Credit for investments that pay back in the medium to long term (three to five years or longer) is in short supply in rural areas. Credit unions and microfinance institutions (MFIs), which generally have better outreach than commercial banks in rural areas, typically provide only short-term credit. Credit available from informal sources (such as moneylenders, family, and friends) is usually both short term and too costly for investment financing. For rural enterprises seeking to acquire equipment—a typical investment need—to modernize production and thereby increase productivity, one solution may be financial leasing.
Leasing offers several advantages. For traditional credit, farmers and rural enterprises are particularly constrained by a lack of assets that can be used as collateral. Leasing overcomes this constraint because it requires no collateral or less collateral than typically required by loans. Because leases also often require lower down payments than the equity required for loans, they are more affordable for rural enterprises that have limited funds and little access to borrowed funds.
From the lessor’s perspective, not having to obtain collateral is particularly advantageous in a rural context. Although the difficulties involved in creating, perfecting, and enforcing security are applicable in both urban and rural contexts in most developing countries, they are more severe in rural areas where enterprises are less likely to hold titles to their assets, asset registries are less likely to be functional, and judicial processes are likely to be slower. Lessors are also likely to benefit from not being restricted by interest rate ceilings and sector-specific credit allocations—factors that have traditionally constrained rural lenders. Boxes 1 and 2 explain key features of a leasing contract, and Figure 1 shows a typical tripartite financial lease transaction involving an equipment supplier, a lessor, and lessee.
This brief is one of series on innovations in rural and agriculture finance.