Cost is a major constraint

Oct 29 - Nov 04, 2007

Consumer finance is a growing activity of commercial banks in Pakistan but it is still smaller in terms of total volume and share in aggregate lending by the banks. Its present level of infection is low and manageable but the quality of assets is deteriorating. There are concerns that if the quality continues to deteriorate it may directly affect the overall quality of assets and profits of the banks.

Cognizant of the riskier nature of this business the State Bank of Pakistan is taking special care in supervising and monitoring the banks undertaking this activity. The central bank has issued separate set of Prudential Regulations limiting the exposures in terms of equity, devising predefined criteria for the banks undertaking this business through implementing a comprehensive and elaborate reporting to the Credit Information Bureau (CIB).

Commercial banks in Pakistan have undergone a significant transformation since early nineties and playing a proactive and substantial role in boosting GDP growth rate. The improvement in the banking sector has been not only in terms of asset growth and profitability but also in terms of diversification of products and risk profile.

Over the years the banks have increased their outreach and penetrated into some of the underserved areas in the past. This includes consumer finance which has witnessed substantial growth over the years. This trend is not exceptional in Pakistan because in many emerging market the growth rate of consumer credit has outpaced other key business segments.

The factors contributing to such a high growth in consumer finance includes low interest rates, overflowing liquidity, product innovation, increased competition, financial liberalization, and growing income level at the back of ongoing high economic growth.

It may be said that due to higher return and risk diversification banks are assuming higher exposures in consumer finance to avail the benefits under Basel II. Consumer finance products relatively require lower capital charge under credit risk compared to unrated corporate finance.

Conducive macroeconomic environment is a must for the healthy development of credit markets including consumer credit. In Pakistan, healthy growth in the economy and the low interest rate environment in the recent past have kept this activity robust. However, recent inflationary trend and subsequent hike in interest rates, in an attempt to curb inflationary pressure not only seem to affect growth of consumer finance but also impair the repayment capacity of the borrowers.

There is no denying to the fact that consumer credit, within prudent and sustainable limits, is desirable for economic growth, smoothing consumption and improving credit risk diversification. At the same time, unsustainable consumer growth in weak macroeconomic environment, ineffective prudential and regulatory framework, weak risk management system and legal infrastructure can create systemic vulnerabilities.

In Pakistan, consumer finance has grown both in terms of rupees and as a percentage of total lending. During 2006, consumer loans witnessed an increase of Rs 72.4 billion or 29% to reach Rs 325 billion level. On the back of persistent higher growth, the share of consumer finance in overall loans increased to 13.5% in 2006 from 9.4% in 2004.

According to analysis of different segments of consumer finance personal loans have the highest share (41%) followed by auto finance, mortgage loans and credit cards. In terms of growth both credit cards and mortgage loans have witnessed the highest growth during last couple of years. A against this consumer durables segment, already having insignificant share, has experienced further erosion in value. In value terms, auto loans have registered highest increase.

In terms of exposure, the level of indebtedness of consumers in all the products except auto and consumer durable has been rising persistently. As per the nature of the product, the average per borrower exposure of mortgage loans was the highest, followed by auto loan, other personal loans and credit cards. Since mortgage and auto loans are adequately secured, the rising exposures in these products do not pose serious credit risk threats to the banks.

An analysis 1.5 million credit cards issued and the number of borrowers reveals that at an average, a borrower against the credit card has more than one card. During 2006, the quality of consumer portfolio witnessed deterioration because non-performing loans of this sector increased to Rs 7 billion from about Rs 3 billion in 2005.

Though the infection ratio of the consumer sector is rising, it is still lowest among all the borrowing sectors. At present level of 2.2% it is considerably lower compared to the weighted average of general provisioning required to be provided against consumer finance. Product wise, the infection ratio of all the categories remains below 3%.

The substantial growth in consumer finance has contributed to a surge in banking profitability but also raised concerns. However, compared to other sectors, consumer finance has a very low level of NPLs in Pakistan. In fact at 2.2%, the NPL ratio is lower than Corporate (6.5%), SME (8.8%) and Agriculture (21%). The level of NPLs of different types of consumer credit is well within the sustainable limits.

A closer look at the share of consumer portfolio in overall context, in terms of total loans or GDP, despite the exceptional growth in recent years, consumer finance accounts for less than 14% of the total outstanding credit of the commercial banks.

Lately, the sub-prime loan issue of the US has forced the experts to also review the consumer finance sector critically. However, Pakistan does not depict any visible signs that banking sector stability is vulnerable due to high exposures in consumer credit. Nevertheless, both the players and the regulators have to remain vigilant to ensure that exposures in consumer finance are kept within sustainable levels, inline with their risk appetite.

Flip side of the story is that while banks are minting money through consumer finance, the clients are forced to pay through their nose and in case of failure in paying the installments often have to face forfeiture of their assets. The problem has aggravated because of lending on floating rates, Kibor plus approach. Since the central bank is following tight monetary policy, resulting in hike in interest rates, making timely and full payment has become a serious problem. On top of this due to higher inflation purchasing power of masses at large is eroding very fast and reducing disposable income.

Commercial banks do not agree with this rationalization. Banks say that they are in the lending business and it is up to the client to accept or reject their offer. Clients know that they are committing their income by availing the facility of using the asset now and paying through easy installments over the years. However, the problem arises when 1) the client assumes liabilities beyond the repayment ability and/or 2) the cash flow of the client is disturbed. The real problem is that clients do not make complete disclosure of his/her liabilities because of desperation to acquire the asset and knowing the repayment capacity.

On such example is that a number of commercial banks are dishing out credit cards up to Rs 5,000 credit limit. Interestingly, once a person acquires a credit card from one bank he/she is bombarded similar offers by the other banks. At an average a person carries two to five credit cards and also prefers to rollover the credit by making minimum payment. The result is persistent increase in the liability and ultimate default. Then the raids of recovery staff start not only the borrower is beleaguered but the introducers are also harassed.

The other common but serious complaint is that the banks charge very high interest on consumer finance. One of the possible rationalizations is that it is still a sellers' market. Banks prefer to deal with corporate clients rather than the retail borrowers. Since the appetite of corporate clients is on the rise commercial banks are not keen in dealing with the retail clients. According to banking sector experts most of the individual borrowers are the employees of large corporation and employers stand guarantor for the collection, in most of the cases.

It is being said that in case of mortgage finance "wata sata" strategy or marriage of convenience is being followed. Most of financial institutions are extending credit to each others' employee or their relatives. This helps them in meeting the target as well as ensuring recovery. However, problems arises once employee switchover from one institution to another. Since the community of bankers is closely intertwined hardly any loan becomes delinquent.

Over the years automobile sales have remained robust because of easy financing. However, a slow down/decline in sales has been observed lately. The reversal in trend can be attributed to hike in automobile prices and interest rates. The other reason is growing competition due to increasing number of players and market saturation.

It is also necessary to point out that Prudential Regulations governing consumer finance are tilted towards the lenders. At times borrowers are not explicitly explained the details and there are some hidden costs. It only dawns when the billing starts.

It is interesting that Pakistan has a population of over 16 million but most of the people do not wish to maintain accounts with the banks. They prefer to receive and pay in cash rather than cheques. Therefore, most of them do not have any profile available with the financial institutions and as a result such people cannot borrow from the financial institutions.

In Pakistan commercial banks are thriving due to high spread, exceeding 7% for the larger entities. The reason stated for higher lending rates or service charges is huge investment in technology. However, the claim is disputed because often the online system and ATMs are not operating properly. Interestingly, clearing is undertaken twice a day through a cyber platform but transfer of funds still takes two to three days.