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Leasing Industry in Pakistan: Problems & Prospects

ARTICLE JULY 2013

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Rukhsar Ahmed

Kamran Siddiqui

SZAB University of Law

DHA Suffa University

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Leasing Industry in Pakistan: Problems & Prospects

Dr. Rukhsar Ahmed

Professor & Dean
Preston University, Karachi
Dr Kamran Siddiqui
Professor
IBA, Karachi, PAKISTAN
Mufti Dr Immamuddin
Assistant Professor
University of Baluchistan, Quetta, PAKISTAN
Introduction
The evolution of leasing in Pakistan particularly in the formal sector dates back to June
1980 when, according to a Report of the Council of Islamic Ideology, the concept of
leasing was recognized as one of the financial services under the Islamic financial system,
which was later introduced in the country in 1985. Accordingly, the Government issued
two notifications effective January 1, 1985 namely "Banking and Financial Services
Ordinance, 1984" and "Banking Companies Tribunal Ordinance, 1984" under which
banks and financial institutions were required to provide banking and financial services in
accordance with the tenets of Islam.
In June 1984, the Government directed the National Development Finance Corporation
(NDFC), a leading financial institution in public sector, to promote the first leasing
company in Pakistan. As such, National Development Leasing Corporation (NDLC) was
established as the first leasing company in the private sector as a joint venture between
NDFC, the Habib Group and the International Finance Corporation (IFC). The Asian
Development Bank (ADB) joined later on. The growth of the leasing industry in Pakistan
initially lacked momentum due mainly to a general lack of awareness regarding its nature
and benefits. During the next five years, only five leasing companies entered the leasing
business. As a result of the Economic Reforms Package introduced by the Government in
early 1990's, a number of leasing companies came on stream. With its distinctive tax
advantage and efficient approval process, leasing became an attractive source of
financing. Accordingly, from a single leasing company in 1985, the total number of
leasing companies presently stands at 33 companies and 8 leasing modarabas.
Leasing Sector in Pakistan
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As stated earlier, lease-financing activity in Pakistan was started in 1985 primarily as a

result of Islamization of the economy. In addition to being one of the permissible Islamic
modes of financing, lease financing also became popular as an alternate source of
financing. With its distinct advantages over conventional sources of finance inclusive of
tax advantage, efficient approval process, cash flow benefits, etc., lease financing has
over the years become a major source of financing. Some of the main assets being
increasingly leased financed in Pakistan these days include industrial machinery and
equipment, automobiles, computer hardware, etc.
Leasing sector in Pakistan presently comprises of 33 leasing companies and 8 leasing
Modarabas involved in the leasing business of around 36 billion. As per Pakistan Leasing
Yearbook (1999), total investments made by the leasing sector in lease finance up to June
30, 1999 amounted to Rs. 29 billion as compared to Rs. 28 billion during 1998, showing
an aggregate growth rate of 21% per annum. The share of the leasing sector in the total
private fixed capital expenditure in Pakistan's economy is estimated at 8 % as compared
to other developed countries where its share is 40 %.

Despite their encouraging growth and potential, the leasing companies and modarabas are
basically secondary lenders, as these do not have adequate leverage and earning potential
of banks. Despite their impressive growth particularly over the last 5 years, the leasing
sector in general is expected to experience a recessionary trend due to a number of
factors. These include liquidity constraints, unfavorable investment climate, competition,
lack of innovative products, etc. Even in these adverse circumstances, some of the leasing
companies have performed well and have regularly been giving handsome dividends.
However, their performances have not been reflected in the market value of their shares,
most of which are much below their par and even break-up value. This is not only due to
reflection of the overall economic scenario but also due to a general perception of the
leasing and modaraba sector as a whole by the individual investor.
With the implementation of the Supreme Court's historic decision on elimination of
"Riba" from the banking system from fiscal year 2001 -2002, leasing as an alternate
source of financing is likely to attain a pivotal position as it is one of the few modes of
financing, which in its modified form (asset based and having a risk element) is
admissible under the tenets of Islam. However, great care and careful research needs to be
conducted in bringing it in conformity with Shariah.

Regulatory framework: In Pakistan, leasing companies and modarabas have separate

regulatory framework. However, certain common ground rules apply to both including
the following:
Companies Ordinance, 1984.
Income Tax Ordinance, 1979.
State Bank of Pakistan's Prudential Regulations, which are applicable to all NBFI's.
Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980.
The Leasing Companies (Establishment and Regulation) Rules, 1996.
Some of the major regulations that apply to the leasing companies are enumerated as
follows:
Commencement of business and operations subject to registration and issuance of a
license.
To be registered as a public limited company.
Tenor not to be less than three years.
Maintenance of accounts according to the International Accounting Standard-17.
Maximum exposure of a leasing company to its directors, affiliated companies and
companies in which any of the directors or his family members hold controlling interest
shall not exceed 10 % of the overall leasing portfolio.
A leasing company shall invest 70 % of its funds in the leasing business.
Appointments of Chief Executives and Directors of leasing companies require specific
approval of the Corporate Law Authority.
The business of real estate or financing of individuals or companies involved in real
estate is not permitted except in case of leasing of machinery, equipment and vehicles to
construction companies.
Leasing of land and buildings is also not permitted save for factory buildings.
Capital base: Initially, leasing companies were allowed to commence their business with
a capital base of Rs. 50 million which was later revised to Rs. 100 million in 1992. Only
recently, the limit has been enhanced to Rs. 200 million and the existing leasing
companies were required to enhance their capital base by November 1999. Presently, only
5 leasing companies out of a total of 33 are eligible under the new regulation. Under the
present scenario, no leasing company is in a position to enhance its capital base by the
stipulated date. In order to comply with the captioned regulation, a number of companies
would need to merge with each other to survive or face extinction.

Major issues pertaining to the Leasing Sector

In Pakistan, the financial sector in general and the leasing sector in particular are
currently beset with a number of issues adversely affecting their performance. A number
of such issues, both general and specific in nature, are enumerated as follows: The general
issues pertain mainly to the macro economic scenario particularly including current
economic trends, which have a great bearing on the performance of various sectors of the
economy.
Economic slowdown: A general recessionary trend has been prevalent in the national
economy particularly since the second half of the last decade. The economic slowdown
has been further aggravated by other disturbing factors like economic fallout of South
Asian economic crisis, imposition of economic sanctions by the world community at
large as a consequence of Pakistan joining the 'Nuclear Club', the IPP issue, freezing of
foreign currency accounts, ever increasing debt burden, devaluation, decreased flow of
Foreign Direct Investment (FDI), political uncertainty etc. As a result of the economic
slowdown, there was a sharp decline in total and fixed investment rates to 17.1% and
15.3% of GDP in the second half of 1990's culminating in a steep fall in 1999-2000 to
15% and 13.4% respectively. Declining investment rates have in effect contributed to the
overall economic slowdown.
The economic slowdown has particularly affected the financial sector as long-term
investments have almost dried-up. Despite a number of confidence building measures
taken by the present Government, the overall aura of uncertainty and gloom is still
hovering around. Taking due cognizance of the multiplicity of social, economic and
political problems being confronted by the present Government, collective efforts need to
be taken by various sectors to pull the economy out of the quagmire of economic
slowdown. Long-term economic policies need to be implemented both in letter and spirit
instead of "Quick Solutions" or ad hoc measures on the part of the Government. On its
part, the Private Sector, in particular, needs to tangibly respond to the confidence building
measures of the Government by way of investing in priority sectors of the economy on
the one hand and enhancing exports on the other. As a first step, a rapport needs to be
established between the Government and the Private Sector to effectively revive the
economy.
All that is needed is a little confidence in our own abilities, the destiny of this great nation
and above all on the 'Almighty Allah' and seek his forgiveness.

Interest rate scenario: Interest rates scenario in Pakistan has also undergone substantial
oscillating transformation over the last two years. Conscious efforts were taken by the
previous Government in lowering the interest or mark-up rates by way of lowering the
return on Government's savings schemes primarily to improve the investment climate in
the country. Whether the move has achieved its desired objective or not is still to be seen,
but it has certainly effected the already low saving rate together with disturbing the
overall interest rate scenario both in the short and long-term perspective. The Money
Market has become so volatile these days that financial institutions find it impossible to
mobilize resources for more than six months and are constrained to miss-match their
investments even for shorter periods. The inter-bank and repo-rates have also become so
volatile that during the last month, these have officially been increased by two percentage
points. Rates of T-Bills also undergo fluctuating trends based on current developments on
the economic front. The underlying uncertainty both in general terms and in terms of
interest rates scenario, adversely affects long-term perspective from the point of view of
an investor together with that of the financial institution.
Resource Constraints: One of the major problems being currently faced by the Non Bank
Financial Institutions (NBFIs) in general and Leasing Companies in particular includes
fund mobilization constraints relating mainly to the currently volatile interest rate
scenario, squeezing of margins, non-availability of long-term funds, non-availability of
multi-lateral credit lines, etc. In order to ease the prevailing situation, a number of leasing
companies like PILCORP, Paramount Leasing Ltd. Network Leasing Company Ltd.,
ORIX Leasing Pak. Ltd. Askari Leasing Company Ltd., Sigma Leasing Company Ltd.,
Saudi Pak Leasing Company Ltd., Atlas Lease Limited, etc. have already issued or are in
the process of issuing their TFC's. In addition, a number of leasing companies are also
issuing COI's to generate funds for their leasing operations.
Non-availability of Level Playing Field: The leasing companies are also experiencing
adverse competition from Investment Banks and DFIs due mainly to non-availability of
level playing field as a number of these institutions have allowed pursuing leasing
business. The competition is particularly severe in respect of mark-up rates vis-a-vis their
cost of funds, which are much lower than rates offered by leasing companies because of
their in-built margins. The issue has time and again been taken-up by the Leasing
Association of Pakistan (LAP) with the SECP for making available a level playing field
for the Leasing Sector to ensure its continued growth process.

Lack of Innovative Products: Being in a relatively nascent stage of growth, the leasing
sector lacks innovative products and confines mostly to small and medium ticket leasing
particularly involving vehicles and machinery. Leasing of machinery and other industrial
equipment has however, slowed down due to recession. Some of the smaller leasing
companies are also involved in micro leasing but are facing difficulties in recoveries.
Presently, most of the larger and medium sized leasing companies are mostly involved in
leasing of vehicles, which has led to increased competition among them. Though the near
future demand perception for vehicle leasing seems to be positive with adequate share for
everyone but long-term demand perspective for innovative products is imperative for
continued growth of the Leasing Sector. For the moment, leasing of machinery and
equipment particularly relating to priority sectors of the economy including Energy
(CNG), IT (Computers and other hardware), textiles (looms & auto coners) need to be
encouraged subject to their intrinsic value.
Tax Issues: A number of tax related issues are presently affecting the overall performance
of the Leasing Sector which includes the following:
o Provisions made as per Prudential Regulations are not treated as tax admissible
expense.
Tax depreciation on vehicles is only to the extent of Rs. 600,000 whereas the price of
popular vehicles is over and above of the admissible limit.
Leasing companies are not allowed to charge initial depreciation on leased machinery
under sale and leaseback arrangement because of being treated as second users.
Other Issues: Other important issues relating to the Leasing Sector include the following:
In addition to imposition of Professional Tax (on the basis of paid-up capital) in the
Province of their registration, Companies are also required to pay Professional Tax on
their branches in other Provinces, which further increases their administrative cost.
Imposition of 1 % Stamp Duty on all financing documents in the Sindh Province has
further increased the cost of funding on account of the following:
_ for lessees on hypothecation
_ for lessors on acquiring credit lines
Future prospects
The Leasing Sector in general has experienced commendable growth over the years and
has adequately proved to be an alternate source of finance. However, its near future
prospects do not seem to be too bright unless its various areas of concern including the
prevailing economic scenario, dried-up foreign funding lines, lack of resource
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mobilization, non-availability of level playing field, lack of innovative financial products,

tax and other issues, etc are seriously investigated and mitigated. In case of an expected
economic revival, the overall Leasing Sector is likely to regain its initial momentum
particularly in the backdrop of Islamization of the economy effective fiscal year 2001 2002 due to its inherent potential of being in close conformity to one of the permissible
modes of financing under Shariah. However, in order to improve the near future demand
prospects of Leasing Sector in particular, the leasing companies need to develop
innovative products along with encouraging leasing of plant and equipment relating to
priority sectors of the economy including energy (CNG), IT (computers and other
hardware), textiles (air jet looms and auto coners), etc subject to their intrinsic value.
Conclusions and Recommendations
Leasing has established itself as a well recognized mode of financing in Pakistan and
progressed well during the last decade. From a few leasing companies in the early 90s the
number has increased to over 30 and the investment volume has grown from about Rs. 9
billion in 1995 to Rs. 29 billion in 1999. By extending medium term credit facilities to the
industrial and service sectors, the leasing companies have played an important role in
capital formation. Being a relatively young industry in Pakistan, the penetration of leasing
at about 6% of fixed private capital formation is still below the level of other developing
countries where it ranges between 10 15%. Thus the potential for growth is good and it
is anticipated that the leasing companies will meet the challenges of the economic
development taking place in our country. We made a few recommendations for the
improvement of leasing sector in Pakistan.
First, improved governance is intended to lay the foundations for a new economic order
in which hard work, business ethics and competitive business practices take the place of
connections, concessions, tax evasion, loan default and a rent seeking environment that
has been prevalent in this country for a long time. This new entrepreneurial class will
need the financial assistance from financial institutions such as the members of Leasing
Association of Pakistan. Second, macroeconomic stabilization efforts have been
successful but need to be sustained over time and provide the impetus for revival of
economic growth. Industrial and services growth have not been up to our expectations.
Here again the leasing sector can help promote investment in the industrial and services
sectors. Finally, one of the tough challenges the present government has taken upon itself
explicitly is poverty alleviation. Empirical evidence from all over the world shows that
Micro enterprises and SMEs the theme of this Conference can prove to be potent
7

agents for reducing poverty. For the leasing sector which is normally faced with a high
risk, high reward situation it is imperative to reduce the risks and for this reduced level of
risk maintain high rewards. To be able to achieve this, you have to diversify across
sectors, diversify across geographic areas, diversify across size of the enterprises and
bring forth new products tailored to the growing needs of the economy. In this regard,
four areas of diversification are recommended here.
First, the Export Development Strategy has identified seven new thrusts for export
development gems and jewelry, fruits and vegetables, I.T. , fisheries, light engineering
goods, granite and marble, chemicals. The textile vision 2005 has identified value added
goods with textiles such as readymade garments as the main area of emphasis. In view of
the characteristics of these sub-sectors the supply of lease financing to these firms should
help reduce the market risk as their goods are destined for a much larger world market.
The correlation in the movements between domestic market and the world market is not
that high. Second, the leasing activities should spread themselves outside the large urban
centres such as Karachi and Lahore. There are formidable new business opportunities at
places such as Sialkot, Daska, Gujranwala, Gujrat, Peshawar, Faisalabad, Hyderabad and
Quetta. The de-concentration away from the main centers would help develop new client
base and thus reduce credit risk, which otherwise is quite high if the portfolios is
concentrated in a narrow client base limited to few cities only. Third, as most of you
know, the governments four priority areas of economic revival are agriculture, SMEs,
Oil and Gas and IT. At least one of these areas SMEs has a natural fit with the leasing
sector. SMEs have a higher capacity for labor absorption, they cater to the demands of the
average household, most of their products are based on domestic raw materials and their
repayment record is much better than that of the large borrowers. The payment risk of
leasing companies is reduced if the SMEs are included as the dominant borrowing class.
Fourth, the leasing sector has done very useful service to the economy but it has focused
mainly on industrial equipment and automobiles. There is a need to go beyond this
narrow focus and develop new products and services which can meet the emerging
demands of the economy. Of course, those within your industry who pioneer these
products will earn higher returns in the initial stages but as these products become
standardized and widespread the risks will become realigned with rewards.
There are too many financial institutions in this country with weak capital base,
rudimentary technology, inadequate human resources and managerial skills and a low
capacity to absorb unanticipated exogenous shocks. Pakistan must see fewer but stronger
8

financial institutions which can mobilize and allocate resources in a cost effective and
efficient manner. This will require voluntary mergers and consolidation both horizontally
and vertically. This will also pave the way for development of exports of financial
services from Pakistan to the rest of the developing world resulting from liberalization
under WTO. The regulators are ready to engage in a dialogue.