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Leasing in Emerging Markets

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Lessons of Experience Series

Copyright 1996

The World Bank and International Finance Corporation

1818 H Street, N. W.

Washington, D. C. 20433, U.S.A.

All rights reserved

Manufactured in the United States of America

First printing July 1996

The International Finance Corporation (IFC), an affiliate of the World Bank, promotes the economic development

of its member countries through investment in the private sector. It is the world's largest multilateral organization

providing financial assistance directly in the form of loan and equity to private enterprises in developing

countries.

The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors and should

not be attributed in any manner to the IFC or the World Bank or to members of their Board of Executive Directors

or the countries they represent. The World Bank does not guarantee the accuracy of the data included in thispublication and accepts no responsibility whatsoever for any consequence of their use. Some sources cited in this

paper may be informal documents that are not readily available.

The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent

to Director, Corporate Planning Department, IFC, at the address shown in the copyright notice above. The IFC

encourages dissemination of its work and will normally give permission promptly and, when the reproduction is

for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted

through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923,

U.S.A.

The complete backlist of publications from the World Bank, including those of the IFC, is shown in the annual

Index of Publications , which contains an alphabetical title list (with full ordering information) and indexes of

subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution

Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from

Publications, The World Bank, 66 Avenue d'Iena, 75116 Paris, France.

Laurence W. Carter is a senior policy analyst in the Corporate Planning Department of IFC. Teresa Barger is a

manager in IFC's Office of the Vice President for Operations, and Irving Kuczynski is Director of Financial

Sector Issues in the same office.


Leasing in Emerging Markets 1


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This serial publication has been cataloged by the Library of Congress as follows:

Library of Congress CataloginginPublication DataCarter, Laurence W., 1960

IFC's experience in promoting leasing in developing countries,

19771995 / Laurence W. Carter

p. cm.(IFC lessons of experience series; 2)

ISBN 0821336754

1. International Finance Corporation. 2. Lease and rental services

Developing countries 3. Industrial promotionDeveloping countries.

I. Title. II. Series.

HG3881.5.I56C367 1996

338.4dc20 9628074

CIP

Statistics sourced to the World Leasing Yearbook, 19881994 , are based substantially on information

compiled by London Financial Group , London , U.K. This data may not be reproduced without the priorpermission of London Financial Group and IFC .break

Many small and new firms in developing countries use leasing to finance their investments. Because the leasing

company retains legal ownership of the leased asset, it enables a firm to qualify for use of leased equipment based

on its generated cash flow rather than its credit history, assets, or capital base. Twenty years ago, new or small

firms without adequate collateral or a credit history would have faced severe difficulties in obtaining financing.

Today, the growth of the leasing industry has made much needed equipment available to a broad range of

enterprises.

Since its first investment in a Korean leasing company in 1977, IFC has vigorously promoted leasing in

developing countries through a combination of advising governments and investing in leasing companies. Leasing

today finances over US$40 billion worth of new vehicles and equipment each year in developing countries.

Leasing in Emerging Markets describes IFC's experience in the leasing industry.break

Preface

The role of capital markets in economic development is becoming increasingly evident. It is now widely

recognized that there is a direct correlation between economic growth and development of the financial sector. A

wellfunctioning financial intermediation system helps to facilitate a virtuous circle of productivity increases,

economic growth, and domestic savings.

IFC has been involved with the capital markets sector for over 25 years, reflecting its focus on assisting

developing countries in building their physical and financial infrastructure. It has helped supplement domestic

resources by mobilizing external savings flows to emerging markets, and focused on developing domesticfinancial institutions and capital markets. This approach to "deepening" and "broadening" domestic markets has

been critical to IFC's strategy of promoting the growth of local savings.

IFC has pursued its capital markets objectives by:

providing technical assistance to help create or change laws and establish regulatory agencies;

creating new institutions . IFC has worked with foreign and local sponsors to create new institutions, often the


Preface 2


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first of their kind in a country;

supporting existing financial institutions . IFC has helped domestic financial institutions expand their access to

local and foreign financing sources (through provision of credit and agency lines, commercial paper programs,

bond guarantees, etc.) and to strengthen their balance sheets (e.g., through swaps, the second tier capital and

securitization of assets); and

encouraging financial institutions to reach underserved business segments especially smalland

mediumsized enterprises (SMEs). IFC has used credit lines and promoted SMEfocused institutions to improve

the access of new, smalland mediumsized firms to financing.

Since 1971, IFC has invested and made available through financial intermediaries some $3.5 billion in the

financial and capital markets sector, covering more than 560 separate transactions to clients in over 50 countries.

In addition, it has provided technical assistance through nearly 800 projects in over 90 countries. The scale of

IFC's capital markets operations has increased dramatically since the beginning of the 1990s, during which time

capital markets have come to the forefront of the development agenda worldwide. During 19911995, investments

in the financial sector accounted on average for 22% of the Corporation's aggregate investment commitments, and

for nearly 35% of its total number of transactions.

Within this framework, the development of the leasing industry has been extremely important. The Corporation

has promoted the development of the industry through a combination of measures, including advice to

governments on leasing regulations, undertaking of feasibility studies, identification of sponsors and technical

partners, and investments in new leasing companies. Between 1977 and 1995 IFC's Board approved 120

transactions involving 63 leasing companies in 36 countries, many of these being the first leasing companies set

up in the country concerned. The impact has been substantial: in virtually every country, the industry has grown

rapidly. Large numbers of smalland mediumsized companies have been able to secure better access to

financing. For instance, in 1994, 16 leasing companies in which IFC had invested wrote over 10,000 new leases

worth over US$2 billion.break

This paper, covering IFC's promotion of the leasing industry in developing countries, is part of the Corporation'sstrategy to further extend its development impact by disseminating the lessons of its experience in key sectors and

activities to external audiences. The paper is one of a series of reports dealing with capital markets issues, all to be

released as part of IFC's Lessons of Experience series. The work on these reports was carried out by a team of IFC

staff under the coordination of Dileep Wagle and Teresa Barger. This paper was prepared by Laurence Carter,

Teresa Barger, and Irving Kuczynski, with research support from Lory CambaOpem and Tracy Rahn. Consistent

with the fundamental basis of the series, the paper draws upon a full range of operational experience from across

the Corporation. Data from the World Leasing Yearbook was provided by David Porter, Chairman of the London

Financial Group. Data on IFC transactions reflect IFC's operational position as of endJune 1995.break

JANNIK LINDBAEK

EXECUTIVE VICE PRESIDENT

INTERNATIONAL FINANCE CORPORATION

JULY 1996


Preface 3


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Contents

Executive Summary link

Financing Opportunities for Small Firms link

What Exactly Is Leasing? link

A Large, Growing Industry link

Why Has Leasing Grown so Fast? link

The Lessee link

Leasing Companies link

Governments link

IFC's Experience link

Lesson's from IFC's Experience link

What Is IFC's Role? linkWhat Is the Development Impact? link

What Makes Successful Leasing Companies? link

1

Development of Leasing Worldwide

link

Background link

Developing Markets Driving Leasing Industry Growth link

Regional Trends link

Leasing: Important to SMEs link

Why Has Leasing Grown so Fast? link

The Lessee link

The Lessor link

Governments link

Leasing and Financial Sector Development link

What Leasing Needs: A Conducive Macroeconomic Environment link

What Leasing Needs: A Conducive Regulatory Environment link

Legal linkSupervision and Regulation link

Tax and Accounting link

2

IFC's Leasing Experience

link

Accelerating Approvals link

IFC's Commitments link


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Wide Geographic Coverage link

Mobilization link

Leasing WorksEven in Risky Countries with Poor Access to

International Capital

link

Low Volume Masks Significance link

DebtEquity Ratios link

Foreign Sponsors and Technical Partners link

IFC's Portfolio link

Regional Split link

Performance Indicators link

Financial Performance of IFC's Portfolio link

Equity link

Loans link

Lessons from IFC's Experience link

More Impressive Than the Numbers Suggest . . . link

. . . But Returns Are Lower Than the Numbers Suggest link

3

IFC's Role in Promoting Leasing

link

Financing Smalland MediumSized Enterprises link

IFC's Proactive Approach to Leasing link

Are Regulatory Barriers Preventing the Development of Leasing? linkCan IFC Catalyze the Industry by Sponsoring a Leasing

Company?

link

Will the Leasing Company Be Able to Mobilize MediumTerm

Local Debt?

link

Can the Leasing Company Use Foreign Currency Loans? link

How Best to Foster Sustainable, Competitive Leasing

Companies?

link

Are the Leasing Company's Assets and Liabilities Matched? link

Can the Product Line of Existing Leasing Companies BeWidened?

link

Can IFC Help to Promote Greater Private and Local Ownership? link

4

Evaluation of IFC's Leasing Experience

link

Leasing Companies Do Lend to New, Smalland MediumSized

Enterprises

link


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Leasing Has Grown Rapidly in Most Countries link

Competition and Private Investment are Increasing link

Leasing Helps Mobilize Savings and Develop the Financial

Sector

link

Checklist for Successful Leasing Companies link

Conclusion link

Future IFC Work to Promote Leasing link

Appendix Tables link

Box A1: Worked Example Using IAS Accounting Standards link

Table A1: Leasing Volume and Market Share, 19881994 link

Table A2: IFC's Leasing Project Approvals, 1977June 1995 link

Table A3: Summary of IFC's Leasing Project Approvals link

Table A4: IFC's Leasing Project Commitments, 1977June 1995 link

Table A5: Summary of IFC's Leasing Commitments link

Table A6: IFC's Leasing Project Droppages and Cancellations link

Table A7: Leasing Market Share, Private Investment, and Broad

Money, 19881993

link

Bibliography link

Text Boxes

Box 1.1: Leasing Definitions link

Box 1.2: Leasing Development in Korea and Thailand linkBox 1.3: Leasing Levels the Playing Field for Investment

Incentives

link

Box 1.4: Competitive Advantage for a Lessor: Processing,

Relationships and Marketing

link

Box 2.1: Examples of Technical Partners in IFC Leasing

Investments

link

Box 2.2: Mobilizing Local Finance for a Leasing Company in

Cte d'Ivoire

link

Box 2.3: High Costs: Introducing Leasing to Senegal link

Box 3.1: Developing a Favorable Regulatory Environment for

Leasing

link

Box 3.2: Identifying Constraints to Leasing in West Africa link

Box 3.3: Assessing the Market link

Box 3.4: Uneven Progress: The Right Conditions Make a

Difference

link


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Box 3.5: Accessing Local Finance and Marketing Channels:

Romania

link

Box 3.6: A Local Currency Issue That Failed: Botswana link

Box 3.7: Providing Dollar Financing to a Chilean Leasing

Company

link

Box 3.8: Typical Operating Guidelines for a Leasing Company link

Box 3.9: Competition and Growth in Thailand's Leasing Industry link

Box 4.1: KDLC and the Development of Korea's Leasing

Industry

link

Box 4.2: Riding the Roller Coaster: Leasing in Peru, 19811993 link

Box 4.3: Legal Difficulties link

Box 4.4: Financial Liberalization Encourages Investors in

Pakistan

link

Box 4.5: Financing Options: With and without a Leasing Industry link

Box 4.6: Leasing to Merchant Banking: Developing the

Philippine Capital Markets

link

Text Figures

Figure 1.1: Leasing in Developing Countries, 19881994 link

Figure 2.1: IFC's Leasing Equity Approvals, FY77FY95 link

Figure 2.2: IFC's Leasing Commitments by Region, 1977June

1995

link

Figure 2.3: A Leasing Company's Balance Sheet link

Figure 2.4: More Projects in Riskier Countries link

Figure 2.5: Sharp Growth: IFC's Leasing Portfolio, 19921995 link

Figure 3.1: Financing SMEs through Building Local Financial

Institutions

link

Figure 3.2: IFC's Specific Roles in Promoting Leasing Companies link

Figure 4.1: Size Distribution of Korean Leasing Company's

Leases, 1993

link

Text Tables

Table 1.1: Top 50 Leasing Markets, 19881994 link

Table 1.2: Private Investment Financed by Leasing, 19881994 link

Table 1.3: Finance Raised by Korean Firms, 19911993 link

Table 2.1: IFC Approvals, 1977June 1995: The Big Picture link

Table 2.2: IFC Commitments, 1977June 1995 link

Table 2.3: Regional Distribution of IFC Commitments,

1977June 1995

link


Contents 7


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Table 2.4: Mobilization Rates link

Table 2.5: Equity Shares in Leasing Companies at Time of IFC's

Entry

link

Table 2.6: Average DebtEquity Ratios, 19911995 link

Table 2.7: IFC's Leasing Portfolio, June 1995 link

Table 2.8: Regional Distribution, 19921995 link

Table 2.9: Good Overall Performance link

Table 3.1: Pioneering the Leasing Industry link

Table 4.1: Falling Spreads Ascribed to Increased Competition link

Table 4.2: Market Share of Leasing Industry Versus Private

Investment, 19881993

link

Table 4.3: Market Share of Leasing Industry Versus Monetary

Depth, 19881993

link

Appendix Tables and Text Boxes

Box A1: Worked Example Using IAS Accounting Standards link

Table A1: Leasing Volume and Market Share, 19881994 link

Table A2: IFC's Leasing Project Approvals, 1977June 1995 link

Table A3: Summary of IFC's Leasing Project Approvals link

Table A4: IFC's Leasing Project Commitments, 1977June 1995 link

Table A5: Summary of IFC's Leasing Commitments link

Table A6: IFC's Leasing Project Droppages and Cancellations link

Table A7: Leasing Market Share, Private Investment, and Broad

Money, 19881993

link

Glossary

CAMENA Central Asia, Middle East and North Africa

DFI Development finance institutions

FY Fiscal year

GDP Gross domestic product

IFC International Finance Corporation

IRR Internal rate of return

LAC Latin America and the Caribbean

LDC Less developed country

OECD Organization for Economic Cooperation and

Development

SME Smalland mediumsized enterprises


Contents 8


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TCD Transferable certificates of deposit

US$m US$ millions

US$bn US$ billions

1

Executive Summary

Financing Opportunities for Small Firms

Consider three entrepreneurs seeking financing:

1) The owner of a small , threeyearold road maintenance company in Ghana has secured his first big break: a

contract from the Ministry of Public Works to maintain roads in a region of the country for three years. He needs

to double his truck fleet from two to four. His bank manager, although sympathetic, points out that the owner has

only two years of accounts and has already mortgaged his house to secure a loan to buy one of the earlier trucks.

The owner approaches a leasing company, which concludes that the firm will be able to make the lease payments

without difficulty. After a 20% down payment from the contractor, the trucks are supplied within two weeks, on athreeyear lease.

2) A Romanian chemist wants to set up a private medical testing laboratory to conduct tests for several local

hospitals. She has identified the equipment required, which needs to be imported from Germany. She has 25 years

of experience, lots of contacts within the local medical community and an option to rent lab space. But she has

limited personal savings, no fixed assets to collateralize, and no corporate sponsor. She approaches several banks,

which suggest that they might consider a loan after two to three years of successful operation, but that they could

not help now. After looking at her business plan, the manager of a leasing company concludes that she will be

able to service the lease payments. The leasing company imports the equipment (handling all of the paperwork)

and supplies it to the chemist under a twoyear lease.

3) Following a year of growing orders, a small textile manufacturer in Bangladesh wants to borrow US$500,000to double the capacity of his factory. He needs US$300,000 worth of new machinery and US$200,000 in extra

working capital. His bank manager tells him that the bank is suffering from constrained liquidity and can only

make loans for under six months. The manufacturer borrows US$200,000 of shortterm working capital from the

bank and arranges a fouryear lease for the machinery with the local leasing firm.

Without leasing companies, investments like these would not happen. Twenty years ago (more recently in most

developing countries), these entrepreneurs would not have found a leasing company. Demand from new, small

and mediumsized enterprises such as these has turned leasing in developing countries into a US$40 billionplus

industryfrom nothingwithin just 20 years.

IFC has played a central role in this change, through a combination of advising governments about leasingregulations, undertaking feasibility studies, identifying sponsors and technical partners, drafting business plans

and operating policies, and investing in new leasing companies. IFC has invested in leasing companies in over

half of the developing countries which have a leasing industry today (and often, IFC investment has been the

country's first leasing company).break


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What Exactly Is Leasing?

Financial leasing is a contractual arrangement that allows one party (the lessee ) to use an asset owned by the

leasing company (the lessor) in exchange for specified periodic payments. Critical to this arrangement, legal

ownership (retained by the leasing company) is separated from economic use of the asset (held by the lessee). The

leasing company focuses on the lessee's ability to generate cash flow to service the lease payments, rather than

relying on its credit history, assets or capital base. This arrangement particularly suits new, small or

mediumsized enterprises (SMEs) without a long history of financial statements. Security for the transaction is

provided by the asset itself.

A Large, Growing Industry

Leasing can be traced back thousands of years, although it has evolved considerably during the last 40 years. The

industry evolved from being a manufacturer's selling technique into a specialized financial service with the

formation of the first independent leasing company in 1952 in the United States. The industry extended to Europe

and Japan in the 1960s and has been spreading through developing countries since the mid1970s. By 1994

leasing had been established in over 80 countries, including over 50 developing economies.

In 1994 over US$350 billion of new vehicles, machinery and equipment was financed through leasing, accountingfor about an eighth of the world's private investment. In OECD countries up to a third of private investment is

financed through leasing.

Developing countries are driving most of the leasing industry's growth today: between 1988 and 1994, new leases

written increased from US$15 billion to US$44 billion. The most spectacular increase has been in South Korea.

Started in 1975 and supported by IFC investments in the first leasing company, the South Korean leasing market

was the fifth largest in the world by 1994.

Furthermore, market penetration (leasing as a share of private investment) more than doubled in both middle and

lowincome countries between 1988 and 1994. By 1994 leasing accounted for an average of 11% of the financing

of capital equipment in middleincome countries, up from just 4% in 1988.

Why Has Leasing Grown so Fast?

Leasing has addressed an unmet demand from new, small and mediumsized firms and attracted borrowers

away from traditional bank loans. It offers advantages to all parties:

The Lessee

Although leasing is a highspread business it offers potential advantages to the lessee:

Simpler security arrangements and the less strict requirements for historical balance sheets mean that SMEs can

access lease finance more easily than bank loans.

Availability . In developing countries leasing may be the only form of medium to longterm finance available

for purchasing equipment.

Convenience . Leasing can be arranged more quickly and simply than conventional loan financing because

outside security often does not need to be established.

Lower transaction costs . Despite the relatively high spreads of leasing, the costs of assigning collateral,

documentation, and slower processing times for bank borrowing can be significant, particularly for smaller


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borrowers.

Little cash required. Leasing can finance a higher percentage of the capital cost of equipment than bank

borrowing, often with little downpayment.

Flexibility . Leasing contracts can be structured to meet the cash flow needs of the lessee.

Tax incentives . In many countries lessees can offset their full lease payments against income before tax,

compared to just the interest on bank loans. Furthermore, lessors may pass on tax benefits associated with their

depreciation to lessees via reduced financing costs. Governments grant tax incentives to leasing because they

recognize that it enables new and small firms to access financing for investment.break

Leasing Companies

Leasing companies also benefit SMEs:

Ownership of the assetgives the lessor strong security. In countries where weak collateral laws hinder bank

lending, leasing offers the advantage of (often) not requiring collateral beyond the security of leased asset itself,and of simpler repossession procedures, because ownership of the asset already lies with the lessor.

Dedicated use of funds . Because the lessor purchases the equipment directly from the supplier there is no

opportunity for the lessee to use the funds for other purposes.

Relatively simple documentation keeps transaction costs down, allowing leasing companies to achieve high

leasing volumes efficiently.

Lighter regulation . Because leasing companies are not usually deposit takers they tend to be less tightly

regulated than banks.

Governments

Many governments have promoted leasing as a way of encouraging investment. But leasing offers other benefits:

it broadens competition in financial services and introduces businesses and financiers to innovations such as

cashflowbased credit analysis.

IFC's Experience

In addition to over 50 technical assistance projects to advise governments on how to promote leasing, between

1977 and June 1995, IFC's Board approved US$523 million via 120 transactions to 63 leasing companies in 36

countries. IFC invested equity in most of these companies at an average of just under US$500,000 per approval.

Over 75% of IFC's leasing financing was approved during the last five years, reflecting:

Industry growth . The industry is quickly spreading to more countries.

Needs of transition economies and lowincome economies . Leasing has proven an appropriate financing source

for the emerging private sector in transition economies and in lowincome regions, such as SubSaharan Africa.

Financial sector stabilization and liberalization . Following severe macroeconomic and financial sector

instability during the 1980s debt crisis, many countries have implemented stabilization and liberalization

programs that have allowed leasing industries to flourish.


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IFC focus . As the importance of leasing to SMEs has become more evident with experience, IFC has stepped up

its promotion efforts.

The leasing companies in which IFC has invested have, on average, proven relatively profitable and efficient.

Returns on equity have averaged over 20 percent. Combined with relatively low provisioning rates (compared to

bank lending), this suggests that leasing is less vulnerable to default than lending. Since IFC made its first loan to

a leasing company in 1977 there have not been any defaults to IFCand none of the loans have shown arrears to

date.

Lessons from IFC's Experience

Within this positive picture, several lessons have emerged from IFC's experience:

Technical partners should have a substantial equity stake (20% 40% ). Although foreign technical partners have

played an important role in the majority of the leasing companies that IFC has sponsored, they have not always

proven effective, for various reasons, including unfamiliarity with the market, cultural differences, and lack of

interest. Technical partners with a substantial investment are more likely to contribute effectively.

Careful portfolio management pays . Many of the problems that arose in IFCsponsored leasing companiesresulted from overly concentrated portfolios by client or sector.

Leasing companies are vulnerable to adverse macroeconomic changes . A worsening of the macroeconomic

climate usually affects smalland mediumsized firms quickly. Such firms often form a high percentage of

leasing customers. Furthermore, if credit is tightened, leasing companies may suffer from financing constraints or

term mismatches.break

Leasing companies benefit from foreign exchange convertibility and reduced tariffs on imported machinery and

equipment. Leasing companies in developing countries often require foreign exchange to purchase imported

equipment, but prefer to denominate their leases in local currency (because of their SME client base). Without

foreign exchange convertibility leasing companies write mostly foreign currency leases to match their loans tofinance imported equipment, which restricts their market to exporters.

Standalone leasing firms compete more vigorously for markets and focus on their portfolios . For this reason

IFC usually prefers to finance standalone companies, although such firms can be at a disadvantage when

competing with leasing subsidiaries of commercial banks, which can tap lowcost depositors' funding from their

parents.

Difficulties in mobilizing domestic financing are often one of the most serious constraints to expansion. This is

one of the key roles that local partners can bring to a new leasing company, as well as knowledge of local

markets.

What Is IFC's Role?

In the long run, IFC's most important and effective approach to financing SMEs is indirect, through promoting

domestic financial institutions that target small and new firms. IFC uses three main mechanisms:

Sponsoring leasing companies ;

Making loans to banks for onlending to SMEs ; and


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Promoting venture capital funds which provide SMEs with equity and managerial advice.

Building these institutions enables a sustainable flow of local financing to reach SMEs, as they all primarily

mobilize domestic financing (appropriate for SMEs, which are not usually prepared to take foreign exchange

risk). Working through such institutions IFC can ultimately reach more SMEs at lower costs than via its

complementary direct financing programs.

Because of its developmental importance, IFC often takes the initiative to promote leasing. Broadly, IFC seeks to

extend the leasing industry to more countries and to promote vigorous, competitive leasing industries in countries

where it already exists. More specifically, IFC advises governments, initiates concepts, undertakes feasibility

studies, sounds out potential technical partners, helps draft business plans and operating policies, mobilizes

funding, invests directly, and sits on the boards of leasing companies.

Mobilizing domestic financing is a particularly important part of IFC's role. Some mobilizating follows almost

automatically after a new leasing company is established because leasing companies typically leverage

themselves. Thus, while a dollar of IFC equity is matched on average by three other dollars of sponsor equity, the

company will leverage its equity by raising 56 times as much debt, enabling it to write over US$20 of leases.

Over the mediumterm, mobilization is higher still because most leasing companies grow rapidly. For example, asample of 11 leasing companies which IFC helped start between 1977 and 1988 had an initial capitalization of

US$61 million (that is, about US$5 million apiece). By 1994 the capitalization of those 11 companies totalled

US$3.3 billion.

What Is the Development Impact?

A rippleeffect of related development impacts from leasing can be identified, with each subsequent impact being

more widespread and powerful than the previous:

More SMEs access financing . In 1994, 16 of IFC's leasing companies wrote over 10,000 new leases worth over

US$2 billion. Lease sizes varied enormously between countries and companies, ranging from one company that

wrote over 2,700 leases worth an average of US$18,000 each to another that wrote a similar number of leasesaveraging US$580,000 each.

The industry grows rapidly as lessors gain experience, and potential borrowers come to understand leasing. For

example, when IFC helped establish Malawi's first leasing company in 1986, it expected the volume of new

leasing business to rise to US$3.6 million after five years. In fact, its new business in 1991 was over double this

level and two new competitors entered the market.break

Increased competition stimulates new product development(leasing to new sectors, crossborder leases, and so

on ) and sometimes reduced spreads . In Bostwana, for example, the new leasing company captured 25% of the

market within its first year. Leasing spreads fell from over 10% in the late 1980s to under 5% in 1994.

Private investment in capital equipment has increasedin many countries which have developed leasing

industries. Although sample sizes are small (18 countries) and direction of causality cannot be proven, there does

seem to be a correlation between the market share of leasing and private investment as a share of GDP.

Leasing companies help develop capital markets . On the assetside, they introduce small and medium businesses

that previously relied on informal financing, supplier credit, and internal cash generation to formal financial

markets. They also increase financing options for larger companies. On the liability side, leasing companies'

efforts to mobilize debt and equity help deepen and broaden domestic capital markets. Leasing companies


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mobilize debtby:

(1) borrowing from banks and finance houses or, where available, pension funds and insurance companies .

Demand from leasing companies broadens the term lending options for all of these institutions.

(2) issuing bonds or other marketable instruments . This broadens the choice and liquidity of instruments on

domestic capital markets. In their search for financing, several of the leasing companies which IFC has supported

have innovated in their domestic bond markets. In Korea, KDLC's W20 billion nonguaranteed corporate bond,

issued in May 1986, was the first domestic securities issue by a Korean leasing company.

(3) finally, securitizing their lease receivables. IFC is working on securitizing lease receivables for some of its

leasing companies.

On the equity side, several IFCsponsored leasing companies have floated their shares. IFC has invested both in

leasing companies that had already listed (for instance, in Sri Lanka and several in India) and has supported others

in which it had stakes to issue shares publicly (Korea, Portugal, Pakistan, and Zimbabwe).

What Makes Successful Leasing Companies?

IFC's experience suggests that six factors enable leasing companies to flourish:

Management. A high standard of cashflowbased credit analysis and supervision of clients, complemented by

followup and equipment insurance procedures are critical.

Competent partners . In many markets where leasing is being introduced, it is important to have an active,

committed and competent foreign technical partner. The technical partner, which should have enough equity to

ensure active participation, should: establish and monitor standards and procedures; train local staff; advise on

lease pricing, marketing and administration; and perhaps second the first general manger.

Funding . The single biggest obstacle to the growth of IFC's investee leasing companies is access to term local

currency funds. Access to term deposits from insurance companies or pension funds or to a local bond markethelps overcome this problem.

Assetliability matching (ALM). Leasing companies must match fixedrate leases with fixedrate term funding,

or if only floating rates are available (locally or internationally), it needs a regulatory framework that allows

periodic adjustments of lease rates.

Attractiveness to lenders . Given their high debtequity ratios, leasing companies must remain attractive to

lenders. Security sharing agreements that establish equal rights to a pool of collateral for senior lenders are often

used in IFC agreements. Also, IFC gives guarantees or direct loans, particularly to new companies that have not

yet established credit histories that allow them to borrow locally.

Regulatory framework. Leasing companies need a regulatory, legal and fiscal environment that at least provides

equal treatment compared withcontinue

other sources of capital investment financing. Clear, simple and effective legal procedures are important to

reclaim assets if the terms of the lease agreement are breached.break


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1Development of Leasing Worldwide

Leasing is big business. In 1994 over US$350 billion of new vehicles, machinery and equipment was financed

through leasing, accounting for about an eighth of the world's private investment. In OECD countries up to a third

of private investment is financed through leases.

Leasing has expanded rapidly over the past 20 years in developing countries. IFC has helped promote this trend

through a combination of technical assistance to governments on leasing regulations, identifying sponsors and

technical partners, and investing in new leasing companies. IFC has invested in leasing companies in over half of

the developing countries with a leasing industry todayoften assisting the country's first leasing company to get

started. IFC has promoted leasing vigorously because of its high developmental impact. It is an especially suitable

financing vehicle for new, smalland mediumsized enterprises (SMEs).

Background

Financial leasing is a contractual arrangement between two parties, which allows one party to use an asset owned

by the other in exchange for specified periodic payments. The lessee usescontinue

Box 1.1: Leasing Definitions

Financial leases are an alternative to bank loan financing of equipmentpurchases. The lessor buys the equipment chosen by the lessee, which is

then used by the lessee for a significant period of its useful life. Financial

leases are often called fullpayout leases because the lease payments

during the lease term usually amortize the lessor's total purchase

costsresidual value is typically between 0% and 5% of the original

acquisition priceplus covering interest costs and providing some profit.

The lessee bears the risk of obsolescence and the cost of maintaining andinsuring the asset. Typically the lessee has the right to buy the asset at the

end of the lease contract for a nominal fee. The companies IFC has

sponsored generally provide financial leases.

Operating leases are not a means of financing equipment purchase.Instead, the lessee contracts for shortterm use of equipment the leasing

company has on hand: car rentals are a typical example. The capital cost

is typically recovered from multiple, serial rentals and the final sale of the

asset. Maintenance and obsolescence risk lies with the leasing company.

Hirepurchase is a hybrid instrument that provides an alternative to

bank financing for purchasing an asset. It is usually sold to retail(individual) customers for financing motorcycles, sewing machines,

refrigerators and other small ticket items. The lessee renders a high down

payment (often around 30% of the cost) and with each lease payment a

higher percent of the title is transferred to the lessee. Thus the lessee

builds equity and transfer is automatic once all the payments are made.

This arrangement is less secure for the lessor juridically because the

lessee is a part owner of the asset; on the other hand, the lessees tend to

have a large enough stake in the equipment that they do not want to risk


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losing it through payment default. Some companies in which IFC invests

provide both hirepurchase and financial leasing.

Table 1.1: Top 50 Leasing Markets,

198819941988 1990 1992 1994

Leasing volume (US$bn )

High income countries

[1]

259 310 292 313

Middle income

countries

12 17 27 39

Low income countries 3 5 5 5

Total [2 ] 274 332 323 357

Market share (% ) [3

]

High income countries 15 15 15 15

Middle income

countries

4 5 9 11

Low income countries 3 4 4 7

Average 9 10 11 13

Source : World Leasing Yearbooks , 19881994.

Note : [1] World Bank classification.

[2] This 1994 survey is based on a sample of 24 high,20 middle, and 6 lowincome countries, as classified

by the World LeasingYearbook.

[3] Unweighted averages. Leasing as % of private

investment.

the asset and pays a rental to the lessor, who owns it. The legal owner relies on the ability of the user to generate

sufficient cash flow to make lease payments, rather than relying on its credit history, assets or capital base.

Security for the transaction is provided by the asset itself. Leasing enables borrowers without welldeveloped

balance sheets or credit histories (especially new or small firms) to use capital equipment in cases where they

would not be able to access traditional bank lending. Box 1.1 describes different leasing arrangements.

Leasing can be traced back thousands of years, although it has evolved considerably during the last 40 years. Inthe nineteenth century, leasing was used by the Bell Telephone Company, and shortterm leases were available

for cotton looms, electricity and gas meters, and some manufacturing equipment. Equipment manufacturers

realized the value of leasing as a marketing tool, and the growth of the aircraft and car industries further

stimulated the development of leasing (partly because repossession of moveable property in the event of default is

relatively easy). The industry evolved from being a manufacturer's selling technique into a specialized financial

service with the formation of the first independent leasing company in 1952 in the United States. The industry

extended to Europe and Japan in the 1960s and has been spreading through developing countries since the

mid1970s. By 1994 leasing had been established in over 80 countries, including over 50 developing economies.


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Developing Markets Driving Leasing Industry Growth

Leasing is now a mature industry in most highincome economies. The United States is a clear leader both in

terms of volume (with US$140 billion of leases written in 1994) and market penetration (with 30% of plant and

equipment purchases). In many developing economies, however, leasing has been growing very rapidly. Between

1988 and 1994 new leases written in developing countries increased from US$15 billion to US$44 billion. By

1994, middle and lowincome countries accounted for five out of the largest twenty leasing markets. The most

spectacular increase has been in South Korea. Started in 1975 and supported by IFC investments in the first

leasing company, the South Korean leasing market was the fifth largest in the world by 1994.

Furthermore, market penetration (leasing as a share of private investment) more than doubled in both middle and

lowincome countries between 1988 and 1994 (see Table 1.1 and Figure 1.1). By 1994 leasing accounted for an

average of 11% of the financing of capital equipment in middle income countries, up from just 4% in 1988.

There are some important caveats to these data which, while they do not affect the broad conclusions, do mean

that crosscountry comparisons should be treated carefully. Euromoney's World Leasing Yearbookpubsoft

Figure 1.1:Leasing in Developing Countries, 19881994

lishes figures on the 50 largest leasing markets, of which about half are in developing economies (see Appendix

Table A1). Definitional differences mean that the numbers are not strictly comparable between countries.

Furthermore the small number of low income countries in the top 50 markets means that the large jump in

market share between 1992 and 1994 should be treated as indicative of the trend rather than representative of all

low income countries.1

On average, leasing was financing 11% of private investment in middleincome countries by 1994, yet wide

variation remains between countries. Thus, leasing's share of private capital investment in South Korea exceeds

20%, while it is below 2% in Thailand (Box 1.2 explains why).

Regional Trends

America still accounts for 40% of worldwide leasing, yet the regional distribution of leasing has changed

markedly during the past five years. In 1993 Asia overtook Europe for the first time, and in 1994 accounted for

28% of the world market compared to Europe's 25 percent. Latin America's share increased by more than five

times from 0.8% in 1989 to 4.2% in 1994. Africa's share of the global total increased marginally from 1% to

1.3%, but the figures should be treated with caution as South Africa and Morocco have been the only two African


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countries in the top 50 leasing markets every year since 1989.

Although variations in data quality between countries mean that the figures should be considered indicative rather

than precise, regional trends in the market penetration of leasing broadly reflect the pattern set by volumes (see

Table 1.2). While leasing has matured in the United States and Europe, leasing's market share grew from an

average of 3.5% in 1988 to 13.4% of capital investment in 1994 in the Latin American countries in the top 50

markets (Brazil, Mexico, Colombia, Venezuela, Chile, Peru and Ecuador). The increase in Asia was almost as

dramatic, from 4.4% to 7.8 percent.break

Table 1.2: Private Investment Financed by Leasing ,

19881994

Regionalaverage

1988(% )

1990(% )

1992(% )

1994(% )

North America 21.3 20.6 21.5 22.1

Asia 4.4 4.9 5.9 8.2

Europe 11.7 12.1 13.5 13.4

Latin America 3.5 5.4 8.8 13.4

All regions 9.0 9.6 10.9 12.5

Source : World Leasing Yearbook. IFC.

Note : Unweighted averages. Market share for Africa

and Australia/NZ not shown because of small sample

sizes; these markets, however, are included in the "All

Regions" average. World Leasing Yearbook, 1995.

Box 1.2: Leasing Development in Korea and Thailand

Why does leasing account for a much higher share of private capital

investment in Korea than Thailand? The answer is mainly in the

countries' different regulatory and fiscal environments.

In 1973 the Korean government, drawing on IFC advice, enacted a

leasing industry promotion law, which defined the regulatory framework

for leasing. In 1976 the government issued leasing regulations, which

stipulated the type of assets that licensed leasing companies may lease,

specified that lessees could deduct lease payments before tax, and that

lessors could deduct interest charges and accelerated depreciation before

tax. In addition, leasing companies were exempted from customsrestrictions on importing equipment, and allowed more expeditious

treatment in the handling of foreign trade transactions. Later in the decade

restrictions on spreads and local borrowing were removed.

As the demand for capital equipment rose with Korea's rapid economic

growth, leasing companies were better placed than banks to meet it. As

part of its tight monetary policy, the government imposed restrictions on

bank lendingwhich meant that bank lending to SMEs was particularly


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constrained. Being less tightly regulated than banks, leasing companies

were able to respond to the increased lending opportunities.

Thailand's first leasing company started in 1978, with IFC participation.

However the industry grew slowly until the early 1990s. Until 1991

reforms, the tax treatment of leasing was harsher than the two

alternatives: bank borrowing or hirepurchase. This is well illustrated bythe change after the law was amended. In 1993 leasing volume tripled to

US$560 million, from US$180 million in 1992.

Leasing:Important to SMEs

Leasing is even more important to new, and small and mediumsized firms than these large, growing volumes

and market shares suggest. Surveys of how companies finance themselves typically focus on how firms draw on

three main sources of capital: internal cash, bank loans and capital markets. Yet in many developing countries

capital markets are relatively undeveloped, and banks (understandably) often prefer to lend to larger firms that can

offer stronger security. Banks are also often reluctant to undertake term lending. New or small firms withoutstrong collateral (or which are located in countries without effective laws for repossessing security) typically do

not have access to much bank lending; leasing or supplier credits may be their only external financing options.

In South Korea for example, leasing (which is provided by both banks and nonbank financial institutions)

accounts for nearly a fifth of total finance raised by the business sector (see Table 1.3). It is the single most

important source of external finance for small firms.

Why Has Leasing Grown so Fast?

The rapid growth of leasing in so many countries suggests that the product has both addressed an important unmet

demand and attracted borrowers away from traditional financial products such as bank loans. It offers advantagesto all parties:

The Lessee

Although leasing is generally a highspread business, there are many advantages for the lessee, compared to

conventional bank borrowing:

Simpler security arrangements and the less strict requirements for historical balance sheets means that new,

small and mediumsized enterprises can access lease finance more easily than bank loans.

Availability . In developing countries leasing may be the only form of medium to longterm finance available

for purchasing equipment.

Convenience . Leasing can be arranged more quickly and simply than conventional loan financing because

outside security often does not need to be established. Furthermore, many leases are provided by specialized

companies, with management focused on providing leasing related services. Speed and ease of processing are an

important source of competitive advantage to such companies.

Lower transaction costs . Despite the relatively high spreads of leasing, the costs of assigning collateral,

documentation and slower processing times for bank borrowing can be significant, particularly for smaller


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borrowers (as many of these costs are fixed and not based on the size of the loan).

Little cash required. Leasing can typically finance a higher percentage of the capital cost of a piece of equipment

than bank borrowing, often with little or no initial down payment required. This allows the company to preserve

its cash or bank facilities to meet working capital needs.

Flexibility . Leasing contracts can be structured to meet the cash flow needs of the lessee.2

Tax incentives . In many countries lessees can offset their full lease payments against income before tax,

compared to just the interest on bank loans. Furthermore, lessors may pass on tax benefits associated with their

depreciation to lessees via reduced financing costs. The tax incentives reflect the fact that governments recognize

that there are economic benefits associated with leasing, as it expands productivity by enabling new and small

firms to access financing for investment (see Box 1.3).break

Table 1.3: Finance Raised by Korean Firms ,19911993(US$ billions ) [1 ]

Financing source 1991 1992 1993

Banks [2] 15.8 10.6 10.5

Nonbanks [2] 17.5 14.9 14.6

Bonds, stocks, and

commercial paper

30.2 29.0 40.9

Borrowing from abroad 3.3 3.2 1.6

Others (trade credits, govt) 12.8 12.5 12.3

Total including leasing 79.5 70.3 76.7

New leasing contracts 9.9 12.0 14.2

Leasing as % of total 12.4% 17.1% 18.5%

Source : Bank of Korea Quarterly Economic Review ,

June 1994.

Notes : [1] Conversion to US$ based on average

conversion rate for the year as cited in Emerging Stock

Markets Factbook, IFC. 1991 = 732W/US$; 1992 =

780W/US$; 1993 = 802.6W/US$.

[2] Including leasing.

Box 1.3 : Leasing Levels the Playing Field for Investment Incentives

Some observers consider leasing to be tax driven and thus without

fundamental economic benefits. To the contrary, while it is true that the

fiscal regime plays a crucial part in development of a leasing industry, it

is inaccurate to say that tax arbitraging does not yield economic benefits.


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Most countries use tax incentives to promote capital investment, through

instruments such as accelerated depreciation, investment allowances or

investment tax credits. However the value of these benefits is not equal to

all firms. They tend to be most useful to existing firms that have taxable

profits against which to offset these allowances. New or small firms

(which may be making losses or only small profits) may not be able to

use these tax benefitsthe firms are deemed "tax exhausted." And yetsome of them might have investment opportunities that would yield

higher returns to the economy than the firms that are able to take

advantage of the tax incentives. Enter the leasing company, which buys

the equipment and (as legal owner) offsets the depreciation against its

taxable profits. It then passes on part of the benefit to the lessee, via a

lower financing costor by making the loan at all. There are variations,

but the principle is the same: giving the same incentives to invest to

taxexhausted firms as to those with tax capacity. Sometimes a leasing

company can act as a broker between a firm with a potential investment

but no tax position and a company with tax capacity but weak investment

alternatives.

The existence of a leasing industry thus may allow a mismatch in tax

positions to be arbitraged, such that capital investment is more likely to

be undertaken by the firm that expects the highest marginal return on

investment, even if it does not have a favorable tax position. The overall

volume and efficiency of capital investment is higher than in an economy

where tax positions cannot be swapped between firms. Governments

recognize these benefits and often devise their tax regimes to encourage

arbitraging and thus promote investment efficiency.

The Lessor

Leasing offers profitable opportunities to reach borrowers and expand into existing markets. Advantages include:

Ownership of the assetgives the lessor strong security. In countries where weak collateral laws hinder bank

lending, leasing offers the advantage of (often) not requiring collateral beyond the security of the leased asset

itself, and of simpler repossession procedures, because ownership of the asset already lies with the lessor. In some

countries, bank loans are commonly structured as leases because problems with the judicial system mean that

recovering collateral on bank loans is difficult.

Dedicated use of funds . Because the lessor purchases the equipment directly from the supplier (often after the

lessee has chosen it), there is no opportunity for the lessee to utilize the funds for other purposes.

Relatively simple documentation keeps transaction costs down, allowing leasing companies to achieve high

volumes efficiently (see Box 1.4).

Lighter regulation . Because leasing companies are not usually deposit takers they tend to be lesscontinue

Box 1.4: Competitive Advantage for a Lessor: Processing ,Relationships and Marketing

A midterm evaluation of an IFC investment in a Sri Lankan leasing


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company found that it was facing competition from two

governmentowned development finance institutions (DFIs) that offered

potential borrowers both leasing and loans. The DFIs had a considerable

funding advantage: they were allowed access to subsidized funds, and

their financings were not subject to the turnover taxes levied on private

leasing companies. Nevertheless, the independent leasing company was

able to compete successfully by exploiting its areas of comparativeadvantage:

speedy processing: Its average processing time for a lease was one week,

compared to 48 weeks for the DFSs;

aggressive marketing;

leasing relatively small items, where other factors than simply the cost of

financing are important; and

close client relationships, which facilitate processing and supervision.

tightly regulated than banks. This may allow them to use higher leverage than some other financial institutions

(and frees them from directed lending mandates sometimes imposed on banks by governments).

Governments

Governments in many countries have realized that leasing facilitates investment in capital equipment and have

promoted the development of the industry. Furthermore, the benefits may go beyond improved access to

financing. A leasing industry broadens competition in financial services and introduces businesses and financiers

to financial innovations, such as cashflowbased credit analysis. And by facilitating the financing of imported

capital equipment, leasing companies can help transfer technology to domestic industries.

Leasing and Financial Sector Development

While there is no single universal pattern of financial sector development, a typical course of development has

been observed in many developing economies over the past 50 years. The banking system has been heavily

controlled or directly owned (private banks were nationalized and/or new stateowned banks set up) by

governments. Banks are the primary means of mobilizing domestic savings and are the major source of credit for

enterprises. Until the end of the 1980s, it was common for governments to direct bank lending to favored sectors,

including SMEs. Numerous stateowned development finance institutions were set up for this purpose. In some

countries, stateowned insurance companies and pension funds were established, sometimes as government

monopolies.

To complement the banking system, usually some form of money market evolves. In some countries government

bonds have provided mediumterm investment vehicles for the market. Where they have developed, security

markets provide vehicles for raising and trading debt and equity. Many LDCs' securities markets are dominatedby government bonds in the early stages but, as they develop, they provide debt and equity capital for enterprises

and new term instruments for investors.

As markets liberalize and governments become more committed to eliminating market distortions, interest rate

and credit controls have been loosened, banks have been privatized and new private banks have been allowed to

bring competition to oligopolistic markets. Banks have started lending more on commercial terms; initially they

focus on larger, established companies with a credit history and collateral. New enterprises and SMEs, without

these benefits, have still faced difficulties in accessing bank credit. Leasing has helped address these needs.


Governments 22


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As leasing develops, it helps fill gaps in the asset, liability and security markets:

Asset side . Leasing companies can profitably lease to smaller enterprises on the basis of the cash flow to be

generated by the leased asset instead of on the lessee's credit history and other collateral.

Liability side . In the early stages of leasing, lessors generally borrow from insurance companies, pension funds

and banks, giving these institutions a broader base of mediumterm assets in which to invest.

Securities markets . As a leasing company develops a credit history, it can issue commercial paper, notes or

bonds on the securities market. Often the companies enhance the security of this paper by giving the security

holders claim to the lease receivables, which represents a diverse pool of lessees and equipment. Lessors may also

tap the equity markets by going public once they have established a satisfactory operating history. At the next

level of sophistication, lessors can securitize their lease receivables (as is done in developed markets) thus

creating another marketable security, tapping a larger pool of funding, and increasing their debt capacity.

What Leasing Needs:A Conducive Macroeconomic Environment

A healthy leasing industry requires private investment activity which, in turn, is facilitated by a positivemacroeconomic environment: fiscal and price stability, undistorted prices of capital and foreign exchange,

competitive markets and availability of mediumterm local currency finance. Leasing companies particularly

need: 1) access to local currency in tenors of three years or more (from banks or institutions such as life insurance

companies); and 2) foreign exchange convertibility. Incontinue

most developing countries, foreign exchange is needed for importing capital equipment but lesseesespecially

small and domesticallyoriented firmsare unwilling to take foreign exchange risk by accepting

dollardenominated leases. So leasing companies need foreign exchange convertibility (or locally available

hedging mechanisms) in order to offer local currency leases to finance imported equipment.

What Leasing Needs:A Conducive Regulatory Environment

The appropriate regulatory treatment of leasing recognizes it as a viable alternative to outright purchase and

provides equal or more favorable regulatory treatment vis vis other methods of financing capital investment.

Creation of a suitable environment involves three elements: legal, supervision/regulation, and tax/accounting.

Legal

The rights and duties of the lessor as legal owner of the equipment and the rights and duties of the lessee as user

should be clearly stated. The legal owner needs a clear, simple, workable and timely process to reclaim an asset if

the terms of the lease are breached by the lessee, including automatic right of repossession without lengthy court

proceedings and the right to claim payments due and other damages. If repossession is legally and juridically

easy, leasing companies can then write riskier business than otherwise, and they can price their leases with a

lower risk premium, allowing them to make credit available more cheaply.

The lessee must have the right to use the equipment unimpeded and gain the full productivity of the asset.

Typically, the lessee also has the right to assume ownership upon the exercise of a preagreed purchase option at

the end of the contract. At the same time, the lessee is obligated to make timely lease payments, and insure and

maintain the equipment.3 In some transforming economies where laws have been evolving, it has been necessary

to clarify that the lessee also has no right to create a lien on leased assets.


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Supervision and Regulation

As most leasing companies do not take deposits from the public and do not participate in central bankoperated

money markets, they are rightly subject to much less regulation than commercial banks. This relative freedom

from government controls has been one key to their success. Governments have been much less tempted to use

leasing companies as vehicles for achieving noncommercial social or political goals.

In countries with regulatory bodies overseeing leasing (usually the central bank or the ministry of finance), thosebodies often oversee the prudential conditions for the operation of leasing companies, such as: maximum

debt/equity ratios, minimum capital requirements, ability to raise wholesale or retail deposits, whether leasing

companies must be standalone entities (for instance, if the company is part of a bank or is operated as a separate

subsidiary), and mandatory provision of transparent and standardized financial statements. IFC often encourages

the development of prudential guidelines to protect both leasing company creditors and their lessees from

unsound lessors, thereby promoting the expansion of the leasing industry.

Tax and Accounting

Tax and accounting regulations vary among countries due largely to differing views as to whether legal ownership

or use of the asset defines which party may depreciate the asset. Often the accounting treatment and the tax

treatment for leasing companies will differ to reflect the differing purposes of the two sets of accounts:

Financial accounting is designed to give shareholders a fair picture of the leasing company's health.

Tax accounting is intended to give national tax authorities the flexibility to encourage capital investment. Most

countries have tax regimes preferential to capital investment and to small businesses so it is consistent to offer

fiscal incentives through firms such as leasing companies that deal almost exclusively in financing capital

equipment and offer finance to new and small businesses.

In many countries with vibrant leasing industries, the lessoris treated as the owner of the asset for tax purposes,

and often for accounting purposes as well. The lessor treats the entire lease payment (interest and principal) as

income and depreciates the asset on its books, usually on an accelerated schedule. For the lessor, income is 1)accelerated and therefore taxed earlier than it would be for a bank, and 2) a larger taxable amount than it would be

for a bank as it includes interest andcontinue

repayment. On the other hand, to level the playing field the leasing company takes the depreciation of the asset.

The lessee claims the full lease payment as a deduction from taxable income. Since the lease payment includes

both interest and the full cost of the equipment, this allows the lessee an effective "depreciation" period equal to

the life of the lease, which is generally shorter than the economic life of the equipment.4

From the point of view of national fiscal authorities there may be a "double dip" in that the lessor takes full

depreciation and the lessee simultaneously expenses the repayment portion of the lease. Most governments have

embraced this fiscal treatment for these reasons:

Promoting investment. The "double dip" enables government to encourage the use and financing of productive

equipment and to facilitate the extension of credit to firms which would not qualify for bank loans and/or are "tax

exhausted" (see Box 1.3).

Limited cost in early stages . A new leasing company has virtually no taxable income with which to offset

depreciation. Thus there is no loss of income to the national treasury in the early years of the industry. Likewise,

SMEs and new enterprises often do not have sufficient taxable income to make the deduction of the full lease


Supervision and Regulation 24


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payment useful.

Encouraging the industry . Empirically, IFC has found that leasing companies do not enter markets aggressively

unless the asset depreciation is available to them, even if they cannot make full use of it until later years.

The International Accounting Standards of 1991/1992 recommended that the lessee , as the economic if not legal

owner of the equipment, include the leased asset on its balance sheet and take the depreciation expense (Appendix

Box A1 gives a worked example). Under these recommendations, the lessor lists the lease receivable as an asset

on its books. While this may be a reasonable accounting treatment, empirically, IFC has found that the adoption

of this principle for tax accounting has led to the demise or decline of the leasing industry in some countries (for

example, Kenya) over certain periods.

IFC has encountered instances where tax incentives, investment allowances and sales taxes have become tax and

accounting issues. In general, leasing companies should receive the same treatment as an industrial company

which is buying an asset with bank finance. For example, the leasing company should be allowed to take the

investment credit or accelerated depreciation that industrial companies are given, as this will simply be passed on

to the user of the equipment in the lease price. Likewise, sales taxes on the original asset purchase should be

levied once. Where a second sales tax is levied when the lessee exercises a purchase option, this should be based

on the amount actually paid and not on the assessed value, as the equipment has usually already been depreciatedfully by the original owner (that is, the lessor).break

1. Definitions of leasing differ between countries. The World Leasing Yearbookuses the local definition. The

denominator used to calculate market penetration varies. In the United States, for example, it is total private

nonresidential investment in producers' durable equipment. In many developing countries such series do not exist;

in these cases the denominator used was total private investment, as reported in Trends in Private Investment in

Developing Countries 1994 (IFC).

2. Examples include: 1) stepup/stepdown lease, which increases/decreases payments over the lease term to fit

in with the lessee's cash flow; 2) seasonal/skipped payments lease, which is structured to meet seasonal cash flow

constraints; 3) fixed or floating payments; 4) adjustable payment terms: in advance or arrears, and at varying

periods.

3. Often lessors actually provide these services on behalf of their clients for a fee.

4. The tax benefit is thus one oftiming , not forgiveness .

2IFC's Leasing Experience

In addition to carrying out over 50 technical assistance projects to advise governments on how to introduce or

promote leasing, IFC has invested in numerous leasing companies in developing countries and worked with alarge number of technical partners and other private investors.

Accelerating Approvals

Between its first investment in the Korea Development Leasing Corporation in 1977 and June 1995, IFC's Board

approved US$523 million via 120 transactions to leasing companies (see Table 2.1 and Appendix Tables A2A5

for a full list). These approvals covered 63 companies in 36 countriesover half of the developing countries that

have leasing industries. IFC supported the growth of many of the companies with several loans and investments


2 IFC's Leasing Experience 25


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over time. For example, IFC's Board approved eight investments in Colombia's Leasing Bolivar between 1980

and June 1995.

Table 2.1: IFC Approvals, 1977June 1995: The Big Picture

Number US$m US$m

Approvals 120 IFC approvals 523 Average approval: 4.4

Companies 63 of which: Debt 6.5

Countries 36 FY77FY90 122 Equity 0.5

FY91FY95 401

Debt 483

Equity 40 Approved for IFC

syndication

232

IFC's average leasing approval was US$4.4 million, well below its overall average of about US$11 million per

project. Even more striking is the small size of the average equity approval of just under US$500,000. Thisreflects several characteristics of leasing companies and IFC's involvement in them:

IFC often participates at the startup stage, which may only require a modest amount of equity and perhaps a

small loan;

Leasing companies are relatively small financial institutions; they raise much of their debt from local financial

markets; and,

Much of their growth is typically financed by internal cash generation.

A frequently observed pattern involves an initial equity investment by IFC in a new leasing company, followedlater by a loan. For example, IFC invested US$0.6 million in Ghana's first independent leasing company in 1991,

invested a further US$0.15 million in 1993, andcontinue

provided a US$5 million loan in mid1993 to help expand the company's foreign currency lease portfolio.

Much of IFC's financing has occurred during the last five years (Figure 2.1 shows the historical pattern of IFC's

equity approvals since 1977). Over threequarters of the US$523 million of IFC's leasing financing was approved

during FY91FY95, reflecting:

Industry growth . This relatively young industry is quickly spreading to more countries.

Needs of transition economies and lowincome economies . The emerging private sector in transition economies

is finding leasing an increasingly important financing source. And leasing has proven an appropriate and

financially successful way of supporting firms in lower per capita income regions, such as SubSaharan Africa.

IFC has been closely involved in promoting leasing industries in both these areas.

Financial sector stabilization and liberalization . Following severe macroeconomic and financial sector

instability during the 1980s debt crisis, many countries have implemented stabilization and liberalization

programs that have allowed leasing industries to flourish.


2 IFC's Leasing Experience 26


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IFC focus . As the importance of leasing to new, small and mediumsized enterprises has become

Table 2.2: IFC Commitments, 1977June 1995

Number US$m

Commitments 92 IFC commitments 374

Companies 49 of which:

Countries 31 FY77FY90 88

FY91FY95 286

Debt 342

Equity 32

more evident with experience, IFC has promoted the industry more vigorously.

IFC's Commitments

By June 1995, IFC had committed US$374 million to 49 leasing companies in 31 countries (see Table 2.2).1 The

difference between approvals (US$523 million) and commitments is partly explained by the large number of

projects approved in 1994 and 1995, many of which had still not been committed. In addition, about 15% of IFC's

leasing approvals (mostly loans) have been dropped or cancelled. The reasons include declines in local interest

rates which have made foreign loans uncompetitive, and the unwillingness of leasing customers to take on the

foreign exchangedenominated leases,2 business difficulties in some leasing companies, and governmentrelated

problems (slow or revoked approvalscontinue

Figure 2.1:

IFC's Leasing Equity Approvals, FY77FY95

source: IFC


IFC's Commitments 27


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Figure 2.2:

IFC's Leasing Commitments by Region, 1977June 1995

source: IFC

and inappropriate regulations). In some cases, the approval of IFC's Board for a new leasing project may be used

to help trigger changes in leasing regulations by a government, or to seal commitment by foreign or domestic

partners to the project. Occasionally these followup actions do not happen, and IFC is unable to participate in the

project.

Wide Geographic Coverage

In terms of volume, nearly half of IFC's commitments have been to leasing companies in Asia (see Figure 2.2 and

Table 2.3). IFC has helped develop leasing in several Asian countries, including setting up the first company in

Korea, Bangladesh, Sri Lanka, Thailand, and some regions of India, as well as encouraging competition by

financing new entrants in Indonesia, Thailand, the Philippines and India.

IFC's US$94 million of commitments to the Middle East and North Africa region are dominated by loans to

several leasing companies in Pakistan. But IFC has been active throughout the region, financing the first

specialized leasing companies in Jordan, Oman, Pakistan, Tunisia, the Lebanon and, most recently, Uzbekistan.

In Latin America , IFC helped introduce leasing to the Dominican Republic and Peru. IFC also helped the leading

Chilean leasing company to access sevenyear finance in the international markets by syndicating half of a

US$30 million loan in 1993.

IFC's involvement in promoting leasing in SubSaharan Africa has been substantial. Leasing companiesoften

the first in the countryhave been financed in Zimbabwe, Botswana, Malawi, Ghana, Senegal, Benin, Tanzania,

Uganda, and Cte d'Ivoire. Reflecting the size of the domestic markets, most of these transactions have been

small and many have involved providing startup equity, so the region does not stand out significantly in overall

volume terms. IFC's leasing activities have intensified in SubSaharan Africa as economic reforms have helped to

improve distressed banking sectors, and governments have recognized the importance of leasing for financing

small and mediumsized companies.

IFC accelerated its leasing promotion activities in Europe with the fall of the Berlin Wall. Leasing has proven a

particularly appropriate financing source for the emerging private sector in the transition economies, where most

firms have a limited track record, legal difficulties often restrict the use of collateral, and many banks are

undergoing major restructuring programs. IFC has financed leasing companies in the Czech Republic, Romania,

Slovenia, and Estonia, with investments in other transition economies being appraised. In addition IFC drafted the

leasing regulations and supported one of the first companies in Turkey.


Wide Geographic Coverage 28


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Table 2.3: Regional Distribution of IFC Commitments, 1977June 1995

(US$ million )

Companies

% of

total

Equity

(US$m)

Loans

(US$m )

Total

(US$m )

% of

total

Asia 18 37 21.6 155.7 177.3 47LAC 5 10 2.4 58.0 60.4 16

CAMENA 11 22 2.2 91.5 93.6 25

Africa 8 16 2.8 18.2 21.0 6

Europe 7 14 3.0 18.6 21.6 6

Total 49 100 32.0 342.0 373.9 100

Source: IFC.

Mobilization

For each dollar provided by IFC to leasing companies, other sponsors have put in over three dollars. Thus, IFC's

commitments of US$374 million have been associated with total financing of US$1.5 billion. Mobilization rates

werecontinue

higher in Europe and Middle East/North Africa (see Table 2.4).

In practice mobilization rates are significantly higher, at least for the equity that IFC invests, as leasing companies

leverage themselves through borrowing (see Figure 2.3). While a dollar of IFC equity is matched by three other

dollars of sponsor equity, the company will leverage its equity by raising 56 times as much debt. Thus, each dollar

of equity that IFC invests typically e

bm leasing in emerging markets

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