Appendix 3

Financing medium-term investment: lessons learned from CECAM (Madagascar) and ANED (Bolivia) leasing

Source: Work by CIRAD–(Cerise) Thematic Action Programme (TAP) and Dakar seminar.

Hire purchase (or leasing), is an alternative to standard medium-term loans for equipment, removing the collateral constraint. Experienced with relative success in animal traction promotion projects, hire purchase was picked up and perfected by microfinance institutions (MFIs). The example of the Mutual Agricultural Savings and Credit Funds (CECAMs) in Madagascar and that of the National Ecumenical Development Association (ANED) in Bolivia provide interesting perspectives on this alternative approach.

The basic principles of hire purchase as practised by the MFIs

  • The financing organization continues to own the asset until it has been paid in full by the beneficiary. The latter is considered as lessee until the full acquisition cost of the asset is paid in full (i.e. original value + interest + charges).
  • The lessee is selected by the financing organization, which also monitors the asset throughout the duration of the lease.
  • The lessee self-finances part of the asset (usually about 25%); this contribution is paid at the beginning of the lease in order to increase lessee accountability.
  • In the event of default in paying the rent, the financing organization may repossess its asset without any specific litigation.

Risks of hire purchase

Although hire purchase alleviates the constraint of collateral, it still involves risks the MFIs should avoid:

  • Insufficient control of the purchase price. Poor condition or overvaluation of the assets acquired by the MFI and leased, or even a fraudulent transaction that could involve MFI stakeholders, are risks that arise, particularly with the CECAMs for transactions involving used equipment or livestock. It is more limited with ANED, only affecting new equipment and transactions with approved equipment suppliers, but paid at full price.
  • Litigation over ownership. The vendor from which the MFI buys the asset might not have legal title (inheritance, joint ownership, etc.), which could lead to litigation, misuse or dispute.
  • Default by equipment supplier on warranty and maintenance.
  • Poor maintenance or abuse of the asset being leased, leading to its deterioration.
  • Trouble applying hire purchase status. In Madagascar, in particular, the hire purchase status contained in banking law is poorly understood in the legal environment, causing problems with repossession of the asset in the event of lessee default.

Lessons learned to replicate these experiences

Hire purchase is a credible alternative to finance agricultural investments over the medium term.

The collateral on the asset offered by the hire purchase should not obscure the risk for an MFI: the amounts at stake are often significant, as the brand name image and the soundness of the institution could be affected by defaults.

Borrower selection is a fundamental step. Three types of criteria are given priority: borrower’s seniority at the MFI and previous payment history; the financial viability and profitability of the programme; and the borrower’s level of technical competence. Evaluation of these criteria requires knowledge of the borrower, the ability to assess their level of technical mastery, and the ability to assess the quality of a financial programme in its environment. The mutual plan formula allows for the association of the borrower’s capital (by the borrower’s peers and by local elected members) with a technical and financial evaluation of the programme. As financial programmes become more complex and innovative, the ability of the MFI to evaluate the various factors may be exceeded, and alliances with more specialized institutions could be required, such as management centres or agricultural councils.

The borrower’s accountability is a deciding factor. Incentives for accountability could be self-financing of part of the asset, borrower selection of the asset acquired, a guarantee based on another of the borrower’s assets, or an endorsement by a number of other members of the MFI.

 

The experience of the mutual hire purchase plan of the Cecams in Madagascar

The Madagascar CECAMs are agricultural credit mutual organizations. Begun in 1991, by the end of 2001 the CECAM network included 41 000 members in 164 local funds. The network is organized in six Regional Unions (URCECAM), federated into an Interregional Union (UNICECAM). The CECAM capital is MGF 6 billion, savings are MGF 8 billion, and the average annual outstanding credit totals MGF 23 billion.

The CECAMs offer seasonal credit for agricultural production, inventory credit, short-term credit for para-agricultural and commercial activities, social credit, and loans to acquire production equipment through mutual plan leasing (LVM).

LVM was introduced in 1991, and by 2001 represented an outstanding balance of MGF 4.7 billion, or 20% of the CECAM portfolio, for 1 780 beneficiaries. The average amount of an LVM agreement (MGF 2.5 million) is relatively high compared to other loans granted by the CECAMs. Although the volumes are high, LVM still represents only 11.5% of the loan beneficiary members and 4.3% of all members.

Most of the assets financed are related to agricultural activity (harrows, ploughs, carts, seeders, dairy cattle, draught oxen, brood hens) and to the first transformation of agricultural products (hullers, grinders, oil presses, etc.). Some LVM agreements finance equipment for crafts and trade, as well as for family life (sewing machines, refrigerators, freezers, etc.).

The modalities for granting LVM are strongly supported by the mutual nature of the network:

  • The credit application is presented by an individual, but must be validated either by the mutual group to which the individual belongs or by the members of the local CECAM; the application is then sent to the local level of the CECAM or to the regional level, depending on the amount of the loan.
  • The CECAM borrower selection criteria emphasizes borrower reliability (trust of peers in the borrower’s ability to honour the contract, prior history of meeting commitments as member of the CECAM, etc.), and the feasibility and profitability of the project. programme analysis will be more significant if the amount of the loan is high.
  • Depending on the circumstances, collateral in an amount varying from 50 to 150% of the loan amount will be requested; identification and evaluation of the value of the asset proposed as collateral will be carried out by the members of the local CECAM; the endorsement of two or three members of the CECAM can also be used as collateral.
  • To limit the risks of litigation, only the lessee shall be responsible for selecting and purchasing the asset (especially when animals are involved).

The modalities for payment of the rent are adjusted according to the value of the asset and the projected cash flow of the borrower, and are formalized by contract. The borrower pays a down payment of 25% of the original value of the asset. The interest rate used varies from 24 to 30% per year, for a maximum duration of 36 months. Interest is calculated on the remaining balance due.

The procedure is monitored regularly by the members of the local CECAM.
In ten years, the CECAMs have signed 20 000 LVM agreements, benefiting 10 000 members. In 93% of the cases, the contract was honoured without default.

Source: Statement from the CECAMs at the Dakar Seminar (Work by CIRAD–Cerise TAP).

  


Monitoring and evaluation of the transaction remain fundamental and should be done regularly throughout the term of the hire purchase. The cost for this action is a deciding element of the final intermediation cost of the transaction. The mutual plan structure allows for minimization of this cost by having it partially taken over on a pro bono basis by the members of the MFI. Proximity management of the records is another factor leading to cost reduction.

 

Hire purchase as practised by ANED in Bolivia

ANED is an MFI established in 1978 by 11 NGOs working on rural development in Bolivia. Its objective is to provide the poor rural populations supported by these NGOs with access to credit Today it has 24 branches in eight of the nine regions of the country. In 2000, it had a credit portfolio of USD 7.4 million, 75% of which was granted to agriculture.

The ANED credit system is based on small-scale integrated loans. Faced with demands to finance agricultural equipment, ANED first tried to respond in this way, but encountered major problems (arrears, household indebtedness, etc.). Leasing has been used since 1997 in a pilot phase, in two forms:

  • single leasing, whereby ANED buys the equipment and delivers it to the borrower, who pays for it in rental charges; and
  • lease back, where the borrower sells ANED an asset belonging to him and uses the amount received for productive investments; ANED then re-assigns the asset to the borrower using a leasing formula.

In 2000, the ANED leasing portfolio was USD 505 671, or 7% of its total portfolio, benefiting 481 borrowers from six regions. Of the contracts, 95% were for agricultural equipment, predominantly tractors and power pumps. The standard profile of the borrower is a dairy producer wishing to modernize production of fodder by purchasing a tractor. Servicing the equipment leased is also encouraged.

The beneficiaries are selected by the ANED technical personnel. The selection criteria involve:

  • the borrower’s respect for commitments in prior relationships with ANED;
  • economic programme analysis, where projected programme revenue must allow the equipment rental to be paid. Other household economic activities are considered only secondarily in order to offer flexibility to the evaluation. Rentals must not exceed 30% of the total revenue of the borrower; and
  • the level of the borrower’s technical mastery. Ultimately, “experienced farmers” in an organized production chain are given priority, especially dairy producers having a marketing contract with a dairy.

Several measures seek to limit the ANED risk:

  • the borrower must self-finance 25% of the original value of the asset;
  • the duration of the lease varies depending on the equipment (two years for a power pump, five years for a tractor), but in any event must be less than the depreciation period for the equipment; and
  • ANED technical personnel frequently check the condition of the equipment.

To improve the leasing environment, ANED develops contractual relationships with institutions providing the farmers with technical training, and with agricultural equipment suppliers to ensure after-sales service and maintenance for the equipment.

The pilot programme had two good years, then experienced reimbursement problems related to an erosion of agricultural prices, particularly in market garden production, which is less organized than dairy production. Many questions remain unanswered regarding the longer-term viability and potential for extension of the programme:

  • to limit the default risks, ANED gives priority to the purchase of new equipment, leading to high costs, rentals that are incompatible with the revenue of most farmers, and a stagnating demand for the products of the leasing;
  • the cost for the checking done by the salaried personnel in the structure is high; and
  • the interest rate applied is 16%. This rate does not cover ANED’s management costs, and the leasing formula is not viable at the moment because ANED has access to concessionary resources.


Source: Statement in the Dakar seminar by the Agricultural Management, Marketing and Finance Service of the Food and Agriculture Organization of the United Nations.

  

Development of hire purchase requires a favourable environment in three areas.

  • Technical. Mastery of techniques by the farmers to use the equipment, existence of nearby services for maintenance and repair of the equipment or for animal care, availability of spare parts, etc.
  • Economic. Remunerative agricultural prices, organized supply chains, etc.
  • Legal. Hire purchase status should be addressed in the banking law and known to the stakeholders in the legal sector.

Despite the removal of the collateral constraint, current experience seems to show that hire purchase is still a relatively elitist product that is accessible, at least initially, to only the most favoured segment of farmers, who already have productive capital and the technical mastery to allow for a profitable financial programme. To expand this original target, an alliance of the MFI with institutions supporting agricultural development (training, improvement of competencies, organization of the agricultural environment, etc.) and with structures servicing agriculture (agricultural equipment suppliers, repairers, veterinarians, etc.) is recommended.

Hire purchase can be developed only progressively by an MFI. It requires a reliable technical structure, a confirmed social base and a solid financial structure (with equity and long-term resources). Stable concessionary resources could be a bargaining chip to initiate this kind of innovation.

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