CONSUMER FINANCING

S.KAMAL HAYDER KAZMI,
(feedback@pgeconomist.com)
Research Analyst
, PAGE
Aug
8 - 14, 2011

Pakistan had witnessed phenomenal growth of consumer financing for seven years. Most of the commercial banks are involved in consumer lending through one or more financing modes, as it has become very lucrative business due to high spread and variable interest rates.

Consumer financing has been helpful in improving the quality of life of the people who have the capacity of servicing the loans.

However, there is mounting evidence that this capacity is deteriorating due to high spread and variable interest rates (13.5 per cent as effective from Aug-2011) on loans.

Depositors are not getting due returns due to high difference between lending and deposit interest rates. As the consumer financing portfolio is increasing, quality of related banking services is becoming a serious issue.

Consumer financing had expanded in Pakistan at an unprecedented rate during the last decade.

The banks capitalized the demand for consumer financing and earned record profits.

SBP policy motivated the banks to do aggressive marketing of products even where no genuine demand was existed. In spite of a regulatory framework, the banks failed to implement SBP's regulations and did not satisfy majority of their customers.

The consumer financing contributed to economic turnaround by encouraging consumption and investments. There has been a phenomenal increase in private consumptions due to easy availability of credit from banks.

However, the consumer financing developed serious problems due to curtailing competitiveness and a cartel was made by big banks.

Moreover, it is estimated that consumer financing has significant impact on inflation.

The increasing liquidity in the banking sector, since fiscal year 2002, encouraged bankers to diversify and expand their earnings by exploiting untouched areas.

In this scenario, consumer financing has become one of the most profitable products for banks. The banks have earned huge profits by charging exceptionally high interest rates.

The annual profitability of banks reached 76 per cent over the last few years. The pretax annual profit of all banks, which was Rs7 billion in 2000, rose to Rs123.4 billion in 2006. The profit of big five banks was 93 per cent of the total profits of all banks in 2010.

High interest rate also indicates that competitiveness in the banking sector in Pakistan is either absent or very poor. The banks are earning huge profits at the cost of savings of the depositors.

From a consumer point of view, consumer financing has been blessing that improved the quality of life of the people. However, this capacity is deteriorating due to too high and variable interest rates on loans.

Further, the volume of consumer complaints is rising day by day due to processing delays, service inefficiencies, hidden charges, and poor disclosure practices.

Presently, individual borrowers do not have the right to access their own credit worthiness report (CWR) maintained by credit information bureau.

The SBP should amend the rules to allow the borrowers to access their CWR.

Although prudential regulations for consumer financing prescribe disclosure requirements for the banks, the data indicate that the present disclosure practices are inadequate. Therefore, the need of the hour is to enact legislation for transparency in lending for protection of consumer rights.

The consumer rights commission of Pakistan recommended that SBP should direct every bank to formulate and implement freedom of information policy. The policies should provide for overall presumption in favor of disclosure while allowing for adequate protection of personal information.

It should be mandatory for all banks to make available consumer credit policy and updated schedule of charges on the website. Copies of the policy and schedule should be made available to any citizen on demand.

All banks should be directed to provide latest copy of terms of conditions and schedule of charges to all applicants for consumer loans and credit cards well before signing the application form.

The applicants should be encouraged to read and understand these documents before they enter into the agreement.

At last, the SBP has revised the credit limit for banks and development finance institutions (DFIs) under consumer financing at Rs5 million.

The central bank has also allowed commercial banks and DFIs to waive the requirement of 50 per cent debt burden in case the borrower's credit card and personal loan happens to be properly secured through liquid assets with a minimum 30 per cent margin.

The SBP introduced the new regulations with immediate effect in 2011 through amending certain provisions of its prudential regulations for consumer financing. Under revised regulation, the banks and DFIs are required to ensure that the overall credit card and personal loan limits, both on secured and unsecured basis, availed by one person in aggregate should not exceed Rs5 million at any point in time. The restriction, however, is 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 million.

However, this condition shall not apply to the consumer financing allowed by the banks/DFIs to their employees as part of compensation package. Furthermore, such consumer financing to the employees should be treated as staff loans and not as general consumer loans.

CONCLUSION

The consumer financing has significantly contributed to economic turnaround by stimulating consumption and investments.