Lease Financing

INTRODUCTION Financial Services basically mean all those kinds of services provided in financial terms where the essential commodity is money. These services include: leasing, hire purchase, consumer credit, investment banking, commercial banking, venture capital, insurance, credit rating, bill discounting, and mutual funds , stock broking, housing finance, vehicle finance, mortgages and car loans, factoring among other things. Various entities that provide these services are basically categorized into (a) Non –Banking Finance Companies b) Commercial Banks, and (c) Merchant Banks. Financial Services in India is too vast and varied too have evolved at one place and at one time. One of the main entities that offer financial services in India is Non-Banking Finance Companies. These NBFCs registered with Reserve Bank of India mainly perform fund based services to the customer. Fund based services of NBFCs include: leasing, hire-purchase and other asset based services whereas fee b ased services of NBFCs include bill discounting, portfolio management and other advisory services.LEASE FINANCING Leasing as financial service is a contractual agreement where the owner (lessor) of equipment transfers the right to use the equipment to the user (lessee) for an, agreed period of time in return for a rental. At the end of the lease period the asset reverts back to the lessor unless there is a provision for the renewal of the contract or there is a provision for the transfers of ownership to the lessee. If there is any such provision for transfer of ownership, the deal is treated as hire purchase.Therefore, a lease could be generally defined as – â€Å"A contract where a party being the owner (lessor) of an asset (leased asset) provides the asset for use by the lessee at a consideration (rentals), either fixed or dependent on any variables, for a certain period (lease period), either fixed or flexible, with an understanding that at the end of such period, the as set, subject to the embedded options of the lease, will be either returned to the lessor or disposed of as per the lessor's instructions†. HISTORY AND DEVELOPMENT OF LEASING The history of leasing dates back to 200BC when Sumerians leased goods.Romans had developed a full body law relating to lease for movable and im movable property. However the modern concept of leasing appeared for the first time in 1877 when the Bell Telephone Company began renting telephones in USA. In 1832, Cottrell and Leonard leased academic caps, grown and hoods. Subsequently, during 1930s the Railway Industry used leasing service for its rolling stock needs. In the post war period, the American Air Lines leased their jet engines for most of the new air crafts. This development ignited immediate popularity for the lease and generated growth of leasing industry.The concept of financial leasing was pioneered in India during 1973. The Firs Company was set up by the Chidambaram group in 1973 in Madras. Th e company undertook leasing of industrial equipment as its main activity. The Twentieth century Leasing Company Limited was established in 1979. By 1981, four finance companies joined the fray. The performance of First Leasing Company Limited and the Twentieth Century Leasing Company Limited motivated others to enter the leasing industry. In 1980s financial institutions made entry into leasing business.Industrial Credit and Investment Corporation was the first all India financial institution to offer leasing in 1983. Entry of commercial banks into leasing was facilitated by an amendment of Banking Regulation Act, 1949. State Bank of India was the first commercial bank to set up a leasing subsidiary, SBI capital market, in October 1986. Can Bank Financial Services Ltd. , BOB Financial Service Ltd. , and PNB Financial Services Limited followed suit. Industrial Finance Corporation’s Merchant Banking division started financing leasing companies as well as equipment leasing and fi nancial services.There was thus virtual explosion in the number of leasing companies rising to about 400 companies in 1990. In the subsequent years, the adverse trends in capital market and other factors led to a situation where apart from the institutional lessors; there were hardly 20 to 25 private leasing companies who were active in the field. The total volume of leasing business companies was Rs. 5000 cores in 1993 and it is expected to cross Rs. 10, 000 cores by March 1995. PARTIES OF LEASE FINANCING ELEMENTS IN LEASE STRUCTUREThis is an explanation of the elements in a lease – the parties, asset, rentals, residual value, etc. This section would also elaborate the unique features of a lease as different from a regular financing transaction. 1. The transaction: The transaction of lease of lease is generically an asset-renting transaction. What distinguishes a lease from a loan is that in the latter, what is lent out is money; in a lease, what is lent out is the asset. 2. Parties to a lease: There are two parties to a lease: the owner and the user, called the lessor and the lessee. The lessor is the person who owns the asset and gives it on lease.The lessee takes the asset on lease and uses it for the period of the lease. Any one can be a lessor, and any one can be a lessee, subject to usual conditions as to competence to contract, or holding of properties. Ownership is no pre-condition for Technically, in order to be a lessor, one does not have to own the asset: one has to have the right to use leasing: the asset. Thus, a lessee can be a lessor for a sub-lessee, unless the parent lessor has restricted the right to sub-lease. 3. The leased asset: The subject of a lease is the asset, article or property to be leased.The asset may be anything – an automobile, or aircraft, or machine, or consumer durable, or land, or building, or a factory. Only tangible assets can be leased – one cannot contemplate the leasing of the intangible assets, s ince one of the essential elements of a lease is handing over of possession, along with the right to use. Hence, intangible assets are assigned, whereas tangible assets may be leased. The concept of leasing will have the following limitations: 1. What cannot be owned cannot be leased. Thus, human resources cannot be â€Å"leased†.Leasing of immovable properties may have complications: 2. While lease of movable properties can be affected by mere delivery, immovable property is incapable of deliveries in physical sense. Most countries have specific laws relating to transactions in immovable properties: if such law provides a particular procedure for a lease of immovable or real estate, such procedure should be complied with. For example, in Anglo-Saxon legal systems (UK, Australia, India, Pakistan, etc. ), transactions in real estate are not valid unless they are effected by registered conveyance.This would apply to lease of land and buildings, and permanent attachments to land . 3. A lease is structurally a rental for the lease period: with the understanding that the asset will be returned to the lessor after the period. Thus, the asset must be capable of re-delivery: it must be durable (at least during the lease period), identifiable and severable. Leased asset is a necessary pre- condition: The existence of the leased asset is an essential element of a lease transaction – the asset must exist at the beginning of the lease, during the lease and at the end of the lease term.Non-existence of the asset, for whatever reason, will be fatal to the lease. 4. Lease period: The term of lease, or lease period, is the period for which the agreement of lease shall be in operation. As an essential element in a lease is redelivery of the asset by the lessee at the end of the lease period, it is necessary to have a certain period of lease. During this certain period, the lessee may be given a right of cancellation, and beyond this period, the lessee may be given a right of renewal, but essentially, a lease should not amount to a sale: that is, the asset being given permanently to the lessee.In financial leases, is common to differentiate between the primary lease period and the secondary lease period. The former would be the period over which the lessor intends recovering his investment; the latter intended to allow the lessee to exhaust a substantial part of the remaining asset value. The primary period is normally non-cancelable, and the secondary period is normally cancelable. 5. Lease rentals: The lease rentals represent the consideration for the lease transaction. This is what the Lessee pays to the Lessor.If it is a financial lease transaction, the rentals will simply be the recovery of the lessor's principal, and a certain rate of return on outstanding principal. In other words, the rentals can be seen as bundled principal repayment and interest. If it is an operating lease transaction, the rentals might include several elements dep ending upon the costs and risks borne by the Lessor, such as: * If the lessor is bearing any repairs, insurance, maintenance or operation Costs, them charges for such cost. Depreciation in the asset. * Interest on the lessor's investment. * Servicing charges or packaging charges for providing a package of the above service. 6. Residual value: Put simply, â€Å"residual value† means the value of the leased equipment at the end of the lease term. If the lease contains a buyout option with the lessee, residual value would mostly mean the value at which a lessee will be allowed to buy the equipment.If there is no embedded purchase option, residual value might mean the value that the lessee or someone else assures will be the minimum value of the equipment at the end of the lease term. This is typical in case of financial leases where the lessor cannot grant a buyout option to the lessee; for the lessor to protect himself against asset-based risks, he would take an assured residua l value commitment either from the lessee himself or from a third party, typically an insurance company.The residual value might also the value that the lessor assures to pay-back to the lessee in case the lessee returns the asset to the lessor: that is, it might be the value the lessor assures as the minimum value of the equipment. Such a lease, obviously an operating lease because the lessor is taking a risk on asset values, is a full payout lease, but the lessor agrees to refund the guaranteed value on the lessee returning the equipment at the end of the lease term. 7. End-of-term options: The options allowed to the lessee at the end of the primary lease period are called end-of-term options.Essentially, one, or more, of the following options will be given to the lessee at the end of the lease term: †¢Option to buy (buyout option) at a bargain price or nominal value (typical in a hire-purchase transaction), called bargain buyout option †¢Option to buy at a fair market v alue or fixed, but substantial value †¢Option to renew the lease at nominal rentals, called bargain renewal option †¢Option to renew the lease at fair market rentals or substantial rentals †¢Option to return the equipment In any lease, which option will be suitable depends on the nature of the lease transaction, as also the applicable regulations.For example, in a full payout financial lease, the lessor would have recovered the whole or substantially the whole of his investment during the primary lease period. Therefore, it is quite natural that the lessee should be allowed to exhaust the whole of the remaining value of the equipment. Regulation permitting, the lessor provide the lessee a bargain purchase option to allow the lessee to complete the purchase of the equipment. Buyout option may characterize the lease However, in many jurisdictions, it is the existence of such buyout option that demarcates between lease and as hire-purchase: hire-purchase transaction.If t he lessor is interested to structure the lease as a lease and not hire-purchase, he would be advised not to provide any buyout option, but Instead, to allow the lessee to renew the lease to continue the use of the asset. In essence, a renewal option achieves the same purpose as a purchase, but the lessor retains his ownership as also his reversionary interest in the equipment. Fair market value options, either for purchase of equipment, or for renewal, are typical of operating leases, but are really speaking no more than assuring to the lessee a continued use of the equipment.If equipment has to be bought at its prevailing market value, it can be bought from the market rather than from the lessor – therefore, the fair market value option carries no value for the lessee. 8. Upfront payments: Lessors may require one or more of the following upfront, that is, instant payments from a lessee: †¢Initial lease rental or initial hire or down payment †¢Advance lease rental à ¢â‚¬ ¢Security deposit †¢Initial fees Margins in leases are taken as initial rental: The initial lease rent or initial hire (the word hire is more common in case f hire-purchase transactions) is a surrogate for a margin or borrower contribution in case of loan transactions. Note that given the nature of a lease or hire-purchase as asset-renting transaction, it is not possible to expect a lessee's contribution to asset cost as such. Hence, the down payment or first lease rent serves the purpose of a margin. Between advance lease rent and initial lease rent – the difference is only technical. The whole of the initial lease rental is supposed to be appropriated to income on the date of its receipt, whereas advance rental is still an advance – normally an advance against the last few rentals.Therefore, the advance rental will remain as a deposit with the lessor to be adjusted against the last few rentals. Types of Lease Agreements Lease agreements are basically of two types. They are (a) Financial lease and (b) Operating lease. The other variations in lease agreements are (c) Sale and lease back (d) Leveraged leasing and (e) Direct leasing. FINANCIAL LEASE Long-term, non-cancellable lease contracts are known as financial leases. The essential point of financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost.At lease it must give an option to the lessee to purchase the asset he has used at the expiry of the lease. Under this lease the lessor recovers 90% of the fair value of the asset as lease rentals and the lease period is 75% of the economic life of the asset. The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor. Financial lea se is also known as ? apital lease‘. In India, financial leases are very popular with high-cost and high technology equipment OPERATING LEASE An operating lease stands in contrast to the financial lease in almost all aspects. This lease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period. Normally the lease is for a short period and even otherwise is revocable at a short notice.Mines, Computers hardware, trucks and automobiles are found suitable for operating lease because the rate of obsolescence is very high in this kind of assets. Differentiation  Between  Operating  lease  and  Financial  Lease BASIS| FINANCIAL| OPERATING| Meaning| Long-term, non-cancellable lease contracts are known as financial Leases. | A Lease which is a short term one and one which does not cover the useful life on a n asset is called an operating lease. Form| In this type of lease, money is provideby lessor and the asset is purchaseform outside| The lessor is carrying on business of leasing and he holds such assets or is a manufacturer of such asset leases its asset| Maintenance| The lessee undertakes the maintenanceof the asset, paying insurance premiumetc. | In this type of lease, repairs and Maintenance is done by the lessor. | Risk ofObsolescence| In this types of lease, the lessee bearsthe risk obsolescence, so far as heUses the asset. In this types of lease, the lessor Bears the risk obsolescence during the period of the lease| Period of Lease| Period of lease – whole useful life ofAsset. | Period of lease – for short time. | Option to Buy| Option to buy for lessee. | Period of lease – for shot time| Accounting| EntriesAccording to the internationalaccounting standard-17, an entry is made in the balance sheet of the lessee on both the side| No entry is made in the bal ance sheet ofthe lessee under this type of lease,because lease is in the form of a hiredasset| 3. Sale and Lease back: It is a sub-part of finance lease.Under this, the owner of an asset sells the asset to a party (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals. However, under this arrangement, the assets are not physically exchanged but it all happens in records only. This is nothing but a paper transaction. Sale and lease back transaction is suitable for those assets, which are not subjected depreciation but appreciation, say land. The advantage of this method is that the lessee can satisfy himself completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement.The sale and lease back transaction can be expressed with the help of the following figure. ? The owner (Lessee) of the equipment sells it to a Leasing company (Lessor). ? The Lessor, leases the equipment back to the Lessee. ? Under this arrangement, the assets are not physically exchanged but it all happens in records only. ? The seller assumes the role of a lessee and the buyer assumes the role of a lessor. ? The seller gets the agreed selling price and the buyer gets the lease rentals. Two sets of cash flows occur: The lessee receives cash today from the sale. ? The lessee agrees to make periodic lease payments, thereby retaining the use of the asset. 4. Leveraged Lease: Under leveraged leasing arrangement, a third party is involved beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third party i. e. , lender and the asset so purchased is held as security against the loan. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor.The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset. ? 3 parties to the transact ion. ? Lessor ( Equity investo ? Lender ? Lessee ? The Leasing company (Equity investor) ? buys the equipment, through substantial borrowing, and ? with full recourse to the Lessee and without recourse to it. ? The Lender obtains an assignment of the Lease and a first mortgage of the equipment. 5. Direct Lease ? Under direct leasing, a firm acquires the right to use an asset from the manufacturer directly. The ownership of the asset leased out remains with the manufacturer itself. ? Bipartite Lease – Equipment supplier-cum-Lessor and Lessee. ? Tripartite Lease (Sales-aid-Lease) – Equipment supplier, Lessor and Lessee. Single Investor Lease †¢Only two parties – Lessor and Lessee. †¢Leasing company (Lessor) funds the entire investment, having appropriate mix of Equity-cum-Debt Finance raised by the Lessor, is without recourse to the Lessee Risk Assessment of a Lessee The first step in structuring a lease is for the lessor to evaluate and then quantify th e risk inherent in the lease.Risk results from the degree of credit worthiness of the lessee combined with the collateral and residual value of the equipment to be leased. In general if the lessor deems a lease risky, any of the following variables might be affected: 1. Lease yield increased with all other factors except payment amount remaining constant 2. Additional advance payments required. 3. Security deposit required or increased. 4. Guaranteed residual required in lieu of a purchase option. 5. Lease term shortened. 6. Personal guarantee required. 7. Additional collateral beyond the leased equipment. . Increased late fees for delinquent rental payments (5% if 10 days late plus18% interest for e. g. ) 9. Security interest obtained to facilitate repossession 10. All insurable risk insured. Assignment of the risk inherent in a lease transaction is primarily a credit Worthiness decision. Many lessors as well as bankers or other moneylenders base their evaluation of risk on the 10 C’s. They are: ? Character ? Capacity ? Capital ? Credit ? Conditions ? Competition ? Collateral ? Cross-border ? Complexity ? Currency Lessor RequirementsOnce the lessor has assessed the risk and credit worthiness of the lessee and converted that into structuring variables, the lessor must look to its remaining needs and then to the requirements of the lessee. Meeting the sometimes conflicting needs of the lessor and lessee represents the more difficult part of lease structuring. Sometimes a lessor will insist on structuring an operating lease in order to retain tax benefits while at the same time the lessee desires a capital lease so it too may avail itself of the depreciation and tax benefits.Typical lessor requirements that might be at variance with lessee needs in lease structuring are: ? A yield sufficient to meet the lessor’s after-tax weighted cost of capital ? accounting for the lease on the lessor’s books as a capital lease. ? Tax structure of the agre ement as an operating lease to obtain tax benefits. ? a net lease rather than a full service lease ? Residual dependence- the lessor may want the equipment purchased by the lessee to avoid resale problems. On the other hand the lessor may want the equipment returned at the end of the lease due to its increased value.Advantages of ‘LEASING’ to ‘LESSEE’ There are several extolled advantages of acquiring capital assets on lease: (1) Saving of capital: Leasing covers the full cost of the equipment used in the business by providing 100% finance. The lessee is not to provide or pay any margin money as there is no down payment. In this way the saving in capital or financial resources can be used for other productive purposes e. g. purchase of inventories. (2) Flexibility and Convenience: The lease agreement can be tailor- made in respect of lease period and lease rentals according to the convenience and requirements of all lessees. 3) Planning Cash Flows: Leasing enables the lessee to plan its cash flows properly. The rentals can be paid out of the cash coming into the business from the use of the same assets. (4) Improvement In Liquidity: Leasing enables the lessee to improve their liquidity position by adopting the sale and lease back technique. (5) Shifting of Risk of Obsolescence: The lessee can shift the risk upon lessor by acquiring the use of asset rather than buying the asset. (6) Maintenance and Specialized Services: In case of special kind of lease arrangement, Lessee can avail specialized services of lessor for maintenance of asset leased.Although lessor charges higher rentals for providing such services, lessee’s overall administrative and service costs are reduced because of specialized services of the lessor. (7)Off-The-Balance-Sheet-Financing: Leasing provides â€Å"off balance sheet† financing for the lessee, in that the lease is recorded neither as an asset nor as a liability. Disadvantages of ‘LEASINGâ⠂¬â„¢ to ‘LESSEE’ (1) Higher Cost: The lease rental include a margin for the lessor as also the cost of risk of obsolescence, it is, thus regarded as a form of financing at higher cost. 2) Risk of being deprived the use of asset in case the leasing company winds up. (3) No Alteration In Asset: Lessee cannot make changes in asset as per his requirement. (4) Penalties On Termination Of Lease: The lessee has to pay penalties in case he has to terminate the lease before expiry o lease period. Advantages of ‘LEASING’ to ‘LESSOR’ (1) Higher profits: The lessor can get higher profits by leasing the asset. (2) Tax Benefits: The lessor being owner of asset can claim various tax benefits such as Depreciation. 3) Quick Returns: By leasing the asset, the Lessor can get quick returns than investing in other projects of long gestation period. Disadvantages of ‘LEASING’ to ‘LESSOR’ (1) High Risk of Obsolescence: The lessor has to bea r the risk of obsolescence as there are rapid technology changes. (2) Price Level Changes: In case of inflation, the prices of asset rises but the lease rentals remain fixed. (3) Long term Investment: Leasing requires the long term investment in purchase of an asset, and takes long Time to cover the cost of that assetHire purchase financing Hire purchase is a popular financing mechanism especially in certain sectors of Indian business such as he automobile sector. In hire purchase financing, there are three parties: the manufacturer, the hiree and the hirer. The hiree may be a manufacturer or a finance company. The manufacturer sells asset to the hiree who sells it to the hirer in exchange for the payment to be made over a specified period of time. A hire purchase agreement between the hirer and the hiree involves the following Three conditions: ?The owner of the asset (the hiree or the manufacturer) gives the Possession of the asset to the hirer with an understanding that the hirer will pay the agreed installments over a specified period of time. ? The ownership of the asset will transfer to the hirer on the payment of all installments. ? The hirer will have the option of terminating the agreement any time before the transfer of ownership of the asset. Thus for the hirer the hire purchase agreement is like a cancelable lease with a right to buy the asset.The hirer is required to show the hired asset on his balance sheet and is entitled to claim depreciation, although he does not own the asset until full payment has been made. The payment made by the hirer is divided into two parts: interest charges and repayment of principal. The hirer thus gets tax relief on interest paid and not the entire payment. How does hire purchase work? When a customer buys goods on hire purchase there are three parties involved ? The customer – who buys the goods ?The retailer – who sells the goods The finance company – who provides the finance You make the init ial agreement with the customer. Once the security agreement has been signed you are likely to assign the agreement (including your security interest in the goods) to the finance company. The customer makes payments to the finance company. Whether the security interest will revert back to you will depend on the terms and conditions of your agreement with the finance company. The normal tripartite hire purchase process between the dealer, customer and the finance company is as follows: ?When the business connection between the finance company and the dealer is first established a master agreement may be drawn up regulating the conditions upon which the finance company is prepared to consider the hire purchase transactions submitted by the dealer. ?After the customer has selected the goods he desires to acquire on hire purchase, the dealer arranges for him to complete the schedule to a form of hire purchase agreement. The larger finance companies have theirown standard forms of printe d agreement. In the schedule to the hire purchase agreement the dealer will insert the hirer’s name, address, occupation, and certain other details indicating his financial standing. It is also the dealer’ responsibility to insert details about the price and the installments payable. ? The intending hirer is often required to make a down payment as an indication of the customer’s financial reliability. The deposit or down payment is usually paid to the dealer at the time the proposal form is completed and is normally retained by him as a payment on account of the price to be paid to him by the finance company. The deposit having duly paid the dealer sends the appropriate set of documents to the finance company, requesting the company to purchase the designated goods from him. ?If the finance company decides to accept the transaction, the hire purchase agreement is signed by one of its officers and a copy dispatched to the hirer with instructions as to the mode o f the installments. At the same time as a copy is sent to the hirer, the finance company notifies the dealer that the proposal has been accepted and that it is in order for the dealer to deliver the goods, if he has not already done so. Upon notification of acceptance the dealer delivers the goods to thehirer and obtains the hirer’s signature to a form of delivery receipt constituting an acknowledgement by the hirer that he has received the goods in proper condition. ?The hirer makes payment of hire installment throughout the period of hire ? On completion of the hire term, the finance company issues to the dealer a completion certificate whereupon the hirer becomes the owner of the asset. Key features of Hire Purchase: ? Repayment schedules are flexible. An Offer to Hire can be arranged with no deposit or an amount that suits you. ? Balloon payments at the end of the term can be arranged. ? Esanda owns the goods until the final payment is made, at which point you gain automa tic ownership. ? the interest component of the rental and depreciation on the equipment are tax deductible, provided it is used to produce assessable income or the expense is necessarily incurred in carrying on a business. DIFFERENE BETWEEN Hire  purchase AND Lease  financing Hire  purchase| Lease  financing| 1. Depreciation-  Ã‚  Ã‚  Hirer  Ã‚  Ã‚  is  Ã‚  Ã‚  entitled  Ã‚  Ã‚  toclaim  depreciation. 1. Depreciation-  lessee  is  not  entitledto  claim  depreciation. | 2. Payments-  Ã‚  hirer  Ã‚  can  Ã‚  charge  Ã‚  onlyinterest  Ã‚  Ã‚  Ã‚  Ã‚  portion  Ã‚  Ã‚  Ã‚  Ã‚  of  Ã‚  Ã‚  Ã‚  Ã‚  hire  Ã‚  Ã‚  Ã‚  Ã‚  purchasepayments  Ã‚  Ã‚  Ã‚  Ã‚  as  Ã‚  Ã‚  Ã‚  Ã‚  expenses  Ã‚  Ã‚  Ã‚  Ã‚  for  Ã‚  Ã‚  Ã‚  Ã‚  taxcomputation. | 2. Payments-  Ã‚  lessee  Ã‚  can  Ã‚  charge  Ã‚  theentire  lease  payments  as  expenses  fortax  computation. | 3. Salvage  Ã‚  value-  Ã‚  Once  Ã‚  the  Ã‚  hirer  Ã‚  haspaid  Ã‚  all  Ã‚  installments;  Ã‚  he  Ã‚  becomes  Ã‚  theowner  Ã‚  of  Ã‚  the  Ã‚  asset  Ã‚  and  Ã‚  can  Ã‚  claim  Ã‚  itssalvage  value. | 3. Salvage  Ã‚  value-  Ã‚  Lessee  Ã‚  does  Ã‚  notbecome  Ã‚  Ã‚  Ã‚  the  Ã‚  Ã‚  Ã‚  owner  Ã‚  Ã‚  Ã‚  of  Ã‚  Ã‚  Ã‚  the asset. Therefore  Ã‚  he  Ã‚  has  Ã‚  no  Ã‚  claim  Ã‚  over  Ã‚  theasset’s  salvage  value. Principle of hire purchase 1. Consumer installment credit The ground for distinction here is whether the goods are producer goods or consumer goods. Finance provided to consumers for acquisition of consumer durables is called installment credit. Installment credit for consumers is usually extended in one of the following forms: (a) Personal loan: this is made directly by the lending a dealer may introduce company through the consumer. The loan may be unsecured or secured. E. g. by a mortgage on the borrower’s property. b) Hire purchase or conditional sale: here funds are advanced for the acquisition of particular goods, which the customer take under a hire-purchase or conditional sale agreement, acquiring title on completion of payment. Where title is reserved in this way the agreement usually used is a hire purchase agreement, though some companies use conditional sale agreements. Retail hire purchase agreements take three different forms namely ? Direct collection- the dealer sells the goods to the finance house, which lets them out on hire purchase to the customer.This is the most common form of installment financing and is known in the trade as ‘direct collection’ because the installments are collected under a hire-purchase agreement concluded direct between the finance house and the hirer, as opposed to an agreement between the dealer and the hirer which is later discounted under block-discounting agreement. Usually the finance house collects the installments itself from the hirer, and the dealer d rops out of the transaction. Such transactions are called ‘non-recourse’ for the dealer. ? Agency collection: this is a variant of direct collection.As before the dealer sells goods to the finance company but in this case signs the agreement himself as undisclosed agent for the finance company and as such agent collects installments on behalf of the company, usually in return for appropriate commission. Because the agreements are in practice handled in blocks, this form of hire purchase is also misleadingly referred to as agency block discounting, though it is not a form of block discounting at all since there is no assignment of the agreement by the dealer to the finance company and the dealer is acting merely as an agent. Block discounting: in this case the dealer enters into the hire purchase agreement direct with the customer and later discounts it to the finance company. Agreements are usually discounted in blocks at a time; hence it is called block discounting. On ce the agreement is discounted the finance company becomes entitled to receive rentals from the hirer concerned but quite commonly, in order not to disturb the business relationship existing between the dealer and his customer, the dealer is made responsible for collecting the installments and remitting these to the finance company. c) Credit sale: here the title passes to the customer from the outset. Again the agreement may be with the finance house from the beginning or it may be entered into between the dealer and customer direct and later assigned by the dealer to the finance house. (d) Rental: the renting of domestic goods is fast developing as a form of installment credit. It is increasingly the practice and to a very larger extent in the U. S. , of finance houses to enter direct into rental agreements relating to domestic goods. DOCCUMENTS IN HIRE PURCHASEAll the parties must sign a hire purchase agreement and the agreement, among other things, must specify the date when the hiring commences, the number of installments, the amount of each installment, the time for the payment of each installment, the description of the goods and where the goods are kept. Note that the agreement must be in writing. An oral agreement is not a valid hire purchase agreement. Benefits of Hire Purchase ? Retention of cash flow ? Regular Payments ? Existing credit lines preserved ? Cost of acquisition spread overtime ? Repayment schedules can be structured to suit your cash flow. You can obtain the use of goods for minimal cash outlay, so working capital is not significantly affected. ? You may be able to make use of the taxation benefits of hiring. The Hire Purchase Agreement When you buy goods on hire purchase, you and the seller sign a written agreement. ? How many agreements will be made ? How often to pay ? The amount to pay ? When to pay ? Where to pay ? The name and address of the seller Other information in the hire purchase agreement ? What happens if payment is not made as agreed ? The right to repossess goods if one fails to make payments on time ?One’s obligation to keep the goods safe and in good order ? How to return the goods if one cannot pay. This information may be in the fine print on the back of the agreement. If any of this information is missing from the agreement one may not be liable for some of the cost of credit. The agreement cannot be enforced until the required information has been supplied. Lease Financing in Bangladesh: Bangladesh is a developing country, but the national calamity and political unrest sluggish the industrial growth as well as economic growth of the country.In spites of all these hindrance the growth of leasing companies is a significant indication of our bright prospects. Lease financing was first introduced in Bangladesh in the early 1980s. Industrial Development Leasing Company of Bangladesh Ltd. (IDLC), the first leasing company of the country, was established in 1986 under the regulatory framewo rk of BANGLADESH BANK. It was a joint venture of the Industrial Promotion and Development Company of Bangladesh Ltd. (IPDC), International Finance Corporation, and Korea Development Leasing Corporation.Another leasing firm, the UNITED LEASING COMPANY Ltd. started its operations in 1989. The number of leasing companies grew quickly after 1994 and by the year 2000, rose to16. The leasing business became competitive with the increase in the number of companies and wider distribution of their market share. There are, however, 6 other companies conducting leasing business in the country, although they do not use the word leasing in their names. In terms of money value, the leasing business in Bangladesh increased from Tk 41. 44 million in 1988 to Tk 3. 6 billion in 2000. The leasing companies now operating in the country are Industrial Development Leasing Company of Bangladesh, United Leasing Company, GSP Finance Company (Bangladesh), Uttara Finance and Investments, Bay Leasing and Inves tment, Phoenix Leasing Company, Prime Finance and Investment, International Leasing and Financial Services, Union Capital, Vanik Bangladesh, Peoples Leasing and Financial Services, Bangladesh Industrial Finance Company, UAE-Bangladesh Investment Company, Bangladesh Finance and Investment Company, and First Lease International.Lease financing, as organized in Bangladesh, operates with the following objectives: (a) to assist the development and promotion of productive enterprise by providing equipment lease financing and related services; (b) to assist in balancing, modernization, replacement and expansion of existing enterprises; (c) to extend financial support to small and medium scale enterprises; (d) to provide finance for various agriculture equipment; and (e) To activate the capital market byOperating as managers to the issue, underwriters, or portfolio managers. The functions of a lease business include lease financing, short-term financing, house building financing, and mercha nt banking and corporate financing. In this last group of functions, the leasing business in Bangladesh moved away from regular leasing activities and is now involved in stock-market related activities such as issue management, underwriting, trust management, private placement, portfolio management, and mutual fund operation.Broad capital market operations of the lease financing institutions include bridge financing, corporate counseling, mergers and acquisition, capital restructuring, financial engineering, and lease syndication. Prominent among the sectors of the economy that now receive lease financing services are textiles, apparels and accessories, transport, construction and engineering, paper and printing, pharmaceuticals, food and beverage, chemicals, agro-based industries, telecommunications, and leather and leather products.Commercial banks and development finance institutions (DFIs) have been the traditional lending institutions in Bangladesh. In fact, the concept of leas e financing is a relatively new one in the country. Initially, leasing companies had to adopt the role of educators to make Bangladeshi entrepreneurs aware of the benefits of leasing. However, as DFIs demonstrated poor recovery and fund recycling performances, leasing got the opportunity to develop as an alternative source of funding.A few other factors also contributed to development of the leasing business in the country. For example, the commercial banks have been keener in providing trade financing and FOREIGN EXCHANGE dealings rather than long-term loans because of the risks involved and their longer gestation period. The selection of lease proposals is relatively free from extraneous pressure and is subject to a quality level appraisal. Under lease agreements in the private sector, projects are sanctioned and implemented expeditiously, resulting in benefits in time and cost savings.Private leasing companies also attract clients by providing relatively better services. The down payments in leasing are not high and the gestation period is low. Also, in case of lease financing, incidental costs incurred in the process of import clearing, installation, and commercial production are capitalized, which substantially reduce the initial investment. Leasing companies, however, face some problems in conducting their business in the country. The relatively slow growth of the demand side compared to the fast growth of the lease business is one such problem.This leads many leasing companies to operate in partial capacity. The culture of loan default that prevails in the country is also a deterrent. Leasing companies often find it difficult to raise funds through short- or long-term borrowing from money and capital markets. They are hard pressed to deal with the financial assets because of the present laws of the country, which are also not fully enforceable. Leasing business is gaining increased importance in the economy of Bangladesh with its gradual transformation from an agrarian to industrial one.The government periodically revises the trade and industrial policy to create a liberal business environment both for domestic and foreign investment. Increased investment in the energy sector as well as in power, transport, telecommunications, water and sanitation, and safe disposal of wastes is expected to bring further opportunities for leasing industries. The traditional sources of funds of our country in the financial market are – the Commercial Banks, DFIs and the stock exchange. But these sources are not enough to effectively meet the growing demand of capital investments for industrialization of the country.And the backdrop of such scenario, leasing companies came forward in the 80s to serving as an alternative source of financing. At present there are 11 leasing companies operating there business. The name of the leasing companies: 1. Industrial Development Leasing Company of Bangladesh Ltd. IDLC 2. United Leasing Company 3. Uttara Finance & Investment company Ltd. 4. Phonenix Leasing Company Ltd 5. Bay leasing & Investment Ltd. 6. International Leasing & Finance Company Ltd. 7. GSP Finance company (BD) Ltd. 8. Prime Finance & Investment Ltd. 9. Vonike 0. Prime Bank Ltd. COMPANIES AT A GLANCE IDLC: Industrial Development Leasing Company of Bangladesh limited is established in 1985 as a joint venture public Limited Company with the multinational collaboration of International Development Finance Institution ,Commercial Banks, Insurance Company and Foreign Leasing Corporation. During the past fourteen years of its operation, IDLC has played a catalytic role in providing alternative source of term and capital asset financing to the private sector.IDLC’s primary focus has been in the area of 3-5 year term financial leasing with particular emphasis on balancing, modernization, replacement and expansion (BMRE) of existing units. With its pioneering vision IDLC has not only established lease financing as an ef ficient and quality financial service but also laid the foundation for the creation of ten other leasing companies. Today lease financing has grown to be an industry of Taka 3. 5 billion per annum.IDLC and its institutional shareholders have upheld their commitment towards the development of the financial service sector by offering high quality service to local entrepreneurs. To ensure steady and long term growth as well as to sharpen its competitive edge in a changing and challenging business environment. Short-term Finance which have broadened its customer base and are expected to contribute significantly to IDLC’s growth and profitability. IDLC established its first branch office in Chittagong in 1990. In January 1993, the company offered its shares to the public.In terms of market capitalization, it is ranked among the top 20 listed companies in both Dhaka and Chittagong Stock Exchange. Services offered by IDLC: Lease Financing: IDLC provides lease financing for all types of manufacturing and service equipment including vehicle, computer and medical equipment to all the major industrial and service sector. Short Term Finance: With an objective to provide solution to working capital problems, STF Unit provides different financial services to clients.Emphasis is given to identifying clients’ actual need and in providing customized service to cater them. House Financing: IDLC extends loan facilities to Individuals for purchase of apartments, Business houses professionals for purchase of commercial spaces (office space chamber display center etc. ) Bangladesh Finance and Investment Company Limited (BFICL): A non-banking finance company incorporated in Bangladesh on 10 May 1999 as a public limited company. It began business on 15 February 2000. It’s authorized and paid up capital are Tk 500 million and Tk 23 million respectively.The capital is divided into ordinary shares of Tk 100 each. Major business objectives of the company are carrying out direct trade, term and working capital financing, equity participation, housing finance, fund management,financial and industrial counseling and merchant banking activities of all types. Main sectors in which the company has targeted to lease and invest are transport, electric and electronic goods (including computers), leather, textile, printing, marine vehicles and equipment, steel and engineering, fishing boats and trawlers, medical equipment and small scale industries.BFICL purchases property in its own name and pays 60% to 70% of the total price of a particular property to its supplier. After accumulating and adding all other elevant/ incidental costs with the original purchase price such as transportation, insurance premium, and costs related to letter of credit, and the rent or profit/income margin, the company determines the lease price of the property. Then it signs lease contracts with the lessee, generally for two to four years, and hands over the properties to him f or use.The lease contracts require security or collateral from the lessee in various forms. Lease installments, payable generally on a monthly basis, are determined on the basis of the lease price of properties and other relevant factors. Lease contracts are renewed each year. On the expiry of the lease periods/contracts, the lessee can gain the ownership of the leased property/equipment upon payment of 5% of the transfer value of the equipment as salvage value of the property. Alternatively, the ownership and physical possession of the property goes back to the lessor.BFICL provides lease facilities against one or more of the following securities: (a) bank guarantee/insurance guarantee; (b) easily AM-HIFC Ahsania-Malyasia Hajj Investment and Finance Company Limited (AM-HIFC) is a Sharia-based non-bank financial institution licenced by Bangladesh Bank under the Financial Institution Act 1993. The company follows the model of Malaysia`s pilgrims fund and management institution, popul arly known as â€Å"Tabung Hajj† which focuses on mobilizing savings from would-be pilgrims who intend to perform Hajj in the Holy Land.It invests its excess fund in Sharia-based activities. As a Sharia-based financial institution, adherence to Sharia is of paramount importance to us and this is embodied in out Vision and Mission statement. Bangladesh Industrial Finance Company Bangladesh Industrial Finance Company Limited (BIFC) is a joint venture Leasing and Financing Company, promoted by a group of' Foreign and Local Sponsors. Incorporated as a Public Limited Company in August 1996 and icensed by Bangladesh Bank as a Non-Bank Financial Institution in February 1998, BIFC has been rendering innovative, customized, prompt and cost effective financial solutions to the socio-economic growth of the country. Delta Brac Housing Finance Delta Brac Housing Finance Corporation Ltd. (DBH) is the pioneer, the largest and the specialist Housing Finance Institution in the private sector of the country. After commencing operation in the early 1997, the company has registered commendable growth in creating home ownership among more than 7,500 families in Dhaka and other major cities of the country.At the same time, the company has been playing an active role in promoting the real estate sector to the large cross sections of prospective clients who had but yet unfulfilled dream of owning a sweet home. Fareast Finance ; Investment Limited Fareast Finance ; Investment Limited-a leasing and financing company started its business in the early 2002 to serve its clients with high ethical standards and accountability. Fareast believes that each of its activities must provide satisfaction to its customers and will start progress for them.Financial Management Reform Programme FMRP is a five-year programme jointly financed by the UK Department for International Development (DFID) and the Royal Netherlands Embassy (RNE), and executed by the Ministry of Finance, Government of Ban gladesh. Grameen Bank Grameen Bank (GB) has reversed conventional banking practice by removing the need for collateral and created a banking system based on mutual trust, accountability, participation and creativity.GB provides credit to the poorest of the poor in rural Bangladesh, without any collateral. At GB, credit is a cost effective weapon to fight poverty and it serves as a catalyst in the overall development of socio-economic conditions of the poor who have been kept outside the banking orbit on the ground that they are poor and hence not bankable. Professor Muhammad Yunus, the founder of Grameen Bank and its Managing Director, reasoned that if financial resources an be made available to the poor people on terms and conditions that are appropriate and reasonable, these millions of small people with their millions of small pursuits can add up to create the biggest development wonder. GSP Finance Company GSP Finance Company (Bangladesh) Limited (GSPB) was incorporated in Dhaka , Bangladesh on 29th October 1995 with the Registrar of Joint Stock Companies and Firms. It started its commercial operation from 17th April 1996 under licence granted by Bangladesh Bank (Central Bank) in accordance with the Financial Institutions Act of 1993. IDCOLInfrastructure Development Company Limited – IDCOL's mission is to promote economic development in Bangladesh by encouraging private sector investment in infrastructure projects. IDLC of Bangladesh Ltd IDLC is a multiproduct financial institution, established in 1985 with the collaboration of reputed international development agencies such as: Korean Development Leasing Corporation (KDLC), South Korea, Kookmin Bank, South Korea, International Finance Corporation (IFC) of the World Bank Group, Aga Khan Fund for Economic Development (AKFED), German Investment and Development Company (DEG).Leasing, initiated by IDLC, today, plays a vital role in the mid term financing of industrial and service enterprises. Over the ye ars, IDLC has served the diverse needs of its customers with product offerings ranging from Home Loans for Individuals to Factoring and Work Order Financing for small and medium enterprises (SMEs) and services such as: Lease Financing, Syndication, Corporate Advisory, Bridge Financing, Underwriting, Issue Management, Private Placement of Stocks and Debt Instruments for Corporate Customers. IIDFCIndustrial and Infrastructure Development Finance Company (IIDFC) Limited is a Development Financial Institution, promoted by wide array of financial institutions like ten commercial banks, from both the public and private sectors, three insurance companies and Investment Corporation of Bangladesh (ICB). Union Capital Limited UNION CAPITAL LIMITED is one of the largest investment banks and fastest growing financial institutions in Bangladesh. Previously, it was known as Peregrine Bangladesh which had its origins and businesses rooted in Hong Kong.Out of the local office of the erstwhile Pereg rine Capital Limited of Hong Kong, Union Capital Limited, Dhaka emerged in early 1998 as a Bangladesh-based company led by a group of the foremost entrepreneurs of the country. Union Capital, within a short span of time, has proved its worth as a most forward-working vigorous organization achieving success with its wide international network and strong local base Leasing Law in Bangladesh Leasing is an asset renting activity, and is therefore, governed by common law. The Contracts Act 1872 applies to contracts of leases.Sections 148 to 171 of the Contracts Act cover provisions relating to bailment. As these provisions are identical to those applicable under English law, the chapter devoted to general law of leasing adequately covers the law in Bangladesh as well. It may be noted that the general law of contracts is limited to bailments of â€Å"goods†. â€Å"Goods† include movable property only – immovable property is not covered by common law. As it the common feature of all Anglo-Saxon legal systems, transactions in immovable properties are covered by a separate system of laws.Taxation of Leases in Bangladesh: The taxation system in Bangladesh has been a subject matter of criticism over a last few years. The system is characterized by a large number of incentives, tax holidays and concessions as a result of which the share of corporate taxation to total tax collection by the Govt. has come down drastically over the past few years. Taxes on corporate profits, of both domestically and foreign owned companies amounts insignificant as a 0. 5% of GDP in Bangladesh, compared with more than 6% in developed nations. The main reason cited for this low contribution is the tax incentives granted by the Govt. Which are very liberal as compared to its counterpart countries. It is probably with tax reform in view that the Govt carried out certain reforms in depreciation laws in Budget 1998-99. Among other provisions, the important change that would ha ve a far reaching effect on leasing companies is the change in