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Leasing in Pakistan; past, present and future.

The leasing companies are required to finance for long and medium term, hence they must also generate matching funds. In our market such funds are not easily available. Presently the major portion of the fund generation constitutes short term borrowings which brings the funding cost quite high. The leasing industry need to be allowed and equipped to generate long term funds by issuing Commercial Papers, Notes etc. Recently the Government of Pakistan has allowed them to raise funds by way of issuance of Certificates of Deposits ranging from three months to five years.

Chief Securities Corporate Law Authority

Before discussing past, present and future of leasing in Pakistan it would be appropriate to have a look at the basic concept of leasing, its classifications, history of leasing, modern development, characteristic of leasing transactions, rationale and advantages of leasing. Lease is a contract for the exclusive possession of property (usually but not necessarily land or building), for a specific time period. The person making available the property is called the lessor and the person making use of the property is called the lessee. Thus two important requirements for a lease are that the lessee have exclusive possession and the lessor's term of interest in the property be longer than the term of lease. Another definition of lease is that it is a contract granting use of land, building, equipment or other fixed assets for a specified period in exchange for payment in the form of rent. Leasing can be broadly classified into two categories:-

a) Finance Lease: International Accounting Standard No. 17 defines finance lease as a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. We can regard a finance lease as a leasing arrangement the principal purpose of which is to finance the use of an equipment for the major part of its useful life. The lessee has the right to use the asset while the lessor retains legal title.

b) Operating Lease: Operating lease is a lease in which the cost of a leased asset is not wholly recovered by the lessor out of rentals receivable during the lease period which is significantly shorter than the estimated useful life of the equipment. Generally operating lease is referred to as a hiring or rental contract.

A number of Anglo-American writers have pin pointed that equipment leasing first appeared in the modern times in 1877 when the Bell Telephone Company began renting out its telephone sets in the United States. But it is interesting to note that leasing, especially equipment leasing, has a long history. The Sumerians leased out goods before 2000 BC, and this form of business activity has thrived ever since. The origin of modern financial leasing is attributed to USA. It developed sale and lease back, when large departmental stores, chain groceries and supermarkets made use of the sale and lease back techniques. As early as 1936 this type of leasing was used by Safeway stores. It was introduced as a new financing mode in the United Kingdom in 1960 after having gradually developed over a period of nearly twenty years although historically the idea of sale and lease back was prevalent there even in 1880s. Incidentally the first law to regulate leasing was passed in UK in 1284.

Indeed these earlier transactions, which were financial lease in name, proceeded smoothly without any formidable legal or fiscal difficulties. However, some important legal changes gave an impetus to the leasing sector. Thus the USA Economic Recovery of Tax Act of 1981 gave a very powerful boost to leases as it introduced the concept of "Safe harbour lease" under which the revenue guaranteed that a transaction would be treated a lease and not a conditional sale or financing arrangement if the parties to lease elected it to be treated as a lease and certain conditions were satisfied. However, with effect from 1st January, 1984 the concept of "Safe harbour leases" was repealed and all finance leases were guaranteed the benefits of Investment Tax Credit. Since 1986 the Investment Tax Credit benefit has been withdrawn but leasing had come of age by then. In UK also from 1984 onward tax concessions were given which gave a boost to the business.

The most phenomenal growth has taken place in Japan which has a share of 86.43 per cent of total leasing markets in Asia and is the second largest leasing nation of the world. The first leasing company was established there in 1963 and by 1986 it had came of age. It is a known fact that the modern financial leasing is a combination of hiring, installment credit, and property/assets leasing. These activities have been continuously modified and developed since the Sumerian times and distinction between them is today sometimes blurred. Leasing as a form of trade was also practiced in pre-Islamic times and it is to the credit of Islam that it was recognised as an admirable Islamic tool of financing which did not work on the principle of interest.
Statement showing fund mobilisation and Investment In Lease
financed by Leasing Companies for the year 1991
(Rs. in million)
 Long
 Term
 Loans
 Head Branches Lease Invest
Name of the Company Office Raised Finance ment in
Atlas Bot Lease Karachi Lahore 20.000 377.540
Co. Ltd.
Asian Leasing Lahore Lahore 123.530 384.250
Corp. Ltd.
National Asset Karachi Karachi 21.808 72.273
Leasing
National Development Karachi Lahore 549.211 1197.123
Leasing Cor. Ltd. Islamabad
Orix Leasing Karachi Lahore 178.655 817.572
Pakistan Ltd.
 Peshawar
 Sialkot
 Faisalabad
Pakistan Industrial Karachi Faisalabad 86.000 154.371
Commercial Leasing Lahore
Limited Islamabad
 Multan
Pakistan Industrial Lahore Karachi 376.397 348.570
Leasing Corp. Ltd. Faisalabad
 Islamabad
 TOTAL:- 1357.601 3351.699


In the Islamic setting the Ijara mode of financing appears to be somewhat similar to the Western leasing mechanism. Ijara is a contract that allows all the benefits of ownership of a hired article on a specified fixed rent for a specified period so that any vagueness, either of benefits of ownership of the hired article, or of the specified fixed rent, or of the specified period may not cause any dispute among the parties concerned. Thus, due to the above characteristics, the Ijara mode of financing has unanimously been approved by the prominent jurists of the recognised schools of Islamic Shari'ah.

The companions (Shahaba-e-Kiram) of the Holy Prophet (peace be upon Him) practiced all lawful forms of Ijara, and Sa'ad ibne Abi Waqqas reported that in the age of Holy Prophet (peace be upon Him) the owners of the lands used to let their lands on rent. In Pakistan, the Council of Islamic Ideology in its report declared, in June 1980, that leasing conforms to the Islamic tenets.

In May 1952, Henry Schoenfeld set up the first modern leasing company by the name of "United States Leasing Corporation", now known as "United States Leasing International Inc." Subsequently leasing has been growing at a rapid pace, offering 100 per cent financing, tax benefits and off-balance sheet treatment. By the end of the 50s, leasing was sufficiently developed in the Untied States and as a result the leading leasing companies started to turn their attention to foreign markets.

During the 70s, leasing expanded dramatically. The amount of new leasing business in both Europe and Japan grew by over 800 per cent between 1970 and 1979, and by the end of the decade, leasing was widely recognised as a primary source of equipment finance, with a number of individual leasing industries reaching maturity.

During the first half of the 80s, the growth of leasing continued, especially in the United States in 1984, as the economy surged forward and businesses nationwide began to re-equip. Else where there was also a strong demand for all types and sizes of leasing facility, Many leasing product innovations were introduced in the 80s, and there was wide geographical diversification. Sales-and leasing schemes have been broadened to encompass a wide variety of different types of equipment, and many lessors have added such new items as natural gas pipelines and film - the latest and fastest growing sector in several leasing markets - to their portfolios.

Leasing has spread gradually to a number of developing countries, following initiatives by international Finance Corporation (IFC), the private sector arm of the World Bank, and several major banking and leasing groups. IFC has been instrumental in establishing leasing companies in several developing countries such as Jordan, Peru, Sri Lanka and Thailand.

IFC participated in the formation of the National Development Leasing Corporation (NDLC) in Pakistan. We also find participation in equity and transfer of knowhow in Orix Leasing Pakistan Ltd. and Atlas-Bot Leasing Ltd. Asian Development Bank has provided a credit line of US $ 5 million to Pakistan Industrial and Commercial Leasing Ltd. for leasing operations. Several international banks and Independent leasing companies have also played a leading role in establishing leasing companies in developing countries.

Characteristics of Leasing Transactions

We need to look the characteristics of leasing transactions which are:

a) The equipment and the supplier are selected by the lessee;

b) The lessee uses the equipment for business purposes and has the exclusive right to use the same;

c) The lessor purchases the equipment;

d) The lessor retains title to the equipment throughout the lease term;

e) The lease term is non-cancellable;

f) The risks inherent in the equipment and occasioned by its use fall primarily on the lessee; and

g) Residual treatments - retention of the whole of residual value by the lessor, or a residual sharing arrangement with no purchase option; or a nominal purchase option.

It is also important that we look at the advantages of leasing which accrue to a lessee as well as a lessor. These are:

a) Leasing provides up to 100 per cent of the cost of the equipment;

b) Leasing does not tie up valuable working capital or credit lines;

TABULAR DATA OMITTED

c) Leasing offers cash flow benefits;

d) Leasing provides certainty;

e) Leasing is a sound hedge against inflation;

f) Leasing may be off balance sheet:

g) Leasing may avoid loan covenants or capital investment restraints,

h) Leasing avoids dilution of share ownership; and

i) Leasing may be tax efficient.

Advantages to lessor includes:

a) Leasing is an additional financial product;

b) Leasing may reduce risk,

c) Leasing may increase profitability:

d) Leasing provides introductions to equipment suppliers;

e) Leasing may be simple to document; and

f) A leasing contract can be closed quickly.

There were no regulation to provide for establishment and regulation of leasing companies in Pakistan till the end of 1989. Formal rules for leasing companies were notified by the Government of Pakistan on 20th December, 1989. The salient features of these rules were:

a) 'Leasing Company' was defined as one intending to engage or engaged in business of leasing;

b) Minimum capital requirement was prescribed at Rs. 50 million;

c) Leasing companies could offer their equity to foreigners with the approval of the Government;

d) Leasing companies were debarred from doing business with the directors, officers, employees and principal shareholders;

e) A leasing company's total exposure to a single group was restricted to 20 per cent of its paid-up capital and free reserves;

f) Maximum exposure of a leasing company to its directors, affiliated companies in which any of its directors or his family members held controlling interest, all taken together, was restricted to 10 per cent of its over portfolios; and

g) A leasing company had to maintain for the first two years of its operation, a ratio of equity to liability of not more than one to seven and thereafter to a maximum of one to ten.

The work relating to approval of leasing companies was transferred from Finance Division to Corporate Law Authority (CLA) in December, 1991. CLA looked at the subject afresh and framed comprehensive rules for leasing companies in consultation with the Central Board of Revenue and the Finance Division. New rules were notified on May 27, 1992. These replaced the rules of 1989. These were further modified in August, 1992 as certain positive recommendations were received from leasing companies. The salient features of these rules are:

* 'Leasing Company' is defined as one whose principal business is leasing;

* A person desirous of forming a leasing company has to first make an application for permission to form such a company;

* A Leasing company is to be registered as a public limited company;

* A leasing company has to have a minimum paid-up capital of Rs. 100 million. Existing companies have been given a period of five years to bring their capital to this level;

* The Chairman and Chief Executive are not allowed to hold such office in any other company;

* Chief Accounting Officer is to be Chartered Accountant or Management Accountant or a Master's degree holder in commerce or Business Administration with five years experience;

* The Chief Executive and one of the directors must have a senior level leasing and investment experience;

* Exposure to a single group is not to exceed 10 per cent of the paid-up capital and free reserves of the company;

* All loans exceeding 10 per cent of paid-up capital and free reserves are required to be disclosed in the annual accounts; and

* All loans taken by the leasing company and use of the same is to be disclosed in the annual accounts.

A leasing company is debarred from:

(a) undertaking of business of real estate or provide funds to the construction companies, builders and developers and companies dealing in real estate. However, lease of machinery and equipment to construction companies is permitted;

(b) engage in leasing operations pertaining to open land, building (other than factory building), and furniture or furnishing of any type. However, leasing of hard furniture, excluding carpets and curtains etc. upto 5 per cent of leasing company portfolio is permitted.

* The period of lease agreement is not to be less than three years;

* The accounts are required to be maintained in accordance with International Accounting Standard-17.

The others include:

* Maximum exposure of a leasing company to its directors, affiliated companies and companies in which any of the directors or any family members hold controlling interest is not to exceed 10 per cent of overall leasing portfolio;

* A leasing company is not allowed to do business with any of its directors, officers, employees or persons who individually or jointly with other family members hold 10 per cent or more shares of the company;

* A leasing company has to invest 70 per cent of its funds in leasing business; and

* A leasing company is subject to such restriction as are laid down in the Third Schedule to the Income Tax Ordinance, 1979 and the rules made thereunder.

Growth of Leasing: lease financing as an organised activity is quite new in Pakistan and started in the early 80s. Within a short span of seven years leasing has shown a phenomenal growth and, gross leasing contracts have run into billions of rupees. The approval and actual execution of leases of the National Development Leasing Corporation alone amounted to nearly Rs. 1,208 billion and Rs. 770 million respectively during 1990-91. A total of 25 companies have so far been granted permission to do leasing business. However, as on October 20, 1992, 14 companies have gone public and stand listed on Stock Exchanges. Their combined paid-up capital is Rs. 1,200 billion. In order to supplement their need of capital, until now five companies have been allowed to mobilize funds through issue of certificates of investment.

Out of 14 listed companies, 7 came between 1985 and 1991. the remaining 7 companies came in late 1991 or early 1992. These companies raised long term loans of Rs. 1,357.601 million and invested Rs. 3,351.699 million in lease financing. Performance of these 7 companies is before us and we find that all these have earned good profits. All have been able to show profits from the very start. Minimum net profit before tax was Rs. 8.58 million (on capital of Rs. 50 million) and the highest was Rs. 145.878 (on capital of Rs. 88.375).

All the companies have been able to give return ranging from 7.5 per cent to 28 per cent to their shareholders. Confidence of the public in the profitability of these companies is reflected by the fact that even in the present bearishness in the market, the share of these companies are being quoted at considerable premium.

It is also of interest to look at the sector wise and province-wise lease financing by the 7 leasing companies. We find that these companies have invested heavily in Textile Spinning - Rs. 636.003 million; Textile weaving - Rs. 81.992 million; and Textile Composite Rs. 470.648 million - this brings total investment in textile sector to Rs. 1,188.643 million. It is followed by investment of Rs. 185.484 million in Engineering sector. The lowest investment is in Vanaspati and Allied sector which is a meagre sum of Rs. 0.635 million. When we look at the province wise investment we find in Punjab it is 58 percent, in Sindh 36 per cent; in NWFP 4 per cent; and in Balochistan it is 2 per cent. It would be of interest to mention that about 28 listed modarabas are also doing leasing business. Out of the total business activities of modarabas in 1991, leasing accounted for 76 per cent.

The leasing companies are required to finance for long and medium term, hence they must also generate matching funds. In our market such funds are not easily available. Presently the major portion of the fund generation constitutes short term borrowings which brings the funding cost quite high. The leasing industry need to be allowed and equipped to generate long term funds by issuing Commercial Papers, Notes etc. Recently the Government of Pakistan has allowed them to raise funds by way of issuance of Certificates of Deposits ranging from three months to five years.

Since, the industry is growing at a very fast pace it requires professionally skilled persons which have a dearth at present. Intensive training facilities need be provided by the leasing companies to its staff in order to overcome this problem. In house as well as external training programmes need to be launched aggressively. The Institute of Bankers and the Leasing Association of Pakistan can provide more effective role in this regard.

As the growth in leasing sector has come up suddenly and the Financial Sector as a whole has become very competitive since recent past, leasing companies need to be better equipped and have flexibility to adopt with changing environments and achieve the capabilities to promote assets base financial services. It is very important that the Lessees as well as general public must be aware of lease business. Presently majority is unaware of this mode of financing.

For every new industry to thrive government support becomes essential. Government of Pakistan does provide limited support to leasing industry. To enable this new industry to stand on its own feet, additional support would be useful. One of these is the extending of funds under local Manufactured Machinery (LLM) as is allowed to other Financial Institutions. Since leasing is a service industry, quality of service must be improved in order to successfully compete in the financial market. This area at present is deficient and leasing companies need to give special attention to increase their share in the financial market.

The leasing business has tremendous growth potential. In the developed countries lease financing as a percentage of total financing is around 32 per cent. Pakistan's ratio is less than 3 per cent. Lease financing on annual basis in USA is about US $ 130 billion, in Japan US $ 70 billion and in Indonesia it is US $ 2 billion. However, in Pakistan it is about US $ 325 million only. Government needed to provide attractive incentives to let lease financing grow in proportions to level of at least 25 per cent of the total financing of equipments.

Leasing companies will be able to find opportunities in the aging of the industrial sector. Most of the industrial units have been assisted by DFIs and have availed tax incentives ranging from three years to eight years tax holiday. Most of these units are now in the tax brackets. Now these units have to do balancing, modernization and replacement of plant and equipment. Due to greater tax advantage available to companies inherent in leasing, most companies are likely to opt for leasing as a mode of financing. Lease financing is also need to provide plant and machinery to the new entrepreneurs. These companies can direct the new investment to such areas which are hitherto unexplored. In this regard a very important factor is provision of liberal rules and regulations which without hindering the working of leasing companies could guide and monitor their performance. Whereas the Corporate Law Authority regulates and monitors the functioning of the leasing companies, the State Bank of Pakistan overseas the working of the leasing companies on the basis of the Prudential Regulations for the non-banking finance institutions (NBFIs).

Regulations in whatever form they come implicitly imply prudence. Discipline and Code of Conduct is a pre-requisite for curbing over-ambitious attempts and keeping things within judicious bonds. The need for regulations has never been as important as it is today. The post privatization era will require formation of more rules. Whereas the Government's objective is to have a free economy it should not mean absence of controls.
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Author:Pannni, M. Javeed
Publication:Economic Review
Article Type:Industry Overview
Date:Mar 1, 1993
Words:3601
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