In Pakistan leasing started, as an organised sector, in the mid-eighties with the establishment of the first leasing company in 1984. Over the period the number of leasing companies in the Country rose to 41 until it was hit by liquidity crisis in 2008 - 2009. Non-availability of long-term funds and withdrawal of credit lines by the banks after the financial crisis of 2008-2009 resulted in closure / merger of a number of leasing companies. Over a decade, only one new leasing company has acquired the leasing license. At present, number of active leasing companies stand at 10.
Total assets of the leasing companies as at June 30, 2015 stood close to Rs 40 billion.
Leasing - Profile:
The fundamental advantage of leasing is that it is asset based financing as opposed to collateral based approach of commercial banks. The basic premise is that a business earns its profit from use of an asset not from its ownership. If the cash flow generated by a machine or equipment is sufficient to cover the lease payments, the asset is leasable. This reliance on the asset itself as security rather than additional collateral is a major advantage of leasing over the traditional bank loan. Hence, financing for acquisition of all types of assets, manufacturing equipment, construction equipment, machinery and vehicles etc is available at affordable rates for businesses and entrepreneurs who could not otherwise have procured them.
The core business of most of the leasing companies in Pakistan is finance lease.
The products offered by leasing companies include:
-- Corporate Lease for machinery and equipment
-- Individual Auto Lease for passenger cars
-- Operating Lease
-- Commercial Vehicle Lease
-- Consumer finance
-- Micro finance
-- Factoring and Working Capital Finance
-- Certificate of Deposits (for mobilisation of funds)
Small and Medium Enterprises:
It has been established that Small and Medium Enterprises (SMEs) form the core of any economy and keep the wheels moving even in recessions and economic downturns. In many countries around 90% of all business enterprises are SMEs so if the sector grows, the impact on the economy is significant.
Direct contribution of SMEs to GDP of Pakistan is over 30% with over 3 million business units, SMEs employ over 70% of total workforce and constitute nearly 90% of all enterprises in Pakistan.
There have been several initiatives to bring about changes to provide access to finance to SMEs including SME policy, establishment of SMEDA, SME support fund. However, the available data on SME financing only shows that over the years SME financing has gone down instead of increasing. The overall credit to SMEs of banks came down from Rs 433 billion in December 2007 to Rs 288 billion in December 2014. The number of outstanding SME borrowers declined from 185 thousand in December 2007 (215 thousand in December 2008) to 134.5 thousand in December 2014. SMEs sector's infection ratio has shown upward trend rising from 20.5% in December 2007 to 30.2% as at December 31, 2014 making the sector highly risky for banks.
The importance of Leasing for SMEs:
There is a natural affiliation between leasing and SMEs. Small businesses do not have collateral to offer to banks and financial institutions and these generally remain excluded from availing credit. Like many developing economies, they then become victims of the informal lenders in Pakistan, who charge usury rates. Leasing, being asset based and not collateral based, opens the doors for SMEs, and thus this segment of business, is usually the core customer base of medium and small ticket leasing companies.
The NBFI sector particularly, leasing company, consider SMEs reliable borrowers and consider them credit worthy despite the fact that they do not offer any collateral. Financing to SMEs require totally different approach and leasing transactions are based on cash flow approach ie Pay as you earn. The largest leasing company of Pakistan which primarily deals in SMEs has a very low default ratio and considers the perception of high default ratio in leasing sector as misrepresentative. The focus on SMEs with relatively small exposures actually helps the leasing company in diversifying risks on large number of small customers.
Leasing is an alternate source of financing for SMEs which in the absence of authenticated documentation rely on alternate sources like market based credits, individuals, friends and associates who offer credit at very high rates. Leasing on the other hand offer asset based financing at competitive rates and convenient terms and conditions. The lease finance is based on understanding the requirement of customer and providing solutions based on ground realities. For medium sized customers, where tax benefits may be a consideration as rentals paid to leasing companies are deductible expense and helps in efficient tax planning. In contrast, small enterprises, operating with limited capital, avail lease finance due to price considerations, structured rental payments over the usage of assets - long and medium term and absence of requirement to provide collateral or guarantees. For Micro customers, small loans offered by leasing companies, create employment opportunities and help in poverty alleviation.
Key challenges:
One of the major and oft-repeated complaints of leasing companies is limited funding resources and availability of longer term funds at competitive rates.
The leasing companies also experience tough competition from commercial banks because of the latter's access to cheaper funds and larger risk-carrying ability given their relative size advantage over leasing companies. This is one reason for the consolidation in leasing industry and the disappearance of smaller players from the industry.
Imposition of minimum and Alternate Corporate Tax (ACT) on the leasing companies has taken away the tax advantage which was available to leasing companies due to accelerated tax depreciation. Banks, Insurance companies and modarabas have been exempted from ACT whereas leasing is not.
The leasing companies continue to be the owner of equipment, machinery etc till the final payment of rentals as per agreed terms of the agreement. However, in case of default or non payment of rentals, repossession of equipment and machinery is a cumbersome and time consuming exercise. Court cases and execution of decrees take a long time and by the time repossession is allowed assets loses its value.
Regulatory environment:
The SECP has recently introduced amendments in regulatory framework. According to new regulations, NBFCs have been segregated between deposit-taking and non-deposit taking entities. Minimum capital requirement for non-deposit taking entity has been reduced drastically in order to encourage such companies. This is likely to facilitate new companies to enter into leasing business and encourage informal players to register as leasing companies.
The regulations have also linked deposit taking with credit rating and equity of the leasing company. This will boost confidence of retail depositors.
Introduction of capital adequacy ratio by SECP in line with SBP requirement for commercial banks will provide confidence to stakeholders, depositors and creditors.
Taxation Laws:
The Leasing companies world-wide prosper based on efficient tax management. New taxation laws in Pakistan have taken away most of the provisions that helped the growth of leasing companies.
1. Initial depreciation allowance on leased machinery was reduced from 50% to 25% vide Finance Act 2013.
2. Cost restriction of Rs 2.5 million for allowable depreciation on vehicles has not been enhanced since 2012 despite increase in cost of vehicles
3. Minimum tax on leasing income was levied and enhanced to 1% in Finance Act 2013
4. The Finance Act 2014 introduced the concept of Alternate Corporate Tax. The banks, modarabas and insurance companies have been exempted from ACT whereas leasing companies have not been considered for exemption.
In the larger national interest leasing companies should be provided the incentives and legal framework necessary for the growth of the leasing industry which in turn would accelerate the growth of SME sector and economy. Further, funding available with SBP for development of SME sector should be deployed through leasing companies as they have the expertise to meet the financing requirements of SMEs.