June 1 - 7, 2009

The consumer financing is a lending to consumers by the banking sector and financial institutions. It is designed to provide the individuals with necessary finance for personal purchases ranging from buying a car and consumer durables to buying a house. Consumer financing is broadly categorized into the following four types of products: personal loans, auto loans, housing finance and credit card. The consumer financing sector should be realigned with macroeconomic discipline, otherwise the growth in consumer financing creates inflationary pressure on the economy.

The consumer financing is basically aimed at providing consumers with financing support to enhance their consumption and improving their standards of living through an institutional arrangement.

Personal loans, which include running finance and revolving credit, are provided to individuals for the payment of goods, services and expenses. The running finance is a credit facility established for a specific time limit at variable interest rates whereas revolving credit is a line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed.

Auto loans are used to purchase a vehicle for personal use. The maximum tenure of auto loans cannot exceed seven years. The banks are also required to keep the customer informed about the repayment schedule.

Housing finance includes the loan, which is provided to individuals for the purpose of purchasing or improving a residential house, or apartment, or land.

The regulations related to house financing allow the banks to determine the finance limit in accordance with their internal credit policy. Normally, the maximum time limit for housing finance is 20 years.

Credit cards include any card, which a customer can use to borrow credit from a bank.

Being the regulator of all scheduled banks and Development Finance Institutions (DFIs) operating in the country, the State Bank of Pakistan (SBP) regulates the consumer financing through its orders, policy directives, and its institutions mandated to deal with various aspects of credit banking including credit information bureau (CIB), banking ombudsman, and consumer protection department (CPD).

The central bank's regulations prescribe minimum standards for consumer financing activities, impose exposure limits on banks, and provide an overall direction for provision of consumer financing services.

Pakistan witnessed unprecedented growth in consumer financing over the last few years. The high inflow of remittances in the 9/11 aftermath stimulated the banks to get into consumer finance businesses. The banking sector has been actively engaged in consumer financing over the last seven years by unleashing a variety of products. Consumer financing has however dropped almost 50 per cent in the country over a period of one year, according to the recent studies. Most banks have either decreased or put a stop to their consumer finance products owing to higher default rates.

Presently, the banks are more cautious, as they conduct a proper assessment of the customer's ability to repay the loan. Analysts believe that over 60 percent drop in auto finance over a period of two years, is one of the major reasons for the drastic decline in auto sales. The decline of auto sale along with the decline in auto finance is also attributed to increase in car financing rates, car prices, and political and economic instability. The political turmoil and law and order situation badly affected almost all sectors of the economy during last two years.

In view of the rising number of default cases, the central bank recently tightened the credit rules for the consumer financing by reducing the credit card limit and personal loan limit for the single person. It has asked banks to obtain credit report from the CIB before allocating any consumer financing facility. The central bank directed the banks and DFIs to extend mortgage loans for housing up to any tenure defined in the bank's and DFI's duly approved credit policy while keeping in view the maturities profile of their assets and liabilities. It has also fixed the personal loan and credit card limit of up to Rs1 million for a single person. The central bank took these steps to help reduce the non-performing loans ratio, which are on the rise for the last two years.

The higher interest rate is the major reason behind rising number of default cases over the last one year. The slowdown in consumer financing is mainly attributed to the spiking cost of credit, as the central bank increased its key discount rate to 15 per cent in less than 18 months. It is still at 14 percent, highest in Asia. The rise in default cases forced the banks to sharply trim their consumer financing businesses. The size of outstanding consumer loans grew by a mere Rs11 to Rs359 billion in June 2008 from Rs348 billion in June 2007.

Soaring inflation, which has reduced the consumers' ability to repay debts, has been another reason behind heavy default rates in consumer financing. Inflationary pressures in the economy have continued to mount over the last two years, despite the efforts to contain the growth in aggregate demand. Central bank has been pursuing tight monetary policy to control the inflationary pressure. The major factors contributing to the rising inflation include demand-supply problems, excessive borrowing by the government and delayed but compulsory adjustment in oil prices. The widening fiscal and current account deficits also continued to add to inflationary pressures.

Though consumer financing has made significant contribution in terms of increased consumption and investments, yet it remained a threat to the competitiveness in the economy. The country's highest interest rate spread in Asia indicates poor competitiveness in the banking sector. The operational costs need to be reduced.

There should be an effective exercise of regulatory powers to determine reasonable rate of returns for the banks as well as the depositors. The main problems for the users of consumer financing products include unsolicited banking, processing delays, service inefficiencies and unauthorized charges deduction. These problems need to be addressed through better consumer education, improved access to information and strengthening the regulatory framework.