EXPANDING THE ROLE OF LEASING IN SME FINANCING IN CROATIA

Leasing

Leasing can be a great way to get around the fact that target group borrowers don’t have much collateral or that it may be difficult and costly to seize and sell any collateral that they do have. Leased equipment provides much or all of its own collateral and (depending on the country’s legal system) can be easily repossessed since the lessee does not become the owner; the leasing company retains ownership. Financial leasing has been tremendously successful throughout the world since its introduction some 40-50 years ago because it meets a demand not met by traditional bank lending. There are a number of reasons businesses lease:

1. It allows for better cash management of working capital 2. It provides a hedge against technological obsolescence.

3. It can provide 100% financing, i.e., no down payment is required. It also requires payment for only the value of the property’s use when the value of ownership is not needed.

4. It provides a fixed payment.

5. It is a flexible form of financing.

6. It provides a hedge against inflation.

7. It allows better utilization of tax benefits by both lessor and lessee.

8. It conserves credit lines.

9. It expands credit sources.

10. It diversifies credit sources.

11. It may provide off-balance sheet financing.

12. The lessor may provide non-financial services not readily available from other credit sources, such as equipment ser vice and maintenance.

13. The lessee may be able to take advantage of the economies of scale of the lessor’s purchasing power.

It may better accommodate capital budgets than alternative financing.

It has fewer restrictive covenants than traditional financing.

End of term options can be varied to suit lessee needs.

Leasing requests generally have a faster response time than bank loan requests.

It can be particularly attractive to small and medium-sized-s enterprises (“SMEs”), which may not otherwise be able to obtain financing—and SMEs

are usually the major engine of growth for an emerging market economy.

In an emerging market, banks are often the first to commence leasing activity in a country, usually through a leasing company wholly owned by the bank and licensed as a “non-bank financial institution,” because of the way the banking laws and regulations are written. In this situation, if the commercial banking sector is not particularly well developed or innovative, it may not be motivated, interested or capable of introducing leasing. Leasing in a developing economy is rarely initiated by the manufacturing sector or existing equipment dealers and almost never by traditional rental companies. If the structure of the banking regulations allow, leasing may be established as a separate stand-alone company not legally a part of a commercial bank or regulated non-bank financial institution, but the investors behind the leasing company will almost certainly come from the financial community.

Leasing can also be initiated by international financial institutions, such as those ones established by IFC. The IFC has been particularly active in promoting leasing in emerging markets, having invested in leasing companies in over 36 emerging markets and completed over 50 leasing- related technical assistance projects to governments.

Leasing Can Contribute to Economic Development in the Financial Sector and the General Economy in many ways.

Leasing provides a number of significant contributions to a country’s economic development.

Allows more businesses, particularly SMEs access to financing. Lessors are often willing to do a lease transaction with parties who may not be able to qualify for traditional bank loans. In doing so, lessors are not necessarily taking greater risks than banks are. In fact, in many countries, defaults on lease contracts are often lower than those on loans. This may be due in part to the additional enforcement clout that a lessor has -it may be able to repossess the equipment more easily than a bank can foreclose on collateral.

The quick and immediate loss of the equipment may be a strong incentive to make the lease payments in a timely manner. This higher level of security against credit risk, along with the more entrepreneurial focus of lease companies, tends to make them more aggressive than the traditional banking community. The result can be more businesses, expanded employment, more tax revenue and increased overall economic growth.

Increases the domestic capital base. As a financial product, leasing needs its own funding, which tends to further mobilize domestic capital. A significant portion of this funding comes from the lease companies’ own bank lines.

The increased borrowing requirements by their lease company customers necessitate an increase in the banks own borrowings, with the consequential increase in the domestic capital base.

Provides competition to traditional banks. Depending upon the language of a country’s banking laws, leasing may first be introduced by a bank acting through a subsidiary established for the purpose, or, if regulations permit, by an independent lease company. Regardless, financial leasing ultimately provides an additional source of financing in the marketplace and a product in competition to traditional bank products. Such competition generally compels banks to become more efficient in their lending practices.

Encourages financial product innovation. Because leasing companies are very capital consumptive in their expanding purchases of more and more equipment for lease to their lessees, leasing companies also tend to be at forefront of new capital market financial product development to meet such capital needs. For example, leasing companies in addition to promoting issuance of commercial paper, bonds, stock offerings and similar capital product, can encourage the introduction of non-recourse lending, securitization, and other more sophisticated investment vehicles—all of which can help the country attract not only domestic capital but foreign capital as well.

Helps to develop secondary markets. Although the initial lease products offered in a country are almost always “full-payout” and the equipment is transferred to the lessee at the end of the lease term for a nominal or token amount, lessors will ultimately begin to take a true residual value position that will force them to dispose of the asset at a price near its fair market value. In a number of emerging economies, there are severely limited organized markets for used equipment. Leasing, because it generates a steady supply of used equipment, can help develop an organized secondary market for a variety of goods. Vehicles and other transportation equipment, because of its high residual values and ready saleability, is typically the type of asset that leads the way.

Recommendation for the leasing industry in Croatia

a) The finance lease/operating lease distinction for VAT purposes should be abandoned and VAT on any transfer at the end of the lease would be upon the actual transfer price.

b) The following measure would be abandonment the Finance/Operating Lease Determination by Customs Officials (that would mean abandoning the practice of analyzing lease transactions for determining their status as finance leases or operating leases).

c) Monetary authorities should form a financial leasing study group for the purpose of familiarizing itself with the business of financial leasing for the purpose of creating an informed awareness of an important financial market product.

d) Croatia should adopt the dual party vehicle registration system, with a recorded distinction between “legal owner” and “registered owner.” The registered owner should not be allowed to dispose of the vehicle without the consent of the legal owner, and the legal owner should not be responsible for traffic fines, accidents or other matters arising from the use of the vehicle.

e) Banks should be required to engage in financial leasing activity only through a subsidiary and not directly as part of the bank’s other financial services. For reasons stated in the general section on licensing, banks engaging in leasing directly have an unfair and undesirable advantage over independent lease companies. The better approach is to require banks to engage in leasing through a subsidiary. Banking prudential norms currently established would remain applicable at the bank level but separate prudential norms for the subsidiary would be unnecessary and should not be established.

f) A registry of interests in collateral can be invaluable in providing creditors and potential creditors of a party applying for financial advance information about what assets of the applicant are currently unencumbered and remain available as security for the pending application. This is true whether the credit application be for a loan or a lease. A computerized, central registry, indexed off the name of the debtor, can quickly and efficiently provide this information. It can also help reduce fraudulent practices by lessees, such as obtaining multiple financing of the same item of equipment or transferring or selling the leased equipment.

OVERVIEW OF THE SME FINANCE