LEASING SECTOR IN PAKISTAN

AROOJ ASGHAR (arooj.asghar@crosby.com)
Feb 04 - 10, 2008

Leasing is a big business internationally. Total lease volumes reported through leasing companies are in excess of $700 billion annually. USA is the predominant market where volumes exceed $400 billion, followed by Japan with over $100 billion. The top five countries account for 70% of the world's leasing business. China and India two of the fastest growing economies have relatively small leasing markets but obviously much bigger than Pakistan. In Pakistan leasing has made good progress and its share of new investment is estimated at above 10%. The current penetration of leasing in Pakistan is estimated at about 7% with a market of about Rs. 15 -20 billion per annum. Leasing companies in Pakistan are currently operating at about 20 -24% pre-tax rates of return. Given the tax incentives, this is not a bad rate of return. The major asset side concentration of leasing in Pakistan is on plant and machinery, which takes about 2/3rds of the total leasing volume. Pakistani leasing companies depend largely on a short-term retail finance instrument called the Certificate of Investment and Term Finance Certificate.

From the Third World perspective where a major source of economic capital is a form of foreign or local debt, leasing acts as a hybrid form of debt cum investment. In the 80's, when Pakistan floated its first leasing company, the characteristic of "asset-based" financing made it a more "Islamic" form of lending. (Asset based lending is a permitted form of debt-financing in Islam). From the perspective of developmental finance, leasing provided an alternative to interest based debt. Neither reliable statistics is available on the Investment in Leasing for leasing sector in Pakistan nor statistics is available regarding the exact percentage of new investment in plant and machinery or other income generating assets but it is believed that more than 80% of the investment is in plant and machinery.

The target markets for leasing companies can be commercial trade /service enterprises and small manufacturers. Commercial trade /service enterprises for obvious reason as they don't invest in capital machinery. A Small manufacturer invests in new project or modernizes existing operations. The reason why this market may find leasing cost effective is because their overall cost of capital is effectively low enough to absorb the cost of leasing.

ADVANTAGES OF LEASING

The highlight of leasing is that it is asset based financing as opposed to equity based approach applied by banks. The concept is that a business enterprise earns its profit from use of assets, not from the ownership of those assets. If the cash flow generated by a machine is sufficient enough to cover its lease rentals; then proposition is viable from the leasing company's stand point. This simplistic approach gets a bit more complex in reality as we live in times of regulatory supervision and prudential rules. Thus audited financial statements, ratio compliance, positive cash flow, etc. become essential tools of appraisal. But the good thing is that the underlying difference between asset based lending and equity based finance does not get distorted. Leasing does not require a lessee to have land for mortgage and usually does not seek additional security from the borrower. This distinction is significant particularly for small and medium size enterprises commonly known as SMEs which lack collateral and are thus not able to approach the formal banking sector. It is also used as a source of working capital and quite often as a competing product with short term loans from commercial banks. A sale and lease back (SLB) transaction is an instant source of funds, payable over the long-term. However, these days an SLB transaction is being used as a vehicle for a direct lease quite often. In addition to the most significant advantage of security, other benefits of leasing are; simple documentation (since no mortgage registry is required), tax benefits (full lease rental is an expense), and medium term finance (3 to 5 year leases).

ISLAMIC ASPECT

In Pakistan and other Muslim countries, leasing has another inherent advantage. It is an accepted mode of financing under Shariah Rules. There is a misconception that Finance Lease is not Shariah compliant and only operating lease is. Both types of leases are recognized. In its purest form Ijara is almost the same as an operating lease. Over the period of time, finance lease or Ijara wa Iktina developed to meet business needs. If the documentation complies with Shariah rules both types of leases are acceptable, otherwise both can be non-compliant.

LEASING EXPERIENCE IN PAKISTAN

In the early phase of automobile industry when assembly plants were established, there weren't too many reliable suppliers of spare parts. The growth of the car/ truck industry depended on local availability of quality parts as deletion requirements increased. The vendor industry was caught in the traditional problem of funding shortage due to lack of collateral. Leasing companies solved the problem by giving them the required machinery or moulds on the strength of their agreements with automobile companies which assured future cash flow. On recovery side, small businesses are within acceptable levels than big businesses. Initially car sales took off with leasing support and now leasing companies are beginning to enter agricultural sector through tractor lease, farm loans and operating leases for harvesters. Microfinance is another area which leasing companies have recently started focusing on.

SECP has imposed restrictions on leasing companies to enter into the real estate sector which number of leasing companies is requesting to remove. Whereas there are instances where local leasing companies are reluctant to introduce a house lease finance scheme despite the efforts of the National Banking Finance Commission, industry sources said. It is said that leasing companies have limited resources and they can not block capital for a long time, and it is difficult for them to lend money for 15 to 20 years. There are few SME sectors in Pakistan namely cutlery, surgical instruments, fan industry and sports goods, barring few exceptions, have not availed the facilities available to them and have not progressed to the level of international quality standards which they are capable of achieving.

With the demise of the development financial institution of Pakistan, a source of cheaper funds for long-term capital investment has dried-up. The private financial sector has grown tremendously in the last few years after the IMF's directives of liberalization and de-regulation were affected. Greater economic efficiency, in terms of resource mobilization and allocation, is expected after the deregulation of the economy However, the expected economic efficiency is still a long-way away. The private sector has not been able to satisfy the long-term capital needs of the economy. Lessors are suffering from chronic mismatch of funds and lack of availability of long-term funds. Foreign investors are a moody resource at the best of times and relying on foreign funds is a risky strategy.

SUMMING UP

In Pakistan, various Governments appreciated the potential of leasing and encouragement was regularly provided. Since the introduction of Prudential Regulations for SMEs by the State Bank of Pakistan, bank financing to this sector has increased substantially. A lot has been done in simplifying rules and consolidating many regulations but much more needs to be done. The leasing sector in general has experienced commendable growth over the years and has adequately proved to be an alternative source of finance. However, in order to improve the future prospects of leasing sector in particular, the leasing companies need to develop innovative products along with encouraging leasing of plant, machinery and equipment relating to priority sectors of the economy including energy (CNG), IT (Computer hardware, software and accessories), textiles, engineering etc subject to their intrinsic value. Agriculture sector is receiving special focus. The presence of commercial banks and DFI's in the lease market has impacted the leasing company's margin, but their capability of offering large ticket leasing has enhanced the acceptability of leasing options. Size of the business doesn't matter much, what matters most is the strategy, approach and attitude. Therefore leasing companies should continue to innovate and take bold steps to keep expanding; whereas there is a consensus that they can't compete with banks and even should not try to waste their resources to do so.