Leasing, Hire Purchase & Consumer

Credit

UNIT- 2
 TYPES/CLASSIFICATION OF
FINANCIAL SERVICES
The financial intermediaries in India can be
classified as follows
 Capital market Services – It consists of
term lending institutions which mainly
provide long term funds.
 Money market Services – It consists of
commercial banks, financial institutions,
co-operative banks which providing short
term funds agencies
FUND BASED SERVICES

It refers to services that are used to acquire

assets or funds for a customer. It consists of –
 Primary market activities- Underwriting or
investment in shares, debentures, bonds, etc.
of new issues (Primary Market Activities)
 Secondary market activities
 Foreign exchange activities
 Specialized financial Services- Participating by
Involved in equipment leasing, hire purchase,
venture capitals money market instruments etc.
Important fund based services are-
 Leasing
 Hire purchase
 Factoring
 Forfeiting
 Mutual funds
 Bill discounting
 Credit Financing
 Housing Finance
 Venture capital
Fund based Activities:
 Underwriting or investment in shares,
debentures, bonds, etc. of new issues
(Primary Market Activities)
 Dealing in secondary market activities
 Participating in money market instruments eg.
Discounting bills, treasury bills, certificate of
deposit etc.
 Involving in equipment leasing, hire purchase,
venture capitals Dealing in foreign exchange
activities
 FEE-BASED SERVICES:
When financial institutions operate in
specialised fields to earn income in form of
fees, commission, brokerage or dividends it is
called a Fee-based Service. They include –

 Issue Management  Stock broking

 Portfolio management  Capital restructuring
 Corporate counseling  Bank Guarantee
 Merchant banking  Letter of Credit
 Credit rating  Debt Restructuring
Fee based Activities:
 Managing the capital issue in accordance
with SEBI guidelines enabling promoters to
market their issue
 Making arrangements for placement of capital
and debt instruments with investment
institutions
 Arrangement of funds from financial
institutions for clients project cost or working
capital
 Assisting in getting all Government and other
clearances
 A lease is an agreement whereby the lessor
conveys to the lessee , in return for rent, the right
to use an asset for an agreed period of time.
 A financing arrangement that provides a firm with
an advantage of using an asset, without owning
it, may be termed as “leasing”.
 The term leasing refers to a contract under which
the owner of an asset allows another person or
party to use the asset in return for some rent.
 Lessor is the owner of the asset and the lessee is
the person getting the benefit of asset taken on
lease.
Lease - definition
 A lease is an agreement whereby the lessor conveys
to the lessee , in return for rent, the right to use an
asset for an agreed period of time.

 A financing arrangement that provides a firm with an

advantage of using an asset, without owning it, may
be termed as ‘leasing’.
• History of leasing dates back to 200 BC when
Sumerians leased goods.
• Romans had developed a full body law relating to
lease for movable and immovable property.
• Modern Leasing appeared first time in 1877 when
Bell Telephone Co. began renting telephones in
USA.
• Since WW II, the use of leasing has been greatly
expanded and is constantly used for new products
and new industries.
• Henry Scholfeld set up US Leasing Corporation with
a capital of $20,000 in May 1952.
• The concept of financial leasing was pioneered in
India during 1973, First company was set up by
Chidambaram group in 1973. 11
STEPS IN LEASING
 FEATURES
 Leasing a product is similar to renting it

 A contract lasts over a number of years,

usually between 2 and 10, depending on the
cost and usable life of the product.

 Have the full use of a piece of equipment

without having to pay the full cost of the
item in one go.
15
Advantages of Leasing
 No large outlay: The cost is spread over a
number of years; there is no need to pay the
entire amount upfront.
 Security: The product is still owned by the
leasing company, meaning that they have
better security on finance.
 Tax advantages
 Budgeting: A fixed contract, it is relatively easy
to budget and forecast with
 Saving of capital
 Improvement in liquidity:
 Flexibility and convenience

The lease agreement can be tailor- made in

respect of lease period and lease rentals
according to the convenience and
requirements of all lessees
Disadvantages of Leasing
 No Ownership

 Costly option - high interest rates,

costlier than straight buying

 Long Term Expense

 Maintenance cost

 No working capital
Characteristics of lease

 The Parties
 The Asset
 The Term
 The Lease Rentals
Types of Lease
 Financial Lease  Ballon Lease
 Operating Lease  Close end leasing
 Leveraged Lease  Swap Leasing
 Sale and Leaseback  Wrap Leasing
 Partial Pay-Out  Import Leasing
Lease  Cross Border
 Consumer Leasing leasing
 International
Leasing
Financial lease...
 It is also known as Capital lease or Long-term
lease. Here the lease period is longer, more
nearly covering the useful life of the
equipment. Rentals tend to be lower because
of the longer term and less residual value
risk.
 The lessee is responsible for the
maintenance of the asset leased.
 The lease generally provides for the renewal
of the lease on expiry of the lease contract.
 Long-term, non-cancellable lease contracts are
known as financial leases.
 The essential point - it contains a condition
whereby the lessor agrees to transfer the title
for the asset at the end of the lease period at
a nominal cost.
 At lease it must give an option to the lessee to
purchase the asset he has used at the expiry of
the lease.
 High cost high tech equip.
Operating Lease
 Here the lease period is shorter than the
expected useful life of the equipment. Rental
payments do not cover the equipment cost
of the lessor during the initial lease term.
 The lease is cancelable at short notice by
the lessee.
 The lessee has the option of renewing
the lease after the expiry of the lease
period
 It is a high risk lease to the lessor, as any
time it may be cancelled by the lessee.
 This type of lease is popular for high-tech
equipment, because shorter term leases help
equipment users stay ahead of equipment
obsolescence.
 Lessor will bear the maintenance expenses
and taxes.
 Contrast to the financial lease
 A lease agreement gives to the lessee only a
limited right to use the asset.
 The lessee is not given any uplift to
purchase the asset at the end of the lease
period.
Leveraged Lease
 Where a financier is involved for the whole or
a part of the financial requirement.
 Used for high value asset.
 The financier will have charge over the
leased asset, over and above the lease
rentals.
Sale and Leaseback:
 Owner of the asset sells it to the lessor, and
gets the asset back under the lease
agreement.
 Ownership transfer from the original owner to
the lessor, who again leases out the asset.
 Immediate financing to the seller company,
whose funds are tied up in the asset.
 Partial pay out lease: Full payment of the lease in
several leases.

 Consumer Leasing :Leasing of consumer durables

like Refrigerator, televisions, etc.

 Balloon Lease : a lease which has zero residual

value at the end of the lease period. i.e. low lease
rentals at the inception, high in the mid years, and
low again at the end of the lease.

 Close end leasing : the asset is reverted to the lessor

at the end of the lease.

 Open end leasing : the lessee guarantees a minimum

value to the lessor , from the sale of the asset at the
end of the lease term. If on sale of the asset, the
residual value is less , then lessee pays to the lessor
the difference amount.
Import Leasing :
 leasing of imported capital goods.

 beneficial to the lessee, because arranging

other sources of funds takes long. Lenders do
not usually finance the import duty which
forms sizable portion of the cost.
 during which the prices of imported goods
may rise + fluctuation in exchange rates may
happen.
Cross Border Leasing :
 A lease where the lessor is in one country and lessee
in another.
 The Jurisdiction of lessors and lessees are in two
different countries.
 Eg. Leasing of airplanes.

International Leasing
 A case where the leasing company is operating in
various countries through its branches.
 International leasing is active in countries like U.S.,
Japan etc.
Regulatory framework of leasing
 Provisions under Contract Act relating to
Bailment:
 two parties - lessor - bailor, lessee-
bailee.
 Transfer of possession of goods from
bailor (lessor) to bailee (lessee), for a
specific purpose.
 As under bailment, on accomplishment
of purpose the goods transferred from
lessee to lessor.
Regulatory framework of
leasing..
 Liabilities of Lessee(Bailee)..
 Reasonable Care :
 The lessee to take reasonable care of the asset. If he
fails he is liable to for loss or damage to the goods
that he has caused.
 If goods damaged despite of reasonable care,
(floods, riots etc), then the lessee is not responsible.
 Generally lease agreements make the lessee
responsible , irrespective of lessee’s negligence.
 Regulatory framework of
leasing..
 Unauthorized Use not Permitted to the Lessee:
 The lessee is not allowed to use the leased asset , for
any purpose other than one specified in the lease
agreement.
 If he does so , then the lease agreement is terminated,
and lessor recovers the possession of the goods.
 Return of Goods :
 The lessee has to return the goods :
 on completion of the lease term; or
 the lease agreement has been terminated by the
lessee or lessor/or automatic termination of the
agreement because of breach of conditions.
 Not to set up an Adverse Title: must
inform the lessor of any adverse claim.
 Payment of Lease Rental
 Insure and Repair the Goods
 Theoretical Framework of Leasing
 Liabilities of Lessor (Bailor):
 Delivery of Goods:
- Ensure delivery of goods to the lessee, along with
documents for lawful use of asset. Lease commences
on delivery.
 Peaceful Possession:
- Lessor must ensure quite possession of the goods
during the lease term
 Fitness of Goods
 To Disclose All Defects: all known defects to be
disclosed. If not then the lessor has to compensate the
losses incurred by the lessee due to such defects.
 Remedies for Breach;
 Remedies to the Lessor:
- Forfeiture : forfeiture of all lease rentals paid up to the
date of termination, even if it exceeds the amt. of
benefit received by the lessee.
- Repossession : repossession of goods on breach of
lease through serving of a notice on lessee. For
repossession of goods physical force can be used by
the lessor.
 Remedies to the lessee: may claim damages for loss
resulting from the termination. This includes
increased lease rentals he has to pay on new lease
asset obtained + damages for not allowing him to use
the asset from termination date to the the date of
expiry of the lease term.
 Insurance of the leased Asset :
Both lessor or lesse can obtain the insurance.
Generally obtained by the lessee, covering
loss due damage by fire, riot, faulty handling,
Act of God etc.
 Claims Proceeds : in case of asset being fully
destroyed, the claims received , adjusted
against the lessor’s dues. In case of partial
damage, the claim proceeds to be adjusted
against amount financed, and then for
balance lease rentals is computed.
 Sub Lease by lessee : not allowed unless
provided in the lease agreement. Except for
assets where sub lease is apparent. Sub
lease becomes the lease of the original lessor
as well. If Main lease is terminated then the
sub lease gets automatically terminated.
 Lease Documentation and
Agreement
 Lease Approval Process:
 Appraisal of the Lease proposal. Sanctioning of the
credit amount.
 Letter of Offer, with stipulated time for acceptance.
 Acceptance of Offer by lessee within stipulated time,
with Board Resolution for acceptance of the offer.
 Documents required:
 Purchase Order, Invoice, Bill of Sale from supplier,
delivery note, insurance policies, import license, copy
of shops and establishments registration certificate,
copies of Audited balance Sheet and P&L A/c. for
3yrs, M of A and Articles of Association, Provisional
results for the first 6 mths, IT returns/Salary certificate.
 All these documents to be obtained by
the lessor from the lessee.
 They are called “Attendant Documents”
as they help in taking a decision for the
lease proposal.
 Insurance Policy compulsory for the
leased asset, in the name of the lessor
account lessee. Policy should be in the
custody of the lessor.
Lease Agreements
 It specifies the legal rights and obligations of
the lessor and lessee.
 Usually a Master lease is signed containing
the qualitative terms in the main part, and the
equipment details, rentals, credit limits and
payment duration etc in attached schedules.
 Additional lease facilities are finalized under
supplemental lease agreements, with
reference to the Main Master Lease
Agreement.
 Clauses in Lease Agreement:
 Nature of the lease : financial lease, operating lease etc.
 Description : of the equipment, its actual condition, size,
estimated useful life, components etc.
 Delivery and Re-delivery : when and how the equipment
would be delivered to the lessee and redelivered by him.
 Lease Rentals ; procedure for payments of lease rentals
with the rates. Besides, the late payment charges.
 Repairs & Maintenance : responsibility of repairs,
insurance etc.
 Title : identification and ownership of equipment.
 Events of default and Remedies : consequences of default
and recourse available to the lessor.
Accounting aspect of Leasing
 Operating lease : Is capitalized in the
book of lesser

 Lease payments are treated as income of

the lessor and expense of the lessee

 Depreciation of the assets should on the

basis of normal depreciation policy of the
lessor for similar assets
 Financial lease: Must be capitalized in
the books of lessee
a) At the time of inception leased asset is
shown as an asset of B/S of the lessee
– Its VALUE = PV of the committed lease
rentals
b) Payments are financial charges (expense in
P/L) and principal amount (deducted from
lease payable in B/S)
c) Leased asset is depreciated in the books of
lessee
Hire Purchase
What is hire purchase ?
 Hire Purchase is the legal term for a contract, in
which persons usually agree to pay for goods in parts or
a percentage at a time.
 Here possession of goods is transferred immediately,
but payment is made in installments.
 Ownership is transferred after all the installments
have been paid
 Hire purchase is used to buy expensive items which a
person cannot afford to payout right: e.g. a car
 A down payment is usually paid and the balance is
paid over several months (monthly instalments).
 The individual availing HP financing is the hirer and
the financier is the owner.
 The rental payment is inclusive of the repayment of
principal as well as interest.
 The hire purchaser acquires the goods immediately
on signing the hire purchase agreement but the
ownership of the same is transferred only when the
last installment s paid.
 HP transactions are governed by the Hire Purchase
Act 1972.
 The HP Act sets out the forms and contents of HP
agreements, the legal rights, duties, obligations of
hirers and financiers.
 The HP Act is administered by the Ministry of
Domestic Trade and Consumer Affairs.
Definition
 According to hire purchase act of 1972. An agreement
under which goods are let on hire under which the
hirer has an option to purchase them in accordance
with the terms of agreement and include an agreement
under which
 Possession of goods is delivered by the owner there of to a person
on the condition that such person pays the amount in periodic
payments‡
 The property of the goods is to pass to such a person on the
payment of the last installment.
 Such a person has a right to terminate the agreement any time
before the property so passes.
 The origin of hire purchase system can be traced
back to the advent of industrial development in
UK.
 Cowper wait & sons, a furniture dealer introduced
the system of Hire purchase in USA, in 1807.
 Bishogate piano-maker introduced the system of
Hire purchase in 1846, in UK.
 In India, Hire purchase finance started only after
WW -I.
 However, it was only after WW- II that it’s growth
assumed visible dimensions.
 With the increase in economic activity, many
Non- Banking financing companies entered the
scene in the fifties and sixties.
Characteristics/Features of Hire
Purchase Agreement/Legal Position
 Possession
 Each installment is treated as hire charges
 Ownership upon the fullpayment
 In case of default in the payment seller has right to
repossess the goods.
 The hirer has the right to terminate the agreement any
time before property passes howevr he can not recover
the sums already paid
 Expands economy
 Additional income
 Hire purchase Vs Leasing
Point of Distinction Lease Financing Hire Purchase
Ownership of Asset Lies with Lessor. The hirer has the
Lessee has the right to option to buy the asset
use the equipment and immediately after
does not have option to paying last installment
purchase.
Depreciation Claimed as an Allowed to the hirer
expenses in the books
Rental Payment Covers the cost of Installment includes
asset principal amount plus
interest for the period
of use
Duration Longer duration for Shorter duration and
bigger asset cheaper assets
Tax Impact Total lease payment Hirer claims the
are shown as an depreciation on the
expense by the lessee asset as an expense.
Extent of Financing It is a complete Normally an amount
financing option in of margin money is
which no down required to be paid
payments are upfront by the hirer
required
Repair and Responsibility of the Responsibility belongs
Maintenance lessee in the case of to the hirer.
finance lease and of
the lessor in case of
operating lease.
Cost of Equipment Leasing used as a HP use as a source of
source of financing finance for low cost
for high cost assets like assets as automobiles,
ships, machinery, office equipments etc.
airplanes etc
Down Payment No Down payment Down payment is
required for using required to be made for
leased assets. acquiring the asset,
Accounting Aspect In Lessee’s books, In hirer’s books ,HP
leased assets shown assets shown as an
as a note only. asset, and installments
payable as a liability.
Point of Distinction Lease Financing Hire Purchase
Type of Asset An asset given on The hire vendor will
lease, is fixed asset for show the HP asset, as
lesser. stock in trade, or as
receivables.
Entry in books of All receipts from lease, Only the interest
Account is shown in P&L, the portion, from
Less or's books. installments is taken to
the hire vendor’s Profit
& loss Account.
Process of Hire Purchase
 The Dealer, contracts with finance co. for financing his hire
purchase deals.
 The customer selects the goods for HP, and dealer arranges for
the complete set of documents.
 Down payment by customer on completion of proposal form.
 Dealer sends documents to finance co. with request to purchase
the goods, and accept the HP transaction.
 The finance co. signs the agreement and sends copy along with
EMI details to dealer.
 Dealer delivers the goods to the customer, property passes on to
the finance co..
 Hirer pays EMIs, and on last payment , the ownership passes on
to him, with loan completion certificate by the finance co.
 Consumer Credit
 Consumer Credit can be defined as "money, goods or
services provided to an individual in the absence of
immediate payment". Common forms of consumer
credit include credit cards, store cards, personal loans
(installment loans).
 Consumer credit is personal debt taken on to purchase
goods and services.
 Includes all asset based financing plans offered to
individuals. (eg. Cars, scooters, VCRs, TVs,
Refrigerators, washing machines etc., personal
computers.).
 Main supplier of consumer credit are Multinational
Banks, commercial banks, Finance cos..etc
Advantages of Consumer Credit
 Consumer credit allows consumers to get an
advance on income to buy products and services. In
an emergency, that can be a lifesaver. Because
credit cards are relatively safe to carry,
 India is increasingly becoming a cashless society in
which people routinely rely on credit for purchases
large and small.
 Revolving consumer credit is a highly profitable
industry.
 Banks and financial institutions, department stores,
and many other businesses offer consumer credit.
Disadvantages of Consumer Credit

 The main disadvantage of using revolving consumer

credit is the cost to consumers who fail to pay off their
entire balances every month and continue to accrue
additional interest charges from month to month.
 A single late payment can boost the cardholder's
interest rate even higher.
Consumer Credit...
Salient Features
 Parties to the transaction : Bipartite arrangement
- two parties viz borrower/consumer and
dealer/financier. Tripartite Transaction - dealer,
financier, and customer. The dealer arranges the
credit from the financier.
 Structure of the transaction :
 Hire-Purchase , Conditional Sale , Credit Sale .
 Hire Purchase - Most tripartite consumer credit
transactions are of this type. Customer option to
purchase the asset on completion of the pay back
period.
 Security :
 First charge on assets. The consumer cannot sell the
hypothecated asset.
 Conditional Sale : Ownership not transferred until full
payment of purchase price, including the credit charge.
The customer cannot terminate the agreement.
 Credit Sale : Ownership transferred to the customer on
first installment payment. But the agreement cannot be
cancelled.
 Payment Period and ROI :
 Payment period - 12 -60 months.
 ROI - generally flat rate. Effective Rates generally not
disclosed. Sometimes in place of ROI, the EMI for
different payment periods is mentioned.
Types of Consumer Credit
Consumer credit falls into two broad categories:
 Closed-end (installments)

 Open-end (revolving)
 Closed-end (installments)
 This form of credit is used for a specific purpose, for a
specific amount, and for a specific period of time.
Payments are usually of equal amounts. Mortgage
loans and automobile loans are examples of closed-end
credit. An agreement, or contract, lists the repayment
terms, such as the number of payments, the payment
amount, and how much the credit will cost.
Open-end (revolving)
 With open-end, or revolving credit, loans are made
on a continuous basis as you purchase items, and
you are billed periodically to make at least partial
payment. Using a credit card issued by a store, a
bank card such as VISA or MasterCard, or overdraft
protection are examples of open-end credit.
 There is a maximum amount of credit that you can
use, called your line of credit. Unless you pay off the
debt in full each month, you will often have to pay a
high-rate of interest or other kinds of finance charges
for the use of credit.
 Revolving check credit. This is a type of open-end credit
extended by banks. It is a prearranged loan for a specific
amount that you can use by writing a special check. Repayment
is made in installments over a set period, and the finance
charges are based on the amount of credit used during the
month and on the outstanding balance.
 Charge cards. Charge cards are usually issued by department
stores and oil companies and, ordinarily, can be used only to
buy products from the company that issued that card. They have
been largely replaced with credit cards, although many are still
in use. You pay your balance at your own pace, with interest.
 Credit cards. Credit cards, also called bank cards, are issued
by financial institutions. Credit cards provide prompt and
convenient access to short-term loans. You borrow up to a set
amount (your credit limit) and pay back the loan at your own
pace—provided you pay the minimum due. You will also pay
interest on what you owe, and may incur other charges, such as
late payment charges. Whatever amount you repay becomes
immediately available to reuse. VISA, MasterCard, American
Express and Discover are the most widely recognized credit
cards.
 Travel and Entertainment (T&E) cards. This cards require that
you pay in full each month, but they do not charge interest.
American Express (not the credit card version), Diners Club and
Carte Blanche are the most common T&E cards.