CONSUMER FINANCING: ISSUES & CHALLENGES

SYED FAZL-E-HAIDER
(feedback@pgeconomist.com)

Feb 14 - 20, 2011

Consumer financing products include credit cards, personal loans, auto loans and housing mortgage. It not only contributes towards facilitating the life patterns of consumers, but it also proves to be a source of improvement for the image of banks. Consumer financing has emerged out as one of most prolific aspects of banking in Pakistan.

Banking sector witnessed unprecedented growth after 2001 due to low interest rate and product innovation in consumer financing. A need is however felt to strengthen the regulatory mechanism for strengthening the consumer financing sector in the country.

The experts have identified the key issues hitting the growth of consumer financing in the country. These issues include the high interest rate, high inflationary impact, unsolicited financing, deteriorating quality of services, lack of consumer education, poor information disclosure practices, intimidating recovery practices, loosing competitiveness in international trade, and weaknesses in regulatory framework.

Global Competitiveness Index (GCI) has placed Pakistan in 2010-2011 at 123rd in the world as compared to 101 in the last fiscal year's GCI (out of 133). Presently, tight monetary policy of central bank is the most important factor hampering growth of consumer financing in the country.

TIGHT MONETARY POLICY

The central bank's tight monetary policy has made making the money more costly for the businesses, which ultimately turn into defaults.

Critics say that the government by raising interest rates is creating hurdles in the growth of business environment in the country. Banks generally find it easy to lend money to large corporate sector, while the medium and small size business entities have been paying much higher interest on borrowing. The private sector has been a victim of government's borrowing from the banking system, which deprived the private sector of using the funds for growth of the economy. During first half of current fiscal year, the private sector borrowed Rs162.9 billion, which was higher than Rs109 billion borrowed during the first half of the previous year, according to the central bank. Last year, the government made record borrowing from the commercial banks.

The central bank's tight monetary policy is one of the key reasons behind the private sector's falling demand for credit. The increased interest rate has made doing business increasingly expensive. In the last financial year, the private sector credit off-take from the schedule banks showed negative growth amid slowdown in the domestic economic activity.

High interest rates have undermined economic growth. The growth is forecast by the government at 2.5 per cent in the current fiscal year, compared with a 9.1 per cent estimate for the current fiscal year in India. The IMF has forecast that the country's economy will grow 2.75 per cent in 2011, 4 per cent in 2012, and 5 per cent in 2013. The heavy government borrowing has been a major cause of whooping inflation

The government's heavy reliance on banking system for financing need is the key risk factor in achieving the basic objective of the financial system in the country. The private sector has borne the brunt of required adjustment in the economy and the government has considerably crowded out the private sector both through reduced availability and price of credit.

Finance Ministry has asked parliament to enact legislation placing limits on borrowing. Under the legislation, the government will be required to limit borrowing from the central bank to 10 per cent of the previous year's revenue.

Analysts fear that if the fiscal deficit goes more than 7 per cent, it would be disastrous for the country because it would create very high rate of inflation forcing the central bank to further tighten its monetary policy.

The government borrowings from the central bank have deteriorated the currency-to-deposit ratio of the banking system. During June 2003 and June 2007, currency in circulation grew by 70 per cent and total deposits of the banking system, excluding government deposits, grew by 104 per cent. In the following three years, currency in circulation increased by 82 per cent, while deposits increased by only 40 per cent.

Analysts believe that cutting interest rates to single digit level will produce multiple benefits for all economic sectors, as it will lower the cost of doing business, give a strong boost to production activities, provide easy credit and loaning facilities to consumers, promote better investment and exports and generate more tax revenue for the government. The expansion in private sector credit will only increase when the real economic activity gains momentum.

NON-PERFORMING LOANS (NPLS)

A challenging economic and business environment continues to affect the growth of banking industry in Pakistan. Deteriorating asset quality and high interest rates are likely to continue to hold back credit growth over the coming months. The NPLs have presently reached all time high and could hit even half a trillion rupees by end of current fiscal year 2010-11.

Surge in the NPLs pose a challenge for the banking industry in the country. The NPLs of the banking industry witnessed a rapid increase since calendar year 2007. Commercial banks' lending to private sector during the Oct-Dec quarter of last fiscal year increased by 4.16 per cent and unlike previous quarters the growth in credit off-take was widely shared by different leading sectors of the economy. The NPLs compel the banks to adopt cautious approach towards advancing of loans.

CONSUMERS' AWARENESS ON BANKING REGULATIONS

The consumers' awareness on banking terms and conditions, policy, rules and regulations is a critical factor in securing financial rights. For example, the State Bank of Pakistan recently amended certain provisions of Prudential Regulations for Consumer Financing. Under the revised Regulation, banks/DFIs shall ensure that overall credit card and personal loan limits, both on secured as well as on unsecured basis, availed by one person from all banks/DFIs in aggregate should not exceed Rs5,000,000 at any point in time, subject to the condition that the overall unsecured/clean facilities on account of credit card and personal loan of that individual do not exceed Rs2,000,000. The central bank has also amended Regulation R-3 by adding a new provision, which states, 'Banks/DFIs may waive the requirement of 50 per cent debt burden in case a credit card and personal loan is properly secured through liquid assets with minimum 30 per cent margin.