Potential for Leasing Products: Asset Financing for Micro and Small Businesses in Tanzania and Uganda
This study explores the potential for the development of products specifically targeted towards asset finance in the MSE sector in East Africa (specifically, Tanzania and Uganda). The study used a combination of in-depth interviews with key actors from MFIs, leasing companies, and commercial banks, and focus group discussions with entrepreneurs to examine both demand and supply issues.
Included in this study is an examination of the demand for and supply of leasing services in East Africa. Provided is an overview of formal sector leasing with an explanation of the legal and tax advantages of leasing for formal sector businesses. The myriad of informal and semi-formal mechanisms used by micro- and small entrepreneurs to finance their assets is listed. These financing sources far exceed the financing provided to small and micro-entrepreneurs by formal sector enterprises.
Leasing products are examined in detail, including lease amounts, terms, degrees of flexibility, grace periods and interest rates. Other costs such as insurance, deposits, collateral, and requirements for guarantors have all been considered. Integrated in the analysis are the processes surrounding the leasing product including: selection criteria, speed of processing, appraisal, approval, selection of asset, mode of disbursement, follow up and collection, payment incentives and repossession.
Options are considered for viable lending to this sector for leasing companies, MFIs and conventional banks in turn. The case for creating strategic relationships between leasing companies and MFIs or business associations is disputed and found to be a poor choice.
The findings of the study are broken into the following categories:
Demand and Supply Issues: There is a large unmet demand for leasing among MSEs seeking medium term (2-3 years) financing ranging from approximately $1,500 to $100,000. The study reflects a preference amongst lessees and leasor for finance leases – Whilst micro and small entrepreneurs demonstrate an overwhelming desire to own the assets they use in their businesses, there are sectors where informal operating lease arrangements are widely used, especially where the entrepreneur cannot use an asset to its full capacity or is not able to purchase outright.
Product/Concept Refinement: Most small enterprise operators were very positive about the typical leasing product. They tend to prefer a product with a low initial deposit of 2-5%, a grace period of 1-4 months, and flexible repayment schedules that are responsive to variations in cash flow.
Minimal collateral, in the form of the asset itself, has often been cited as one of the attractions to leasing. However, in the East African markets, leasors routinely require large deposits ranging from 15-30% of the value of the asset in addition to the asset and other collateral, compared to 1-4% elsewhere in the world. Many upper end micro- and small enterprises feel that this large deposit is not only difficult to raise but that it ties up working capital, which can no longer be pledged as security for working capital credit.
The effective interest rate of leasing companies is frequently much higher than that of conventional banks. Although nominal interest rates are comparable to those of banks, large deposit requirements (15-30%) combined with transaction fees increase effective interest to a level sometimes equivalent to interest rates charged by East Africa MFIs.
The document is broken down into the following sections:
- Introduction and Background
- Demand for MSE asset financing by enterprise sector
- Current Sources of Asset Financing for Micro and Small Enterprises (both formal and informal, including banks, hire purchase, MFIs, relatives, savings, liquidating assets, reciprocal asset useage agreements, informal operating leases, RoSCAs, ASCAs, moneylenders, and layaway arrangements)
- Overview of Leasing (covers finance, hire purchase, and operational leases; also financial and tax classifications of leasing)
- Potential for Leasing—Examining the Leasing Concept in the East African Context (investigates issues such as lease amounts, terms, flexibility, grace periods, interest rates, insurance, deposits and collateral, ownership, guarantors, information, sensitisation, eligibility, selection, disbursement, payment, follow-up, repossession, legal action, and auctioning)
- Strategic Considerations for Venturing into SME leasing (including staffing and management, information systems, liquidity concerns, pilot testing, regulatory considerations, strategic partnerships, delivery channels, and options for the various actors)
- Filling the MSE Financing Gap—What Can Donors and Governments Do?
There are also a number of appendices attached to the document which include a glossary, product comparison matrices for Uganda and Tanzania, terms of reference, and a list of the institutions involved in the study.