Oct 29 - Nov 04, 2007

Pakistan is among the countries where consumer financing entered very late as compared to the region. Its penetration as a percentage of total advances is still very low in Pakistan when compared to India. The big foreign banks started this business in Pakistan and dominated the market for a very long time. Their operations were limited to a selected population and never showed aggressiveness to tap the potential of a huge population. One of the reasons for this was slow economic growth and a very low per capita income. The privatization of the state owned banks brought a turn around in the banking industry. Injection of trained human resource helped banks to adopt innovative practices. The economy also started showing growth and as a result increasing number of middle class due to rising per capita income greatly supported this innovation. However, international institutions like IMF and World Bank warned Pakistani private banks to be careful in the area of consumer finance as they were relatively inexperienced in that area and had become very aggressive.


State bank of Pakistan recently published its quarterly report on the performance of Pakistani commercial banks which clearly shows that NPLs have substantially increased for the Pakistani private commercial banks. Analysts believe that consumer finance is the main contributor to this increasing number. A close look at the NPLs shows that most of them are at the last stage where they can be considered as defaults and thus will adversely impact the bottom line of the banks. When World band and IMF were with the view that Pakistani banks should limit their exposure in the area of consumer finance, the local private banks turned a deaf ear to it. They argued that consumer banking is relatively a low risky area where the base is diversified to many individual clients and hence risk is diversified accordingly. They also quoted India as an example where living styles of the people are same and consumer financing had shown tremendous growth in the recent times and still the future forecasts by the banking pundits is very bullish about the retail banking in India


When one looks at the way consumer banking is done in Pakistan, he can easily come to know about the reasons that have contributed to the ever increasing number of NPLs in the consumer segment of the total loan portfolio. The commercial banks followed a strategy that hires commission agents; the salary of these agents is dependent on the number of clients brought by them to the bank. These agents are also responsible to collect all the documents from the clients and process them for all the due diligence. This brings conflict of interest in the process.

Another factor was the lack of knowledge and training in these agents about the product that they were selling. When you receive a call from a commercial bank and someone starts non stop marketing for the product, just ask him the rate at which the bank is offering loan and whether it is compounded or flat. The person, who was speaking non stop a while ago, has no words to speak now. This is the level of training given to these people.

Another thing that has created these NPLs is the misguidance that the agents usually practice when marketing their product. Pakistan is not a heavily banked country and its people do not a long history of experiences in the area of consumer finance. The marketing of consumer products is done in a way as if it will resolve all the problems being faced by the common people who are eligible and can avail the product. None of the advertisements educates people about the future proceedings once they have used the product. This job is also not done by the poor commission agent who himself has just a superficial knowledge about the product and his sole objective is to sell the product either by hook or by crook


Sub prime mortgage crisis in America can also be considered the result of the same phenomena as discussed above. The agent system who did not educate the borrowers about the future implications of these mortgages is one of the main factors that led to this crisis. Moreover, agents also encouraged people to show false statements about their earnings in order to get more loans. This was done on a larger scale. It did not appear as a problem until prices of the property increased and created a positive wealth effect on the consumers. However, when interest rates started increasing and the burden was passed on in form of increased installments to the consumers, debt servicing became a big problem and it has become a very disturbing feature for the economic managers there..


Auto loans have become very troublesome for the private banks. The rate of defaults has increased at a phenomenal pace after the recent hike in interest rates. The cars are auctioned at lower prices which do not recover the entire amount invested by the bank. Even in this case, the conflict of interest is a problematic area for the commercial banks which is multiplying its losses. If there is any non payment of installments for consecutive months, the car is taken away by the people who are nominated by the banks for this purpose. The car is sold next immediate day without bringing it into the notice of the finance. A notice should be sent to the finance that if he will not pay the amount his car will be auctioned. It happens because employees in the banks have formed a chain from lifting of cars to its auctioning. In many instances, after the car is lifted, the finance has contacted the banks very next day for making payment but he is told that his car has been auctioned.


Personal loans contribute a great chunk to the total banking advances of the industry as it has a share of 40.4% in overall consumer loans. Pakistani inexperienced banks were very aggressive in this area where loans are given without collateral and risk is further increased when conflict of interest is involved due to agents. Banks adopted the policy of charging very high interest rates so that the principal amount can be recovered soon before any default payment takes place. All this was going well till the time interest rates were low. Since, a big portion of that money was used for speculative purposes; the recovery has become a big problem now.

Islamic banking is a very good alternate of personal loans. The concept of personal loans in Islamic banking is commodity based i.e. no cash money will be given to the consumer but he will be provided the commodity on credit that he intends to buy with the borrowed money. It stops the use of personal loans in speculative businesses and also restricts its use in socially unethical things that are also not allowed in Islam.


Pakistan has a housing backlog of about 6mn. It could be in the benefit for consumers and for economy as a whole if the bank would have focused on mortgage financing as a primary growth area for their consumer portfolio. However, higher interest rates coupled with lack of transparency in the real estate of Pakistan have not let any growth in this area. This is the reason why the share of mortgage loans is meager in the overall consumer loan portfolio of the banks


The penetration of credit card business is still very low. Almost, all the banks have been very innovative in this business and have launched new schemes. The advertisements also make these schemes even more lucrative than they actually are. The lawlessness in the country has made it very difficult for the credit card users to keep cards with them as snatching and kidnapping is no more the news but has become a routine for the citizens. The shopkeepers are required to check the national identity card of the customers before charging their bills through credit cards. However, they do not practice it. This is the reason why cards are illegally used and hence impact the holder adversely.

Government has taken a very good initiative by making the department of "Banking Mohtasib" which listens to the complaints of the customers and takes required action after thorough investigation of the issue from both, the bank and the customer. Banking Mohtasib has been given enough powers by the Government to penalize banks and compensate banks for their losses if there is any thing that has gone wrong with customer. Banks do abide by the decision of this department and act accordingly. However, consumers do not have much awareness about banking Mohtasib and it should be marketed properly.


Consumer financing has started slowing down now. The growth was 29% or Rs.72.4bn in the first half of the calendar year 2006 to make the total consumer portfolio equal to Rs.325bn or 13.5% of the overall loans of the banking sector. The growth has shrunk to just 9% in the first half of 2007. The reason for this is not the precautionary measures taken by the bank but higher rates due to which the consumers are shying away from consumer financing. The diversion of the Government borrowing from central bank to the Government is also creating a crowding out impact thus leaving a little room to the banks to remain aggressive in the area of consumer finance.


The bank density has increased in the urban areas like Karachi, Lahore and Islamabad. Commercial banks are now required by the state bank of Pakistan to open up their branches in the rural areas. According to the top officials of the leading private banks, consumer banking can be excel in rural areas as well. However, the banks will have to target that market with different sort of innovative products that can appeal to the segment whose income largely depends on agriculture.

State bank has done a great job by implementing the reforms in the banking system. It has consolidated the banking sector in Pakistan and it is playing a vital role in the economic growth of the country. However, rules and regulations should be tightened on the area of consumer financing by these banks so that they may not face problems in the future in the same way as sub prime crisis in America.