Lease Financing

Meaning: A lease is a contractual agreement in which the owner of an asset (the lessor) grants another party (the lessee) the right to use the asset in return for a periodic payment. In short, it is the renting of an asset for a specified period. The lessee pays a fixed periodic amount — the lease rental — for the use of the asset, and the terms are set out in the lease contract. At the end of the lease period the asset returns to the lessor.

Where it is used: Lease finance is an important means of modernisation and diversification. It is especially common for assets like computers and electronic equipment that become obsolete quickly due to fast technological change. When deciding to lease, a firm should compare the cost of leasing with the cost of owning the same asset.

Merits

• Lets the lessee acquire the asset with a lower investment.
• Simple documentation makes financing assets easier.
• Lease rentals are tax-deductible when computing taxable profits.
• Provides finance without diluting ownership or control of the business.
• Does not affect the debt-raising capacity of the enterprise.
• The risk of obsolescence is borne by the lessor, giving the lessee flexibility to replace the asset.

Limitations

• The lease may impose restrictions on the use of the asset (for example, barring any alteration or modification).
• Normal operations may be disrupted if the lease is not renewed.
• Premature termination can lead to a higher payout obligation if the equipment proves not useful.
• The lessee never becomes the owner, so is deprived of the asset's residual value.

Who the lessors are (Box A):

• Specialised leasing companies: about 400-odd large companies focused organisationally on leasing.
• Banks and bank-subsidiaries: since February 1994 the RBI allowed banks to enter leasing directly; earlier only bank subsidiaries could (the RBI treated leasing as a non-banking activity).
• Specialised financial institutions: several central- and state-level institutions use the lease instrument; ICICI was one of the pioneers of Indian leasing.
• Manufacturer-lessors: manufacturers sell products on lease to add value ("vendor leasing"); vendors of automobiles and consumer durables now ally with leasing companies.

Who the lessees are (Box A): …