Executive Summary:

The emergence of the leasing companies, since inception successfully created public awareness about lease financing and definitely made significant progress with the objective of assisting the development of productive enterprises. In this study, I tried to highlight operational and financial aspects and overall status of leasing Company in Bangladesh, and to have an insight about the role of leasing company in Bangladesh.

Leasing in Bangladesh, like in many of its peer countries, owes its origin to the efforts of the International Finance Corporation (IFC), Washington. At the instance of IFC, the first Leasing Company in Bangladesh, Industrial Development Leasing Company of Bangladesh Ltd. (IDLC) was set up in 1984 and commenced its operations in 1986, with a 20% shareholding from Korea Development Leasing Corporation.The country’s central bank, Bangladesh Bank, put in place a regulatory mechanism under the Financial Institutions Act 1993 and the Financial Institutions Regulations 1994.

Lease financing, as organized in Bangladesh, operates with the following objectives: to assist the development and promotion of productive enterprises by providing equipment lease financing and related services; to assist in balancing, modernization, replacement and expansion of existing enterprises; to extend financial support to small and medium scale enterprises; to provide finance for various agriculture equipment; and to activate the capital market by operating as managers to the issue, underwriters, or portfolio managers.

The operations of NBFIs in Bangladesh are regulated by the Bangladesh Bank. The grant of authority to engage in borrowing from the general public is normally based on such factors as minimum capital requirement, quality of management, compliance with the concerned laws, rules, and regulations, and stability of financial standing. NBFIs may grant loans to their members and the general public up to a certain amount and may also engage in trust functions with prior permission of the central bank. They are not allowed to engage in foreign exchange transactions.

Than I have discussed about Prime Finance & Investment Ltd, covering Prime Finance and Investment Ltd., at a glance, corporate information, background of the company, promoters & shareholding structure, Fund Based Activities, Lease Financing, Fee Based Activities, Merchant Banking Activities, Issue Management, Underwriting, Private Placement Management, Lease Operational Procedures, financial highlights of Prime Finance.

Finally, I have discussed about development of non banking financial institutions that strengthen the financial condition of our country. Emergence of NBFIs such as leasing has created a new avenue in our bank dominance traditional financial system. As leasing is considered as an alternative of long term financing many NBFIs have strong performance in leasing business. The performance of the NBFIs in leasing business suggests that the industry can be growing up in a sustainable basis. But leasing must not be confined with selected sectors. NBFIs have to be equipped with highly professional personnel and technological advancement to chase the future opportunities and competition as well.

So I think that a modern and dynamic regulatory framework is required for the rapid and effective development of NBFIs. It is hoped that in future NBFIs would be able to play more significant role in the development of economy of Bangladesh. Further research on the significance of their contribution in the economy is required.

INTRODUCTION:

Leasing business is gaining increased importance in the economy of Bangladesh with its gradual transformation from an agrarian to industrial one. The government periodically revises the trade and industrial policy to create a liberal business environment both for domestic and foreign investment. Increased investment in the energy sector as well as in power, transport, telecommunications, water and sanitation, and safe disposal of wastes is expected to bring further opportunities for leasing industries.

Lease financing was first introduced in Bangladesh in the early 1980s. Industrial Development Leasing Company of Bangladesh Ltd. (idlc), the first leasing company of the country, was established in 1986 under the regulatory framework of Bangladesh Bank. It was a joint venture of the Industrial Promotion and Development Company of Bangladesh Ltd. (ipdc), International Finance Corporation, and Korea Development Leasing Corporation. Another leasing firm, the united leasing company Ltd. started its operations in 1989. The leasing business became competitive with the increase in the number of companies and wider distribution of their market share.

Commercial banks and development finance institutions (DFIs) have been the traditional lending institutions in Bangladesh. In fact, the concept of lease financing is a relatively new one in the country. Initially, leasing companies had to adopt the role of educators to make Bangladeshi entrepreneurs aware of the benefits of leasing. However, as DFIs demonstrated poor recovery and fund recycling performances, leasing got the opportunity to develop as an alternative source of funding. A few other factors also contributed to development of the leasing business in the country. For example, the commercial banks have been keener in providing trade financing and Foreign Exchange dealings rather than long-term loans because of the risks involved and their longer gestation period. The selection of lease proposals is relatively free from extraneous pressure and is subject to a quality level appraisal. Under lease agreements in the private sector, projects are sanctioned and implemented expeditiously, resulting in benefits in time and cost savings. Private leasing companies also attract clients by providing relatively better services. The down payments in leasing are not high and the gestation period is low. Also, in case of lease financing, incidental costs incurred in the process of import clearing, installation, and commercial production are capitalized, which substantially reduce the initial investment.

Leasing companies, however, face some problems in conducting their business in the country. The relatively slow growth of the demand side compared to the fast growth of the lease business is one such problem. This leads many leasing companies to operate in partial capacity. The culture of loan default that prevails in the country is also a deterrent. Leasing companies often find it difficult to raise funds through short- or long-term borrowing from money and capital markets. They are hard pressed to deal with the financial assets because of the present laws of the country, which are also not fully enforceable.

Origin of the Report:

This report is written as a fulfillment of the internship Program of MBA degree by Mohammad Fuad Shahariar, Roll # 663, 5th Batch MBA Program for Chairman, Internship and Placement Committee, Faculty of Business Administration, University of Dhaka.

Objectives:

To develop a clear idea about the leasing sector in Bangladesh.
To get a thorough know-how about lease loan financing in Bangladesh.
To identify the major lease loan providers in the market and analyze their offers to the clients.
To compare the performances of the current lease loan providers.
To recognize the customers’ perspective of the story – what criteria they look into before choosing a financier.
To identify the different processes of appraising a prospective client by the financial institutions.
To find out market potential for lease loan products.
To prepare a guideline for PFI in terms of lease loan offering, process and marketing,

Scope of the Report:

The Study will determine future market prospects for the company and clear concept about the term of leasing. If it wants to introduce new products in the market by analyzing different factors influencing the market it will provide guidelines regarding product, marketing strategy and approval process based on the analysis of selected competitors. The study will not include details marketing, financial, operational and human resource plan.

Methodology:

Develop questionnaires for both the lease loan providers and the clients.
Conduct detailed interview with the representatives of the leading five lease loan providers.
Conduct a sample survey on both the current and prospective clients of lease loan.

Information Tools:

Brochures and websites of the NBFI institutions.
Annual Reports of the current market players.
Publications related to lease finance and NBFI sector.

Limitations:

Getting adequate information about the market scenario was the most difficult part of the project. Market share of different companies, information regarding growth of income and expenditure, were not available which is essential to determine or project the market. The vague term of leasing is also the problem of making a clear distinction among them.

Concept and Definition of Lease

Lease is a contract between the owner and the user of assets for a certain time period during which the second party uses an asset in exchange of making periodic rental payments to the first party without purchasing it. Under lease financing, the lessee regularly pays the fixed lease rent over a period of time at the beginning or at the end of a month, 3 months, 6 months or a year. At the end of the lease contract the asset reverts to the real owner.

However, in case of long-term lease contracts, the lessee is generally given the option to buy the leased asset or renew the lease contract. The three major types of leases are the operating lease, financial/capital lease and the direct financing lease. The operating lease is a short-term lease contract where the lessor bears all operating and repairing costs of the asset and the lessee pays periodic rental payments to the lessor, and where the lease is cancelable, and there is no bargain purchase option. Financial/capital lease is a long-term lease contract where the lessee bears all operating, repairing and maintenance costs, and makes periodic rental payments to the lessor. The lease is not cancelable and the lessee has the option for bargain purchase or renewal of lease contract at the end of the original lease period. In a direct financing lease, the lessor leases the asset by manufacturing or by purchasing from the manufacturer to the lessee directly and the lessee makes regular rental payments to the lessor. The lessor holds the ownership of the asset until the end of the lease period and the lessee holds the possession of the asset. In addition to these major types, there are some other types of lease such as sale and lease and leveraged lease.

Legally, others define a leasing company as one having the business of hiring plants or equipment or of financing their hire. The International Finance Corporation promotes leasing as a method of financing industrial development in the developing countries as a part of its Capital Market development strategies.

A “financial lease” is defined as a transaction in which the lessor purchases leased property selected by the lessee; the lessee has the right to possession and use of the leased property in exchange for payment of rent; and upon expiration of the lease, the lessee may renew the lease, exercise an option to buy the leased property or return it to the lessor. Or

“An agreement where the leaser receives lease payments to cover its ownership cost. The lessee is responsible for maintenance, insurance, and taxes. Some finance leases are conditional sales or hire purchase agreements”.

Researchers have examined the features of leasing from economic, legal, fiscal and accounting angles. While no universally accepted definition can be said to have evolved, various bodies have formulated their own definition of the word. The European Leasing Association, the association of leasing companies in Europe, defines leasing as:

“A contract between a lessor and a lessee, for the hire of a specific asset, selected from a manufacturer or vendor of such asset by the lessee. The lessee has possession and use of the asset on payment of specified rentals over a period.”

Legally, others define a leasing company as one, having the business of hiring plants or equipment or of financing their hire. The International Finance Corporation promotes leasing as a method of financing industrial development in the developing countries as a part of its Capital Market development strategies.

Under lease financing, the lessee regularly pays the fixed lease rent over a period of time at the beginning or at the end of a month, 3 months, 6 months or a year. At the end of the lease contract the asset reverts to the real owner. However, in case of long-term lease contracts, the lessee is generally given the option to buy the leased asset or renew the lease contract.

Where as Leasing, one of the financing techniques, allows a company to use some of its operating fixed assets (i.e. buildings, plant and other fixed assets) under a rental system. In certain cases, the company may purchase the asset at the end of the contract for a pre-determined and usually very low amount. A leasing transaction is called a lease.

In accordance with the Law, financial leasing is a form of investment activity, in which a lessor is obligated to transfer a leased asset acquired from a supplier, held in ownership by the lessor, and agreed upon with the lessee, to a lessee for an agreed upon fee and terms for temporary use and possession for commercial purposes for a period of no less than three years. The transfer of the lease asset in the lease agreement must meet at least one of these \ following conditions:

The transfer of the leased asset to the lessee’s ownership and/or the lessee’s right to acquire the leased asset at a fixed price are stipulated by the lease agreement;
The term of the lease agreement shall exceed 75% of the useful life of the leased asset;
The current (discounted) amount of the lease payments over the length of the lease agreement shall exceed 90% of the price of the transferred leased asset.

Legal Framework for Leasing

The leased asset may be any non-consumable good, including companies, property complexes, building and structures, equipment, transportation, land, and other movable and unmovable property. Leased assets cannot be natural resources, and property barred or restricted from general public circulation.

The parties to a lease (lessor, lessee, and supplier) may be any legal entity or physical person:

Physical persons operating as lessors or lessees must have the status of a certified sole proprietor; and,
Suppliers may be any physical person.

Subleasing

Subleasing is a form of subhire of the leased asset in which:

The lessee has the right, with written permission of the lessor, to sublease the leased asset, received through a lease agreement, to a third party for the temporary possession and usage on the basis of a sublease;
The sub lessor and the sub lessee act in this relationship as the lessor and the lessee, and have the same rights and obligations accorded in the civil legislation for these parties to the lease;
The period of the sublease cannot be longer than the original lease agreement; and,
If the original lease agreement is terminated, the sublease agreement is automatically terminated, if this point is not otherwise addressed in the lease agreement.

Rights and Obligations of the Parties to a Lease

Leasing legislations throughout the region create a clear balance of rights and obligations for each party to the lease, equally defending the interests of each party. A progressive aspect of the legislation is that the norms in the legislation are based on imperative law, which means that even though the legislation contains concrete principles of behavior that must be observed; at the same time, the parties to the lease also must have the right to decide upon the extent of their rights and obligations, observing the concept of freedom of contract.

The lessor is not accountable to the lessee for the non-fulfillment of the sale-purchase contract, except for those cases in which the selection of the supplier and the leased asset was conducted by the lessor, as well as in cases when non-fulfillment of the sale-purchase contact was the result of the wrongful acts (omissions) of the lessor.
The lessee has the right to address all the claims which stem from the sale-purchase contract directly to the supplier even though the lessee is not the party to that contract. As a result, the legislation imposes an obligation on the lessor to notify the Supplier about the purpose of purchasing an asset for lease.

Insurance

Insurance of the leased asset against all potential detriments attributed to the risk of incidental loss, deprivation, larceny, damage or premature wear and tear is voluntary and is decided through agreement of the parties. Agreement on insurance can take the following terms:

Which party to the lessee will be the insurer, and who will pay for the insurance premiums:
Will the insurance premiums compensate which party?
Which insurance company will be used and who will select the insurance company?
Who will receive compensation from the insurance company, and how will this compensation be used?

Secondary Leasing

The Law on Financial Leasing has introduced the concept of a secondary lease or a secondary transfer of the leased asset to another lessee following the end or termination of the initial lease agreement.

In this way, the law allows for the return of the leased asset to the lessor, and in the case of repossession following default, the subsequent transfer of the returned leased asset to a new lessee.

The law furthermore states that in the case of secondary leasing , the lessor is obligated to inform the supplier in written form that the leased asset has been transferred to a new lessee for use and possession within one month after the transfer. In the case of a secondary lease, the lessor is considered the party, which selected the supplier and the leased asset.

Lease Payments

The law defines lease payments as periodic payments that include the total amount of the payments stipulated in the lease agreement over the entire period of the agreement. Lease payments must be calculated subject to full or partial repayment of the cost of the leased asset, based on its value at the moment of lease agreement execution. The lease payments must be paid during the term of the lease agreement and include:

Reimbursement to the lessor for expenses incurred through the acquisition of the leased asset and other expenses affiliated with the acquisition, delivery, and installation of the leased asset for its use as defined in the lease agreement; and,
Fees for the provision of the lease.

Repossession of the Leased Asset

Interviews with lessors indicated that repossession of leased assets through the court system has operated fairly efficiently. However, court decisions are not always provided in a desirable time length that meet the needs of the lessor as inactive leased assets and unpaid lease payments could quickly result in losses to the lessor. For this reason, Kazakhstan has also implemented non-court mechanisms to repossess the leased asset.

The Law on Financial Leasing allows for the right of non-disputed repossession of the leased asset on the basis of court order for use in those cases in which the lessee admits fault but does not return the leased asset.

To take advantage of the court order proceedings, the lessor must officially submit a claim to the court, which within three days issues a court order, a copy of which is sent to the lessee. The lessee has the right within 10 days to submit its objections to the court. If the lessee files an objection, the court must cancel the court order as the court order proceedings can only be used on the basis of non-disputed demands.

If within the 10-day period, the lessee does not submit any objections, the court order is executed and enforced in the manner prescribed, and the lessor can repossess the leased asset based upon the court order.

This repossession procedure provides the lessor an alternative and more effective method to defends its interests.

Term Uses in Leasing

Lessor

The lessor’s business license must have a scope of business that includes financial leasing operations.

Lessee

The “lessee” is defined as any natural person or enterprise/company that enters into a financial leasing contract with the lessor to obtain funds to finance the acquisition of the leased property, and to obtain the right of possession and usage by paying the rent on the agreed terms.

Leased Property

The “leased property” is defined as any real property and movable durable property (including the accessory technologies), other than natural resources. Examples include (i) equipment, machinery and instruments; and (ii) vehicle, vessels, aircraft and space shuttles. The Outline does not distinguish between commercial and consumer leases, although other consumer protection laws are also under consideration. These laws could affect financial leases with consumers.

Registration of Leased Property

Leased property (other than real property, aircraft, vessels and motor vehicles) must be registered at the State Administration of Industry and Commerce, the government authority in charge of registration of mortgage or security interests of movable assets, or with any industry association authorized thereby. Such registration is needed to protect the parties’ interests against bona fide purchasers or creditors.

Nature of the Rights to Leased Property

The financially leased property is excluded from the bankruptcy estate of the lessee. If the lessee fails or delays in making a rental payment, the lessor may terminate the contract and repossess the leased property.

Term

In general, the financial lease term should be shorter than the permissible period for depreciation for the leased property, but in no event less than 20% of the depreciation period.

Rent

The financial lease rent shall be determined by the cost of the leased property, plus the reasonable profit of the lessor, unless otherwise agreed by the parties.

Acceleration and Repossession

If the cumulative past-due rent is more than one-fifth of the rent under the financial lease or the number of defaults in making the rental payments exceeds one-fifth of the total number of the rental payments, the lessor may demand immediate payment of all the rental payments or terminate the financial lease repossess the leased property and recover damages including expenses. However, the total amount of the compensation cannot exceed one-fifth of the total rent under the financial lease .The lessee may not prevent the lessor from exercising its right of repossession or resist the lessor in this regard.

Risk Assumption

When the lessee possesses the leased property, unless otherwise agreed upon by the parties, any damages, losses and risks to the leased property shall be the sole responsibility of the lessee.

Conditions for Setting Up Financial lease Companies.

Minimum registered capital of RMB 80,000,000 (equivalent to slightly less than USD 10,000,000)
Required management team with professional knowledge of financial leasing and the law
Adequate organization, management, internal management systems and systems for risk control and handling
Business premise, safety measures and other required facilities corresponding to the business operation

Regulatory Requirements for a Financial Leasing Operation

Assets/Debt Ratio.

Risk assets, including contingent liabilities, shall not exceed ten times the total assets
Investment in industries other than the financial lease industry cannot exceed 30% of the total assets
The leased assets under the financial lease and other financial leases cannot be less than 60% of the total assets

Management of Leased Property. The leasing company shall set up separate accounts for leased property under sublease and entrusted b lease business.
Cost Control for Leased-Back Property. In a sale-and- lease -back transaction, the acquisition cost for the leased property shall not exceed 20% of the actual value or the book value of the leased property.

Incentives for Financial Leasing

Tax Incentives and Accelerated Depreciation.

Any tax incentives and holidays applicable to manufacturers apply to the lessor or lessee that is eligible to record the leased property on its books as fixed assets for depreciation.
Accelerated depreciation is permitted, provided that depreciation period is not shorter than three years.

Special Reserve. Reserve for uncollectable accounts is permitted for the leasing companies.
Source of Funding. A leasing company, after its establishment has been approved, may finance its operation through public equity offerings or issuance of corporate bonds.
Special Treatment for Purchase and Leaseback. The sale/purchase in a purchase and leaseback transaction is not considered as a true purchase; therefore, relevant taxes and fees imposed on sales/purchases will not be imposed

What are the Types of Leases and How Do They Work?

The three main types of leasing are:

I) The Financial Lease

Financial/capital lease is a long-term lease contract where the lessee bears all operating, repairing and maintenance costs, and makes periodic rental payments to the lessor. The lease is not cancelable and the lessee has the option for bargain purchase or renewal of lease contract at the end of the original lease period. In a direct financing lease, the lessor leases the asset by manufacturing or by purchasing from the manufacturer to the lessee directly and the lessee makes regular rental payments to the lessor. The lessor holds the ownership of the asset until the end of the lease period and the lessee holds the possession of the asset.

A long-term lease over the expected life of the equipment, usually three years or more, after which you pay a nominal rent or can sell or scrap the equipment – the leasing company will not want it anymore.
The leasing company recovers the full cost of the equipment, plus charges, over the period of the lease.
Although you don’t own the equipment, you are responsible for maintaining and insuring it.
You must show the leased asset on your balance sheet as a capital item, or an item that has been bought by the company.

ii) The Operating Lease

The operating lease is a short-term lease contract where the lessor bears all operating and repairing costs of the asset and the lessee pays periodic rental payments to the lessor, and where the lease is cancelable, and there is no bargain purchase option. Under an operating lease, the risk and rewards incident to ownership of an asset remain with the lessor. Also the value of the asset is not fully amortized in the lessor’s book during lease period.

A good idea if you don’t need the equipment for its whole working life.
The leasing company will take the asset back at the end of the lease.
The leasing company is responsible for maintenance and insurance.
You don’t have to show the asset on your balance sheet.

iii) Contract hire

This offers you an opportunity to have the use of a piece of equipment, often tied in with a maintenance contract, for the duration of the agreement. Ownership remains with the finance company and you will pay a set fee over a period to use that equipment. The contract will outline a residual value at which the finance company will take back the equipment at the end of the contract.

Often used for company vehicles.
The leasing company takes some responsibility for management and maintenance, such as car repairs and servicing.

Essentially, there are two types of leases – finance lease and operating lease.

The other types of lease are:

iv) Sale and Lease Back

A sale and lease back transaction involves the sale of an asset by the vendor and the leasing of the same asset back to the vendor. The rentals and the sale price are usually interdependent as they are negotiated as a package and need not represent fair values.

v) Full and Partial Payoff Lease

A lease, which seeks to recover the investment in lease along with interest and profit from a single lessee. This is also equivalent to the finance lease. It is quite possible for the lessors to sign non-cancelable leases for part of the useful life of the asset, to recover part of the investment. The recovery of the remaining investment through subsequent leases or through the sale of the asset at the end of the first contract. Such leases are called partial payoff leases.

vi) Domestic and International Leases

A lease is called a domestic lease if all the major participants in the arrangement, the lessor the lessee and the equipment supplier have one nationality. Hence, the funds deployed in acquiring the asset are usually from local sources.

An international lease transaction takes place when one of the parties to the lease is situated in a different country.

Objective

Lease financing, as organized in Bangladesh, operates with the following objectives:

(a) To assist the development and promotion of productive enterprises by providing equipment lease financing and related services;

(b) To assist in balancing, modernization, replacement and expansion of existing enterprises;

(d) To provide finance for various agriculture equipment; and

(e) To activate the capital market by operating as managers to the issue, underwriters, or portfolio managers.

Functions Of Leasing Companies:

The functions of a lease business include lease financing, short-term financing, house building financing, and merchant banking and corporate financing. In this last group of functions, the leasing business in Bangladesh moved away from regular leasing activities and is now involved in stock-market related activities such as issue management, underwriting, trust management, private placement, portfolio management, and mutual fund operation. Broad capital market operations of the lease financing institutions include bridge financing, corporate counseling, mergers and acquisition, capital restructuring, financial engineering, and lease syndication. Prominent among the sectors of the economy that now receive lease financing services are textiles, apparels and accessories, transport, construction and engineering, paper and printing, pharmaceuticals, food and beverage, chemicals, agro-based industries, telecommunications, and leather and leather products.

1. Lease Financing,

2. Short-term Financing,

3. House building financing,

4. Merchant Banking

5. Corporate Financing.

6. Issue Management

7. Underwriting

8. Trust Management.

9. Private Placement

10. Portfolio Management.

11. Mutual Fund Operation.

12.Bridge Financing,

13. Corporate Counseling

14. Mergers and Acquisition,

15. Capital Restructuring,

16. Financial Engineering,

17. Lease Syndication.

The Benefit of Leasing

Leasing conserves capital

We live in a world where demands on working capital always seem to exceed supply. By providing 100% financing, leasing allows your customer to have more money available to put into profit-generating activities.

Leasing provides tax-timing advantages

Lease payments are normally treated as a fully deductible operating expense for tax purposes. In addition, since the lease term is often shorter than the depreciable life for tax purposes, a lease can enable your customer to expense the equipment more rapidly than a purchase.

Leasing provides an alternate source of credit

Leasing provides your customers with an additional source of financing. Unlike most bank loans, which require 20% to 30% down, leasing offers, financing for 100% of the equipment cost. Furthermore, leasing does not impact a customer’s bank line of credit – the existing line remains intact for essential short-term needs.

Leasing means equipment flexibility

As their businesses grow and change, customers may need more equipment or equipment with increased capabilities or additional accessories. Leasing allows customers to add to or trade up their equipment at any point during the lease term.

Leasing lessens the impact of inflation

Inflation is a fact of life; every year the purchasing power of the dollar declines in value. By leasing, customers get the equipment they need at today’s prices and pay for it with tomorrow’s cheaper dollars.

Lease payments are fixed payments

Since lease payments are fixed, leasing lets your customer plan ahead with the assurance that his monthly payments will not change. With revolving bank loans, payments can change depending upon credit strength and / or prevailing interest rates.

Lower cost

Leasing conserves capital. Monthly lease payments are less than monthly purchase payments or monthly depreciation plus interest expense.

Convenience

Leasing provides on-the-spot, one-stop financing for a total solution. Hardware, software, maintenance and asset management can be included in the lease.

Protection against obsolescence

The lease can be structured to include upgrades and partial or complete equipment swaps either at mid-term or at lease-end.

Eliminates risk

The equipment can be returned at the end of the lease without regard for its book value or the expense of proper disposal.

Provides for off balance sheet financing

This potentially increases your borrowing capacity while easing the budgeting process and preserving key financial ratios.

Disadvantages

Cost consideration:

Interest rate is higher than it would be for a purchase loan. Delinquent charge increases the cost of lease.

Ownership flexibility:

In opting for a lease, the lessee may sometimes invite restrictions on equipment use, insurance covenants, etc.

Ineligibility of certain incentives:

Certain grants and incentives are available to owners of assets who themselves use the assets. By setting up a lease arrangement, such benefits are sometimes lost by both the lessor and the lessee.

Taxation:

In a case where the lessee has adequate tax capacity to utilize the tax benefit, long-term leases may sometimes prove inefficient.

Under statement of assets:

Leasing leads to an effective under statement of a lessee’s assets and leads to an under valuation of the firm.

Leasing Company In Bangladesh

The leasing companies now operating in the country are:

Government-owned (1)

Acronyms:

1. Infrastructure Development Company Limited

IDCOL

Completely local and privately owned (11)

2. Phoenix Leasing Company Limited

PLC

3. Prime Finance and Investment Limited

PFIL

4. Bay Leasing and Investment Limited

BLIL

5. National Housing Finance and Investment Limited

NHL

6. Peoples Leasing and Financial Services Limited

PLFSL

7. Union Capital Limited

UCL

8. First Lease International Limited

FLIL

9. Midas Financing Limited

MIDAS

10. Bangladesh Finance and Investment Limited

BFIL

11. Industrial and Infrastructure Development Finance Company Limited

IIDFCL

12. Islamic Finance and Investment Limited

IFIL

Established Under Joint venture (13)

a) Bangladesh Government and Foreign Government (2)

13. The UAE- Investment Company Limited

UAEBIC

14. Saudi Bangladesh Industrial and Agricultural Investment Company Limited

SABINCO

b) Bangladesh Government/ Company and Foreign Government/ Company (11)

15. Uttara Finance and Investment Limited

UFIL

16. United Leasing Company Limited

ULCL

17. Industrial Promotion and Development Company of Bangladesh Limited (IPDC)

IPDC

18. Industrial Development Leasing Company of Bangladesh Limited (IDLC)

IDLC

19. Vanik Limited

VANIK

20. International leasing and Financial Services Limited

ILFS

21. GSP Finance Company (Bangladesh) Limited

GSP-FCL

22. Bangladesh Industrial Finance Company Limited

BIFCL

23. BahrainBangladesh Finance and Investment Company Limited

BBFIL

24. Delta Brac Housing Finance Corporation Limited

DBH

25. Fidality Assets

Industrial Development Leasing Company (IDLC)

Industrial Development Leasing company (IDLC) is a multi-national joint venture public limited company and the first leasing and multi-product Non-Bank Financial Institution in Bangladesh. Foreign sponsors hold 45% of the company’s shares

The company commenced leasing business on 22 February 1986. It became a listed company in the Dhaka Stock Exchange on 20 March 1993 and in the Chittagong Stock Exchange on 25 November 1996. IDLC started to accept deposits after receiving the license from Bangladesh on 10 September 1994. On 7 February 1995, Bangladesh Bank gave it the license to operate as non-bank financial institution under the Financial Institution Act 1993.

IDLC has a significant contribution to capital asset financing to private sector industries in Bangladesh. Its business focus in the early years was in the area of 3-5 years term financial leasing with particular emphasis on balancing, modernization, replacement and expansion of existing units. Driven by the demand for funds from different classes of people and the competition with other similar institutions, IDLC diversified its functional areas into other financial services including short-term finance, corporate finance and merchant banking activities.

United Leasing Company (ULC)

a second leasing company, United Leasing Company (ULC) was established in 1989 with participation of Asian Development Bank(ADB), Commonwealth Development Bank (CDC) and the Lawrie Group PLC of UK. It was incorporated on 27 April 1989 as a public limited company

ULC was set up with the objective of introducing a new instrument of finance to assist mainly the private sector industries. The paid up capital of the company is 70 million Taka out of which foreign and domestic sponsors held 40.29% and 33.57% respectively and the remaining 26.14% was held by institutional shareholders (19.46%) and the general public (6.68%).

Phoenix Leasing Company Ltd.

Phoenix Leasing Company Limited incorporated in Bangladesh on 19 April 1995 as a public limited company under the Companies Act 1994 with registered office at Dhaka. The company obtained license as a Non-bank Financial Institution on 9 May 1995 under Section 4(1) of the Financial Institutions Act 1993

The company provides lease financing for various types of machinery and equipment including vehicles for industrial, commercial and agricultural purposes. It invests in sectors such as transport, electric and electronic goods, leather, textile, printing, marine vehicles and equipment, steel and engineering, fishing boats and trawlers, medical equipment and small-scale industries. The company first purchases a property in its own name and pays the total price to its supplier. After accumulating and adding all other relevant/incidental costs with the original purchase price, it determines the lease price of the property and then signs lease contracts with the lessee for a period of two to five years.

Lease contracts require security or collateral from the lessee in various forms and lease installments are determined on the basis of price of the properties to be leased and other relevant factors. On the expiry of the lease periods/contracts, the lessee can gain the ownership of the leased property/equipment upon payment of 5% of transfer value of the equipment as salvage value of that property. Alternatively, the ownership and physical possession of the property goes back to the lessor.

International Leasing and Financial Services Limited (ILFSL)

International Leasing and Financial Services Limited (ILFSL) a jointly owned equipment leasing and financial services company incorporated in Bangladesh on 15 January 1996 as a public limited company under the Companies Act. It obtained license from Bangladesh Bank on 19 February 1996 and commenced business on 24 March 1996. The company was established with an authorised and paid up capital of Tk 300 million and Tk 60 million respectively.

The clients established the company to carry out the business of leasing all kinds of industrial, agricultural, commercial, scientific, electrical and electronic equipment and machinery, and vehicles for all possible uses. It also provides other financial services including long-term loans to customers of selected groups. It was recently allowed to participate in merchant banking activities ie, to act as issue manager and underwriter of public issues of shares and debentures.

A 7-member board of directors manages the company. The managing director is the chief executive of the company. In 2000, the company had a total of 21 employees including 13 executives.

Bay Leasing and Investment Ltd.

Bay leasing and Investment Ltd. is locally owned company. The major shareholder of the company is Mr. Motlub Ahmed, who holds 50% of the company share. Several individuals own the other shares. It went into operation in May 1996. The company’s initial target is to finance prospective clients only on transport sectors like bus, trucks etc. They have made an arrangement with Nitol Motors for financing bus and truck that Nitol supplies. The paid up capital of the company is 25 million taka.

Bangladesh Leasing Finance Company Ltd.

Bangladesh Leasing Finance Company Ltd is another joint venture leasing company, which haven’t started their operation. The major shareholders of the company are Pakistan Industrial Leasing Corporation Limited (30%), Netherlands development Finance Company (20%), M. M. Ispahani Limited (25%), Green Delta Insurance Company (12. 5%) and Delta Life Insurance Company Ltd (12.5%). The company’s paid up capital is 150 million.

Infrastructure Development Company Limited

(IDCOL) a Non-Bank Financial Institution established in Bangladesh in 1997 as a government owned public limited company to promote participation of the private sector in investment in infrastructure facilities and in operation, ownership and maintenance of them. On 30 June 2001, the authorized and paid up capital of the company was Tk 100 million.

IDCOL provides long-term senior and subordinate debt financing for viable infrastructure projects in the private sector. The company finances projects of power generation, telecommunication, urban environmental services, gas and gas related infrastructure, ports, toll roads, water supply, and other infrastructure development. The company has a preference for build-own-operate and build-operate-transfer type of projects. It finances up to 40% of the total project costs and to be eligible for its funding support, the project must meet the government’s priority criteria.

The company is managed by a 7-member board of directors appointed by the government from amongst senior government officials and prominent entrepreneurs. A team of project-finance advisors of international repute assists the board. An 11-member management team assists the chief executive officer (CEO) of the company in carrying out its day-to-day business.

Peoples Leasing and Financial Services Limited (PLFSL)

It is a leasing and financing company registered in Bangladesh as a public limited company under the Company Act and as a Non-bank Financial Institution under the Financial Institutions Act 1993 with license from the Bangladesh Bank to transact all kinds of leasing and financing businesses.

The company assists industrial and other productive sectors through investment in sustainable projects in the form of lease and other long-term finance. It participates in the Capital Market by investing in shares and debentures, acting as issue, fund and portfolio manager, providing bridge and syndicated loans, and underwriting public issue of shares and debentures. Corporate finance and consumers’ credit financing are also included in the functions of the company.

The company provides lease financing for machinery and equipment of large and medium scale industries, marine vessels and equipment, generators and boilers, lifts/elevators, ice plants, air conditioners, vehicles of all types for use in industrial or commercial purposes, medical instruments, light and heavy agricultural equipment, computer hardware and software, and some durable consumer items.

Activities of Leasing in Bangladesh

For several years, IDLC remained the sole leasing company in Bangladesh. However, the real momentum began in the 1990s. The country’s central bank, Bangladesh Bank, put in place a regulatory mechanism under the Financial Institutions Act 1993 and the Financial Institutions Regulations 1994.

In 1997, there were 15 leasing companies in the country. Besides, some of the banks and financial institutions also added leasing divisions to their existing operations.

Licensing and regulation:

Who or what is a leasing company?

Leasing in Bangladesh is a “financial business” and cannot be carried on except in terms of a license granted by Bangladesh Bank.

Sec. 4 of the Financial Institutions Act prohibits any person or institution from carrying any “financial business” in Bangladesh except in accordance with a license granted by the Bank.

Sec. 2 (1) defines “financial business” as the business carried on by a financial institution. “Financial institution” as defined in sec. 2 (2) includes a leasing company.

“Leasing company” is defined in sec. 2 (17) of the Act as a company, which carries on as its business or part of its business hiring of plant or equipment, or the financing of such hiring business.

A first look at the definition suggests that even if a company, otherwise engaged in a manufacturing or non-financial activity, carries on a leasing activity as a part of its business, such company would be treated as a “financial institution” under the Act. This, however, could not be intent of the lawmaker as demonstrated later. The use of the words “part of its business” in sec. 2 (17), not found in definitions of other varieties of financial institutions in the Act, seems to be a surpluses and cannot lead to a technical extension whereby even a single lease transaction by a non-leasing company would bring such company under the fold of the Act.

The central definition in the Act is the definition of “financial institution” in sec. 2 (2). It is defined as “such non-banking financial institution, which is engaged in…..”. Apparently, what sec. 2 (2) enumerates are categories of financial activities such as lending or giving of advances, merchant banking, venture capital, leasing, Investment Company, etc. The definition is not divested of the element of principality of such business in order to characterize a company as a financial institution. For example, giving of loans or advances is a financial business. But that cannot be taken to mean that a manufacturing company, which in case of a short-term surplus in its business, grants a loan to someone, will be treated as a “financial institution”. In other words, the principal business of an entity should be one of the several financial businesses listed in sec. 2 (2).

This would mean that the ban under sec. 4 of the Act on carrying any “financial business” should be understood as a ban on carrying such business as a principal business. Such an understanding is very important, since there are ample opportunities to extend leasing activities to non-leasing or unlicensed entities as follows:

In many markets, leasing has flourished because of its tax appeal: leasing has been organized for high-net worth individuals to shelter against their taxes. That is, a high net worth individual may do one lease transaction, not as his principal business, and shelter his taxes. In many cases, an individual may participate in a lease syndicate organized by a leasing company.

Restricting leasing to only leasing companies would eliminate any possibility of leasing activities being carried, on a one-off basis, by manufacturing or non-financial companies. This is a common practice in many countries. A non-leasing company, say a hotel, would carry one lease transaction and shelter against its taxes.

As leasing markets develop, leasing by vendors or manufacturers would become common. That is, the manufacturer of capital goods will be prepared to provide his own product on lease, instead of selling it directly. Obviously, such manufacturer cannot be treated as a “financial institution.”

Securitisation of lease receivables is a very important development in leasing markets. In strict sense, securitisation means participation in leasing transaction by the participants in the securitised portfolio. A literal ban on “financing of a leasing transaction” would inherently imply a ban on participation in a securitised portfolio as well.

Restrictions on leasing companies

Having put leasing companies at par with other non-banking financial institutions, the Act puts the following principal restrictions on leasing companies:

Corporate form:

1. Apparent from the definition of sec. 2 (17) is the intent that only corporate bodies should be allowed to engage in leasing business.

What can leasing companies do?

2. There are no restrictions in the Act in leasing Companies undertaking non-leasing activities. Apparently, leasing companies can engage themselves in other financial businesses, principally hire purchase. Most leasing companies in Bangladesh currently do not take up hire-purchase or long-term corporate lending activities, though they do have exposures in money markets such as bills discounting, short-term deposits etc.

There is a bar in sec. 15 in leasing companies taking up any non-financial business such as import, export, retail or wholesale business.

Hire purchase, it may be noted, is clearly covered by sec. 2 (2) (c) of the Act.

Minimum capital, branching, etc

3. The Act empowers the Bank to fix minimum capital for leasing companies. Opening of offices and branches is also regulated.

Restrictions on declaration of dividend

4. Sec. 10 prohibits a financial institution from declaring any dividends without fully writing off all direct and administrative expenses, share issue expenses, brokerage, losses, and other capitalized expenses.

Exposure restrictions

5. Very important restrictions are contained in sec. 14 on exposure by leasing companies. These restrictions are:

Not accept any deposit which is withdraw able by cheque, draft or order of the depositor; in other words, not to accept any call deposits;

Not deal in gold or any foreign exchange;
Not to expose more than 30% of its capital in a single individual, firm, body corporate or companies controlled by such individual;
Not to provide any unsecured loan facility exceeding Tk 5 lacs to any person; it may be noted that in the language of the Act, a lease transaction will be treated as a secured financing since the lessor retains title over the asset, etc.
Not to acquire immovable properties exceeding 25% of its paid-up capital and reserves.

Maintenance of liquid reserves

6. Companies accepting deposits from individuals shall maintain 10% of their aggregate liabilities invested in prescribed securities.

Maintenance of reserve fund

7. Each company every year shall transfer at least 20% of its divisible profits to a reserve fund, unless the aggregate of its share premium along with such fund is equal to or more than the paid up capital of such company.

Leasing law in Bangladesh

Leasing is an asset renting activity, and is therefore, governed by common law. The Contracts Act 1872 applies to contracts of leases. Sections 148 to 171 of the Contracts Act cover provisions relating to bailment.

As these provisions are identical to those applicable under English law, the chapter devoted to general law of leasing adequately covers the law in Bangladesh as well.

It may be noted that the general law of contracts is limited to bailments of “goods”. “Goods” include movable property only – immovable property is not covered by common law. As it the common feature of all Anglo-Saxon legal systems, transactions in immovable properties are covered by a separate system of laws.

Taxation of leases in Bangladesh

The taxation system in Bangladesh has been a subject matter of criticism over a last few years. The system is characterized by a large number of incentives, tax holidays and concessions as a result of which the share of corporate taxation to total tax collection by the Govt. has come down drastically over the past few years.

Taxes on corporate profits, of both domestically and foreign owned companies amounts insignificant as a 0.95% of GDP in Bangladesh, compared with more than 6% in developed nations. The main reason cited for this low contribution is the tax incentives granted by the Govt., which are very liberal as compared to its counterpart countries.

It is probably with tax reform in view that the Govt carried out certain reforms in depreciation laws in Budget 1998-99. Among other provisions, the important change that would have a far reaching effect on leasing companies is the change in depreciation system by scrapping of initial year depreciation allowance, extra shift allowance and normal depreciation, replaced by a single rate of normal depreciation.

The following are the important features of taxation of leasing in Bangladesh:

No true lease guidelines

There are apparently no rules to distinguish genuine lease transactions from plain financing transactions. This is one of the most important rules to have in a developing market and an important lesson can be learnt in this regard from India.

A lease, in order to qualify for tax deduction, has to be different from a plain financial transaction. Evidently, no depreciation benefit can be claimed in case of a transaction of simple financing of an asset. In addition, one must also appreciate that if an agreement has the color of a lease transaction but in essence is nothing but a financial transaction, the outer form of the transaction will be ignored, and based on its intrinsic substance, it would be reckoned as a financial transaction.

The meaning of the above is that if a lessor in Bangladesh writes a lease transaction that has the legal form of a lease, but is in substance nothing but a financing transaction on the security of an asset, such lease will not be regarded as a lease but as a secured financing. Obviously, it is not enough to call an agreement a lease agreement: in taxation, nomenclatures are ignored and the reality is looked into.

To guide parties as to what are the important attributes of a lease transaction that would distinguish it from a financial transaction, one would find, in advanced leasing markets, detailed rules or standards that define a true lease. In absence of such guidelines, it is quite common, particularly in nascent stages of development of an industry, for players to make mistakes, which turn out to be costly both for the revenue and for the players themselves.

India, like Bangladesh, does not have true lease guidelines. As a result, around 1987-1989, when leasing grew very rapidly in the country, a number of lessors wrote leases for assets that never existed. There was obviously no intent to cheat the revenue, but such practices were founded on a premature belief that all agreements, which look like lease agreements will be acceptable for, tax purposes.

Even today, in spite of the fact that India today is a mature market compared to many others, a number of Indian lessors make mistakes, which would only prove to be fatal over time.

The trouble with a no-rule regime is that it encourages unintentional malpractices. Of course, tax avoidance and evasion can exist even where there are elaborate rules, but the trouble with absence of rules is that it breeds innocent non-compliance.

Bangladesh must notify true lease guidelines, and sooner the better. It must, most importantly, educate taxpayers on what is the elementary distinction between a lease and a hire-purchase transaction, since in the latter case; the lessor cannot claim depreciation.

No clear distinction between lease and hire purchase

The difference between lease and hire purchase transactions is a crucial difference for all countries that allow depreciation based on ownership of an asset. It is a basic rule of law that “ownership” for tax purposes is not merely legal ownership – it must be backed by beneficial ownership. Beneficial ownership implies the right to attain benefits of ownership at some point of time. In a hire-purchase transaction, the legal owner (finance company) cannot be treated as beneficial owner, since, having provided the user with a right of purchase; the owner has divested himself of beneficial interest completely.

Currently in Bangladesh many of the lease transactions are in fact hire-purchase transactions, as the sale of the asset to the lessee, even if not incorporated in the contract of lease, is mostly inherent and pre-agreed.

This practice, which in opinion of the author will be a problem over time as the revenue officials get more of education on lease taxation, can be resolved either by proper training or by a proper law.

Incentives claimable by the lessor

Tax incentives are surely responsible for the growth of leasing in most markets. In many markets, tax incentives have been a very strong reason for reducing the cost of lease transactions to make it viable for lessors to operate.

On an impassioned study of Bangladesh taxation statutes, one finds there are plenty of incentives that can be claimed by leasing companies in Bangladesh, in spite of major reforms in taxation in 1998-99.

Primarily, the following incentives are provided for in the Income-tax Ordinance in relation to capital assets:

Depreciation allowance as per Third Schedule, being:

Normal depreciation allowance

Extra-shift allowance, deleted from 1998-99-assessment year

Initial depreciation, deleted from 1998-99 assessment year]

Accelerated depreciation for plant or machinery used in new undertakings, or expansion of existing undertakings.

Accelerated depreciation for plant for treatment and disposal of toxic waste, or in research and development in any undertaking owned and managed by a company

Obsolescence allowance on sale or disposal of a depreciable asset.

Investment allowance for assets eligible for accelerated depreciation

Investment allowance in respect of balancing, modernization and replacement equipment

Though the practice among companies in Bangladesh presently is to claim only depreciation, there appears to be little reason for not claiming the investment allowance and accelerated depreciation allowance as well, in respect of eligible assets.

If normal depreciation as well as investment allowance/accelerated depreciation is claimed by leasing companies, leasing in Bangladesh is a very profitable proposition and is considerably better than loans or hire-purchase. However, if investment allowance is not claimed or allowed to leasing companies, then leasing will be considerably disadvantageous to hire purchase in most cases, as may be seen with numerical calculations.

Conditions for claiming depreciation

For claiming depreciation on assets, the following conditions apply:

The asset should be a depreciable asset

The lessor should own the asset.
The asset should be used for the purposes of business or profession of the tax payer
The asset should have a useful life of more than one year
The lessor must file the prescribed particulars for claiming depreciation.

The first condition implies that the asset must have a natural wear and tear. This is clear from sec. 29 (1) (viii), which says: “In respect of depreciation of any building, machinery, plant…” That is to say, the allowance as provided in the Third Schedule is to be allowed if there is a depreciation, that is, wear and tear in the property. If the asset in question were, for example, land, which is not subject to wear and tear, no depreciation will be allowable. On the same logic, intangible assets, which are not subject to wear and tear by usage or efflux of time, are not depreciable assets.

The second condition of “ownership” implies legal as well as beneficial ownership. No doubt, the lessor is the legal owner of the asset, but if the lessor has divested all his beneficial interest in the asset for all time to come, he may own the chaff of legal title, which will not entitle him to claim depreciation.

The other notable issues with regard to ownership are:

The asset should be proved to exist. The onus of proof, evidently, lies on the lessor.

The asset should not have become an unseverable fixture on land belonging to the lessee or some other person, as that would be fatal to the ownership interest of the lessor. Notable ruling in this regard in the case of Costain v. Stokes Properties and BMI Investment (Newford) v Melluish will be applicable to Bangladesh too.
The asset should be the property of the assessed: it is not enough for the lessor to have ownership interest, that is, joint-ownership interest in the asset. Hence, jointly owned assets will not be eligible for depreciation.

The third condition is the condition of use. Both the Act and the Schedule require that the asset must have been used for business purposes. It is also provided in Para 2 (3) (b) of the Schedule. It must be understood that the “use” that qualifies a lessor to depreciation is not the physical use by the lessee, but the use by the lessor in his business of leasing. The lessor makes the use of the asset in the lessor’s business of leasing the asset, and that use qualifies the lessor to stake a depreciation claim.

Having understood the condition of use in this light, it becomes clear that:

If a lessor has let out an asset during the year, depreciation can be claimed even if the lessee has not put the asset to actual use.

If an asset let by a lessor has been used for carrying agricultural operations, the rate of depreciation will not be the one provided in Para 1 of Third Schedule but as provided in Para 3 of the Schedule.
If assets given on lease remain idle for a whole year that would be no ground to disallow depreciation. Assets on lease are always in use, whether physically used by the lessee or not.
The realization of rentals is also no precondition for claiming depreciation.
The classification of assets into furniture, buildings and plant is based on functional test held in Yarmouth v. France. On this basis, an asset is treated as plant or machinery if it is used as a tool of trade by the assessee, irrespective of what is its physical attribute or description. For example, a chair used in a cinema hall would be a plant or machinery, while it would be furniture if used in an office. Since the leasing company uses its assets for generating rental income by letting them, it sounds possible to claim that the assets let out by a lessor would qualify for treatment as plant or machinery, even if they be in the nature of furniture or fixtures.

Claim for accelerated depreciation

The conditions for claiming accelerated depreciation are:

It must be machinery or plant, not being road transport vehicle or office appliance

It must not have been previously used in Bangladesh

It must be used in an industrial undertaking set up in Bangladesh between 1.7.97 and 30.6.2000

A Bangladeshi company or state undertaking must own the industrial undertaking

It must belong a class of companies as notified by the Board

Application in prescribed form must be made within 4 months of commencement of production, with a declaration that the undertaking has not come for tax exemption under sec. 45.

None of these conditions seem to be failing in case of a lease of plant or machinery by a lessor to an eligible industrial undertaking. To understand the point, let us assume the following facts: a lessor leases out a machine to be used in an industrial undertaking set up in Bangladesh by a lessee. Everything else is clearly satisfied, and the only area of doubt can be whether the lessor, who is not the owner of the industrial undertaking, can claim the depreciation.

The answer, in opinion of the author, is YES, both from a technical viewpoint, as also from the point of the view of the intent of providing the incentive measure.

Taking the second viewpoint first, as the intent of the Govt. in providing for accelerated depreciation or investment allowance is to encourage industrialization in the country, granting such depreciation to a leasing company that finances acquisition of the machine to such an undertaking would advance the cause of the Govt. Denying it would be defeating the purpose of the law, because in case the lessor cannot claim such benefit, nor can the lessee, which means the incentive meant for use by a new industrial undertaking is completely frustrated.

Now, the technical viewpoint. The only requirement in Para 7 or 7A of Third Schedule is that the plant or machine should be used in an eligible industrial undertaking. Where such plant or machine is leased by a lessor, the owner thereof is the lessor, and the user for tax purposes is the lessor, but it no requirement of the law that the owner of the industrial undertaking can only claim the benefit. The equipment is still used in the industrial undertaking, though the lessor is its user.

On analogous provisions, Indian courts have allowed investment allowance in India. Though investment allowance has long back been repealed in India, this matter was still pending in courts, and it recently was ruled by the Supreme Court of India that the requirement of the law nowhere postulate that the owner of the plant or machine should be the same person who owns the industrial unit.

In view of the above, it is very logical to permit lessors to claim accelerated depreciation in Bangladesh. In fact, doing so would be an ideal situation since the lessee being a new unit would not possibly be having profits for first few years to absorb the depreciation, and the lessor may make good use of it and pass on the benefits to the lessee in form of lower cost of funding.

Claim for investment allowance

Investment allowance is claimed under sections 29 (1) (x) and 29 (1) (xa). The once claimed under sec. 29 (1) (x) is associated with accelerated depreciation: if the equipment is eligible for accelerated depreciation, it is also eligible for investment allowance. As in the opinion of the author above, the lessor can claim accelerated depreciation, the lessor can also claim investment allowance.

The second investment allowance under sec. 29 (1) (xa) is in respect of balancing, modernization, and replacement equipment (BMRE). The condition is not linked with any eligible industrial undertaking, and simply lies down that if the assessee being a company invests in the purchase of any BMRE, to be installed in an industrial undertaking, a 25% investment allowance shall be allowed.

There should be hardly any difficulty in claiming this investment allowance in case of BMRE let out by the lessor.

Obsolescence allowance, balancing charge & capital gains:

These allowances arise on the sale or disposal of a capital asset, and are covered by Para 10 of the Third Schedule.

An important provision here is that the “sale proceed” of an asset that is actually sold means the higher of the actual selling price or the fair market value of the asset. “Fair market value”, defined in sec. 2 (30) means the price the asset may fetch in open market, or a value to be assessed by the tax authorities.

This provision, in itself, throws a significant limitation to the transfer of leased assets at pre-fixed prices. As was discussed earlier, it is a practice in nascent markets for lessors to agree to a price for transfer of leased assets at the time of entering into the lease. This price, obviously, is not the market price or estimated market price of the asset but a nominal value to complete the transfer of the asset. Let us say, a lorry, given on lease, is transferred at an agreed price of 5% of the cost after 3 years, while the actual market value is 50%. In such a case, the tax office has clear rights under the law to disregard the actual selling price, and to treat the fair market value as the selling price, and tax the lessor to capital gains or balancing charge accordingly.

The only solution to this could be a renewal of the lease for a secondary period, so that the fair market value of the asset could be brought down to the pre-agreed transfer price.

Obsolescence allowance shall be granted if the sale proceeds are less than the written down value. If the sale proceeds exceed the written down value, there shall be a charge to tax up to the cost of the asset. If the sale proceeds exceed the cost of the asset, this would be taken as a capital gain.

Accounting for leases

Bangladesh has so far not implemented the International Accounting Standard no. 17. Neither has any similar standard been enunciated by the Institute. Hence, Bangladesh continues to adopt the operating lease accounting method, that is, assets leased are capitalized by the lessor, and depreciated in the lessor’s books. The entire rentals received by the lessor are treated as the lessor’s income and the lessee’s expenses. Such a method leads to a significant distortion, particularly when the leases are structured.

Fund Collection:

Non-bank Financial Institutions financial intermediaries that accumulate funds by borrowing from the general public and lend the same to meet specialized financing needs, but are prohibited to accept such deposits payable either on demand or by cheque, draft, etc, and operate checking accounts for which their liabilities are not a part of the money supply. The first non-bank financial institution (NBFI) was a fire insurance company established in 1680 in London.

Although all financial institutions have a common basis for their operations and some role with respect to lender-borrower relationships, there are some fundamental differences between the banks and NBFIs. The liabilities created by the banks are unique in that these liabilities are themselves ‘spend able’ i.e., the holders of the deposits use the deposits in banks as money whereas the liabilities of a NBFI, such as a building society cannot be used in this way. Banks can actually increase the total volume of spending in the economy by their capacity to add to the stock of credit in existence. But the non-bank financial institutions do not have that capacity and they are merely ‘honest brokers’ and transmitting funds, which have been created elsewhere, eg, by the Bangladesh Banks now have less savings deposits and more demand deposits. The NBFI, such as

A leasing company receives additional funds and is capable of adding to its mortgage lending by withdrawing from its larger demand deposits kept with the deposit money bank. The leasing company thus adds to the volume of credit and enables additional spending (on house purchase) to take place. The combination of financial assets created by the banks and NBFIs for ultimate lender varies depending on the origin of the asset.

NBFIs are specialists of the intermediation process and their origins can be traced to the development of specialized financial institutions. Some survived centuries of changing economic and financial developments. Others appeared in response to special opportunities or needs and have disappeared just as quickly. Their survival and existence depend upon their ability to (a) offer contracts that serve the needs of specialized customers, (b) maintain a spread between the rate they pay for funds and the rate they receive that will support their costs, and (c) meet commitment to suppliers of funds.

The non-bank financial sector has a wide diversity of institutions. Despite their importance as alternative sources of finance to the commercial banks, their liabilities may nevertheless be regarded as ‘near money’. The most important NBFIs, among others, are the building societies, hire purchase companies, leasing companies, mortgage companies, insurance companies, saving banks, pension funds, investment companies, investment trusts, security dealer/brokers, pawn shops, central provident fund (CPF), post office saving banks, discount houses, securities companies, fund managers, venture capital companies, stock exchanges, and factoring companies.

The non-bank financial institutions operating in East Pakistan were the Industrial Development Bank of Pakistan, Equity Participation Fund, Pakistan Industrial Credit and Investment Trust Corporation, Investment Corporation of Pakistan, National Investment Trust and insurance companies. Such institutions established in Bangladesh in the 1970s include the House Building Finance Corporation (1973) and the Investment Corporation of Bangladesh (1976). Other NBFIs established in the country up to 31 August 2000 are United Leasing Co., Industrial Development and Leasing Company, Industrial Promotion and Development Company, Saudi-Bangladesh Industrial and Agricultural Investment Company, Phoenix Leasing Company, Union Capital, Uttara Finance and Investment, UAE-Bangladesh Investment Company, International Leasing and Financial Services, Prime Finance and Investment, Bahrain Bangladesh Finance and Investment Company, Bay Leasing and Investment, Delta-BRAC Housing Finance Corporation, Vanik Bangladesh, Peoples Leasing and Financial Services, Infrastructural Development Company, Bangladesh Industrial Finance Company, National Housing Finance and Investment, MIDAS Financing, First Lease International and Bangladesh Finance and Investment. These institutions extended their business in industrial, commercial and housing financing, and in the stock market activities. They are also granted permission by the Bangladesh Bank to participate in the inter-bank money market transactions. As on 31 December 1999, the total paid up capital and reserves of these NBFIs in Bangladesh stood at Tk 5.885 billion and their investment in different sectors totaled to Tk 12.087 billion.

Bangladesh Bank is empowered to oversee and regulate the affairs of the NBFIs under the provisions of the Financial Institutions Act 1993 and the Financial Institutions Rules 1994. To improve the quality of financial intermediation and meet up the growing needs of funds for financing investments in different sectors of the economy, the government intends to intensify the financial market by granting permission to establish private NBFIs in conjunction with the private commercial banks. At present, non-bank financial sector of the country comprises investment and finance companies, merchant bankers, leasing companies, mortgage banks, insurance companies, and the Capital Market Although small, the NBFI sector in Bangladesh is a growing component of the entire financial sector and NBFIs as a group create an opportunity to improve financial intermediation for the economy. NBFIs account for only 4% of the assets of the financial sector, compared to 70% accruing to the nationalized commercial banks (NCB) and 25% to the local private banks. NBFIs, however, account for 25% of the term financing (FY 1998-99) through leasing, project finance and merchant banking activities. The volume of term finance they provided increased at the rate of 41% per annum, while that of the NCB decreased by 40% between 1997 and 1999.

Central Bank Policy that affect the Non-banking financial Institution like leasing

The financial system of Bangladesh consists of Bangladesh Bank (BB) as the central bank, 4 nationalized commercial banks (NCB), 5 government owned specialized banks, 30 domestic private banks, 10 foreign banks and 28 non-bank financial institutions. The financial system also embraces insurance companies, stock exchanges and co-operative banks.

Central Bank and its policies

Bangladesh Bank (BB), as the central bank, has legal authority to supervise and regulate all the banks. It performs the traditional central banking roles of note issuance and of being banker to the government and banks. It formulates and implements monetary policy manages foreign exchange reserves and supervises banks and non-bank financial institutions. Its prudential regulations include: minimum capital requirements, limits on loan concentration and insider borrowing and guidelines for asset classification and income recognition. BB has the power to impose penalties for non-compliance and also to intervene in the management of a bank if serious problems arise. It also has the delegated authority of issuing policy directives regarding the foreign exchange regime.

Interest Rate Policy

Under the new interest rate policy, which became effective in January 1990, all deposit rates are decontrolled. The market, except for exports, freely determines all lending rates.

Capital Adequacy

In January 1996, BB announced a new policy on Capital Adequacy along the lines recommended by the Basle Committee on banking supervision. The Revised policy on capital adequacy requires scheduled banks to maintain at least 9% of off-balance sheet risk and risk in different types of assets as capital.

Loan Classification and Provisioning

Bangladesh Bank introduced new accounting policies with respect to loan classification, provisioning and interest suspense in 1989 with a view to attaining international standards over a period of time. A Revised policy for loan classification and provisioning was introduced from 1st January, 1999.The Revised policy calls for an independent assessment of each loan on the basis of qualitative factors and objective criteria. Each loan is branded with the worst level of classification resulting from these independent assessments.

If a Continuous Credit or a Demand Loan remains non-performing for 6 months or more it is classified Sub-standard. It is classified as Doubtful if it remains non-performing for 9 months and classified as Loss if non-performing for 12 months or more.

In the case of a Term Loan, which is repayable within a maximum period of 5 years, if any installment is not repaid within the specified period and if the time-equivalent of such unadjusted balance is 6 months, it is classified Sub-standard. A Term loan is classified Doubtful and Loss if the time-equivalent of unadjusted balance is 12 months and 18 months respectively.

Agricultural Loan and Micro-Credit is classified Sub-standard if non-performing for 12 months, Doubtful if non-performing for 36 months and Loss if non-performing for more than 60 months.

Under the existing system scheduled banks are required to maintain provisions against unclassified and substandard loans in addition to doubtful and loss loans. They are allowed to book interest against classified loans only on cash basis.

Whether a credit is classified or not under the objective criteria, it is subjected to classification under qualitative judgment if any doubt arises regarding repayment of loan.

Foreign Exchange System

On March 24, 1994 Bangladesh Taka (domestic currency) was declared convertible for current transactions in terms of Article VII of the IMF Articles of Agreement. Consequent to this, current external settlements for trade in goods and services and for amortization payments on foreign borrowings can be made through banks authorized to deal in foreign exchange, without prior central bank authorization. However, because resident owned capital is not freely transferable abroad (Taka is not yet convertible on capital account), some current settlements beyond certain indicative limits are subject to bonafides checks.

Direct investments of non-residents in the industrial sector and portfolio investments of non-residents through stock exchanges are repatriable abroad, as also are capital gains and profits/dividends thereon. Investment abroad of resident-owned capital is subject to prior Bangladesh Bank approval, which is allowed only sparingly.

Exchange Rate Policy

The exchange rate policy of Bangladesh Bank aims at maintaining the competitiveness of Bangladeshi products in the international markets, encouraging inflow of wage earners’ remittances, maintaining internal price stability, and maintaining a viable external account position. Prior to the inception of floating exchange rate regime, adjustments in exchange rates were made while keeping in view the trends of Real Effective Exchange Rate (REER) index based on a trade weighted basket of currencies of major trading partners of Bangladesh and the trends of other important internal and external sector indicators. However, the interbank foreign exchange market sets the exchange rates for customer transactions and interbank transactions based on demand-supply interplay; while the exchange rates for the Bangladesh Bank’s spot purchase and sales transactions of US Dollars with ADs is decided on a case to case basis. Bangladesh Bank does not undertake any forward transaction with ADs. The ADs are free to quote their own spot and forward exchange rates for interbank transactions and for transactions with non-bank customers.

Bank Licensing

Bank Company Act, 1991, empowers BB to issue licenses to carry out banking business in Bangladesh. Pursuant to section 31 of the Act, before granting a license, BB needs to be satisfied that the following conditions are fulfilled:

“That the company is or will be in a position to pay its present or future depositors in full as their claims accrue; that the affairs of the company are not being or are not likely to be conducted in a manner detrimental to the interest of its present and future depositors;
that, in the case of a company incorporated outside Bangladesh, the Government or law of the country in which it is incorporated provides the same facilities to banking companies registered in Bangladesh as the Government or law of Bangladesh grants to banking companies incorporated outside Bangladesh and that the company complies with all applicable provisions of Bank Companies Act, 1991.”

Licenses may be cancelled if the bank fails to comply with above provisions or ceases to carry on banking business in Bangladesh.

Commercial Banks

The commercial banking system dominates Bangladesh’s financial sector with limited role of Non-Bank Financial Institutions and the capital market. The Banking sector alone accounts for a substantial share of assets of the financial system. The banking system is dominated by the 4 Nationalized Commercial Banks, which together controlled more than 54% of deposits and operated 3388 branches (54% of the total) as of December 31, 2004.

Specialized Banks

Out of the 5 specialized banks, two (Bangladesh Krishi Bank and Rajshahi Krishi Unnayan Bank) were created to meet the credit needs of the agricultural sector while the other two (Bangladesh Shilpa Bank (BSB) & Bangladesh Shilpa Rin Sangtha (BSRS)) are for extending term loans to the industrial sector.

Financial Institutions (FIs)

Twenty-eight financial institutions are now operating in Bangladesh. Of these institutions, 1(one) is govt. owned, 15 (fifteen) are local (private) and the other 12(twelve) are established under joint venture with foreign participation. The total amount of loan & lease of these institutions is Tk.29, 729 million as on 30 April 2003. Bangladesh Bank has introduced a policy for loan & lease classification and provisioning for FIs from December 2000 on half-yearly basis. To enable the financial institutions to mobilize medium and long-term resources, Government of Bangladesh (GOB) signed a project loan with IDA, and a project known as “Financial Institutions Development Project (FIDP)“ has started its operation from February 2000. Bangladesh Bank is administering the project. The project has established “Credit, Bridge and Standby Facility (CBSF)“ to implement the financing program with a cost of US$ 57.00 million.]

Capital Market

The Capital market, an important ingredient of the financial system, plays a significant role in the economy of the country.

1.Regulatory Bodies

The Securities and Exchange Commission exercises powers under the Securities and Exchange Commission Act 1993. It regulates institutions engaged in capital market activities. Bangladesh Bank exercises powers under the Financial Institutions Act 1993 and regulates institutions engaged in financing activities including leasing companies and venture capital companies.

2. Participants in the Capital Market

The SEC has issued licences to 27 institutions to act in the capital market. Of these, 19 institutions are Merchant Banker & Portfolio Manager while 7 are Issue Managers and 1(one) acts as Issue Manager and Underwriter.

I) Stock Exchanges

There are two stock exchanges (the Dhaka Stock Exchange (DSE) and the Chittagong Stock Exchange (CSE), which deal in the secondary capital market. DSE was established as a public Limited Company in April 1954 while CSE in April 1995. As of 30 June 2000 the total number of enlisted securities with DSE and CSE were 239 and 169 respectively. Out of 239 listed securities with the DSE, 219 were listed companies, 10 mutual funds and 10 debentures.

ii) Investment Corporation of Bangladesh (ICB)

The Investment Corporation of Bangladesh was established in 1976 with the objective of encouraging and broadening the base of industrial investment. ICB underwrites issues of securities, provides substantial bridge financing programmes, and maintains investment accounts, floats and manages closed-end & open-end mutual funds & closed-end unit funds to ensure supply of securities as well as generate demand for securities. ICB also operates in the DSE and CSE as dealers.

iii)Specialized Banks

Bangladesh Shilpa Bank (BSB), Bangladesh Shilpa Rin Sangstha (BSRS), BASIC Bank Ltd., some Foreign Banks and NCBs are engaged in long term industrial financing.

Insurance

The insurance Sector is regulated by the Insurance Act, 1938 with regulatory oversight provided by the controller of Insurance on authority under the ministry of commerce. 21 companies provide general insurance and 6 companies provide life insurance. The industry is dominated by the two large, state-owned companies–SBC for general insurance and JBC for life insurance–which together command most of the total assets of the insurance sector.

Micro finance Institutions (MFIs)

The member-based Micro finance Institutions (MFIs) constitute a rapidly growing segment of the Rural Financial Market (RFM) in Bangladesh. At present, Grameen Bank is the only formal financial institution among them, established in 1983 under a special law with the initial support from Bangladesh Bank. The poor borrowers of Grameen bank who are mostly women own the bank and it is the pioneer organization of this type. Besides Grameen Bank there are more than 1000 semi-formal institutions operating mostly in the rural sector of the country; BRAC, ASA, and PROSHIKA are being considered three big NGO-MFIs. These institutions have an explicit social agenda to cater to the needs of the poorer sections of population, and have a focus towards women clients.

Till June 2002 the total coverage of micro finance programs in Bangladesh is approximately 13 million households. Four big institutions including Grameen Bank dominate the micro finance market of Bangladesh. Grameen Bank, BRAC, ASA, and PROSHIKA account for 60% of the total amount of outstanding loans made by all MFIs, and it is widely believed that top 20% institutions account for 80% of the total market. The Grameen Bank alone provides about one-third of the total amount of outstanding micro loans. There is no cap or spread on interest rate offered for deposit and loan in case of NGO-MFIs. However, in practice on average NGO-MFIs offer mostly 5-7% interest on deposits to the members and charge 15% interest on loan in flat method.

At present NGO-MFIs are not regulated or supervised or monitored by any single authority in Bangladesh; they are under the system of off-site supervision by the authorities that provide them registration as non-government organizations (NGOs). However, the regulatory issue has come to the forefront because MFIs are providing financial services and products to the poor, outside the formal banking system.

Considering the need to develop an appropriate regulatory and supervisory system for this sector the Government of Bangladesh has established a Unit named “Micro finance Research & Reference Unit (MRRU)” in Bangladesh Bank. A high power national Steering Committee under the leadership of Governor of the bank looks after the various functions of the unit. The Committee is also responsible for formulating a uniform guideline and the legal framework of a regulatory body for this rapidly growing financial sector.

The unit has already published an operational guideline for these NGO-MFIs with the help of the committee and has been collecting quarterly information since January 2004 on governance, savings, credit, receipt and payment from them. The unit is also providing training to these institutions on the operational guideline supplied to them. Recently the committee has submitted a draft law to the Government, hence it is expected that after the promulgation of the law this sector will be under formal financial system in near future. All these programs mentioned above (guideline, training and information collection) going on under the unit are being considered as the background work towards the formulation of a full-fledged regulatory framework for the micro finance sector in Bangladesh.

Case study on Prime Finance & Investment Limited

Prime Finance & Investment Limited is one of the leading Non-Banking Financial Institutions. It was listed as a financial institution in 1996. The company call themselves as an Investment banker.It provides diversified financial services to the business sector. It is the fifth ranked leasing company in Bangladesh. With a view to expand the business into the consumer market, PFI management is planning to introduce new products in its product portfolio. Before the introduce of the product in the market, a comprehensive competitor and consumer analysis has been done by the author as a requirement of his internship.

The company is one of six that does not use the word “Leasing” with their name.

Corporate Profile

Prime Finance & Investment Limited commenced its journey in the year 1996 with the spirit of rendering innovative, customized and cost effective financial solutions to the corporate houses of Bangladesh as a closely held public limited company. Realizing the untapped market potential for the innovative financial institutions, a number of reputed corporate houses along with some individual professionals joined hands to form PFI with an endeavor to contribute to industrialization and to actively participate in the capital market development of the country.

The spirit and Corporate philosophy of PFI is reflected in the diversified product and service mix of the company. PFI is constantly engaged in its effort to broaden its range of product offering from financial leasing, equity financing, issue management, underwriting and many more. PFI is slowly but surely emerging as one of the innovative financial institution in Bangladesh known for its creative pursuits and professional management endeavoring towards offering of a commercial supermarket of financial services to the customers. Result – an extensive clientele – a broad spectrum of industrial houses from fledgling entrepreneurs to many among the market leaders.

A new economic order is emerging in the world we operate in with different social and political implications. Century old bottlenecks that once cordoned off the economic units from venturing into uncharted areas have vanished with the emergence of new technology and business concepts. PFI is poised to fill the void.

In today’s competitive world there are few opportunities to make a big difference and many opportunities to make a little difference. At PFI, we strive to seize all these opportunities with a pro-market attitude making a big difference to the clients.

Mission Statement

To be the most innovative investment force enterprising the creation of wealth.

Goals

To be a commercial supermarket for financial products and services.
To establish a strong market presence
To optimize stakeholders’ rewards.

Values

To maintain integrity and intellectual ingenuity of highest standard.
To infuse professional and entrepreneurial spirit among the associates.

Corporate Information

PFI at a Glance

Incorporation of the Company	10 March 1996
Licensed as Financial Institution under FI Act, 1993	25 April 1996
Signing of First Issue Management Agreement	09 September 1996
Signing of First Underwriting Agreement	22 September 1996
Signing of First Lease Agreement	08 February 1998
Licensed as Merchant Bank by SEC	25 January 1999

Authorized Capital	Tk. 500 million
Paid-up Capital	Tk. 100 million
Constitution	Public Limited Company
Auditors	Rahman Rahman Huq
Lawyers	Omar Sadat & Associate
Registered Address	63, Dilkusha C.A. (7^th Floor), Dhaka-1000.