Financing Or Fleecing

Oct 29 - Nov 04, 2007

Recent years have witnessed a phenomenal growth in consumer finance or consumer credit in the banking system. Flush with the all time excessive liquidity- basically the outcome of 9/11 incident- the commercial banks in Pakistan have resorted to aggressive marketing tactics to dump their excessive cash in the cash starved segments of the society. The tools of house finance, car finance and credit cards have been employed for the purpose. The "haves" pounced on the opportunity to use the abundant cheap credit to heat up the real estate market, whereas the "have nots" fell prey to the charms of car financing and credit cards to raise the level of their social status.

House and car financing are safe modes of loaning from the bankers point of view as the ever rising real estate and car prices coupled with the safety margin in the shape of down payment allow the bankers to enjoy a sound night sleep. Credit card is a risky mode of finance as no collateral is available to cover the risk. Perhaps this is the reason that this segment of bank finance has been allowed to operate on the terms of the bankers without any worthwhile monitoring by the State Bank. The lending terms are quite harsh and the recovery tactics ruthless and in some cases inhuman too.

The increase in the size of consumer loans has a direct relationship with the two main factors :

1. Constant inflow of foreign remittances after 9/11.

2. The banks enjoying, without any active interference by the State Bank, an all time high spread (the difference between the cost of lending and the cost of borrowing).

Gone are the days when the banking operations revolved around a decent spread of 3 per cent. The steep fall of State Bank discount rate gave bankers a reason to disproportionately reduce the interest rate on customer deposits to a level which allowed them a double digit spread. The bank profits soared and so did the prices of their shares on the stock market. The bulging bellies of banks balance sheets definitely carry something illegitimate and one is inclined to assume that this has happened with the connivance of the State Bank who has been making some meek polite requests to the banks to increase the rate of interest on customer deposits instead of coming down heavily on them in the capacity of a regulatory body.

The constant inflow of foreign remittances coupled with the resultant high operational profits have placed the banks in a welcome vicious cycle of excessive liquidity. This excessive liquidity has been transmitted to the ranks and files of the society in the shape of consumer credit. The spectre of default is now looming large. With the sluggishness in the real estate market, the size of non performing house loans is increasing with the passage of time. The highest default within the consumer credit portfolio has been in credit cards where the infected ratio has increased from 1.4 per cent in December, 2006 to 3.7 per cent in March, 2007.

The increasing size of non performing credit card loans can be attributed to the following factors :

1. Extra aggressive marketing efforts
2. Non professional attitude of the marketing personnel.
3. Lack of focus on after-sales services.
4. Exorbitantly high rates of interest and other charges.
5. Inability of the consumer at large to comprehend the intricacies of interest system
6. Non professional attitude of recovery personnel

Points 4 and 5 are inter connected and combine the Shylock mentality of lenders and the inherent naivety of borrowers. A typical credit card consumer is an office employee having a fixed monthly income who, either out of a real need or a desire to show off beyond his means avails credit. He will be often seen advocating the use of credit card in his circle of friends telling them that the charge is quite nominal i.e three or two and a half per cent, The poor chap hardly realizes that three per cent per month comes to 36 per cent per annum. The rate soars as high as 50 or even 60 per cent per annum taking into consideration the other service charges and calculating on effective rate basis. Now in a society where the State Bank discount rate is nine and a half percent, how inhumanly it is to charge a naive borrower as high as fifty percent.

To prove the point mentioned above, below given is the real data of transaction taken from a recently issued credit card bill :





Cash advance fee


Federal excise duty


Finance / service charges


(The effective annual rate on the basis of these figures comes to 63 per cent)

Installment paid after one month


Outstanding balance


Finance / service charges


(The effective annual rate on the basis of these figures comes to 47 per cent)

The vicious cycle of banks excessive liquidity will result in a constantly growing size of consumer credit which in turn will critically infect the banks loan portfolios.

Will the State Bank realize that it is not an advisory body to give business suggestions to the bank. It is a regulatory body and is expected to behave as such. It is high time that it directs the banks to keep their average spread well within a prescribed limit and not to charge credit card users more than a maximum annual effective rate of fifteen per cent.