INNOVATIONS IN RURAL AND AGRICULTURE FINANCE


Rural Leasing: An Alternative to Loans in Financing Income-Producing Assets AJAI NAIR


FOCUS 18 • BRIEF 6 • JULY 2010 C


redit for investments that pay back in the medium to long term (three to five years or longer) is in short supply in rural


areas. Credit unions and microfinance institutions (MFIs), which generally have better outreach than commercial banks in rural areas, typically provide only short-term credit. Credit available from informal sources (such as moneylenders, family, and friends) is usually both short term and too costly for investment financing. For rural enterprises seeking to acquire equipment—a typical investment need—to modernize production and thereby increase productivity, one solution may be financial leasing. Leasing offers several advantages. For traditional credit,


farmers and rural enterprises are particularly constrained by a lack of assets that can be used as collateral. Leasing overcomes this constraint because it requires no collateral or less collateral than typically required by loans. Because leases also often require lower down payments than the equity required for loans, they are more affordable for rural enterprises that have limited funds and little access to borrowed funds. From the lessor’s perspective, not having to obtain collateral is particularly advantageous in a rural context. Although the difficulties involved in creating, perfecting, and enforcing security are applicable in both urban and rural contexts in most developing countries, they are more severe in rural areas where enterprises are less likely to hold titles to their assets, asset registries are less likely to be functional, and judicial processes are likely to be slower. Lessors are also likely to benefit from not being restricted by interest rate ceilings and sector-specific credit allocations—factors that have traditionally constrained rural lenders. Boxes 1 and 2 explain key features of a leasing contract, and Figure 1 shows a typical tripartite financial lease transaction involving an equipment supplier, a lessor, and lessee.


Box 1—What is a financial lease?


Leasing is a contract between two parties, where the party that owns an asset (the lessor) lets the other party (the lessee) use the asset for a predetermined time in exchange for periodic payments. Leasing separates use of an asset from ownership of that asset. There are two main categories of leasing: financial leases and operating leases. In a financial lease, lease payments amortize the price of the


asset. At the end of the lease period, the lessee can purchase the asset for a token price. The lessee is responsible for maintenance and risk of obsolescence of the asset. Because of the option to purchase the asset and the risks transferred to the lessee, a financial lease is a close substitute for a loan. Nearly all rural leases are financial leases. In contrast, operating leases do not include the option to


purchase the asset. Maintenance costs and risk of obsolescence are borne by the lessor, and leases are cancelable.


Box 2—Key features of a financial lease contract


• Security: The primary security is the leased equipment. In some cases a small amount of cash or other asset owned by the lessee may be taken as additional security.


• Insurance: The lessor insures leased assets with commercial insurance and includes the cost in the lease price.


• Lease term: Lease terms range from two to five years.


• Lease cost: It includes cost of insurance, operating cost, loss provision, and profit.


• Lease payment schedule: The payment schedule can be monthly, quarterly, half-yearly, or annual.


• Option to purchase: On completion of the lease payments, lessees have the option to purchase the leased assets at a certain percentage of the lease cost.


Figure 1—Financial lease transaction Supplier


8 3


7 5


6 1 4 Lessor


FOR FOOD, AGRICULTURE, AND THE ENVIRONMENT


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2 9 Lessee


1. Initial negotiations about model, specification, price, discounts, warranty, delivery, etc. At this time the method of payment for the asset may not have been discussed.


2. Request for a leasing quotation (the supplier may also provide quotations on behalf of lessors).


3. Purchase contract agreement signed between lessor and supplier based on information supplied by the lessee to include those issues in (1) and also payment terms.


4. Lease contract signed and downpayment paid by lessee.


5. Invoice created by supplier giving title in asset to lessor (assuming full payment received by supplier).


6. Asset delivered to lessee.


7. Delivery and acceptance notice (protocol) signed by supplier and lessee.


8. Supplier’s invoice paid by lessor. 9. Regular lease repayments paid.


Source: IFC (International Finance Corporation), Leasing in Development: Guidelines for Emerging Economies (Washington, DC, 2009).


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