managing risk.pdf

Managing Risk and Creating Value with Microfinance79Most business owners would probably agree with Saint-Exupery—although machinery holds the key toincreasing production, it comes with a cost. Acquiring new machinery can mark the evolution fromartisan production to more specialized and efficient production, but it can also mean plunging the businessmore deeply into problems in the short term. Growing microbusinesses crave new equipment as a path togrowth and greater efficiency, but they must confront the costs of increased financial commitments, workertraining, wasted materials during the learning process, installation costs, maintenance obligations, increasedenergy use, and more security. 1On the financial side, the lack of sufficient collateral and audited financial statements may prevent the owner fromapproaching traditional banks. Leasing offers an alternative to a traditional bank loan. A leasing arrangementguarantees access to new machinery while avoiding the long-term problems of traditional loans. Leasing is afinancial product that enables businesses to rent new machinery for a defined period of time without providingcollateral or increasing debt. For the microfinance institutions (MFIs), microleasing provides new opportunitiesfor long-term financial relationships with growing microbusinesses.The Basics of MicroleasingThe two types of equipment-leasing arrangements are the financial lease and the operational lease. In a financiallease, the client pays the full price of the equipment, plus interest, in installment payments throughout the leaseperiod. At the end of the lease period, the client may purchase the equipment outright for a nominal amount(usually the remainder of the asset’s cost). A financial lease can be cancelled only by mutual agreement. In anoperational lease, the client rents the equipment for a specified period, at the end of which the client returnsthe equipment, buys it outright, or renews the agreement. The client may cancel the agreement and returnthe equipment before the end of the lease period. Because MFIs more commonly offer financial leases andrarely offer operational leases, this chapter focuses on financial leases, their advantages, taxes, regulations, andmanagement considerations and provides some examples from Latin America. The chapter ends with somerecommendations for a microleasing program.Advantages of Leasing for MicrobusinessesFrom the microbusiness owner’s point of view, the advantages of microleasing are related to collateral, paymentflexibility, and a chance to upgrade technology after a specific period of time. In financial terms, collateral isfar less of a constraint with a leasing contract than if the microbusiness were to apply for a long-term loan topurchase machinery or equipment. Collateral is built into the lease, because the title of the equipment remainswith the lender until the end of the contract.There are important cashflow advantages for the microbusiness. The leasing arrangement’s fixedratefinancing makes the arrangement “inflation friendly.” As costs for energy, rent, and labor increase,the client pays the same amount each month throughout the lease period. The upfront cash outlay istypically less. Because the lease usually covers 100 percent of the asset purchase, the client does notneed to make a large initial down payment in cash. This arrangement means that the business can use its ownfunds for its working capital needs. Leasing payments can also be structured to match a business’s cashflow—whether through a grace period, balloon payments, step-up or step-down payments, deferred payments, or even1. This chapter is based on the October 2007 dialogue with Glenn Westley (Inter-American Development Bank) and EduardoGutiérrez (National Ecumenical Development Association, Bolivia).