INDEX

1.
2.
3.
4.
5.
6.
7.

INTRODUCTION
OBJECTIVE OF THE STUDY
COMPANY PROFILE
RESEARCH METHODOLOGY
DATA ANALYSIS
CONCLUSION
BIBLIOGRAPHY

INTRODUCTION

INTRODUCTION
INTRODUCTION

Financial Services basically mean all those kinds of services provided in financial terms where the
essential commodity is money. These services include: leasing, hire purchase, consumer credit,
investment banking, commercial banking, venture capital, insurance, credit rating, bill discounting, and
mutual funds , stock broking, housing finance, vehicle finance, mortgages and car loans, factoring among
other things.

Various entities that provide these services are basically categorized into
(a) Non Banking Finance Companies
(b) Commercial Banks, and
(c) Merchant Banks.

Financial Services in India is too vast and varied too have evolved at one place and at one time. One of
the main entities that offer financial services in India is Non-Banking Finance Companies. These NBFCs
registered with Reserve Bank of India mainly perform fund based services to the customer. Fund based
services of NBFCs include: leasing, hire-purchase and other asset based services whereas fee based
services of NBFCs include bill discounting, portfolio management and other advisory services.

LEASING
Leasing as financial service is a contractual agreement where the owner (lessor) of equipment
transfers the right to use the equipment to the user (lessee) for an agreed period of time in return
for a rental. At the end of the lease period the asset reverts back to the lessor unless there is a
provision for the renewal of the contract or there is a provision for the transfers of ownership to
the lessee. If there is any such provision for transfer of ownership, the deal is treated as hire
purchase. Therefore, a lease could be generally defined as A contract where a party being the owner (lessor) of an asset (leased asset) provides the
asset for use by the lessee at a consideration (rentals), either fixed or dependent on any
variables, for a certain period (lease period), either fixed or flexible, with an understanding
that at the end of such period, the asset, subject to the embedded options of the lease, will
be either returned to the lessor or disposed off as per the lessor's instructions.

Leasing was prevalent during the ancient Sumerian and Greek civilizations where leasing of land,
agricultural implements, animals mines and ships took place. The practice of leasing came into being
sometime in the later half of the 19 th century where the rail road manufacturers in the U.S.A resorted to
leasing of rail cars and locomotives.
The equipment leasing industry came into being in 1973 when the first leasing company, appropriately
named as First Leasing This industry however remained relegated to the background until the early
eighties, because the need for these industry was not strongly felt in industry. The public sector financial
institutions IDBI, IFCI, ICICI and the State Financial Corporations (SCFs) provided bulk of the term
loans and the commercial banks provided working capital finance required by the manufacturing sector
on relatively soft terms. Given the easy availability of funds at reasonable cost, there was obvious no need
to look for alternative means of financing.

The credit squeeze announced by the R.B.I coupled with the strict implantation of the Tandon & Chore
committees norms on Maximum Permissible Bank Finance (MPBF) for working capital forced the
manufacturing companies to divert a portion of their long term funds for their working capital .

HISTORY AND DEVELOPMENT OF LEASING

The history of leasing dates back to 200BC when Sumerians leased goods. Romans had
developed a full body law relating to lease for movable and immovable property. However the modern
concept of leasing appeared for the first time in 1877 when the Bell Telephone Company began renting
telephones in USA. In 1832, Cottrell and Leonard leased academic caps, grown and hoods.
Subsequently, during 1930s the Railway Industry used leasing service for its rolling stock needs. In the
post war period, the American Air Lines leased their jet engines for most of the new air crafts. This
development ignited immediate popularity for the lease and generated growth of leasing industry.

The concept of financial leasing was pioneered in India during 1973. The First Company was set up by
the Chidambaram group in 1973 in Madras. The company undertook leasing of industrial equipment as its
main activity. The Twentieth century Leasing Company Limited was established in 1979. By 1981, four
finance companies joined the fray. The performance of First Leasing Company Limited and the Twentieth
Century Leasing Company Limited motivated others to enter the leasing industry. In 1980s financial
institutions made entry into leasing business. Industrial Credit and Investment Corporation was the first
all India financial institution to offer leasing in 1983. Entry of commercial banks into leasing was
facilitated by an amendment of Banking Regulation Act, 1949. State Bank of India was the first
commercial bank to set up a leasing subsidiary, SBI capital market, in October 1986. Can Bank Financial
Services Ltd., BOB Financial Service Ltd., and PNB Financial Services Limited followed suit. Industrial
Finance Corporations Merchant Banking division started financing leasing companies as well as
equipment leasing and financial services. There was thus virtual explosion in the number of leasing
companies rising to about 400 companies in 1990.

In the subsequent years, the adverse trends in capital market and other factors led to a situation
where apart from the institutional lessors, there were hardly 20 to 25 private leasing companies who were

active in the field. The total volume of leasing business companies was Rs.5000 crores in 1993 and it is
expected to cross Rs.10, 000 crores by March 1995.

ELEMENTS IN LEASE STRUCTURE

This is an explanation of the elements in a lease - the parties, asset, rentals, residual value, etc.
This section would also elaborate the unique features of a lease as different from a regular
financing transaction.

1. The transaction:
The transaction of lease of lease is generically an asset-renting transaction. What distinguishes a
lease from a loan is that in the latter, what is lent out is money; in a lease, what is lent out is the
asset.

2. Parties to a lease:
There are two parties to a lease: the owner and the user, called the lessor and the lessee. The
lessor is the person who owns the asset and gives it on lease. The lessee takes the asset on lease
and uses it for the period of the lease.
Any one can be a lessor, and any one can be a lessee, subject to usual conditions as to
competence to contract, or holding of properties.

Ownership is
no precondition for

Technically, in order to be a lessor, one does not have to

own the

asset: one has to have the right to use the asset. Thus, a lessee can be a
lessor for a sub-lessee, unless the parent lessor has restricted the right

to sub-lease.

3. The leased asset:

The subject of a lease is the asset, article or property to be leased. The asset may be anything - an
automobile, or aircraft, or machine, or consumer durable, or land, or building, or a factory. Only
tangible assets can be leased - one cannot contemplate the leasing of the intangible assets, since
one of the essential elements of a lease is handing over of possession, along with the right to use.
Hence, intangible assets are assigned, whereas tangible assets may be leased.
The concept of leasing will have the following limitations:
1. What cannot be owned cannot be leased. Thus, human resources cannot be "leased".
2.

While lease of movable properties can be affected by mere delivery,

Leasing of
immovable property is incapable of deliveries in physical sense.
immovable
Most countries have specific laws relating to transactions in
properties may
immovable properties: if such law provides a particular procedure
have complications:
for a lease of immovable or real estate, such procedure should be complied with. For example, in

Anglo-Saxon legal systems (UK, Australia, India, Pakistan, etc.), transactions in real estate are
not valid unless they are effected by registered conveyance. This would apply to lease of land and
buildings, and permanent attachments to land.
3. A lease is structurally a rental for the lease period: with the understanding that the asset will be
returned to the lessor after the period. Thus, the asset must be capable of re-delivery: it must be
durable (at least during the lease period), identifiable and severable.

Leased asset
is a
necessary
pre-condition:

The existence of the leased asset is an essential element of a lease

transaction - the asset must exist at the beginning of the lease, during
the lease and at the end of the lease term. Non-existence of the asset,
for whatever reason, will be fatal to the lease.

4. Lease period:
The term of lease, or lease period, is the period for which the agreement of lease shall be in
operation. As an essential element in a lease is redelivery of the asset by the lessee at the end of
the lease period, it is necessary to have a certain period of lease. During this certain period, the
lessee may be given a right of cancellation, and beyond this period, the lessee may be given a

right of renewal, but essentially, a lease should not amount to a sale: that is, the asset being given
permanently to the lessee.
In financial leases, is common to differentiate between the primary lease period and the
secondary lease period. The former would be the period over which the lessor intends recovering
his investment; the latter intended to allow the lessee to exhaust a substantial part of the
remaining asset value.
The primary period is normally non-cancelable, and the secondary period is normally cancelable.

5. Lease rentals:
The lease rentals represent the consideration for the lease transaction. This is what the Lessee
pays to the Lessor.
If it is a financial lease transaction, the rentals will simply be the recovery of the lessor's
principal, and a certain rate of return on outstanding principal. In other words, the rentals can be
seen as bundled principal repayment and interest.
If it is an operating lease transaction, the rentals might include several elements depending upon
the costs and risks borne by the Lessor, such as:

Interest on the lessor's investment.

If the lessor is bearing any repairs, insurance, maintenance or operation costs, them charges for
such cost.

Depreciation in the asset.

Servicing charges or packaging charges for providing a package of the above service.

6. Residual value:
Put simply, "residual value" means the value of the leased equipment at the end of the lease term.

If the lease contains a buy out option with the lessee, residual value would mostly mean the value
at which a lessee will be allowed to buy the equipment.
If there is no embedded purchase option, residual value might mean the value that the lessee or
some one else assures will be the minimum value of the equipment at the end of the lease term.
This is typical in case of financial leases where the lessor cannot grant a buyout option to the
lessee; for the lessor to protect himself against asset-based risks, he would take an assured
residual value commitment either from the lessee himself or from a third party, typically an
insurance company.
The residual value might also the value that the lessor assures to pay-back to the lessee in case
the lessee returns the asset to the lessor: that is, it might be the value the lessor assures as the
minimum value of the equipment. Such a lease, obviously an operating lease because the lessor
is taking a risk on asset values, is a full payout lease, but the lessor agrees to refund the
guaranteed value on the lessee returning the equipment at the end of the lease term.

7. End-of-term options:
The options allowed to the lessee at the end of the primary lease period are called end-of-term
options. Essentially, one, or more, of the following options will be given to the lessee at the end
of the lease term:

Option to buy (buyout option) at a bargain price or nominal value (typical in a hire-purchase
transaction), called bargain buyout option

Option to buy at a fair market value or fixed, but substantial value

Option to renew the lease at nominal rentals, called bargain renewal option

Option to renew the lease at fair market rentals or substantial rentals

Option to return the equipment

In any lease, which option will be suitable depends on the nature of the lease transaction, as also
the applicable regulations. For example, in a full payout financial lease, the lessor would have
recovered the whole or substantially the whole of his investment during the primary lease period.
Therefore, it is quite natural that the lessee should be allowed to exhaust the whole of the
remaining value of the equipment. Regulation permitting, the lessor provide the lessee a bargain
purchase option to allow the lessee to complete the purchase of the equipment.

Buyout option
may characterize
the lease as hirepurchase:

However, in many jurisdictions, it is the existence of such buyout

option that demarcates between lease and hire-purchase transaction.
If the lessor is interested to structure the lease as a lease and not hirepurchase, he would be advised not to provide any buyout option, but

instead, to allow the lessee to renew the lease to continue the use of the asset. In essence, a
renewal option achieves the same purpose as a purchase, but the lessor retains his ownership as
also his reversionary interest in the equipment.
Fair market value options, either for purchase of equipment, or for renewal, are typical of
operating leases, but are really speaking no more than assuring to the lessee a continued use of
the equipment. If equipment has to be bought at its prevailing market value, it can be bought
from the market rather than from the lessor - therefore, the fair market value option carries no
value for the lessee.

8. Upfront payments:
Lessors may require one or more of the following upfront, that is, instant payments from a
lessee:

Initial lease rental or initial hire or down payment

Advance lease rental

Security deposit

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Initial fees

Margins in
leases are
taken as initial
The initialrental:
lease rent or initial hire (the word hire is more common in case of hire-purchase
transactions) is a surrogate for a margin or

borrower contribution in case of loan transactions.

Note that given the nature of a lease or hire-purchase as asset-renting transaction, it is not
possible to expect a lessee's contribution to asset cost as such. Hence, the down payment or first
lease rent serves the purpose of a margin.
Between advance lease rent and initial lease rent - the difference is only technical. The whole of
the initial lease rental is supposed to be appropriated to income on the date of its receipt, whereas
advance rental is still an advance - normally an advance against the last few rentals. Therefore,
the advance rental will remain as a deposit with the lessor to be adjusted against the last few
rentals.
The security deposit is a proper deposit to secure against the lessee's commitments under the
contract - it is generally intended to be refunded at the end of the lease contract.

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OBJECTIVE OF THE
STUDY

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OBJECTIVE OF THE STUDY

13

METHODS
&
TYPE OF LEASE
FINANCING

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TYPES OF LEASING

FINANCE LEASE
A lease is defined as finance lease if it transfers a substantial part of the risks and rewards
associated with ownership from the lessor to the lessee. According to the International
Accounting Standards Committee (IASC), there is a transfer of a substantial part of the
ownership-related risks and rewards if:
i. The lease transfers ownership of the asset to the lessee by the end of the lease term; (or)
ii. The lessee has the option to purchase the asset at a price which is expected to be
sufficiently lower than the fair market value at the date the option becomes exercisable and,
at the inception of the lease, it is reasonably certain that the option will be exercised; (or)
iii. The lease term is for a major part of the useful life of the asset. The title may or may not
eventually be transferred; (or)

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iv. The present value of the minimum lease payments (See Glossary) is greater than or
substantially equal to the fair market value of the asset at the inception of the lease. The title
may or may not eventually be transferred.
The aforesaid criteria are largely based on the criteria evolved by the Financial Accounting
Standards Board (FASS) of USA. The FASS has in fact defined certain cut-off points for
criteria (iii) and (iv). According to the FASS definition of a finance lease, if the lease term
exceeds 75 percent of the useful life of the asset or if the present value of the minimum lease
payments exceeds 90 percent of the fair market value of the asset at the inception of the lease,
the lease will be classified as a 'finance lease'
Financial leases are "loan look-alike":
However, financial leases, though being leases by structure, are financings by contrivance. To
achieve the financing purpose, the leasing structure here tries to eliminate the substantive
differences between leasing and plain financings
As you might notice, in the above example, the lessee has been put virtually in the position of an
asset owner - he has the right to use the asset for 5 years, with a power to extend the lease period
for another 5 years.

The
primary
and

The first 5 years are called the primary lease period and the extended
period is called the secondary lease period.
The lease is non-cancelable during the primary lease period - that is, the
lessee cannot return the asset and not pay balance of the lessor's rentals.

For the secondary period, the lessee will have no incentive of returning the asset, as what the
lessee has to pay is nominal, whereas the asset might still carry substantial value. Thus, the asset
will be enjoyed by the lessee virtually for the whole of its economic life.

Full payout
lease:

The lessor too has no significant risk/reward other than that of a virtual
money-lender: he would continue getting the lease rentals for the primary

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period which will fully-payout the lessor's investment in the lease as also give him his desired
return on investment, irrespective of the state, value or utility of the asset. If the lessee performs
as per agreement, the lessor would get no more, and no less, than such pre-fixed return on
investment.
Incidentally, in the present example, the lessor gets a return of 12.98% -

The IRR:

this is equivalent to the rate of interest in case of loans. As this rate is not
explicit, but implicit in the rate of rentals, the rate is implicit rate of
return or IRR.

Features of financial leases:

The above discussion leads to the following features of financial leases:
Financial leases allow the asset to be virtually exhausted by the same lessee. Financial leases put
the lessee in the position of a virtual owner.
The lessor takes no asset-based risks or asset-based rewards. He only takes financial risks
and financial rewards, and that is why the name financial leases.
The lease is non-cancelable, meaning the lessee cannot return the asset and not pay the whole
of the lessor's investment.
In this sense, they are full-payout, meaning the full repayment of the lessor's investment is
assured.
As the lessor generally would not take any position other than that of a financier, he would
not provide any services relating to the asset. As such, the lease is net lease.
The risk the lessor takes is not asset-based risk but lessee-based risk. The value of the asset
is important only from the viewpoint of security of the lessor's investment.

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