Performance evaluation of lease financing as an instrument of financial market in Bangladesh

Abstract

Lease financing is becoming increasingly important and getting prominence as a mode of finance with the expansion of the economy of Bangladesh. Lease financing has some unique features that might be more favorable than other types of financing. Lease financing can support the expansion of SME sector which is considered to be the engine for the growth in Bangladesh. Lease financing has given the SMEs the opportunities to accumulate funds in easy terms and conditions. Large organizations of Bangladesh are also utilizing lease financing as a mode of finance. The leasing companies in Bangladesh are providing leasing activities and also they are involved in stock market related activities such as underwriting, issue management, private placement, trust management, portfolio investment and mutual fund operation. Leasing companies in Bangladesh are facing competition with banks and they have some problems and limitations to compete with banks. This research has attempted to find out the reasons behind the competition between banks and leasing companies in Bangladesh. It is also important to reveal whether leasing is the substitute of term financing in Bangladesh at present or not. This research has also attempted to know why some of the borrowers in Bangladesh prefer lease financing to term loan. Banks and leasing companies are not providing operating lease in Bangladesh. It is also essential to identify the reasons behind the absence of operating lease in Bangladesh and the future prospect of operating lease in the country. The thesis has started with the introduction chapter. Lease financing in Bangladesh has been described in this chapter. This chapter also includes problem statement, research issues. research objectives, scope of the study, sampling design and the benefit of the study. The second chapter is ‘Financial Market and The Economy of Bangladesh’. Descriptions about the financial market of Bangladesh and its components have been included in the chapter. The economic sectors of Bangladesh have also been described in this chapter. Third chapter is Literature Review. Summaries of different articles are included in this chapter. Methodology of the research study has been spelt out in the fourth chapter. The study has used several inferential statistical tools and techniques including Data Envelopment Analysis (DEA) and Factor Analysis Model. Data Envelopment Analysis (DEA) has been used to measure the allocative efficiencies, technical efficiencies and cost efficiencies as well of leasing companies over the period of 2006 to 2011. Factor Analysis has also been used to identify the reasons for preference of leasing over term financing by borrowers in Bangladesh. Whether leasing is a substitution of term financing for different types of firms has also been tested in the context of Bangladesh. Reasons and problems of competition have been measured by key informant’s interview and lending institutional survey. Key informants interviews have been used to identify the reasons behind the absence of operating lease in Bangladesh and the prospects of operating lease in Bangladesh. Herfindhal-Hirschman Index (H.H.I) has been used to measure the the degree of competition and concentration of the banks and leasing companies. Weighted Average Cost of Capital (W.A.C.C) of leasing companies and banks have been estimated to reflect the cost of capital being used by these institutions. Fifth chapter is Competition between banks and leasing companies in Bangladesh. It describes the reasons behind the competition between banks and leasing companies in Bangladesh. Banks are providing term loan and as well as lease financing. For that reason the competition exists between banks and leasing companies. Banks can provide short term loan but leasing companies are prohibited to provide short term loan. It has been found that both banks and leasing companies have increased their marketing expenses. Marketing expenses has increased the demand for the products of both banks and leasing companies. Leasing companies can provide faster service for financial solution than banks. Technological advancement has increased the competition of banks and leasing companies. Transaction cost have been minimized by both banks and leasing companies. Flexibility of terms and conditions of loan and lease has increased the competition between banks and leasing companies. Competition of banking sector and as well as leasing sector can be measured by using Herfindhal-Hirschman Index (H.H.I). H.H.I can be found by squaring the market share of each firm competing in the market, and then summing the resulting number. High concentration means less competition. It has been found by H.H.I that banks have more competition among themselves than leasing companies in Bangladesh. Banks can collect short term deposits but the leasing companies cannot collect short term deposits. As a result, the cost of capital of banks is low as compared to leasing companies. Leasing companies have less qualified personnel than banks. High cost of capital is the most challenging issues for leasing companies in Bangladesh. Leased asset recovery problem is another challenging issue for leasing companies. There is a risk of capital losses due to obsolesce of the equipments or machines. Leasing companies have to pay high interest for the commercial loan to banks. Due to manpower shortage, the leasing companies in Bangladesh are facing challenges. It has been observed that the WACC of leasing companies are higher than the WACC of banks. Banks can collect demand deposits but leasing companies cannot collect demand deposits. As a result the WACC of banks is lower than WACC of leasing companies. The banks can utilize the low cost of fund by investing more in profitable sectors. Different profitable sectors should be identified and invested by the banks as their cost of fund is low compared to leasing companies. Banks should try to motivate their employees. The transaction cost of banks could be minimized to utilize the low cost of funds and to increase profit. Sixth chapter is Efficiency analysis of leasing companies in Bangladesh through D.E.A. Data Envelopment Analysis (DEA) is a nonparametric method for the estimation of production frontiers. DEA is a linear programming methodology to calculate the efficiency of different firms from multiple inputs and outputs of firms. Utilizing the selected variables, such as unit cost and output, DEA software searches for the points with lowest unit cost for a given output and can form the efficiency frontier. Any company which is not on the frontier is considered as inefficient. A numerical coefficient is given to each firm, defining its relative efficiency. Data Envelopment Analysis (D.E.A) has been used to measures the technical efficiencies, allocative efficiencies and as well as cost efficiencies of 17 leasing companies for the period of 2006 to 2011 assuming variable return to scale and constant return to scale. Optimum level of inputs for efficient production assuming both variable return to scale and constant return to scale have been identified in this research study. Technical Efficiencies and its decompositions have been identified for the period of 2006 to 2011. Output slacks and input slacks have also been identified in the study. Output slacks are created when the hypothetical firm on the efficient frontier belongs in a position that the firm can increase its output by the slack quantity without increasing inputs. Input slacks can also be explained as the output slacks. The firms are compared to a hypothetical firm that belongs on the efficient frontier. When a hypothetical firm belongs in a position on the production frontier that the firm yet can reduce the inputs by the slack quaintly without reducing outputs. Seventh chapter is comparison between lease financing and term financing in Bangladesh. Lease financing has some advantages that some of the borrowers prefer lease financing than term loan in Bangladesh. Leasing companies face some problems to conduct their business in Bangladesh. Though lease financing has some advantages, it has some disadvantages also. Provision of collateral, no third party guarantee for lease, faster service, less documentation etc. are the advantages for lease financing. Higher interest rate, restriction on equipment use, loss of residual value etc. are the disadvantages for lease financing. 50 firms capital structure for 5 years that have taken lease financing from banks or leasing companies has been collected. From the capital structure of these firms, proportion of loan and proportion of lease have been analyzed. Proportion test has been used to find out whether there is any significant difference between the proportion of loan and proportion of lease of 50 firms for 5 years or not. It has been found that the Z value for the proportion of loan and proportion of lease is 2.386 which is more than the critical value of 1.96. Based on Z value, it has been observed that the proportion of loan and lease of 50 firms have significant difference at 5 percent level of significance. Depending on Z value, it can be said that the lease financing is not the substitution of term loan at present in Bangladesh. Eighth chapter is preference of lease financing over term loan in Bangladesh. Different high official’s interviews from banks and leasing companies have been taken to detect the reasons of preference of lease financing over term loan by some of the borrowers in Bangladesh. Provision of collateral, the time of lease repayment, E.M.I (Equal Monthly Installment) for lease, longer grace period for lease, no secondary security for lease, no third party guarantee for lease, lack of funds to choose lease financing, faster service for lease financing, less procedural complexity for lease financing, fewer documentation and submission of documents in one package, avoidance of many restrictive covenants, lease financing for low cost assets, sale and leaseback arrangements and total financing for lease are the reasons for the preference of lease financing over term loan by some of the borrowers in Bangladesh. Factor analysis has been used to detect different factors and their correlated variables. From the overall factor analysis ( Borrowers who takes lease from banks as well as leasing companies) it has been revealed that under first factor the correlated variables are less procedural complexity for lease financing, fewer documentation and submission of documents in one packages and avoidance of many restrictive covenants. The percentage of variation is 14.10. It means that these three variables explain 14.10 percent of total influencing variables. Ninth chapter is operating lease in Bangladesh. In chapter nine, causes for the absence of operating lease and the future prospects of operating lease have been described. The operating lease is not much popular in Bangladesh. The culture of using operating lease has not been developed yet in Bangladesh. Because of low technological development, the risk of becoming obsolete of the equipment or machine is comparatively low in Bangladesh. People can easily handle and use financial lease for a long period of time. Operating lease should be handled by the professional persons. Workshop/service centre is needed for the after sale service of leased assets. Proper maintenance, Pools of assets, skilled operators and service centers are essential for operating lease. In Bangladesh, there is lack of proper set up for operating lease. Weak legal framework is another problem for operating lease to be developed in the country. Operating lease is becoming popular day by day in the context of Bangladesh. Bangladesh is moving towards the industrial development. Infrastructural development is taking place within the country. Power backup, truck, escalator etc. are needed for the expansion of infrastructure. Those organizations which are involved in the infrastructural development process like operating lease asset for shorter time period. For that reason, there is the chance for the development of operating lease in Bangladesh. As because of the expansion of the economy, operating lease has a prospective future in Bangladesh. Summary, recommendations and conclusion have been described in the tenth chapter. Finally, future scope of research has been described in the eleventh chapter.