The State Bank of Pakistan (SBP) has invited feedback on its revised scheme for financing Locally-Manufactured Machinery (LMM).
The revision is intended to make it more responsive to the requirements of small and medium enterprises (SMEs) and to broaden its scope for financing machinery manufacturers.
The LMM Scheme was introduced in 1972. Since then SBP has been providing refinance to designated banks and DFIs for financing the industrial sector.
The scheme operates in two parts: Part-A (Local Sales) and Part-B (Export Sales).
The present revision covers Part- A (Local Sales) of the scheme only.
Three main feature of the new scheme are: its focus on the financing SMEs; financing the manufacturers of machinery; and selection of leasing companies as financiers with DFIs and banks.
Only revolutionary changes from the original scheme can make it attractive for the industry and financiers.
The paper highlights the main features of the draft policy document and offers suggestions to SBP.
The banks, DFIs and leasing companies selected by SBP are known as the Participating Financial Institutions (PFIs).
The scheme appears more conservative and SBP would be monitoring PFIs more closely.
The scheme offers opportunities for SMEs and the machinery manufacturers.
For determining eligibility of banks and DFIs, SBP notes the compliance of capital adequacy requirements and the Return on Equity.
Banks with no experience of project financing will not be eligible to provide financing facilities.
However, by forming a consortium under a bank/DFI with a record of project financing, they shall be allowed to participate, albeit for a smaller limit.
The leasing companies must also be in operation for the last five years; with profitable operations with Return on Equity at least twice the rate applicable under the scheme on an all-time basis.
The infected portfolio, as per audited accounts should not be in excess of 8% of the total advances net of provision.
The leasing companies must place, with the SBP under lien, government securities equivalent to at least twenty-five percent of the amount of limit, which they intend to seek.
For leasing PFIs, their total financing under the scheme should not exceed 10% of their total leases or 25% of the lease business of machinery financing, which ever is lower.
They shall not be entitled to provide facilities to the manufacturer. The last two requirements on leasing companies appear more restrictive which the SBP could relax.
Applications for sanctioning limits, each year, in favour of a PFI must be sent to the SBP in May for allocation in the yearly credit plan approved by the NCCC.
The PFI must to ensure that no new disbursements are made for the next year before the limit.
The SBP should approve the limit to PFIs by end July. Refinance against the PFI's disbursement to manufacturers will be after a certified copy of the Inland LC and according to the agreed disbursement schedule.
The PFIs must request refinance on Form LMM-1 along with Agreement on Form LMM-2 and DP Note from the borrower on Form LMM-4 with a DP note on form LMM-3 executed in favour of SBP for the full value of the limit and service charges.
The PFIs shall first give funds to the borrower or the manufacturer and then request for refinance from the SBP using Form LMM-1.
The SBP has the right to appoint independent consultants at PFIs' cost for verifying cases of refinance and to reimburse the refinance. If there is any irregularity on PFIs part the refinance must be reimbursed to SBP.
The SBP shall allow refinance to each PFI on service charge basis in terms of the SBP Act.
The service charge will be determined at a rate equivalent to the average of weighted average yields of the last two auctions of PIBs of 5 years tenor, determined on annually on 1st July.
The spread to PFIs under the scheme is 2%, which is low as many PFIs would have higher administrative costs.
There is not enough financial space to cover the credit risk. Banks flooded with liquidity, do not appreciable LMM finance at 2% spread.
Compensation has to be better. With the reduction of import duties next year, local machinery manufacturers will not have an advantage over imported machinery, the scheme, would therefore, not be received well by customers.
The SMEs should benefit most from the industries specified for financing. However, power plants thermal/hydro, which are highly capital-intensive, are only included for manufacturers.
Large industries such as cement, sugar, fertiliser, textile spinning/finishing, etc are not included.
Financing, will not be available for trading purposes ie purchase of machinery for subsequent sale.
The grant of facilities to manufacturers shall be available at pre-delivery stage only, whereas the purchaser shall enjoy the facilities at post delivery stage.
Financing shall be available for local contents used in the LMM, however, if the landed cost of the imported component used in LMM is more that 80% of the ex-factory price, such LMM shall not be eligible.
The cost of insurance, transit insurance, erection and commissioning charges and other incidentals etc shall not be financed under the scheme.
The borrower must prepare a proper feasibility of the proposed project, appraised by the PFI.
While the facilities shall be sanctioned in favour of the purchasers of the machinery, the payments shall be made to the manufacturer's bank.
It shall not be binding on the purchaser to purchase the LMM from the lowest bidder. The financing bank would evaluate such justification.
The working capital facilities for the project financed must be adequately arranged.
The sponsor will contribute their equity share in an escrow account with the PFIs. The SMEs would prefer one-window facility.
The manufacturer intending to avail LMM finance from PFIs must fulfil the conditions below: (i) The manufacturer is a successful bidder for supply and manufacturer of LMM being purchased by the borrower under the scheme.
The PFIs shall obtain proof from the manufacturers and a certificate accepting this bid from the bank of the purchaser; (ii) The PFI shall obtain a copy of the inspection report prepared by the bank of the purchaser (iii) Financing shall be for the 90% value of the local contents including value addition; (iv) The manufacturer shall executing an agreement with the PFI on the assignment of the receivable from the inland LC, in addition to the normal security that the PFI shall require; (v) Where the payment, against the machinery has been withheld for any reason, the manufacturer must make arrangements for payment to his bank from his own source.
This condition might be hard for the manufacturers.
The PFIs shall undertake due diligence as per their lending policies and Prudential Regulations as well as the areas identified by the SBP in the scheme.
The PFIs shall ensure pre-disbursement formalities are fulfilled by the borrower to avoid mis-utilization Over-regulation has the risk of killing the initiative and interest of the SMEs in the scheme.
If the PFIs sanction the facilities for a period less than 7.5 years with 1.5 years grace as allowed, the SBP shall accordingly adjust period of refinance to PFIs.
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