AN ASSESSMENT OF EQUIPMENT LEASE FINANCING
CHAPTER ONE
1.0 Introduction
1.1 Background of the Study
Since the commencement of lease financing by indigenous institutions in the early 1970’s the leasing industry has been going through various problems. Although modest growth has been recorded over the years with the establishment of more merchant banks in the 1970’s 1980’s and the early 1990’s.
The introduction of the Structural Adjustment Programme (SAP) in 1986 brought in its wake, local currency against major international currencies. This single most important feature of SAP imposed severe operating conditions on business occasioned by high rates of inflation and the attendant high cost of raw materials, spare parts, capital equipment and other inputs.
As though this was not enough the trade Liberalization aspect of the programme encouraged the influx of foreign goods, produced under much more efficient systems (with, more efficient technologies) which were inevitably more competitive in price as well as quality, compounded the problem of local manufacturers, who could hardly muster enough foreign exchange required to procure raw materials and essential parts to operate at economic level.
The result was that the local businesses that were somehow able to remain in business were operating at low or no profit. For those few that were able to record either absolute profits, the profit represented sharp declines in real term; in other words the profit were only inflation profits.
Severe cash crush was, therefore, the lot at most business and, it was virtually unimaginable to general adequate cash flow to acquire capital equipment for expansion or moderating programmes not to talk of setting up new facilities.
It was during this period that equipment leasing presented itself as perhaps the most attractive means through which business could acquire equipments they so badly needed (Osaza: 1-3). This was so because under a lease, a business concern could, with little or no financial outlay have the use of the equipments it desired (which it would eventually own) in return for which it was to make periodic payments to the leaser (the equipment provider) during the lease term.
Ironically, the same conditions brought about by SAP, which naturally opened the eyes of many equipments users to the irreversible alternative of equipment leasing also contained the capacity of the banks to meet the enormous lease financial needs.
For one, the sheer volume of funds required to fiancé equipment acquisition imposed a stain on he funds of banks available for lending activities. The situation was compounded by the news requirement in 1991. That lease financed is counted in the aggregate credit volume determination for banks. To further compound matters, the Nigerian Accounting Standards Board (NASB) released almost simultaneously, statement of accounting standards No. II (SAS II). SAS II ruled that bank leases finance lease and therefore, banks as lessons should not claim capital allowances (Akinfeiwa, 1993:8). These developments drastically reduced the enthusiasm of banks in lease financing.
The issue of capital assets inspection provision of inspectorate division of the federal ministry of industry (which is very vigorous and clumsy) (Akinfemwa, 1993: 8-11). Before procurement of acceptance certificates by lessors is frequently being cited as another major disincentive of growth of lease finance by Banks in Nigeria.
The withholding tax normally charge on lease income is also disincentive to bank lessors as it reduces income on lease transactions.
In both of these cases, the financing of capital equipment tends to be accomplished through other types of credits e.g. loans, overdrafts, and commercial papers etc and because some of these facilities are inappropriately utilized to fund equipment acquisition. This often leads to problems of default in their servicing or repayment. Bank would, therefore do well to consciously discourage the use of these facilities were lease finance may be more appropriate, this will consequently lead to a health, growth in the leasing industry, which will in turn help the growth of the leasing industry in Nigeria.
Although lease financing by indigenous financial institution is well over two decades old and although training and retraining of leasing personnel is to be vigorously pursued, knowledge of the subject is still either inadequate or is not being put to use in the promotion of lease financing. The many different ways a lease can be structured or tailored to suit the circumstances of the lease, while meeting the investment objective lease and lessor, can decide both a prospective lease and lessor to have a lease transaction instead of some other format of leasing knowledge by banks personnel involved in leasing will, therefore, go a long way in generating or increasing interest in lease financing.
1.2 Statement of the Problem
Leasing is an aged old business dealings but the subject has not received adequate attention from authors particularly in Nigeria. Some of the problems are:
- The banking industry substantially lost interest in lease financing in the wake of the issuance of the Statement of Accounting Standards No. II (SAS II).
- The limited growth of lease financing in the banking industry is significantly related to the use of other forms of credits at the expense of lease finance to finance equipment acquisition.
- Commercial banks do not appear to have been making conscious efforts to employ this innovative vehicle of finance in meeting relevant needs of their customers.
- This is because these facilities are in many cases unsuited for the purpose they are growth (mismatch). However, owing to the relative case and convenience with which they are arranged in some cases, they are preferred by especially the borrowers, to meet their immediate needs.
- Also, the assets used to cover such lines of credit may not be realistically valued or revalued. Their nature (e.g. floating assets in a floating debenture securing arrangement) may also quit easily get the odds stacked against the lender when it comes to realization.
The problem of limited growth of lease finance, that leads to other problems in other form of credit which may in turn plunge the organization into the more serious problem of distress. The consequences of this for the banking industry need not be overemphasized.
1.3 Objective of the Study
The objectives of this research are:
- To find out whether banks lost interest in the leasing as a result of the introduction of SAS II?
- To find out whether the use of other forms of credits at the expense of lease to finance equipment acquisition affect the growth of lease financing positively in the banking industry.
- To recommend solutions to the problems militating against the growth of the leasing business in the banking industry.
- To emphasize the main features of the different types of lease, their implications, and how these can be adapted to suit the circumstances of the borrowers.
- To emphasize the relevance of lease financing compare to equipment lease financing.
1.4 Research/Questions
As the main focus of this study is to identify the major problem in assessing the growth of lease finance in the Nigerian banking industry and recommend solutions for them, questions have been developed to know the most important assessment in lease financing. The following are the questions:
- Do banks lost interest in the leasing as a result of the introduction of SAS II?
- Does the use of other forms of credits at expense of lease to finance equipment acquisition affect the growth of lease financing positively in the banking industry?
- What are the solutions to the problems militating against the growth of the leasing business in the banking industry?
- What are the main features of the different types of lease, their implications, and how these can be adapted to suit the circumstances of the borrowers?
- What extent is the relevance of lease financing, compare to equipment lease financing?
1.5 Significance of the Study
Although leasing is an aged old business activity, the subject has not received adequate attention of authors. Operators in Nigeria have not adequately exploited the vast potentials of the economy in the area of leasing, while banks in particular (especially commercial banks) do not appear to have been making conscious efforts to employ this innovative vehicle of finance in meeting relevant needs of their customers.
Some of the reasons for this situation include the attitude of some business of using other forms of credit (including short tern finance) finance equipment acquisition and the seeming lack of adequate education on the subject. The later factor is responsible for the lack of good understanding and, therefore, its advantages over and above other of lending. This work is expected to make a significant contribution to the body of knowledge in leasing in Nigeria in general, but in particular on the problems of lease financing in the country’s banking industry.
It is hoped that the study would promote those banks that have been relatively active in the business of good sight in to the problems the need to address to make the business more worth while as well as sensitize and expose those that have not been so active on the potentials that exist.
1.6 Scope of the Study
This study covers the assessment at equipment lease financing in Nigerian banking industry. The period covered by this study is form the reconstruction of the bank in 2001 till date. Therefore most of the data collected for this research purpose is strictly within the boundaries of the bank of the industry.
1.7 Historical Background of the Case Study
The Bank of Industry Limited (BOI) is Nigeria’s oldest, largest and most successful development financing institution. It was reconstructed in 2001 out of the Nigerian Industrial Development Bank (NIDB) Limited, which was incorporated in 1964. The bank took off in 1964 with an authorized share capital of 2 million (GBP).
The international finance corporation which produced its pioneer chief executive held 75% of it equity along with a number of domestic and foreign private investors. Although the banks authorized share capital was initially set at N50 billion in the wake of NIBDs reconstruction into BOI in 2001. It has benne increased to 250 billion in order to put the bank in a better position to address the nation’s rising economic profile in line with its mandate.
Following a successful institutional and financial restructuring programme embarked upon in 2002, the bank has transformed into an efficient, focused and profitable institution that is well placed to effectively carryout its primary mandate of providing long term financing to the industrial sector of the Nigerian economy.
MANDATE
Vision: to be a leading self sustaining development finance institution, operating under sound management and banking principles, that would promote the emergence and development of a virile competitive in both the domestic and external markets.
Mission: to transform Nigeria’s industrial sector and integrate it into the global economy by providing financial and business support services to attain modern capabilities for the production of goods that are competitive in both the domestic and external market.
Providing financial assistance for the establishment of large, medium and small projects as we as expansion, diversification and modernization of existing enterprises; and rehabilitation of ailing ones.
1.8 Definition of Terms
In this section, definitions of major terms used in leasing which also appear in various parts of hits study is given. The definitions are largely as they appear in statement of accounting standards No: II (SAS II, 1991: 76-10).
Lease: the Nigerian Accounting Standard Board (herein after abbreviated as NASB) defines a lease in its statement of accounting standards No: II (SAS II) as “a contractual agreement between an owner (the lessors) and another party (their lessor which conveys to they lessee the right to use the leased assets for an agreed period of time in return for a consideration, usually periodic payments called rentals”).
Lessor: the provider of lease finance or leased assets who retains the legal ownership of the assets during the lease term of tenor. The lessor may be a bank, a finance house or other non-bank financing institution (NBFI), a non-financial leasing outfit such as the multinational leasing outfits operating in Nigeria, or even a manufacturer or dealer of equipment.
Lessee: this is the party in a lease contract, which uses the equipment and pays periodic rental fee to the lessor.
Lease term/tenor: this refers to the period over which the lease subsists and during which rentals are paid by the lessee to the lessor it is usually stated in years, but it can also be stated in terms of the periods (months, quarters or half years) comprising the lessee term. Lease term can vary from a few months to the entire economic life of the leased asset(s).
Economic life: the period during which an asset is or can be profitably employed. It may also be referred to a the useful life of the assets.
Fair value: is the amount that can be realized from the sale of an asset in a free market and in an arm’s length transaction between two known legible parties.
Residual value: is the estimated fair value of the leased asset at the end of the lease term. In Nigeria, leasing environment, however, the term is frequently loosely used to mean the amount payable under a bargain purchase option which is usually lower than the fair value.
Bargain Purchase Options: this is provision in the lease agreement granting the lease, the option purchase the lease asset at a nominal sum considered lower than the likely prevailing value of the asset at the time the option is exercisable. Given the attractiveness of the option, it is reasonably certain that it will be exercised.
Bargain Renewal Option: is a provision in lease contract allowing the lessee the option to extend the lease for an additional period in return for rentals, which net present value at the time of the extension discounted at the implicit interest rate is lower than the fair value of the asset at that time. This obtains in leases that are initially structural as operating leases.
Contingent Rentals: these refers to the increases or decreases in the original lease rentals, which are required to be paid or enjoyed by the lessee/lessor usually as a result of changes in the implicit rate occasioned by changes in the lessor’s prime lending rater. This is usually provided for in the lease agreement.
Implicit Rate: this is the interest rate at which the rentals are computed. It is the rate at which when all the lease rentals payable over the lease are discounted, the net present value of the assets equals the cost of the lessed assets at the inception of the lease period. It is also referred to as the lessors pre-tax yield or nominal rate.
Investment Allowance: an allowance, presently 10% of the initial cost of qualifying equipment plant and machinery permitted to be deducted from the rental income of the lessor during the first year (in addition to the applicable capital allowance), to arrive at the tenable amount. This makes it similar in application to the initial allowance component of capital allowance, but differs from it in the sense that it (investment allowances) is granted engratia. This means that it does not write down the value of the asset for tax purpose.
Capital Allowance: this is an allowance that is deducted from assessable profit to reduce tax liability. It is in two parts; initial allowance and annual allowance. Initial allowance is enjoyed only once during the first year following that of the acquisition of the equipment, while annual allowance is enjoyed yearly, including the first year until the cost of the equipment is fully amortized. Capital allowances are given as an incentive for capital equipment acquisition and in leasing it, it enjoyed by the party, which bears the risks and renewals of ownership. This issue will be a subject for further discussion in the subsequent parts of this study.
Capital Allowances are different for different equipment and have been reviewed over the years to reflect government’s increased desire to encourage industrialization and its emphasis on certain economic activities.
AN ASSESSMENT OF EQUIPMENT LEASE FINANCING
