A Financial Lease is a means of financing capital equipments. It is a contract between the Bank (Lessor) and the Customer (Lessee) for the hire of a specific asset, selected from a manufacturer / Supplier of lessee’s choice and to suit the lessee’s requirements. The lessee has possession of the asset and uses the same on payment of specified rentals and other usual charges / fees, while the lessor retains ownership of the asset. All the risks (major or minor) and rewards of ownership are normally transferred to the lessee and the obligations are non-cancellable. The lessee is to bear the costs of insurance, maintenance and other related costs and expenses for the leased equipment.
Benefits of lease to the borrower
The benefits of the lease to the borrower are as under;
Lease finance may be Cheaper Compared to Term Loans under certain circumstances.
100% Financing – No margin is generally required in leasing whereas term loans generally stipulate a margin of 30% to 50%. * Terms Of Payment Extremely Flexible – Structured as per the cash flow of the lessee
Lease is an Off-Balance Sheet financing option which increases capability to raise additional resources for expansion, diversification modernization
The lead time for sanction of lease assistance is much less compared to term loans etc.
Steps involved in leasing
1. Decission of the leasee regarding the asset required and determine the manufacturing and other requirements such as price warranties, terms of delivery etc.
2. Entering into a lease agreement with the lessor containing the rights and obligations of both the lessor and lessee.
3. Signing the lease agreement.
4. Finally lessor intimates the manufacturer / supplier to supply the asset to lessee. The lessor makes the payment
to supplier after the asset has been delivered to lessee
Different types of leases
1. Financial Lease
Financial leasing is a contract involving payment over a longer period. It is a long-term lease and the lessee will be paying much more than the cost of the property or equipment to the lessor in the form of lease charges. It is irrevocable. In this type of leasing the lessee has to bear all costs and the lessor does not render any service.
2. Operating Lease
In an operating lease, the lessee uses the asset for a specific period. The lessor bears the risk of obsolescence and incidental risks. There is an option to either party to terminate the lease after giving notice. In this type of leasing
- lessor bears all expenses
- lessor will not be able to realize the full cost of the asset
- specialized services are provided by the lessor.
This kind of lease is preferred where the equipment is likely to suffer obsolescence.
3. Leveraged and non-leveraged leases
In leveraged and non-leveraged leases, the value of the asset leased may be of a huge amount which may not be possible for the lessor to finance. So, the lessor involves one more financier who will have charge over the leased asset.
4. Conveyance type lease
In Conveyance type lease, the lease will be for a long-period with a clear intention of conveying the ownership of title on the lessee.
5. Sale and leaseback
In a sale and leaseback, a company owning the asset sells it to the lessor. The lessor pays immediately for the asset but leases the asset to the seller. Thus, the seller of the asset becomes the lessee. The asset remains with the seller who is a lessee but the ownership is with the lessor who is the buyer. This arrangement is done so that the selling company obtains finance for running the business along with with the asset.
6. Full and non pay-out lease
A full pay-out lease is one in which the lessor recovers the full value of the leased asset by way of leasing. In case of a non pay-out lease, the lessor leases out the same asset over and over again.
7. Specialized service lease
The lessor or the owner of the asset is a specialist of the asset which he is leasing out. He not only leases out but also gives specialized personal service to the lessee. Examples are electronic goods, automobiles, air-conditioners, etc.
8. Net and non-net lease
In non-net lease, the lessor is in charge of maintenance insurance and other incidental expenses. In a net lease, the lessor is not concerned with the above maintenance expenditure. The lessor confines only to financial service.
9. Sales aid lease
In case, the lessor enters into any tie up arrangement with manufacturer for the marketing, it is called sales aid lease.
10. Cross border lease
Lease across national frontiers are called cross border lease, Shipping, air service, etc., will come under this category.
11. Tax oriented lease
Where the lease is not a loan on security but qualifies as a lease, it will be considered a tax oriented lease.
12. Import Lease
In an Import lease, the company providing equipment for lease may be located in a foreign country but the lessor and the lessee may belong to the same country. The equipment is more or less imported.
13. International lease
Here, the parties to the lease transactions may belong to different countries which is almost similar to cross border lease.