Silver jubilee of Indian Leasing: any silver across?

by Vinod Kothari

This article was written close to Sept., 1998. Lot of things have changed since then, which have not been included in this article. However see other occasional articles by the Author on this site.

14th largest place in the WorldChart showing growth
Factors in growth of Indian leasingCurrent problems of Indian leasing
What does the future holdClick here for article on State Progress and problems of Indian leasing

This page is dedicated to mark the Silver Jubilee of Indian leasing – 10th September 1998. This site was opened on that date.

25 years ago, Farouk Irani quit his high profile job in Citibank to launch his dream project: a leasing company in India. On 10th 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. Click here for details of the evolution and cycles in Indian leasing.

As it celebrates its 25th 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.

Though it is currently passing through a testing time, leasing has had an undeniable role in Indian economy. From consumer finance to small industry, heavy industry to automobiles, from railways to electricity boards, almost every sector of the economy has utilized leasing as its source capital. Having attained an average over-30% growth rate over past 7 years, Indian leasing has reached the 14th largest place in the World, a fact which is least realized by most.

14th Largest place in the World: Wow!:

India at the 14th largest place in World leasing sounds incredible! But it is true, and true contrary to the internationally available statistics published by the London Financial Group. The Group’s data, published every year in the World Leasing Yearbook would place India at some 36th place, but admittedly that data is only the estimate of the author thereof, and the author of the data might have ranked Indian leasing volume based on India’s per capita income ! When it comes to size, India has the obvious advantage of being such a vast nation.

Center for Monitoring of Indian Economy compiles data about Indian leasing volumes, which is carried as a part of India Leasing Yearbook published by the Association of Leasing and Financial Services Cos. The data compiled by the Center shows aggregate balance sheet value of leased and hired assets (though for balance sheet purposes, lease and hire-purchase transactions are distinguished, there is no material difference between the two – hence the volumes have been clubbed here) at about Rs. 261 billion (End March 1997). This is based on reporting by 226 companies, whereas the business, particularly hire-purchase, is spread amongst some 3000 large and small companies. Estimated outstanding business done by these firms is about Rs. 15 billion (at Rs. 5 million per such firm).

That apart, the data also excludes the massive annual volume of business by the Indian Railway Finance Corporation (IRFC). IRFC is a hundred percent subsidiary of Indian Railways, and its leases are dedicated to the parent Railways only. Of late, almost entire floating stock acquisition by Railways is being acquired on lease from IRFC. The outstanding value of leases done by IRFC adds to about Rs. 120 billion.

Thus, the aggregate volume comes to about Rs. 396 billion, which is about USD 11 billion as per then-prevailing exchange rates.

USD 11 billion of outstanding volume cannot by itself give India a ranking in the London Financial Group data, since these rankings are based on incremental volume. However, a rough estimate of new business can be made from the above data (unfortunately, the Centre for Monitoring of Indian Economy data do not give any idea of new leasing and hire-purchase volume). Supposing 30% of the outstanding business of last year was paid, and there was a 20% growth in net business (as can be seen from the Chart above), there was a 50% new business, over the volume outstanding at the beginning of the year. Relative to the business at the end of the year, the incremental volume should have been about 33% (50/150).

Therefore the annual leasing volume in India is estimated at about USD 3.67 billion, on a rough and conservative estimate.

In London Financial Group data, this should put India at 12-13th place, close to Hong Kong. This would also be the third largest market in Asia, next only to Japan and Korea.

The only infirmity in the above ranking is that the London Financial Group data are not as of March 1997 – that, however, should not seriously disrupt the ranking of India, because other Asian markets in 1996-7 period have generally registered a negative growth.

Factors that contributed to growth of Indian leasing:

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  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 barriers – 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 companies – 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: 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: 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: 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: 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.

Current Problems of Indian leasing:

In 1996-97, the profits of Indian leasing came down a bit -this was the year of the minimum alternative tax: so everyone thought, there was nothing serious to be concerned about.

However, 1997-98 proved to be a year of debacle. Several things combined to make this year one of worst years in history so far, including the sudden and serious breach in public confidence caused by the collapse of CRB Capital Markets (if this could be attributed to an organized fraud, how about ITC Classic, a company promoted and supervised by the tobacco giant ITC), generally bad economic environment due to political uncertainty, hesitation on part of banks to continue to finance leasing ventures, and closer to the end of the fiscal year, the Reserve Bank of India (RBI) came out with one of the least thought-about, most casually-drafted regulations on Non-banking finance companies (NBFCs). The RBI is still not sure of what it wants to regulate and how, and has changed in the regulations 3 times in 5 months, and there are still Committees and Task Forces on the reconstruction job. There could not have been a worse way of handling a sensitive sector of the economy, already in a crisis of public confidence!

The current problems of Indian leasing could be listed as follows, again without any order of listing:

Asset-liability mismatch: 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: 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: 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: 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: 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.

From here on, where? :

Having gone through a very bad 1997-98, there is currently nothing that points to a better time – the general business sentiment remains as depressed as before, if not more because of the post-nuke sanctions and continuing political uncertainty, business investments are not picking up, and more NBFCs may fail during the current year when most of them are supposed to tone down their dependence on public deposits very significantly. At the same time, fresh entry from foreign banks and financial institutions has not stopped – on the contrary, one sees a number of foreign players entering India. Perhaps they have found it to be a good time, particularly as vultures on the lookout for failing or falling NBFCs.

The question, therefore, is, what does the future hold?

Much of the following may be pure conjecture, but the author’s views on what the future holds for NBFCs in India are as under:

  • Reduced number of players:

Not too many people will dispute the observation that India has far too many finance companies that can possibly sustain in time to come. If we forget about the 37000-odd companies that have registered with the RBI as NBFCs (that number is a miracle – and the entire credit can be taken by the draftsman of the RBI legislation), there are, no doubt, about 500 reasonably large NBFCs in the country. The Association of Leasing and Hire-purchase Cos. (ALFS) itself has over 500 members. If one ignores the honorary members, and those who are not into leasing, but including the members of the Equipment Leasing Association, 500 is a very safe number.

ALFS does not have too many regionally centered smaller players as its members. They have their membership with local hire-purchase associations. There are about dozen hire-purchase Associations in the country, and not all players can be expected to be a member of one of these. The combined membership strength of all of the Associations would be not less than 2000 firms, and an equal number of firms may be taken as those who are not registered with any Association at all.

The number adds to an astounding 4000 players!

This means that at the current juncture, the number of lessors in India is more than the total number of players in USA, which is the largest market in the World!

A number of factors will precipitate the consolidation in Indian leasing, and the process is already on. First, bifurcation of leasing and non-leasing activities, such as merchant banking, will go a long way in breaking the financial conglomerates, who may find themselves better focusing on investment banking rather than dabbling into leasing at the same time. Second, in whichever forms of business, mass distribution is possible, that is, where the customer is more or less homogenous, larger firms will eat up the shares of the smaller ones. This is something everyone can see happening in the car finance market. Three, reduced rates by the industry leaders will set benchmark rates in the market which will force many marginal players out. Fourth, regional players will survive but will find their relevance in a new avtar as “lease brokers”, or to use a better word, “lease originators”. These firms will originate small ticket leases, sell their portfolios to larger players, thereby encashing their wafer-thin spreads and walking out to originate another transaction. Such activity has flourished in USA, and we will see much of the same story in India too.

  • Cross-border competition:

Cross-border competition will come in two forms: direct cross-border transactions, and cross-border investments in lease transactions. This author estimates 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.

  • Segmentation and positioning:

This is a common feature of growth: during the initial phases of growth of any industry, there is a trend towards diversification: 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.

Leasing companies in time to come will not only choose their segment within the financial services industry but also within the leasing industry. Equipment-type focus will also be seen in time to come. This change may take some time to be noticed.

  • 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, the leasing industry must take the matter across to the Central Board of Direct Taxes and get a set of guidelines on true leases. Not having any guidelines leaves too many things to the discretion of the tax officer which does not provide a safe harbour to the transaction.

  • 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.

  • Price-based competition:

This factor might as well have been placed as the first in order of significance, but its impact on the leasing market is subjective. In the author’s opinion, the intensity of price-based competition will be split between the corporate finance market and the consumer finance market. The latter has always placed emphasis on service, accessibility, and nonquantifiables of that sort, but the corporate finance market consists of a professional treasury manager who will have to justify the cost of money to his boss. So far, leasing has continued to sell itself on several intangibles as speed, smile, and simplicity, but corporate finance quickly moves to a dilemma where every one is fast, everyone smiles and every one is simple enough for the sophisticated audience. It is there the price becomes decisive. Leasing, with all its cost additives as sales-tax and stamp duties, will have to sustain as a cost-competitive financing option.