A Profile of the Leasing Business in India

25 years ago, Farouk Irani quit his high profile job in Citibank to launch his dream project: a leasing company in India. On 10thA Sept., 1973, Irani was able to convince Dr A C Muthia, Industrialist, to have the First Leasing Company of India incorporated. For several years, First Lesing Company remained the Only Leasing Company. Ever since IFC, Washington decided to support Indian leasing with investment in companies in 4 metros, Indian leasing has never looked back. This was about 1980. Early eighties' capital market boom found many young entrepreneurs riding the leasing wave.A As it celebrates its 25thA Birthday, Indian leasing is today a central part of the financial system. On its way, it has passed through several twists and turns. Financial industry World-over has a very high beta factor: it is hyper-sensitive to changes in economic scenario. Periods of general prosperity are extremely good for the leasing industry; downturns in economic cycle cost is extremely high. That apart, financial system is invariably affected by the contagion effect: failures of a few players affect even the healthy ones.

Evolution of Indian Leasing Industry

Leasing activity was initiated in India in 1973. The first leasing company of India, named First Leasing Company of India Ltd. was set up in that year by Farouk Irani, with industrialist A C Muthia. For several years, this company remained the only company in the country until 20thA Century Finance Corporation was set up - this was around 1980. By 1981, the trickle started and Shetty Investment and Finance, Jaybharat Credit and Investment, Motor and General Finance, andA Sundaram FinanceA etc. joined the leasing game. The last three names, already involved with hire-purchase of commercial vehicles, were looking for a tax break and leasing seemed to be the ideal choice. The industry entered the third stage in the growth phase in late 1982, when numerous financial institutions and commercial banks either started leasing or announced plans to do so.A ICICI, prominent among financial institutions, entered the industry in 1983 giving a boost to the concept of leasing. Thereafter, the trickle soon developed into flood, and leasing became the new gold mine. This was also the time when the profit-performance of the two doyen companies, First Leasing and 20th Century had been made public, which contained all the fascination for many more companies to join the industry. In the meantime,A International Finance CorporationA announced its decision to open four leasing joint ventures in India. To add to the leasing boom, the Finance Ministry announced strict measures for enlistment of investment companies on stock-exchanges, which made many investment companies to turn overnight into leasing companies. As per RBI's records by 31st March, 1986, there were 339 equipment leasing companies in India whose assets leased totaled Rs. 2395.5 million. One can notice the surge in number - from merely 2 in 1980 to 339 in 6 years. Subsequent swings in the leasing cycle have always been associated with the capital market - whenever the capital markets were more permissive, leasing companies have flocked the market. There has been appreciable entry of first generation entrepreneurs into leasing, and in retrospect it is possible to say that specialized leasing firms have done better than diversified industrial groups opening a leasing division. Another significant phase in the development of Indian leasing was the Dahotre Committee's recommendations based on which the RBI formed guidelines on commercial bank funding to leasing companies. The growth of leasing in India has distinctively been assisted by funding from banks and financial institutions. Banks themselves were allowed to offer leasing facilities much later - in 1994. However, even to date, commercial banking machinery has not been able to gear up to make any remarkable difference to the leasing scenario. The post-liberalization era has been witnessing the slow but sure increase in foreign investment into Indian leasing. Starting with GE Capital's entry, an increasing number of foreign-owned financial firms and banks are currently engaged or interested in leasing in India.

Pre 1970

1970-1995

1995-2004

- Only HP companies

- Automobile financing mainly for commercial vehicles

- Fixed Deposit: main source of funds - Entry into equipment finance through: * Leasing * Hire Purchase

- Commencement of car finance

- Access to Capital Markets

- Funds from FDs and Banks - Exit of large no. of companies: * Small &Large * Indian &Foreign - Regulation by RBI - Few companies diversified into related financial services

Major Constituents of Indian Leasing Industry

Lessors

Specialized leasing companies: There are about 400-odd large companies which have an organizational focus on leasing, and hence, are known as leasing companies. Till recently, most of them were diversified financial houses, offering several fund-based and non-fund based financial services. However, recent SEBI rules on bifurcation of fund-based and non-fund based activities has resulted into hiving-off of merchant banking divisions of these entities. Banks and bank-subsidiaries: Till 1991, there were some ten bank subsidiaries active in leasing, and over-active in stock-investing. The latter variety was ravaged in the aftermath of the 1992 securities scam. In Feb., 1994, the RBI allowed banks to directly enter leasing. So long, only bank subsidiaries were allowed to engage in leasing operations, which was regarded by the RBI as a non-banking activity. However, the 1994 Notification saw an essential thread of similarity between financial leasing and traditional lending. Though State Bank of India, Canara Bank etc have set up leasing activity, it is not currently at a scale to make any difference on the leasing scenario. This is different from the rest of the World, where banks are front-runners in leasing markets. Specialized Financial institutions: There is a wide variety of financial institutions at the Central as well as the State level in India. Apart from the apex financial institutions, viz., the Industrial Development Bank of India, the Industrial Finance Corporation of India, and the ICICI, there are several financing agencies devoted to specific causes, such as sick-industries, tourism, agriculture, small industries, housing, shipping, railways, roads, power, etc. In most States too, there are multiple financing agencies for generic or focussed cause.Most of these institutions are using the lease instrument along with traditional financing instruments. Significantly, the ICICI was one of the pioneers in Indian leasing. At State level also, financial institutions are active in leasing business. One-off lessors : Some of the companies engaged in some other business which gives them huge taxable profits, have resorted to one-off leasing on a casual basis to defer their taxes. These people are interested only in leasing of high-depreciation items, preferably those entitled to 100% depreciation. Manufacturer-lessors: This part of the lessor-industry is in highly under-grown form in India, for simple reasons. Vendor leasing is a product of competition in the product market. As competition forces the manufacturer to add value to his sales, he finds the best way to sell the product is to sell it without the buyer having to pay for it instantly. Product markets so far for most durables were oligopolistic, and good products used to sell even otherwise at a premium. With the economy decisively moving towards market orientation, competition has become inevitable, and competition brings in its wake sales-aid tools. Hence, the potential for vendor leasing is truly great.

The Lessees

Corporate customers with very high credit ratings:A These essentially look at leasing to leverage against assets which are otherwise not bankable, or for pure junk financing. Public sector undertakings:A This market has witnessed a very rate of growth in the past. With budgetary grants to the PSUs coming to a virtual halt, there is an increasing number of both centrally as well as State-owned entities which have resorted to lease financing. Mid-market companies: The mid-market companies, that is, companies with reasonably good creditworthiness but with lower public profile have resorted to lease financing basically as an alternative to bank/institutional financing, which to them is time-consuming and tedious. Consumers:A Retail funding for consumer durables was frowned-upon at one point of time, but recent bad experience with corporate financing has focused attention towards consumer durables which incidentally, is all the all-time favorite of financiers World-over. Most of the larger companies have expressed interest in consumer funding, with ticket size going as low as Rs. 5000. Car customers:A Car leasing World-over is a very big market, and the same is true for India. So long, most car leases were plain-vanilla financial leases but one now finds few instances of value-added car lease services also being offered. Commercial vehicles:A Commercial vehicles customers have always relied upon funding by hire-purchase companies. The customer profile ranges from large fleet owners to individual truckers. Earth-moving machinery customers:A These customers have also traditionally relied upon lease financing. Their requirements are generally large - each excavator costs more than Rs. 25 lacks. The income-stream is based on contracts they have - at times, the income generation may be sporadic, or the need might itself be temporary. In fact, operating leases would have been ideal in this market, but they are yet to be launched to any serious degree. Govt. depts. and authorities: One of the latest entrants in leasing markets is the Govt. itself. The Dept. of Telecommunications of the Central Govt. took the lead by floating tenders for lease finance worth about Rs. 1000 crores. In its reforms, India has limits to the extent to which it can resort to deficit financing, and leasing is easily going to appeal to the Govt. , if not for cost reasons, at least for the fact that it will not feature in national accounts as a commercial financing. As a spin-off, it might even help reducing the reported deficit, as the Govt. resorts to what is loved World-over as a tool of off-balance-sheet financing.

Factors that contributed to the growth of Indian Leasing Industry

With the exception of 1996-97 and 1997-98, the 1990s have generally been a good decade for Indian leasing. The average rate of growth A on compounding basis works out to 24% from 1991-92 to 1996-97. Broadly, the following factors have been responsible for the growth of Indian leasing, in no particular order: No entry barriersA - any one could float a leasing entity, and even an existing company not in leasing business can write a lease purely for tax shelters. Buoyant growth in capital expenditure by companiesA - The post -liberalization era saw a spate of new ventures and fresh investments by existing venturers. Though primarily funded by the capital markets, these ventures relied upon leasing as a source of additional or stand-by funding. Most leasing companies, who were also merchant bankers, would have funded their clients who hired them for issue management services. Fast growth in car market:A Needless to state with facts, the growth in car leasing volume has been the highest over these years - the spurt in car sales with the entry of several new models was funded largely by leasing plans. Tax motivations:A India continues to have unclear distinction between a lease that will qualify for tax purposes, and one which would not. In retrospect, this is being realized as an unfortunate legislative mistake, but the absence of any clear rules to distinguish between true leases and financing transactions, and no bars placed on deduction of lease tax breaks against non-leasing income, propelled tax-motivated lease transactions. There was a growing market in sale and leaseback transactions, which, if tested on principles of technical perfection or financial prudence, would appear to be a shame on everyone's face. Optimistic capital markets:A Data would establish a clear connection between bullish stock markets and the growth in both number of leasing entities and lease volumes. Year 1994-1995 saw the peak of primary market activity where a company, even if a new entrant in business, could price itself on unexplainable premium and walk out with pride. Access to public deposits:A Most leasing companies in India have relied, some heavily, on retail public funds in the form of deposits. Most of these deposits were raised for a 1 year tenure, and on promise of high rates of interest, at times even more than the regulated rate (which was lifted in 1996 to be reintroduced in 1998). A generally go-go business environment: At the backdrop of all this was a general euphoria created by liberalisation and the economic policies of Dr. Manmohan Singh.

Present industry order

Only few major players exist

SREI International Finance

Sundaram Finance

Cholamandalam Finance

Mahindra & Mahindra

GE Capital

Shriram Finance

Tata Finance

Countrywide Finance

Citicorp

NBFCs on strong turf

NBFCs are today an Integral Part of Indian Financial System showing improving health: Increase in resource profile Significant decline in NPA Substantial improvement in brand image Improvement in profitability margins Maturing industry in which financially & managerially weak companies already weeded out . Surviving companies are large corporate with good brand image. NBFCs enjoys a Niche position in the financial sector due to: Better Customer service Innovative & flexible financing options Continuously reducing NPA's Healthy Capitalisation Innovative resource mobilisation Focused Operation - Products/Customers/Geography Formation of Finance Industry Development Council - a Self Regulatory Organisation for NBFC's.

Challenges before the Industry

The current problems of Indian leasing could be listed as follows, again without any order of listing: Asset-liability mismatch:A Most non-banking finance companies in India had relied extensively on public deposits -this was not a new development, as the RBI itself was constantly encouraging and supporting the deposit-raising activities of NBFCs. If the resulting asset-liability mismatch, to everybody's agreement, is the surest culprit of all NBFC woes today, it must have been a sudden realization, because over all these years, each Governor of the RBI has passed laudatory remarks on the deposit-mobilization by NBFCs knowing fully well that most of these deposits were 1-year deposits while the deployment of funds was mostly for longer tenures. It is only the contagion created by the CRB-effect that most NBFCs have realized that they were sitting on gun-powder all these years. The sudden brakes put by the RBI have only worsened the mismatch. Generally-bad economic environment:A Over past couple of years, the economy itself has done pretty badly. The demand for capital equipment has been at one of the lowest ebbs. Automobile sales have come down, corporates have found themselves in a general cash crunch resulting into sticky loans. Poor and premature credit decisions in the past:A Most NBFCs have learnt a very hard way to distinguish between a good credit prospect and a bad credit prospect. When a credit decision goes wrong, it is trite that in retrospect, it invariably seems to be the silliest mistake that ever could have been made, but what Indian leasing companies have suffered are certainly problems of infancy. Credit decisions were based on a pure financial view, with asset quality taking a back-seat. Tax-based credits:A In most of the cases of frauds or hopelessly-wrong credit decisions, there has been a tax motive responsible for the transaction. India has something which many other countries do not- a 100% first year depreciation on several assets. Apparently, the list of such assets is limited and the underlying fiscal rationale quite holy and sound - certain energy saving devices, pollution control devices etc qualify for such allowance. But that being the law, it is left to the ingenuity of our extremely competent tax consultants to widen the range with innovative ideas of exploiting these entries in the depreciation schedule. Thus, there have been cases where domestic electric meters have been claimed as energy saving devices, and the captive water softenizer in a hotel has been claimed as water pollution control device ! As leasing companies were trying to exploit these entries, a series of fraudsters was successful in exploiting, to the hilt, the propensity of leasing companies to surpass all caution and all lending prudence to do one such transaction to manage its taxes, and thus, false papers for non-existing wind mills and never-existing bio-gas plants were fabricated to lure leasing companies into losing the whole of their money, to save the part that would have gone as government taxes ! Extraneous problems - frauds, closures and regulation:A As they say, it does not rain, it pours. Several problems joined together for leasing companies - the public antipathy created by the CRB episode and subsequent failures of some good and several bad NBFCs, regulation by the RBI requiring massive amount of provisions to be created for assets that were non-performing, etc. It certainly was not a good year to face all these problems together.

Opportunities for the Industry

Huge leasing opportunity

Large Potential

Outstanding lease & hire purchase assets around Rs 20,000 crores Large variety of user segment High growth potential in Vehicle Finance Commercial Transportation - Govt. support, Diverse products Personal Transportation - Wide Variety, Low finance costs, Increasing Propensity for credit purchase, Huge used car finance market New Products - Dealer Finance, Working Capital Finance, Personal Loans Low lease penetration ratio Around 1.5% as a % of Gross Domestic Capital Formation Very low in sectors like equipment & infrastructure Substantial upside possible

Expansion Opportunity

Huge infrastructure spending in next 5yrs (apprx Rs 3,60,000 crores) Steadily rising disposable income - Generating huge demand for consumer goods

With growth ingredients in place

Global opportunities - Cross-Border Leases allowed Substantially reduced dependence on public deposits as a source of fund - Out of a total asset base of Rs 40,050 crores, public deposits account for Rs 5,850 crores as against NOF Rs 4,500 crores . Comparatively Low Default Rate - Particularly in consumer loans and vehicles financing as compared to many other markets

Future Strategy

Segmentation and positioning: Firms try to attain growth in numbers by unfocused diversification, but soon realise that diversified presence creates organisational pressures which are difficult to cope with. This leads to a trend towards consolidation and focused growth. Leasing firms of yesteryears were everything: money market players, merchant bankers and discount houses. Gradually, both regulators and industry participants have realised that clearer roles are necessary for stability. Cross-border competition: Cross-border competition will come in two forms: direct cross-border transactions, and cross-border investments in lease transactions. It is estimated that the second variety of transactions will gain momentum before the first. A number of global leasing giants have already occupied their positions in India. Capital account convertibility measures will precipitate the process. The impact of foreign investments will be greater consolidation activity at home. Emergence of vendor leasing: There are so many merits in vendor-based leasing that it is surprising that it has not made its debut in India still. For the asset vendor, a leasing plan is a sales-aid, and for the lessor, it is easy access to a vast market, with equipment support from the vendor. In 1997-98 and after, many lessors will be forced to leave general equipment leasing market and line up with suppliers of equipment. Vendor leasing in time to come will be a very significant part of the leasing market. Asset-based funding: True asset-based funding is an extension of the vendor lease market. The two generally go together to develop into operating leasing. Full scale operating leasing, that is, leases will in-built cancellation options, will take quite some time to develop in India, but features of operating leases will be introduced once vendor tie-ups take place End of tax-based leasing: This author has consistently opined against tax-based leasing, and that advice has so far fallen flat because most of the leasing in the past was triggered by tax motives, sometimes greedy tax motives. Spate of income-tax problems in the past has made some leasing companies wiser, but there will be more of such problems when the disputed questions reach appellate levels. In the opinion of the author,A the leasing industry must take the matter across to the Central Board of Direct Taxes and get a set of guidelines on true leases.A Not having any guidelines leaves too many things to the discretion of the tax officer which does not provide a safe harbor to the transactions.

A Profile of Factoring Services: A Concept Note

Introduction

Factoring service in India is of recent origin. It owes its genesis to the recommendations of the Kalyanasundaram Study Group appointed by the RBI in 1989. Pursuant to the acceptance of these recommendations, the RBI issued guidelines for factoring services in 1990. The first factoring company - SBI Factors and Commercial Ltd (SBI FACS) started operation in April 1991.

How old is the concept of factor?

Factoring has been in existence long before ago during the reign A of Mesopotamian King Hammurabi . Then it gets extended to 14thA century during British Rule specially in textiles industries ,but it gained its importance in 1905 from Canada ,especially in American colonies .Now it is no more concentrated in America but have widespread to other countries also .A At that time factoring was used as a mode of advancing funds to the seller, before theyA received the payment from the buyer for the raw materials they sold.A  But with industrial revolution factoring concept have changed as aA mode of giving credit .The concept got revolutionized during 80's with the growth of banking sector .And now the concept is gaining importance day by day because of the added advantages the corporate gained from factoring. It is generally a well defined arrangement where financial institution engaged in factoring business provides an array of services like recording, collecting, controlling and protecting the book debts for its clients including the purchase of his bills receivable.

Why account receivable is an important part to handle with?

CompanyA generally give credit to customers for payment in order to increase sales .If customers pays in time then the company tries to provide more and more services to that customers .But if any customers don't make payment even after the end of credit period then this is a matter of concern for the company .More and more delay causes account receivable to increase further and so the debtors list also increases. This becomes a very hard situation to handle with. Especially if the corporate is a huge one, then to maintain accounts receivable becomes a headache for the company .So to avoid this, factoring is an ideal solution. Seller sell all its accounts receivable to factor and obtain cash in turn which it would have received after . So firm don't have to experience unnecessarily cash crunch situation. So in brief in process of factoring - 3 parties are involved viz Seller - Factor - Buyer .But in return seller has to pay factor charges to factor for the services rendered to seller by factor.

Types of Factoring

1. Recourse Factoring - Client bear all the risk, factor is not liable for any debts .Factor is not responsible for collecting debts from customers. So, recourse factoring is cheaper than non recourse. 2.A A A Non Recourse Factoring - Factor bear all the risk besides providing services of collection of bad debts. 3.A A A Advance Factoring - Factor advances to the client for the amount of receivable purchased. 4.A A A Maturity Factoring - Factor provides dual services collection as well as insurance against debts. 5.A A A Bank Participation Factoring - Bank provides advances not against the full receivables purchased but against a part of the receivable. 6.A A A Disclosed Factoring - Name of the factor is disclosed in the invoices raised by the supplier. 7.A A A International Factoring -A Factoring services against export sales.

Factoring Mechanism

Steps involved in Domestic factoring: There are 3 parties involved viz seller (client), buyer (customers) and the intermediary -factor . 1.A The customers buys goods from client and in return client gives invoice to customers. 2.A The client now assigns/send invoice to factor. 3.A Checking the invoice, the factor make prepayment advance of 80 %/90 % to client. 4.A Factor sends statement of payment to customers. 5.A Customers make full payment to factor. 6.A Finally upon receipt of full payment from customers, factors make the balance payment to client.

In International factoring 4 parties are involved -client ,customers, overseas correspondent and factor Steps: Customers places orders to client. Client fixes prepayment limit with factor. Client delivers goods to customers . Client sends a copy of invoices to factor . Factors sends another copy of invoice to the overseas correspondent Based on the invoice, factor makes prepayment advances upto 80 %/90 % to client. Customer make payment to overseas correspondent. A A A  8.Overseas Correspondant make this payment to factor. A A A  9 Finally after receiving the full amount factor make the balance 20 % payment to client .

FORFAITING

Under this mode of export finance, then exporter forfaits his rights to the future receivables and the forfaiter loses recourse to the exporter in the event of non-payment by the importer.

Difference between Factoring and Forfaiting

Factoring

Forfaiting

Suitable for ongoing open account sales, not backed by LC or accepted bills or exchange. Oriented towards single transactions backed by LC or bank guarantee. Usually provides financing for short-term credit period of upto 180 days. 2. Financing is usually for medium to long-term credit periods from 180 days upto 7 years though shorterm credit of 30-180 days is also available for large transactions. Requires a continuous arrangements between factor and client, whereby all sales are routed through the factor. 3. Seller need not route or commit other business to the forfaiter. Deals are concluded transaction-wise. Factor assumes responsibility for collection, helps client to reduce his own overheads. 4. Forfaiter's responsibility extends to collection of forfeited debt only. Existing financing lines remains unaffected. 5. Separate charges are applied for financing collection administration credit protection and provision of information. Single discount charges is applied which depend on guaranteeing bank and country risk, credit period involved and currency of debt. Only additional charges is commitment fee, if firm commitment is required prior to draw down during delivery period. Service is available for domestic and export receivables. 6. Usually available for export receivables only denominated in any freely convertible currency. Financing can be with or without recourse; the credit protection collection and administration services may also be provided without financing. 7. It is always 'without recourse' and essentially a financing product.

Changing Scenario of Factoring Business in India

SBI Factors purchases the 91 % stake in A Global Trade Finance to gain a market share of around 75 % in factoring business by April 2008. HSBC is going to provide factoring business for SME's Specially in Mumbai, New Delhi, Kolkata, Pune, Bangalore and Chennai.SME with turnover of more than 5 crore can avail the facility of factoring from HSBC. A HSBC ties up with New India Assurance for credit risk insurance. A WithA the increasing demand for factoring services, foreign players such as Development Bank of Singapore (DBS) and GE Capital have shown their keen interst to A getting into the factoring business in India. Both DBS and GE Capital have global exposure in the factoring business. A Many global players in the field of banking(Standard Chartered Bank, Citi Bank ,etc ) are coming forward to India to carry on factoring business in SME segment since the scope for financing large corporates is reaching saturation point.A SME sector plays a major role in India's present export performance, contributing to 45-50% of the Indian exports. Global Trade Finance has dedicated most of its facilities to the SME sector. A With the growth of factoring business ,credit insurance is also getting edge day by day today specially for the global factors who are operating in India . A According to Factors Chain International, the observer of all factoring companies, India with just eight companies clocked a total turnover ofA Rs.A 19,860.5 crore in 2006 way below Japan'sA Rs.A 4,15,789.1 crore Taiwan'sA Rs.A 2,23,152. 6 crore and China'sA Rs.A 7,97,77.1 crore in Asia. The Indian factoring market has grown by 176 per cent fromA Rs.7,196.7 crore toA Rs.A 19,860.5 crore between 2002 and 2006. Global leaders are the UK, France and Italy

Challenges faced by global A factors operating in India

Indian Market is attractive ,but to get into it is not so easy for foreign markets There are various reasons for this: Factoring is a new concept which is not widely known among Indian business community .A Because of the banks' failure to "educate'' potential customers on its benefits. Debt recovery is very slow in India as compared to other developed countries .Comparision of duration of debt recovery case resolution in (calendar days).India - 1420 days where as on Average OECD - 351 days. A Huge competition from Indian banks in this field . Increased interest ratesA impact sales either through increased financing costs or through reduced sales. ForeignA factors faces lot of risk through a higher cost of capital and increased business risk as the credit risk of customers increases. And A the ideal solution is credit insurance .(A Because of credit insurance with Atradius A ,Global Trade Finance's turnover grew 121% in its 2007 fiscal year and its total market share grew to 25% from 20% including a 70.4% share of export factoring and a 62.7% share of import factoring.) But A credit insurance is a newer concept in India .Where as ECGC started only A export credit insurance in 1957 . In India assignment of debt is a very complicated process and involves stamp duty .Stamp duty varies from state to stateA in India . As a result the process becomes expensive by nature. No clear laws exist in India regarding transfer/assignment of debt,bankruptcy ,debt recovery etcA as in other countries ,so foreign operators have to face lots of problems . Also proper information access is very slow in India. NBFC operating as factors is a difficult proposition in India as compared to banking sector as there is no protection under Debt Recovery Tribunal or securitization act .

Conclusion

At the end it is to be concluded that factoring is now gaining its importance in India slowly with the increase in customer's access to benefits of factoring. India's future in factoring business seems to be luring on the facts obtained regarding the fast growth of 174 % in only 4 years .So for factoring to be successful in India government regulation/ policies need to be modified further A so that more and more private players can come forward to start up their factoring business in India .Customer awareness about benefits of factoring is to be increased further to fight back the global leaders in factoring business .

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