MODULE 2: RISK MANAGEMENT IN LEASING

INCREASING AGRICULTURAL PRODUCTIVITY THROUGH INNOVATION

AGRICULTURAL MECHANISATION LEASING PROJECT
MODULE CONTENT*

►1. Introduction to Risk Management

►2. Risk Management tools in Lease Financing
►3. Risk Identification and Management in AMLP

4/7/22 No 2
INTRODUCTION TO RISK MANAGEMENT

►Objectives
§ Explain risk
§ Introduce the concepts of risk management in leasing
§ Discuss the risk management framework
§ Identify risks inherent in leasing

4/7/22 No 3
SAFETY AND SOUNDNESS*

►CAMELS ratings

►Risk-based supervision

4/7/22 No 4
WHAT IS RISK?*

1 Probability of an event occurring affecting capital and earnings

2 Risk event may affect the reputation of the company also

3 Risk event can come from both external and internal sources

4
Risk event may have high, significant, moderate or low impact
on the business
5 Risk event may have high, medium and low probability of
occurrence

4/7/22 No 5
CLASS EXERCISE*

►Describe all the risks in a leasing business

4/7/22 No 6
FOUR STEPS IN RISK MANAGEMENT IN LEASING*

Risk Risk
monitoring identification

Risk
Risk control
measurement

4/7/22 No 7
RISKS IDENTIFICATION IN LEASING*

• Derived from significant business activities and from documents like

balance sheet, profit and loss, business plan, central bank report and so on

• Beware of blind spots

Class exercise to identify risks arising from significant business activities.

4/7/22 No 8
TYPES OF RISKS IN LEASING *

Liquidity

High Financial
Impact Credit

Market
Identified
Operations

Risk Low Financial

Impact Strategic

Keep eyes
Unidentified and ears open Compliance

4/7/22 No 9
RISK MEASUREMENT

How to measure risk?

• High/significant/moderate/low impact

• Quality of risk management: strong/adequate/inadequate/weak

4/7/22 No 10
RISKS MEASUREMENT (CONT’D)*
Sample Risk Matrix with Significant Weights
Weighted
Risk Inherent Quality of Risk Significance Composite Direction of
Risk Category Score Management Composite Score Weight Risk Score Risk

Lease Default Risk 3 [Significant] 2 [Adequate] 3 [Significant] 40% 1.2 Increasing

Liquidity Risk 2 [Moderate] 1 [Strong] 2 [Moderate] 25% 0.5 Stable

Market Risk 3 [Significant] 2 [Adequate] 3 [Significant] 10% 0.3 Decreasing

Operational Risk 1 [Minimal] 15% 0.15 Stable
Strategic Risk 2 [Moderate] 5% 0.1 Stable
Compliance Risk 2 [Moderate] 5% 0.1 Stable
TOTAL 100% 2.35
OVERALL RISK
RATING &
DIRECTION MODERATE STABLE

4/7/22 No 11
RISKS CONTROL AND MONITORING IN LEASING*

►Board and Senior Management’s Oversight

§ Approve risk management programmes and policies
§ Periodic Review
►Policies, Procedures and Limits
§ Credit risk policy, liquidity policy, market risk policy, operations risk policy, compliance risk policy
§ Credit: limit setting, stress testing, credit administration, customer grading and rating, Periodic
review
§ Liquidity: Contingency Funding Plans (CFP), Maturity Ladder, Liquidity Ratios and Limits (Liability
Concentration Ratios and Limits, Other Balance Sheet Ratios)
§ Market: MIS, Sound market risk strategy, Portfolio mix
§ Operations: Business Continuity and Disaster Recovery Plan, Self-Assessment, Risk Indicators,
Risk Mapping
§ Strategic: Organizational structure, Work processes and procedures, Personnel , Information,
Technology
§ Compliance: Self-Assessment, Risk Indicators, Risk Mapping

4/7/22 No 12
RISKS CONTROL AND MONITORING IN LEASING (CONT’D)*

►Adequate Risk Measurement, Monitoring and Management Information Systems

§ Risk matrix
§ Monitoring, MIS and timely, accurate and relevant ESMS regulatory reports
►Adequate Internal Control
§ Internal audit, segregation of duties and audit committee

4/7/22 No 13
RISKS MANAGEMENT TOOLS IN LEASING*

RISKS MANAGEMENT TOOLS IN

LEASING

►Risk ATRAC (pun intended)

►How to?

4/7/22 No 14
CLASS EXERCISE*

►Using all the risks you have identified at the beginning, please use ATRAC tools
to manage them.

Transfer

Reduce Accept

4/7/22 No 15
WHO IS RESPONSIBLE FOR RISK MANAGEMENT?*

EVERYONE
Shareholders
is responsible
to manage
Accountability
Board
risk and
CEO accountable
to the
Management shareholders

Team

4/7/22 No 16
WHO IS RESPONSIBLE FOR RISK MANAGEMENT? CONT’D*

• Leasing business is no riskier than any financial institution

• Follows the same risk management principles as banks and other credit
institutions.
• The risk management framework of the leasing business follows
international best practices and NBE guidelines and directives.

• Every employee up to the Board of Directors is a risk manager.

• More and more employing risk and compliance director/managers.

4/7/22 No 17
RISKS INHERENT IN LEASING*

1 Credit Risk

2 Liquidity Risk

3 Market Risk

4 Operations Risk

5 Strategic Risk

6 Compliance Risk

4/7/22 No 18
 1 CREDIT RISK*

►Credit risk arises from the potential that a

lessee is either
§ unwilling to perform on a leasing contract
or
§ its ability to perform in accordance with a
leasing contract is impaired resulting in
economic loss to the DBE.

►From a credit risk management perspective,

§ leasing has a better risk rating compared to
other forms of credit:
o as the lessor has the legal ownership of
the asset which confers upon it an
expeditious repossession and sale of the
asset to recover capital tied up.

4/7/22 No 19
CREDIT RISK STRATEGY/APPETITE*

The very first purpose of a DBE’s capital goods finance strategy should be to determine its
credit risk appetite. Once it is determined DBE could develop a plan to optimize return while
keeping credit risk within predetermined limits. The credit risk strategy thus should spell out:

• DBE’s plan to grant capital goods finance based on various client segments and
products, economic sectors, geographical location, currency and maturity;

• Target market within each lending segment and level of diversification or

concentration; and

• Pricing strategy.

4/7/22 No 20
COMMON SOURCES OF CREDIT RISK*

A Capital goods finance sector and/or lessees concentrations:

§ These are viewed as any exposure where the potential losses are large relative to DBE’s total
capital, its total assets or, where adequate measures exist, DBE’s overall risk level.

§ This may be in the form of single lessees or counterparties, a group of connected

counterparties, and sectors or industries, such as trade, agriculture, etc or in the form of
common or correlated factors;

4/7/22 No 21
COMMON SOURCES OF CREDIT RISK (CONT’D)*

B Capital goods finance granting and monitoring process issues

§ Many capital goods finance problems reveal basic weaknesses in the capital goods granting
and monitoring processes.

§ While shortcomings in underwriting and management of capital goods finance exposures

represent important sources of losses in leasing businesses, many lease default problems
would have been avoided or mitigated by a strong internal capital goods finance granting and
monitoring process.

4/7/22 No 22
2 LIQUIDITY RISK*

►Liquidity risk is the potential for loss to DBE

arising from either:
§ its inability to meet its obligations as they
fall due or
§ to fund increases in assets without
incurring unacceptable cost or losses.
►Liquidity risk includes inability to manage
§ unplanned decreases or
§ changes in funding sources.
►Liquidity risk also arises from the failure to
§ recognize or address changes in market
conditions that affect the ability to
liquidate assets quickly and with minimal
loss in value.

4/7/22 No 23
LIQUIDITY RISK*

The leasing business will be funded from liabilities raised from the market

The treasurer will be responsible for liquidity management and transfer pricing

The leasing activity does not carry more than normal risk

Moreover, rigorous debtors’ management and monitoring processes and

procedures should be put in place to quickly identify bad leases, recover the
assets and sell them to unlock liquidity being tied up.

4/7/22 No 24
COMMON SOURCES FOR LIQUIDITY RISK*

A Composition of Assets and Liabilities

§ The strategy should outline the mix of assets and liabilities to maintain liquidity

§ Liquidity risk management and asset/liability management should be integrated

to avoid high costs associated with having to rapidly reconfigure the asset liability
profile from maximum profitability to increased liquidity.

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COMMON SOURCES FOR LIQUIDITY RISK (CONT’D)*

B Diversification and Stability of Liabilities

►A funding concentration exists when a single decision or a single factor has the
potential to result in a significant and sudden recall of funds/facilities.
►Since such a situation could lead to an increased risk, the board of directors
and senior management should specify guidance relating to funding sources
and ensure that DBE has diversified sources of funding for day-to-day liquidity
requirements.
►DBE would be more resilient to tight market liquidity conditions if its liabilities
were derived from more diversified and stable sources.

4/7/22 No 26
COMMON SOURCES FOR LIQUIDITY RISK (CONT’D)*

To comprehensively analyze the stability of liabilities/funding sources DBE needs

to identify:
o liabilities that would stay with DBE under any circumstances;
o liabilities that run-off gradually if problems arise; and
o liabilities that run-off immediately at the first sign of problems.

4/7/22 No 27
COMMON SOURCES FOR LIQUIDITY RISK (CONT’D)*

C Managing Liquidity in different currencies

§ DBE should have a strategy on how to

manage liquidity in different currencies.

4/7/22 No 28
COMMON SOURCES FOR LIQUIDITY RISK (CONT’D) *

D Dealing with liquidity disruptions

§ DBE should put in place a strategy on how to deal

with the potential for both temporary and long-
term liquidity disruptions.

§ The strategy should take into account the fact

that in crisis situations access to funds from the
market could be difficult as well as costly.

4/7/22 No 29
SOME PROPOSED LIQUIDITY RISK MANAGEMENT AND MONITORING TECHNIQUES*

►Contingency Funding Plans (CFP) –what if scenarios and stress situations

►Maturity ladder
►Liquidity ratios and limits
§ Liquidity concentration ratios
§ Other ratios - investment in leases to borrowings, liquid to demand liabilities,
borrowed funds to total assets
►Foreign currency liquidity management

4/7/22 No 30
 3 MARKET RISK*

Market risk is the risk of losses in on and off-balance sheet positions as a

result of adverse changes in market prices i.e. interest rates and foreign
exchange rates.

Market risk exists in the leasing portfolio in the form of interest rates risk.

Leasing contracts normally attract fixed interest rates and this gives the lessor
a protection from the downside interest rate risk.
In an environment of declining interest rates, DBE is protected from the
impact of interest rates changes. However, the contrary is also true. This risk
can be mitigated by offering floating rates leasing contracts.

4/7/22 No 31
COMMON SOURCES OF MARKET RISK*

►Changes in interest rates

►Currency exchange rates variations-depreciation
good for exporters bad for importers
►ALCO

4/7/22 No 32
TECHNIQUES TO USE AND MEASURE MARKET RISK*

foreign currency leased assets to foreign currency liabilities

foreign currency leased assets to total leased assets
foreign currency liabilities (borrowings) to total borrowings
foreign currency borrowings to total leased assets

Stress testing

4/7/22 No 33
4 OPERATIONS RISK*

►Operational risk is the current and prospective

risk to earnings and capital arising from:
§ inadequate or failed internal processes,
§ people and
§ systems or
§ from external event.
►Some of the elements are analysed below:

4/7/22 No 34
PEOPLE*

►DBE has to ensure it recruits only the best talents

in the market on the job and provides them with
the required training and coaching to deliver to the
level expected from them.
►The right person in the right place should be the
order of the day and wrong choices often have
severe consequences.
►Human intervention should be reduced or
altogether eliminated, where possible, to reduce
the risk of frauds.
►Salaries and benefits should also reflect the
industry norms to reduce the risk of losing talents
in favour of competitors.

4/7/22 No 35
SYSTEMS*

►DBE should have its own leasing system:

Origination, activation, administration,
CRM, MIS and accounting systems
►This system is capable of developing and
issuing all types of reports required both
for management and compliance
perspectives.

4/7/22 No 36
FAILURE OF INTERNAL PROCESSES AND SYSTEMS*

Damage to physical assets

Inadequate or obsolete technology
Lack of proper documentation
Lack of or inadequate policies, procedures and controls

Poor management information system

Lack of or inadequate contingent plans

4/7/22 No 37
EXTERNAL EVENTS*

►Terrorism, vandalism, earthquakes, fires and floods are examples of events that may
cause operational risk at DBE.
►Business continuity and recovery plan

4/7/22 No 38
LEGAL*

►All standard leasing documents (including but

not limited to: applications forms, approval
letter, lease agreement, tripartite agreements,
cooperation agreements, sale and purchase
agreement, standing order forms, declaration
form, 1st, 2nd and 3rd reminders, and any other
binding document) have to be vetted and
approved by the legal team (internal and
external, where required and compliance).
►All original lease contracts are registered with
the appropriate registering organ, in and
outside Addis.

4/7/22 No 39
 5 STRATEGIC RISK*

►Strategic risk is the current and prospective impact on earnings, capital,

reputation or good standing of DBE arising from:
§ poor business decisions,
§ improper implementation of decisions or
§ lack of response to industry, economic or technological changes.
►This risk is a function of the compatibility of an organization’s strategic
goals, the business strategies developed to achieve these goals, the
resources deployed to meet these goals and the quality of implementation.

4/7/22 No 40
COMMON SOURCES OF STRATEGIC RISK*

• External-competition, changes in target market (demographics, profile),

technology
• Economic conditions, regulations

• Internal- organizational structure, processes and procedures, people,

information collection dissemination, technology

4/7/22 No 41
6 COMPLIANCE RISK*

►Compliance risk is the current or prospective

risk to earnings, capital and reputation
arising from violations or non-compliance
with laws, rules, regulations, agreements,
prescribed practices, or ethical standards, as
well as from incorrect interpretation of
relevant laws or regulations.
§ The CGFB is exposed to compliance risk
due to relations with a great number of
stakeholders, e.g. regulators, customers,
counter parties, as well as, tax authorities,
local authorities and other authorized
agencies.
►Customer complaints and litigation

4/7/22 No 42
ENVIRONMENTAL AND SOCIAL RISK MANAGEMENT GUIDELINES*

►EBRD
►IFC

4/7/22 No 43
CLASS EXERCISE*

►Prepare a list of all risks that DBE is faced with under the AMLP
►Discuss what happens if no action is taken and what are the benefits of acting on
those risks.
►Hint: You may use knowledge gained yesterday on “How leasing works in general”
to identify those risks.

4/7/22 No 44
4. HOW LEASING WORKS IN GENERAL

4/7/22 No 45
4. HOW LEASING WORKS IN GENERAL

4/7/22 No 46
4. HOW LEASING WORKS IN GENERAL

4/7/22 No 47
2. RISK MANAGEMENT IN AMLP

Lessee’s
creditworthiness Asset risk

Lease risks

Supplier risk

4/7/22 No 48
RISK MANAGEMENT IN AMLP*

►In many aspects, the AMLP hire-purchase leasing product is similar to a conventional
financing product:
§ An AMS provider needs capital goods, which he cannot afford to buy outright or to
get a loan from a bank because he does not have the required capital.
§ This is where the AMLP hire-purchase leasing product offers a solution.
§ The AMS provider eventually gets access to the AMLP hire-purchase leasing product
and starts using the capital goods sooner than he would have had otherwise.
§ As long as the lessee fulfills his obligations as per the AMLP hire-purchase leasing
contract, the consequences for him are exactly the same as if he had bought the
asset by using a loan.
►The most important risk to DBE under the AMLP hire-purchase is the lessees’ credit
risk.

4/7/22 No 49
RISK MANAGEMENT IN AMLP

Lessee’s
creditworthiness Asset risk

Lease risks

Supplier risk

4/7/22 No 50
LESSEE’S CREDITWORTHINESS*

►The analysis of the AMLP hire-purchase leasing applicants’ creditworthiness is done

in the same way as any other lender would do:
§ same cash flow projections are developed,
§ same ratios are calculated,
§ same non-financial features of the applicant are considered.

4/7/22 No 51
LESSEE‘S CREDITWORTHINESS

►How do we assess lessee’s creditworthiness?

§ Balance sheet, income statement, cash flow statement – historical
§ Financial ratios and indicators
o Debt service coverage
o Profitability
o Indebtedness
o Operational efficiency
o Liquidity
§ Projected income statement and BEP
§ Projected cash flow statement with 3 scenarios – realistic, optimistic and pessimistic

4/7/22 No 52
LESSEE RISKS

►Risks typical for (larger-scale) farmers:

§ Dependence on the weather
§ Prone to fast spreading diseases
§ Long production cycle
§ Irregular cash flow
§ Outdated methodology
§ Limited access to modern machines and implements and agro-chemicals. Limited access to
irrigation
§ Potentially limited access to high-quality maintenance
►Risks typical for agricultural service providers:
§ Collecting accounts receivables
§ Potentially limited access to high-quality maintenance

4/7/22 No 53
SUPPLIER RISK

Lessee’s
creditworthiness Asset risk

Lease risks

Supplier risk

4/7/22 No 54
SUPPLIER RISK*

►Under the AMLP, a supplier will be allowed to supply the capital goods only after
passing the supplier due diligence test and signing a cooperation agreement with
DBE.
►This is because during the entire lifespan of the lease there are specific risks arising
from the transaction with the supplier itself:
§ Starting from the asset’s procurement – it is the lessor’s task to purchase the asset
from the supplier and lease it to the lessee.
o Having a pre-selected supplier by its side can save a lot of headaches to the
lessor. Because of this, under the AMLP, DBE created a shortlist of selected
suppliers, which have undergone rigorous due diligence and minimum eligibility
criteria tests.

4/7/22 No 55
SUPPLIER RISK (CONT’D)*

§ The specifications of the asset delivered might differ from the lessee’s initial order.
o In which case the supplier, with the approval of the lessor, agrees to replace it or
to compensate the lessee for accepting a slightly different asset from the
expected one.
§ The supplier requires the lessee/lessor to put a substantial advance payment in
order to initiate the process and order the manufacturing of the asset to the
producer.
o In the case of the AMLP, the lessee deposits 20% of the total cost of machine and
implements in a blocked account with DBE.
§ DBE then opens the Letter of Credit (LC) in favor of the exporter/ manufacturer/
overseas reseller. In this case, DBE starts carrying all the risks associated to this
transaction once the LC is opened.
o Then, DBE, the supplier and the lessee sign a “Tripartite contract for purchase
and lease of capital goods”.

4/7/22 No 56
SUPPLIER RISK (CONT’D)*

►Under the AMLP, DBE signs a cooperation agreement with each selected supplier, to
create an understanding of the roles and responsibilities of each party in the leasing
transaction which include:
§ After delivery and acceptance certificate, the supplier must be able to deliver
training to the lessee’s machine operators
§ Provide adequate after-sales service by developing a very good network of agents
(mechanics and maintenance specialists).
§ Failure to service the machine and implements by authorized mechanics on regular
basis usually voids the warranty conditions and accelerates the wear and tear.
§ It is important for the supplier to respect the warranty conditions to maintain the
brand reputation and keep the equipment on good condition, fair wear and tear
excepted.

4/7/22 No 57
ASSET RISK

Lessee’s
creditworthiness Asset risk

Lease risks

Supplier risk

4/7/22 No 58
ASSET RISK*

►This is the most important variable in the leasing equation.

►There are two underlying reasons:
§ Firstly, with the lessor keeping at least part of the asset’s ownership until the lease
is fully repaid, repossession of the asset is considered much easier as compared to
other types of financing.
§ Secondly, with the lack of any other tangible collateral, the underlying asset is the
only spare source of repayment and hence its importance amplifies further.
►All considerations listed below originate from these two specifics.

4/7/22 No 59
ASSET RISK*

1 Type of capital goods

2 Value

3 Loss of value

4 Procurement

4/7/22 No 60
 1 TYPE OF CAPITAL GOODS

The preferred capital good for the lessor under the AMLP is a “standard” capital good,
which has the following characteristics:
§ Wider usage.
§ Regular and on-going demand, high utilization rate, with little or no idle time (e.g. a
tractor).
§ Easy to market and sell on a secondhand market.
§ Satisfies the minimum ISO Standards.
§ Strong brand, model and dealer reputation.
§ Separate and easily movable from one farm to another
§ After-sales service, repairs and maintenance facilities and spare parts are available
and accessible.
§ Warranty type and duration match international standards.
§ Has the required capacity and power to lift and operate the implement.

4/7/22 No 61
 2 VALUE

►Determining the value of the asset at the inception of the lease reliably is a key
success factor for the lessor.
§ If the asset was overvalued from the very beginning, then the lessor might be
forced to sell the asset at a loss at a later stage, in case of repossession.
►DBE, in the case of the AMLP:
§ Takes every precaution to make sure that the quote/pro-forma invoice they get from
the supplier is realistic.
§ Ask for two additional quotes from other selected/partner suppliers, to check for
any potential over-invoicing or price rigging.

4/7/22 No 62
VALUE (CONT’D)*

§ Determining the value of the asset correctly is of paramount importance, on top of the Free on
Board (FOB) basis cost. These costs elements are:
o FOB cost of machinery and implements at port of loading.
o International freight.
o Marine insurance
o Freight forwarding agent’s cost.
o cost of customs clearance.
o import duties (if any).
o and VAT (if any),
o Inland transportation from Djibouti port to supplier’s warehouse plus insurance thereon.
o cost of installation and commissioning.
o cost of production testing.
o cost of training employees.
o cost of maintenance contract (may be for the first year); and
o cost of consumables and recommended spare parts (may be for the first year).

4/7/22 No 63
 3 LOSS OF VALUE*

►“Loss of value” means the gradual decrease of the asset’s fair or market value
(normal wear and tear), not the accounting depreciation.
►Lessor must be able to estimate the market value of the asset at any moment during
the life of the lease contract and make sure it does not drop below the remaining
balance of the lease.
§ In case this happens, then theoretically, the lessee would be better off throwing the
asset away and buying another one of the same characteristics on the secondary
market, instead of repaying the lease until the end.
§ If this happens, the lessor will repossess the asset, but will sell it at loss.

4/7/22 No 64
LOSS OF VALUE (CONT’D)*

►Almost all new assets lose between 10% and 20% of their value immediately after
their sale. Reasons being:
A. If somebody is selling a 2-months old tractor or machine, all potential buyers may
be suspecting a problem with the asset,
B. The lessee immediately loses all the supplementary costs, added by the supplier
over the Cost, Insurance and Freight (CIF) price and part of the CIF cost, as well,
because the machine and implements are deemed “used”, as opposed to “new”.
►As time passes, the gap between the remaining lease balance and the asset’s
market value gets smaller and smaller, because the obsolescence rate (“fair wear
and tear”) is apportioned throughout the “useful life” of the asset.

4/7/22 No 65
LOSS OF VALUE (CONT’D)*

Arbitrary Lease Structure

Parameter Value
Initial loss of value at month 1 15%
Monthly loss of value after 1%
that
Tenor 60
months
Down payment 5%
Point where remaining lease Month 16
balance drops below asset’s
market value

4/7/22 No 66
 LOSS OF VALUE (CONT’D)*

New Lease Structure – Shortening Tenor

Parameter Value
Initial loss of value at month 1 15%
Monthly loss of value after 1%
that
Tenor 36
months
Down payment 5%
Point where remaining lease Month 6
balance drops below asset’s
market value

Shortening the lease tenor will mitigate this risk but not completely. Cutting the tenor by half shortens
the vulnerability period – which lasts until month 5 only – but does not eradicate the danger.

4/7/22 No 67
 LOSS OF VALUE (CONT’D)*

New Lease Structure – Increasing Down Payment

Parameter Value
Initial loss of value at month 1 15%
Monthly loss of value after 1%
that
Tenor 60
months
Down payment 15%
Point where remaining lease Month 0
balance drops below asset’s
market value

If we increase the down payment so that it at least equals the initial percentage loss of value, then we
might arrive at a situation where the asset’s fair value is higher than the lease outstanding from the
very beginning.

4/7/22 No 68
LOSS OF VALUE (CONT’D)*

►In the case of the AMLP, the down payment has been set at 20% of the total cost of
the machinery and implements at delivery and the tenor at around five years.
►The 20% down payment partly caters for normal loss of value plus the ancillary costs
on the invoice.
►Though the tractors may have a useful life of between 8 - 12 years and the
implements between 5 -12 years, (depending in technology, quality and brand), by
shortening the lease tenor, DBE wants to ensure it minimizes its loss of value in case
the lease turns bad, by procuring optimal quality and technology machines.

4/7/22 No 69
LOSS OF VALUE (CONT’D)*

►The loss of value of the leased asset is also dependent on other factors like:
§ Usage: whether or not there is excessive usage.
§ Operators’ knowledge and skills
§ Scheduled maintenance and replacement
§ Repairs
§ Qualified technicians
§ Original manufacturers’ recommended parts and consumables

4/7/22 No 70
 4 PROCUREMENT *

►In the case of the AMLP, most of the machines and implements are not available ex-
stock, they have to be procured by DBE from the producer/manufacturer or foreign
reseller, through the supplier. The procurement activity and delivery of the asset to
Ethiopia gives rise to risks which are borne by DBE. Those risks are:

A Counterparty credit risk

B Misspecification risk

C Maritime insurance risk

4/7/22 No 71
 A COUNTERPARTY CREDIT RISK

►The supplier asks for a down-payment before starting the process for ordering the
leased asset from the foreign counterparty. The lessor may not be protected in this
process.
►Therefore, to mitigate this counterparty credit risk, under the AMLP:
§ DBE, the supplier and the lessee sign a binding “Tripartite contract for purchase
and lease of capital goods”,
§ Procurement will be done by irrevocable and confirmed letter of credit (LC).
►Some suppliers/producers may insist on a down payment although there is an LC.
§ In these situations, the lessors normally ask for a similar down payment from the
lessee, thus transferring the counterparty credit risk to the latter.
§ In the case of the AMLP, the lessee has to make a down payment of 20% of the
total cost of the machines and implements at delivery and DBE pays the ends
supplier/producer 100% of the CIF cost when documents are received from the
advising bank.

4/7/22 No 72
 B MISSPECIFICATION RISK

►The risk that when the asset is finally delivered it will not be in conformance with the
lessee’s order or specifications.
►This may happen for many reasons – human error, limited knowledge by the lessee,
bad advice by the supplier, etc. However, the result is that the lessee gets a useless
or less productive asset than expected and hence does not want or cannot afford to
pay the leasing instalments.
►Lessors mitigate this risk by working with the supplier or producer to compensate
the lessee for this mistake.
§ According to DBE policy, the lessee cannot refuse acceptance of the asset, and this
is an event of default.
§ If there is a defect in the asset, at the time of delivery, which reduces its usefulness
to the lessee, the latter can terminate the lease agreement and return the leased
asset to the lessor.

4/7/22 No 73
 C MARITIME INSURANCE RISK*

►International goods are shipped via maritime transport and ships do sink, albeit
rarely. Of course, the asset will be insured before being loaded on the vessel.
►Nevertheless, in many countries’ insurance companies have long history of trying to
reduce the insurance coverage, thereby reducing the potential insurance claim and
payout amount.
►They take all their time to settle the claim, at times avoid paying it or prefer to go to
court and going through a lengthy and tedious court battle.
►Maritime insurance clauses are normally standard and follow international maritime
laws.

4/7/22 No 74
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►Open Discussions

4/7/22 No 75