The first leasing company was launched in 1984, and by the end of FY99 the sector strength had risen to 25 firms in spite of the chaos caused by high mark-up rates in the late 1990s.

Today, however, the sector has only 15 companies, and all of them face the toughest test of survival.

Given the rapid growth and profitability witnessed during 2000-03, the decline since has been alarming. This bouncy was induced by lower mark-up rates and growth of industrial units in the SME sector besides auto leasing that had become a craze. However, like other sectors, weaknesses of the leasing sector reached their peak in 2008.

Problems began with the shift to floating rates of mark-up in 2003, though leasing companies didn’t realise then the operational and credit risk the change entailed. Under the fixed mark-up regime, leasing companies took post-date cheques from their lessees for each periodic rental receivable; it meant taking all cheques for an identical amount and obtaining their proceeds on the due dates.

With mark-up rates changing daily, the scenario changed; lessees had to be advised the change in lease pricing and the differential amounts were collected separately implying increased customer inter-action, recovering rental differentials, and monitoring and limiting delays in realisation thereof. More importantly, lessees’ inability to pay the rising rental amounts steadily increased the credit risk.

Beginning 2002, stiff competition from the banking sector began the real woes of the leasing sector because it remained dependent on banks for funding support knowing fully-well that, with the sort of spreads being earned by banks, in the long run, leasing companies could not compete with them unless they aggressively began mopping-up savings directly by offering COIs and floating TFCs.

Leasing companies began offering COIs and TFCs, but this gradually became harder as liquidity began to vanish from the market. How significant the consequent drop in business growth has been, is visible from the fact that while in FY07, the sector wrote fresh leases for over Rs40 billion, in FY08, the figure is likely to drop below Rs20 billion; in FY09, it could fall drastically.

According to an internal Leasing Association of Pakistan (LAP) paper, by October 31, 2008 investment in leases fell to Rs49.9 billion compared to Rs63 billion on June 30, 2007 implying that while sector players vigorously recovered their lease rentals (a tough job at present), they virtually stopped writing fresh leases. In spite of this recovery performance, banks reneged on their lending commitments to the leasing sector.

Of the money market and running finance lines totalling Rs15.6 billion they had sanctioned to the leasing sector, banks disbursed only Rs4.5 billion and stopped thereafter although leasing companies (except one) had a safe repayment record due to their robust recovery arrangements. To ride out the present crunch, the leasing companies sought extension in repayment periods, which was denied.

On October 31, total bank borrowing of the sector was Rs19.45 billion or roughly 0.6 percent of the total bank credit. Besides being an insignificant fraction, the exposure was on listed financial institutions that, by all standards, are more prudent borrowers than the vast majority that accounts for banks’ bad debts. But, obviously, banks hold a different view of things.

On November 26, SECP chairman Razi-ur-Rehman repeated to the SBP governor the desperate appeal that LAP had earlier made to the SBP. He pointed out that “owing to the liquidity crunch, NBFCs are forced to roll-over these lines. [But], the lenders, especially commercial banks, are charging exorbitant mark-up rates ranging from 20 per cent to 55 per cent [per annum].”

In view of the liquidity and confidence crisis, he requested SBP to “persuade the commercial banks to restore NBFCs’ already sanctioned limits and convert their short-term lines to 18 to 24-month secured facilities.” He went on to emphasize that illiquidity of leasing companies (courtesy the attitude of some commercial banks) could pose a systemic risk to the financial sector.

By the time Dr Shamshad Akhtar relinquished charge as SBP Governor, a no response to this request from the SECP was awaited; the reason this is not hard to imagine. The revised draft of the Banking Companies Ordinance submitted by SBP to the parliament recommends that SECP should hand back the supervision of NBFCs (purportedly not supervised well) to the SBP.

According to a LAP Executive Committee member if, in the context of lending to leasing companies banks maintain the status quo, several leasing companies could go under due to the liquidity crunch. Given the investment sentiment (not the result of leasing sector’s conduct) leasing companies will neither succeed in raising funds through COIs nor TFCs, nor be able to float additional capital.

This could help banks acquire these distressed entities on favourable terms, turn them into subsidiaries, and thus facilitate their coming within SBP’s purview. Surely, that’s not what is intended but it may eventually happen, and the apathy of those who could foresee this outcome but did not act, will be debated for a while because this is the oddest way of going about changing the system.

It is unfortunate that the obvious under-capitalisation of the sector players wasn’t noticed and remedied before 2007 when the investment climate (though deceptive even then) was conducive for equity expansion. With leasing companies doing reasonably well at the time, raising equity was not too tough though not as easy as for the banking sector that was reporting amazing increases in its return on equity.

Only in late 2007 when the economic downswing became certain was it realised that leasing sector’s capital adequacy needed a hike. Put all of these oversight failures (by sector players and its regulator) together and what you see is an unintended yet apparently concerted effort to undermine the leasing sector. Pitifully, we are again living up to our reputation for undermining institutional arrangements.

Leasing sector is performing a vital function – supporting the SMEs – imperative for poverty alleviation. In emerging economies, up to a third of the fixed asset base is financed by leasing companies because they are better suited to meet asset acquisition needs, and also fill the disintermediation gap that prevails in all developing economies. With its huge unregulated moneylender population, Pakistan is one of them.

In this context, it is crucial that institutions for loaning to SMEs must not be high intermediation cost and bureaucracy-ridden outfits like commercial banks. The leasing companies fulfill these conditions and deserve to be supported. Right now, competition within the financial services sector is undermining that objective to our collective detriment, and needs to be checked forthwith by the banking sector regulator.