FRA Issues Rules for Micro-Leasing

Following a series of decisions regulating financial leasing and factoring, the Board of Directors of the Financial Regulatory Authority (“FRA”) published on its website decision No. 14 of 2019 (the “Decision”) with the rules for companies, associations, and NGOs to undertake micro-leasing, a particular form of financial leasing.[1] The Decision specifically focuses on micro-leasing and differentiates between the regulations that pertain to micro-leasing companies and those pertaining to micro-leasing associations and NGOs. The decision also elaborates on financial adequacy standards for associations and NGOs undertaking micro-leasing while referring to a previous FRA decision for the financial adequacy standards required of companies undertaking micro-leasing. The Decision will go into effect a day following its publication in the Egyptian Gazette, which is yet to occur.

Background

Micro-leasing lies at the intersection of financial leasing and microfinance.[2] It addresses the gap in funding created by high interest rates and prohibitive collateral and credit history requirements that entrepreneurs, SMEs, smallholder farmers, low-income individuals, and underprivileged and marginalized groups face. As such, micro-leasing offers an alternative to bank loans through a leasing arrangement which enables access to productive assets – such as machinery, vehicles, or basic agricultural tools – while providing the client with the option of purchasing the leased asset at the end of the lease period for a nominal price (which is usually the remainder of the asset’s price after deducting the installed payments). This lease-to-buy model of financing mitigates the risks faced by both micro-businesses (lessee/clients) and microfinance institutions (lessor). It offers micro-businesses payment flexibility and less constraining collaterals; in particular, the collateral is built into the lease, which is advantageous for clients who lack other assets that could serve as collateral for traditional loans. Furthermore, the focus is usually directed to the lessee’s expected cash flow rather than credit worthiness/history. On the other hand, micro-leasing provides microfinance institutions the opportunity to establish financial relations with micro-businesses over longer terms while maintaining ownership of the leased asset until the end of the contract.[3] Last August, Law No. 176 of 2018 was issued, regulating both financial leasing and factoring (the “FLF Law”).[4] Among other things, the FLF Law introduced micro-leasing for companies, associations, and NGOs, although the concept itself had not been completely absent from Egyptian policy-making circles (as evident from a comprehensive study on the topic published by the Ministry of Finance in 2004).[5] The FLF Law allows companies, associations, and NGOs licensed to undertake microfinance, and hence falling under the umbrella of Law No. 141 of 2014 on Microfinance (the “Microfinance Law”),[6] to practice micro-leasing after being licensed to do so by the FRA. Their microfinance portfolio, since the last approved financial statements, must not be less than EGP 5 million, and they must comply with the micro-leasing regulations that the FRA Board of Directors issues. Following the issuance of the FLF Law, the FRA issued several decisions regulating financial leasing and factoring. In particular, FRA Decision No. 137 of 2018, published in September 2018, sets out the regulations for obtaining licenses for financial leasing companies and factoring ones. It lists the conditions and procedures for licensing microfinance companies, associations, and NGOs to undertake financial leasing. In addition to the aforementioned minimum threshold for the microfinance portfolio, financing contracts must not exceed the limits set in the Microfinance Law and the companies, associations, or NGOs must not have any administrative sanctions or precautionary measures against them in three years prior to the request for practicing financial leasing (unless the violation was rectified and six months have passed since).

The New Decision

The new Decision elaborates on the FLF Law and FRA decisions, setting out the requirements for the practice of micro-leasing specifically. As per the new decision, microfinance companies, associations, and NGOs that are licensed by the FRA to undertake micro-leasing must allocate at least EGP 10 million for the practice of micro-leasing,[7] and maintain separate accounts and financial statements for their micro-leasing activities. In addition, the total funding that could be granted to clients must not exceed the cap stipulated in the Microfinance Law.[8] With regards to financial adequacy, the Decision specifies that microfinance companies licensed to undertake micro-leasing must comply with FRA’s financial adequacy standards for financial leasing companies, except for concentration standards, as set out in a previous FRA board decision on the matter.[9] These include the maintenance of a minimum capital adequacy ratio of 10% that is gradually increased to 12% and which is calculated through a certain formula that is specified in the decision. The Decision, however, lists the financial adequacy standards that associations and NGOs undertaking micro-leasing must comply with, which slightly differ from those required of financial leasing companies. These encompass rules for debt leverage, liquidity ratio, provisional accounts, standards for the assessment of client creditworthiness, and periodic reports. Finally, micro-leasing companies, associations, and NGOs must comply with the rules and regulations for financial leasing and factoring companies contained in both FRA Decisions No. 138 of 2018 and 7 of 2019. The former relates to financial statements while the latter includes internal policy system requirements such as credit policies, risk management, consumer protection, and creditor rights.

Conclusion

Besides clarifying the executive rules and regulations regarding the practice of micro-leasing, the Decision is also aimed at promoting financial inclusion and expanding the financing tool set available to SMEs, as per a statement published on FRA’s website.[10] In this manner, regulating micro-leasing, through the FLF Law and FRA decisions, is a constructive step towards strengthening the economy, for not only does micro-leasing provide an alternative to taking on more debt when other forms of financing are not feasible or accessible, but it could also provide smaller businesses with incentives to join the formal sector in addition to contributing to job creation.[11]   [1] FRA Board of Directors Decision No. 14/2019 on the rules and regulations for companies, associations, and NGOs to practice micro-financial leasing, available through this link (in Arabic). [2] Theoretically, micro-leasing could be done through operational leases in addition to financial leases. However, microfinance institutions rarely offer operational leases, focusing more on providing financial ones. FRA Decision 14/2019 clearly identifies that it is regulating “micro-financial leasing.” [3] World Bank, “Managing Risk and Creating Value with Microfinance”, Mike Goldberg and Eric Palladini, 2010, available through this link. [4] Law No. 176/2018 regulating financial leasing and factoring activities, Official Gazette, Issue No. No. 32 (bis) (c), 14 August 2018. [5] Ministry of Finance, “The Application of Leasing Within the Small and Medium Enterprises Sector”, developed by FinBi (Finance & Banking Consultants International), July 2004 (updated in October 2005), available through this link. [6] Presidential Decree-Law No. 141/2014 on Microfinance, Official Gazette, Issue No. 46 (cont.), 13 November 2014. ^[7] It is unclear whether this stipulation is in conflict with the FLF Law’s specification of a minimum microfinance portfolio of EGP 5 million. [8] In the Microfinance Law, Microfinance is defined as all funding for the purpose of economic productivity, service, or trade in specific fields and values determined by the FRA Board, provided that it does not exceed EGP 100,000. This value, however, could be increased via a prime ministerial decree at a rate that does not exceed 5% annually. [9] FRA Board of Directors Decision No. 191/2018 on the financial adequacy standards for companies licensed to undertake financial leasing, available through this link (in Arabic). [10] Financial Regulatory Authority, “FRA Makes Available Alternative, Non-Traditional Financing Options to a Large Segment of Society”, dated 13 February 2019, available through this link (in Arabic). [11] International Finance Corporation, “Leasing in Development: Guidelines for Emerging Economies”, 2009 (2nd ed.), available through this link.