• Fiscal regime
• Legal issues
• Draft legislation
TechnicalAssistance
FeasibilityStudy
• Size of potential market
• Obstacles to growth
• Local funding
IdentifySponsors
• Local – with funding or distribution capability
• Foreign technical partner
BusinessPlan
• Structure company
• Organization and management
OperatingPoliciesAnd
Agreements
• Prudential guidelines
• Shareholders’ agreements
• Articles of association
Funding
• Local term funds
• Foreign funds
GovernanceAnd
Follow-upFinancial
• Board• Later loans• Rights issues• Bond
guarantees• Securitization
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IFC’s Experience in Leasing (Cont’d)
• 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.
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Challenges Facingthe 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.
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Enabling Environment: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 thanfor deposit-taking institutions
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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
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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
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Conclusions
• Leasing is an important source of funding for MSMEs, 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.