Interest rates are unrealistically high and increases default probability

Apr 10 - 16, 2006

The demand for auto finance has emerged contrary to the forecast of financial sector experts. As against the forecast for possible slow down the demand for auto loans has grown, even at a faster pace. Interestingly as the emerging trend of interest rates movement is becoming evident more and more customers are getting desperate to lock their transactions. According to financial sector experts the rates now ranges from 14 to 20 percent per annum, as against at an average of around 12% couple of years back.

According to a report by AKD securities automobile sector has reported another robust performance during first eight months of current financial year. Sales volume has registered a growth of 26% YoY. The local assemblers sold 95,000 cars during July-February 2006 compared to 75,000 cars during the corresponding period last year.

The two main cost factors, Japanese Yen movement and steel prices, which have been haunting the auto manufacturers have changed over the past three months and stabilized at attractive levels. Therefore, any threat on margins can be ruled out for next couple of quarters. During first eight months of current financial year Pak Suzuki registered 26% increase in sale, going up from 37,600 units to 47,200 units. The hike in sales was mainly driven by Cultus followed by Alto and Mehran. The company has also initiated production of Liana. Having doubled its capacity during 2005, Honda Atlas Cars has managed to report the highest growth in car sales volume. The growth in sales was driven by Civic and City. The surge in sales can be attributed to introduction of new models, after which average monthly sales have touched 2,000 level. As against this, Indus Motors Company reported below average performance by posting an increase of 18%. Sales volume increased from 20,290 units to 23,800 units. However, lower sales could be attributed to plant shut down. Overall growth in sales was driven by Corolla. There was decline in Cuore sales as the focus of production was on Corolla.

According to market sources not only there has been an increase in sales of imported new as well as reconditioned car sales, there has also been reduction in 'on money'. The focus seems to have shifted from local cars to imported cars. This shift is due to virtually no 'on money' on imported cars but also these cars being perceived more attractive.

It is estimated that nearly 75 percent cars sold in the country are being financed by the financial institutions. Two divergent trends seem to be there 1) number of higher engine capacity cars also being financed and 2) less than 1,000cc cars having the largest share in the total cars being financed. According to market sources people who had acquired financing for smaller cars are now switching over to medium and higher capacity. One of the factors facilitation this transition is availability of factory fitted CNG kits in the cars of higher engine capacity.

The hike in financing rates, despite yield on T-Bills being almost flat, is being questioned by many analysts. They say that financial institutions are charging exorbitantly high rates on consumer finance particularly auto finance. They say, "The average spread now touches nearly 8% and spread is fabulous in case of auto loans/car leasing. At an average auto financing is being done at rates ranging from 14 to 20 percent." They also fail to find a plausible reason for rates being so high.

One of the possible reasons for fabulous rates could be higher default rate of the car financing business. However, industry sources are of the view that rate of default in auto financing is very low. They say, "Most of the people buying cars on deferred payment terms belong to 'white collar workers', who want to move away from use of old/second hand cars to newer models. They just cannot afford to default giving an opportunity to financial institutions to forfeit their 'status symbol'. They will continue to pay the installments even by forgoing all other expenses".

According to majority of people seeking auto financing, "One of the reasons for the hike in auto financing rates is relatively liberal instance of the central bank. The bank has granted too much liberty to the financial institutions to fix rates or charges. Since these institutions are no longer accountable to the central bank they are exploiting the vast majority of accountholders, depositors and borrowers. Whatever is being done in the name of liberalization tantamount to exploitation. The reason being that a small percentage of borrower is benefiting from the deposits of millions of people, who are also being paid pathetically low return on their deposits".

Having said this it is also necessary to take into account the opinion of banking sector experts. They say "One of the reasons for higher spread is the difference in size of various commercial banks. While the large banks, also enjoying the advantage of extensive branch network are able to mobilize virtually zero rates deposits, smaller commercial banks, leasing companies and modarabas suffer from very high cost of funds."

Whatever may be the reality, the depositors and the borrowers deserve better treatment by the banks. Financial institutions must fix their service charges at realistic level and contain lavish spending in the name of network expansion and technology. The quantum of advances could grow manifold and rate of default could also be brought down only if interest rates in Pakistan also become comparable with result of the world.