INTERVIEW WITH MR A.B.SHAHID, A RENOWNED ECONOMIST
July 30 - Aug 5, 2012
PAGE: TELL ME SOMETHING ABOUT YOURSELF, PLEASE?
A.B.SHAHID: After serving in the oil and financial services sectors for 40 years, both abroad and in Pakistan, I retired in 2009. The institutions I served in were Esso Eastern Pak Inc. (now called Exxon), Bank of Credit & Commerce Intl'l, MCB Bank Ltd., Gulf Commercial Bank Ltd. and Hatton National Bank Plc. While working in the banking sector, I supervised practically all functions and also assisted the regulators in policy-making, abroad as well as Pakistan. This long journey also taught me how to respond to recessions because I lived through the recessions of the early and late 1980s, 1997, 2001 and the current recession.
PAGE: DESPITE EFFORTS BY THE STATE BANK OF PAKISTAN TO BOOST CONSUMER FINANCING, COMMERCIAL BANKS HAVE SHOWN LITTLE INTEREST AS CONSUMER FINANCING HAS GONE DOWN. IN A REPORT, THE SBP STATED THAT CONSUMER FINANCING, WHICH INCLUDES CREDIT CARDS, CAR PURCHASING AND HOUSE BUILDING, DECLINED IN THE LAST FISCAL YEAR. YOUR VIEWS:
A.B.SHAHID: Yes, there has been a decline in consumer lending. In 2007, consumer loans accounted for 17% of the total bank credit, which too wasn't a good sign for a country like Pakistan. The fact is that consumer lending always dips during recessions because, as a result of reduced demand, to begin with, businesses cut their operations, and later shut down completely. Consequently, workers lose jobs and their repayment capacity erodes very substantially making them very high risk customers. To be reasonably secure, consumer lending must be backed by institutional arrangements to credibly verify the precise amount and sustainability of a borrower's repayment capacity. Unfortunately, in both these areas we have not developed either the requisite infrastructure or the disciplines that obligate the information suppliers to be honest. Undoubtedly, even in the worst phase of a recession there is need for genuine consumer finance because if an individual can generate economies by using certain assets acquired through a consumer loan, he or she can increase savings that can be used to repay the loan, provided the borrower's source of income/earnings is sustainable. That's what needs verification by the lending institutions, but because the institutional arrangements and disciplines to assist in this investigative effort are inadequate or lack requisite skills and networking, banks opt in favour of simply suspending consumer finance, which is a rash response.
PAGE: CONSUMER FINANCING FOR CREDIT CARDS, CAR PURCHASING AND HOUSE BUILDING HAS DECLINED HOWEVER, IMPROVEMENT HAS BEEN WITNESSED IN PERSONAL LOANS. WHAT COULD BE THE REASON?
A.B.SHAHID: Consumer credit is by far the most profitable venue for lending because the risk factor incorporated in mark-up rates is the highest and therefore the spread earned by banks are also the highest. This was the reason why in 2007, consumer credit accounted for over 17% of the total bank credit in Pakistan. This rise reflected the reckless quest of profit by short-sighted bankers because of which credit card limits were granted without a logical relationship to the borrower's monthly income i.e. his or her repayment capacity. Not surprisingly, many of these loans became non-performing, and because they were not secured by any collateral, banks had to bear the loss. In the case of auto finance, while this distortion was there i.e. lack of a logical relationship between borrower's monthly income and the amount that could be recovered as instalment, the more serious error was that, in thousands of cases, the vehicles purchased from the loan were not registered in the name of the lending banks. As for the personal loans being extended now, they are being offered largely to corporate employees after confirmation of repayment ability by the borrowers' employers. Not only that, the employers are being informed about the loan liability their employees are incurring. This is a lesson learnt at a huge cost.
PAGE: BANKERS ARGUE THAT CONSUMER FINANCING IS ON THE DECLINE BECAUSE OF HIGHER RATE OF DEFAULT. DEFAULT REPORTS SHOW THAT DEFAULT RATE IS HIGH ON ALL SEGMENTS OF LOANS EXTENDED BY BANKS. WHAT IS YOUR TAKE ON IT?
A.B.SHAHID: That is a weak excuse for bad lending. The key disadvantage with consumer loans was that not all of them were secured by a collateral security that the banks could acquire and dispose off to partly recover their losses. As I said earlier, imprudent banking during 2003-08 was not restricted to consumer lending; it was, I might say, pervasive without adequate regard for the vital dependencies of the commercial and industrial borrowers i.e. continued good health of the supplier and buyer markets they were serving. Systemic risk, that became much higher because of inter-connection of the global markets courtesy globalization of trade, was simply ignored. As you have seen, the bursting of the 'mortgage' bomb in the US had its impact right up to Japan because banks everywhere had been lending to mortgage companies against asset-backed securities issued by the mortgage companies, without checking the health of the assets bundled up in those securities. After banks realized that their lending against these securities was bound to go bad, to avoid liquidity stress, even bankruptcy, they went for attracting savings at higher rates and lending at progressively higher rates. The proof thereof is that, in early 2009, a well-reputed bank accepted my 5-year term deposit at a profit rate of 14.5% p.a. You can imagine what this bank must be charging on loans funded by such expensive deposits. This trend caused even otherwise efficient and safe businesses to collapse, which worsened the current economic recession.
PAGE: IT IS PERCEIVED THAT BECAUSE OF CONSUMER FINANCING, CONSUMERS' STANDARD OF LIVING IMPROVES BUT PUBLIC SAVINGS GET SLASHED DOWN SIGNIFICANTLY. YOUR COMMENTS PLEASE:
A.B.SHAHID: The flaw in consumer lending has been that it enticed borrowers into the trap of 'improving standard of living' without realizing that that improvement also had to be paid for. Besides, this attractive slogan capitalized on the financial-illiteracy of the ordinary borrowers. Lending on floating rates of mark-up without incorporating 'caps and floor' mark-up rates in the finance agreement exposed borrowers to unlimited repayment liabilities. The logical result of following this flawed practice, which was also not checked by the regulators, was simply reckless lending to meet lending targets in order to earn hefty performance bonuses. It was bound to make people get into the habit of living beyond their means and virtually evaporate savings, which it did. That outcome, I think, was the biggest macroeconomic loss to Pakistan. We need a savings to GDP ratio of at least 15%. As of now, it is just about 8.7%. Finally, lending money to a borrower for buying an asset that increases savings, and hence generates the repayment capacity, makes economic sense. For instance, buying a washing machine could cut the borrower's laundry bill but would replacing a 21 inch screen TV with a 90 inch screen TV result in any savings? Consumer lending doesn't imply giving people money to buy just about anything; it must also ensure that they buy what could generate large savings to pay for those assets.
PAGE: HOW WOULD YOU COMMENT ON THE STATE BANK OF PAKISTAN'S RULES FOR CONSUMER FINANCING?
A.B.SHAHID: I think in response to your earlier questions I have given you my point of view about what should be the logic for consumer lending in a country that must make optimal use of every penny of the public savings. SBP policy on consumer lending should incorporate the conditionalities that are essential for truly productive lending and the procedures for conclusively verifying the borrower's source of income, its past track record to establish its sustainability over the life of the loan, and health insurance of the borrower for the loan amount to secure loan recovery in case the borrower becomes disabled to earn or, God forbid, dies. There should also be a requirement to check the health of the asset, at least twice a year, to ensure its proper up-keep while in the borrower's use. In the context of high value assets such as automobiles and properties, banks must be registered as the joint owners; although this is mandatory even now, the almost unforgivable instances of its violation requires that procedure of its conclusive recording is strengthened. The compliance discipline that has now been introduced in banks should be made accountable for any lapses in complying with these conditionalities. Finally, these directives should be up-dated based on emerging trends in bad lending and frauds.