State Bank's scheme for local machinery


Apr 26 - May 09, 2004





The State Bank of Pakistan (SBP) has invited feedback from the stakeholders on its revised scheme for financing Locally Manufactured Machinery (LMM). The revision has been necessitated to make it more responsive to present requirements of small and medium enterprises (SMEs) and to broadening its scope for the financing of machinery manufacturers. The LMM Scheme was originally introduced in 1972 and since then SBP has been providing refinance to the designated banks and DFIs for financing of industrial sector. The scheme operates in two parts viz. Part-A (Local Sales) and Part-B (Export Sales). The present revision covers Part- A of the scheme only.

Three main feature of the new scheme are: its focus on the financing of SMEs; financing of the manufacturers of machinery; and selection of leasing companies as financiers along with DFIs and banks. In the changed economic scenario, only revolutionary measures from the original scheme can make it attractive for the industry as well as the financiers. This article highlights main feature of the nineteen-page draft policy document and offers suggestions to SBP and other stakeholders with a view to improve the scheme for the SMEs.

The banks, DFIs and leasing companies selected by SBP as eligible for participation shall be known as the Participating Financial Institutions (PFIs). On overall basis, the scheme appears more conservative and SBP would be monitoring PFIs more closely. The scheme offers opportunities for SMEs and the machinery manufacturers. It is expected that the prospective PFIs and stakeholders would carefully review the parameters/requirements of the scheme and provide feedback to SBP on timely basis.

For determining eligibility of banks and DFIs, SBP will largely watch compliance of capital adequacy requirements and the Return on Equity. The banks having no prior experience of project financing shall not be eligible to independently provide the financing facilities; however, they may provide facilities by forming a consortium under the lead of a bank/DFI having proven track of project financing. They shall be allowed to independently participate, albeit initially for a smaller limit, after SBP is satisfied about their inhouse capabilities to appraise the financial, technical and economic viability of the projects.

Apart from compliance of the minimum capital requirements prescribed by the SECP, the leasing companies must be in operation for last five years; and must have profitable operations during last five years with Return on Equity at least twice the rate applicable under the scheme on all time basis. Moreover, the infected portfolio as per the audited accounts should not be in excess of 8% of the total advances net of provision. The leasing companies fulfilling the above conditions shall be required to place with SBP under lien the government securities equivalent to at least twenty-five percent of the amount of limit, which they intends to seek. For leasing PFIs, their total financing under the scheme should not exceed 10% of their total leases written by them or 25% of the lease business in respect of the machinery financing, which ever is lower. They shall not be entitled to provide facilities under the scheme to the manufacturer. The last two requirements imposed on the leasing companies appear more restrictive and SBP might reconsider relaxation.

Applications for sanction of limits for each fiscal year in favour of a PFI shall be sent by the interested eligible PFIs to SBP during May for timely allocation in the yearly credit plan approved by the NCCC. The PFI shall be under obligation to ensure that no new disbursements are made/committed for the next financial year before intimation of the limit. The SBP is urged to advise approval of the limit to PFIs preferably by end July. Refinance against disbursement made by the PFI to the manufacturers shall be released on the basis of the certified copy of the Inland LC established in favour of the manufacturer and the agreed disbursement schedule. The PFIs shall be under obligation to submit request for refinance to SBP on Form LMM-1 along with Agreement on Form LMM-2 and DP Note from the borrower on Form LMM-4 duly endorsed in favour of SBP in addition to the DP note of the PFI on form LMM-3 executed in favour of SBP for the full value of the limit and service charges thereon.

The PFIs shall first disburse their own funds to the borrower or the manufacturer and then request for refinance from SBP using Form LLM-1, duly supported by required documents and confirmations. The PFIs to confirm that terms and conditions contained in SBP's sanction letter have been complied with; all the requirements of the scheme have been fully met; eligibility of borrower and the relevant plant has been properly determined; procedure for procurement of the machinery and mode of payment are in accordance with PFIs procedure and the scheme guidelines; and the information/data given are complete and correct. PFIs to acknowledge SBP's right to appoint independent consultants at PFIs' cost for verifying cases of refinance and to reimburse the refinance to SBP if there is any irregularity on PFIs part. The PFIs to also undertake that in case such irregularities have been made by the borrower with the involvement of PFIs personnel, besides initiating appropriate action against the personnel, PFIs shall indemnify SBP.

The SBP has released agreement Form LLM-2 to be stamped and executed on sanction of the refinance facility. The PFIs shall be bound to operate the scheme as per agreement which specifies the requirements and seeks their undertakings and concurrences on matters some of which are mentioned here. The PFIs shall undertaking that maximum rate of mark up to be charged from the borrower shall not exceed 2% per annum from the service charges payable to SBP. The PFIs shall agree that they shall neither sanction nor permit any of the customers to use the finances for any purpose other than prescribed under the scheme and PFIs shall obtain a declaration from the customer to this effect. PFIs shall endorse and deliver to SBP demand/usance Promissory Notes executed in PFIs favour by the customers with a certificate that (i) the same arises out of bonafide finances provided by PFIs; (ii) all parties liable thereon are financially sound, solvent and credit-worthy and that by virtue of such endorsement and delivery, PFIs certify the genuineness of signatures as well as authority of all persons thereon; (iii) the finances provided to parties liable on such promissory notes have not been classified as doubtful/loss. In addition, PFIs shall hold upon trust securities/security documents presently held by PFIs or which may be obtained by PFIs from the customers. PFIs to agree that as and when SBP demands, PFIs shall create valid legal charge on any or all of PFIs' assets as may be demanded by SBP. PFIs also expressly agree that SBP has the sole right to vary, amend, alter or add to the terms and conditions of the agreement.



The SBP shall allow refinance to each PFI on service charge basis in terms of SBP Act and the service charge shall be determined at a rate equivalent to the average of weighted average yields of last two auctions of PIBs of 5 years tenor, determined on annual basis on 1st July each year. The spread to PFIs under the scheme is 2% which is low as many PFIs would have higher administrative cost due to complexity of the scheme and rigorous compliance. There is not enough financial space to cover the credit risk. The banks are flooded with liquidity. In such a situation the banks do not appear to have strong appetite for LMM finance at 2% spread. Compensation has to be better for better performance in a more competitive world. There was big different between LMM interest rate and the rate on local currency loans for other purposes when the scheme was originally launched in 1972. Overall impact on capital cost and debt servicing was attractive and the entrepreneurs opted for LMM. In view of reduction in import duties in the next year or so, the local manufacturers of machinery would not be having big advantage over imported machinery. The scheme, therefore, might not be received by the customers with the same enthusiasm as in the past.

The SMEs should benefit most from the industries specified to be eligible for financing under the scheme. However, power plants- thermal/hydro, which are highly capital-intensive are included for the manufacturers only. While large industries such as cement, sugar, fertilizer, textile spinning/finishing, etc are not included. Financing, however, shall not be available for trading purposes i.e. purchase of machinery for subsequent sale. The grant of facilities to manufacturers shall be available at pre-delivery stage only, whereas the purchaser shall enjoy the facilities at post delivery stage. Financing shall be available for local contents used in the LMM, however, if the landed cost of the imported component used in LMM is more that 80% of the ex-factory price, such LMM shall not eligible. The cost of insurance, transit insurance, erection and commissioning charges and other incidentals etc shall not be financed under the scheme.

The borrower/sponsor of the project shall be under obligation to prepare proper feasibility of proposed project, which shall be appraised by the PFI so as to determine the economic, technical and financial viabilities of the project. While the facilities shall be sanctioned in favor of the purchasers of the machinery, the payments shall be made to the manufacturer's bank for credit to the account of the manufacturer or adjustment of the loan, if availed by the manufacturer for manufacturing of such machinery. It shall not be binding on the purchaser to purchase the LMM from the lowest bidder. The financing bank before allowing payment would evaluate such justification keeping in view the ground realities. It shall be ensured that the working capital facilities in respect of the project being financed are adequately arranged. The sponsor will contribute their equity share in an escrow account with the PFIs. The SMEs would prefer one-window facility.

The manufacturer intending to avail LMM finance from PFIs shall be required to fulfill the conditions such as: (i) The manufacturer is successful bidder for supply and manufacturer of LMM being purchased by the borrower under the scheme. The PFIs shall obtain proof from the manufacturers and a certificate as to acceptance of bid and placement of order to the manufacturer from the bank of the purchaser, who will pay for such order through confirmed Inland Letter of Credit; (ii) The PFI shall obtain a copy of inspection report prepared by the bank of the purchaser as to the manufacturing capabilities of the manufacturer; (iii) Financing shall be for the 90% value of the local contents including the value addition thereof; (iv) The manufacturer shall executing an agreement with PFI as to the assignment of the receivable from the inland LC, in addition to the normal security that the PFI shall require; and (v) Where the payment, against the machinery has been withheld for any reasons, the manufacturer shall be under obligation to make arrangements for payment to his bank from his own source. Machines are not like off-the-shelf items and as such this condition might be hard for the manufacturers.

The PFIs shall undertake due diligence as per their lending policies and Prudential Regulations as well as the areas particularly identified by SBP in the scheme. The PFIs shall reasonably ensure fulfillment of the pre-disbursement formalities by the borrower through due diligence to avoid mis-utilization through over invoicing, wrong selection of machinery etc while extending financing to the borrower. The disbursement shall be released after ensuring that all the pre-disbursement formalities have been duly completed. In this context it might be noted that over-regulation has the risk of killing the initiative and interest of the SMEs in the scheme.

The requirements described above shall also be fulfilled by the leasing PFIs and they shall not seek waiver from them merely on the reasons that they are governed by the rules framed by SECP. There will be no maximum limit for borrowing by the prospective entrepreneurs under this scheme. However, in case of large financing requirements i.e. over Rs 300 million, it would be prudent for each PFI to provide the facilities under consortium arrangements to diversify risk. In case of consortium financing, the payment to the bank of the supplier/manufacturer shall be made by the leader of the consortium, who shall therefore, be under obligation to certify the share of each member and the amount disbursed by it, to enable the member of the consortium to avail refinance from SBP to the extent of his share, and only after the payment has been made through the leader of the consortium. The PFIs acting as consortium leaders shall be doing extra work for no apparent benefit to them. Some compensation might be considered to cover their expenses.

If the PFIs sanction the facilities for a shorter period than 7.5 years with 1.5 years grace as allowed, SBP shall accordingly adjust period of refinance to PFIs. In case where the PFIs have allowed rescheduling of the loan granted to the borrower under the scheme refinance shall continue to be repayable according to original repayment schedule. The PFIs shall, however, be free to charge mark up as per their policy on the differential amount worked out on the basis of the rescheduling. By pursuing the above approach, the SBP appears to assume 100% performing loans for all times. This is impossible. In genuine cases the SBP might consider allowing matching rescheduling facility to the PFIs.