UNIT 2- FUND BASED FINANCIAL SERVICES I

LEASING , HIRE PURCHASE & CONSUMER CREDIT

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I: LEASING, HIRE-PURCHASE AND CONSUMER CREDIT 14 Hrs.

Leasing – Introduction, Concept of Leasing and Classification,

Advantages and Limitations of Leasing, Financial Evaluation of
Leasing – from Lessor’s perspective and Lessee’s Perspective.

Hire-Purchase and Consumer Credit: Introduction, Conceptual

Framework, Legal Framework, Financial Evaluation
FUND BASED FINANCIAL SERVICES

• It refers to services that are used to acquire assets or funds for a

customer.

• Following are some of the examples of financial services:

• Leasing, credit card services, factoring, portfolio management,

financial consultancy services, Underwriting, discounting and
rediscounting of bills, Depository services, housing finance, Hire
purchases, Mutual Fund management.
Non- Fund Based Financial Services

• This would help them to increase their revenue while optimizing the
use of funds and would help to spread their risk over variety of
activities.

• The non-fund based financial services of the public sector banks

include loan syndication, consultancy and advisory services, capital
issue management etc.

• The public sector banks have been marketing all the non-fund
based financial services either directly by starting merchant banking
division or by indirectly floating their subsidiary companies or both.
 MEANING OF LEASING

• Leasing is a process by which a firm can obtain the use of a

certain fixed assets for which it must pay a series of contractual,
periodic, tax deductible payments.

• The lessee is the receiver of the services or the assets under

the lease contract and the lessor is the owner of the assets.

• The relationship between the tenant and the landlord is called a

tenancy, and can be for a fixed or an indefinite period of time
(called the term of the lease).

• The consideration for the lease is called rent.

Lease can be defined as the following ways:

1. A contract by which one party (lessor) gives to another (lessee)

the use and possession of equipment for a specified time and
for fixed payments.

2. The document in which this contract is written.

3. A great way companies can conserve capital.

4. An easy way vendors can increase sales.

Lease financing is based on the observation made by Donald
B. Grant:

“Why own a cow when the milk is so cheap? All you really
need is milk and not the cow.”
Features of Lease Contract:

The important features of lease contract are as follows:

1. The lease finance is a contract.

2. The parties to contract are lessor and lessee.

3. Equipment are bought by lessor at the request of lessee.

4. The lease contract specifies the period of contract.

5. The lessee uses these equipment’s.

6. The lessee, in consideration, pays the lease rentals to the lessor.

7. The lessor is the owner of the assets and is entitled to the benefit
of depreciation and other allied benefits e.g., under sections 32A
and 32B of the Income-tax Act.

8. The lessee claims the rentals as expenses chargeable to his

income.
 TYPES OF LEASE

(a)Financial lease

(b)Operating lease.

(c)Sale and lease back

(d)Leveraged leasing and

(e)Direct leasing.
1)Financial lease

• Long-term, non-cancellable lease contracts are known as financial

leases.

• The essential point of financial lease agreement is that it contains a

condition whereby the lessor agrees to transfer the title for the
asset at the end of the lease period at a nominal cost.

• At least it must give an option to the lessee to purchase the asset he

has used at the expiry of the lease.

• Under this lease the lessor recovers 90% of the fair value of the
asset as lease rentals and the lease period is 75% of the economic
life of the asset.
• The lease agreement is irrevocable. Practically all the risks
incidental to the asset ownership and all the benefits arising
there from are transferred to the lessee who bears the cost of
maintenance, insurance and repairs.

• Only title deeds remain with the lessor. Financial lease is also
known as ‘Capital Lease‘.

• In India, financial leases are very popular with high-cost and

high technology equipment
2) Operational lease

• An operating lease stands in contrast to the financial lease in almost all

aspects.

• This lease agreement gives to the lessee only a limited right to use
the asset.

• The lessor is responsible for the upkeep and maintenance of the asset.

• The lessee is not given any uplift to purchase the asset at the end of
the lease period. Normally the lease is for a short period and even
otherwise is revocable at a short notice.

• Mines, Computers hardware, trucks and automobiles are found suitable

for operating lease because the rate of obsolescence is very high in this
kind of assets.
3) Sale and Lease Back
• It is a sub-part of finance lease.

• Under this, the owner of an asset sells the asset to a party (the buyer),
who in turn leases back the same asset to the owner in consideration
of lease rentals.

• However, under this arrangement, the assets are not physically

exchanged but it all happens in records only. This is nothing but a
paper transaction.
• Sale and lease back transaction is suitable for those assets, which
are not subjected depreciation but appreciation, say land.

• The advantage of this method is that the lessee can satisfy himself
completely regarding the quality of the asset and after possession of
the asset convert the sale into a lease arrangement.
4) Leveraged Leasing
• Under leveraged leasing arrangement, a third party is involved
beside lessor and lessee.

• The lessor borrows a part of the purchase cost (say 80%) of the
asset from the third party i.e., lender and the asset so purchased is
held as security against the loan.

• The lender is paid off from the lease rentals directly by the lessee
and the surplus after meeting the claims of the lender goes to the
lessor.

• The lessor, the owner of the asset is entitled to depreciation

allowance associated with the asset.
5) Direct Leasing

• Under direct leasing, a firm acquires the right to use an asset

from the manufacture directly.

• The ownership of the asset leased out remains with the

manufacturer itself.

• The major types of direct lessor include manufacturers, finance

companies, independent lease companies, special purpose
leasing companies etc
 Advantages of Leasing

a. Leasing helps to possess and use a new piece of machinery or

equipment without huge investment..

b. Leasing enables businesses to preserve precious cash reserves.

c. The smaller, regular payments required by a lease agreement enable

businesses with limited capital to manage their cash flow more
effectively and adapt quickly to changing economic conditions.

d. Leasing also allows businesses to upgrade assets more frequently

ensuring they have the latest equipment without having to make
further capital outlays.
e. It offers the flexibility of the repayment period being matched to the
useful life of the equipment.

f. It gives businesses certainty because asset finance agreements

cannot be cancelled by the lenders and repayments are generally fixed.

g. However, they can also be structured to include additional benefits

such as servicing of equipment or variable monthly payments depending
on a business’s needs.

h. It is easy to access because it is secured – largely or entirely – on the

asset being financed, rather than on other personal or business assets.
i. The rental, which sometimes exceeds the purchase price of the
asset, can be paid from revenue generated by its use, directly
impacting the lessee's liquidity.

j. Easy instalments are exclusively material costs.

k. Using the purchase option, the lessee can acquire the leased asset
at a lower price, as they pay the residual or non-depreciated value of
the asset.

l. For the national economy, this way of financing allows access to

state-of-the-art technology otherwise unavailable, due to high prices,
and often impossible to acquire by loan arrangements.
 LIMITATION OF LEASING

a. It is not a suitable mode of project financing because rental is

payable soon after entering into lease agreement while new project
generate cash only after long gestation period.

b. Certain tax benefits/ incentives/subsidies etc. may not be available

to leased equipments.

c. The value of real assets (land and building) may increase during
lease period. In this case lessee may lose potential capital gain.
d. The cost of financing is generally higher than that of debt financing.

e. A manufacturer(lessee) who want to discontinue business need to

pay huge penalty to lessor for pre-closing lease agreement

f. There is no exclusive law for regulating leasing transaction.

g. In undeveloped legal systems, lease arrangements can result in

inequality between the parties due to the lessor's economic dominance,
which may lead to the lessee signing an unfavourable contract.
 Contents of a Lease Agreement:

The lease agreement specifies the legal rights and obligations of the
lessor and the lessee. It typically contains terms relating to the following:
1. Description of the lessor, the lessee, and the equipment.
2. Amount, time and place of lease rentals payments.
3. Time and place of equipment delivery.
4. Lessee’s responsibility for taking delivery and possession of the leased
equipment.
5. Lessee’s responsibility for maintenance, repairs, registration, etc. and
the lessor’s right in case of default by the lessee.
6.Lessee’s right to enjoy the benefits of the warranties provided by the
equipment manufacturer/supplier.

7. Insurance to be taken by the lessee on behalf of the lessor.

8. Variation in lease rentals if there is a change in certain external

factors like bank interest rates, depreciation rates, and fiscal
incentives.

9. Options of lease renewal for the lessee.

10. Return of equipment on expiry of the lease period.

11. Arbitration procedure in the event of dispute.

PROBLEMS OF LEASING IN INDIA

Leasing has great potential in India. However, leasing in India faces

serious handicaps which may bar its growth in future. The following are
the some of the problems.

1. Unhealthy competition – There is over supply of lessor in India. The

stiff competition between these lessors are force them to reduce their
profit margin to bare minimum level. More over subsidiaries of banks
and financial institution have competitive edge over private sector
lessor due their cheap source of finance.

2. Lack of qualified personnel- leasing requires qualified and experienced

personnel at the helm of its affairs. In India, leasing is of recent one
and hence it is difficult to get right man to deal with leasing business
3. Tax Consideration- In reality, the lessee’s tax shelter is lessors’ burden.
The lease becomes economically viable if lessors effective tax rate is low.
more over taxes like sale tax, wealth tax, additional tax , surcharge etc,
add to the cost of leasing. It makes leasing relatively more expensive

4. Stamp Duty- States treats the leasing transaction as a sale for the
purpose of making them eligible to sales tax. On the contrary, for stamp
duty, the transaction is treated as pure lease transactions. Accordingly
heavy stamp duty imposed on lease document.

5. Delayed payment and bad debts- The problem of delayed payment of

rents and bad debts add to the cost of lease. This problem would disturb
prospects of leasing business.