HIGH INTEREST RATE CONTAINING DEFAULTS
SHABBIR H. KAZMI
Jan 24 - 30, 2011
Over the last few years, consumer financing has declined for a number of reasons from rising interest rate to slow recovery procedure and from shrinking purchasing power to manifold increase in prices of cars, consumer durables, and real estate.
While bankers may be willing to lend money, the rising appetite of government coupled with persistent hike in T-bills yields provide banks incentive to invest in risk-free government papers. The reap of situation from 2008 to date helps in understanding the situation but does not allow in reaching the consensus that consumer financing helps the industries working at higher capacities, creates new job opportunities, and above all improves the living standard of people who have stable income stream.
The heads of different domestic banks have been expressing their serious concern over decline in the consumer financing and increase in the non-performing loans of the banks since July 2008. The bankers raised this issue in a meeting with the then finance minister Syed Naveed Qamar in Karachi. The State Bank of Pakistan (SBP) had arranged this introductory meeting between the top bankers and the finance minister so that the bankers could candidly discuss the major issues being confronted by the banking sector in the country due to a variety of reasons.
The bankers discussed in detail the issues like macroeconomic situation, decline in consumer financing and rise in NPLs due to increase in mark-up driven by the tight monetary policy.
Consumer financing that witnessed robust growth at its beginning, showed sharp fall in 2008 as each sub sector showed decline instead of rise. Some experts attributed this to global recession but Pakistani banking authorities have been denying any bad impact of global recession on the local banking industry. According to a report, the outstanding credit under consumer financing fell to Rs334 billion in November 2008 against Rs367 billion in November 2007, a decline of Rs33.5 billion. Personal loans fell by Rs16 billion during this period to Rs126 billion from Rs142.5 billion.
The detail shows the credit card business, which has been a great booster for the banking industry, showed a dismal picture.
Loans for purchasing of cars and other vehicles showed sharp decline. The slow recovery and high interest rate especially high leasing rates damaged the credit to this sector. Bankers said most of the housing loans were given for alteration or additional construction in a house. Banks did not extend loans for purchasing of a complete house as the prices had gone much beyond the affordability of banks since the risk is very high. Banks faced liquidity crunch and the high interest rate cut down the flow of credit to private sector.
The consumer financing in Pakistan faced massive decline mainly because of failure of recovery from the borrowers. Banks have been asking the government to protect their credit, which goes through credit cards by making strict laws for recovery. They were of the view that poor recovery in consumer financing was hurting the banking sector.
According to the data released by the SBP, overall consumer financing plunged by Rs50 billion or 17 per cent to Rs224 billion at the end of June, 2010 as compared to Rs294 billion a year earlier. Almost every segment of consumer financing witnessed a decline during 2009-10. Outstanding loans, under the credit card business, shrank to Rs28 billion from Rs35 billion during this period.
A report issued by the Banking Ombudsman revealed that the highest number of complaints submitted to it were against this business of banks.
Car purchasing was the next highest attraction for consumers, but outstanding loans under this head also declined to Rs64 billion by end June, 2010 as against Rs78 billion a year earlier and Rs105 billion at the end June 2008.
The stock of personal loans reduced to Rs94 billion from Rs115 billion in June 2009 and Rs140 billion end June 2008. Loans under consumer durables dropped almost by half from Rs420 million end June 2009 to only Rs211 million by end June, 2010, while advances for house building, under consumer financing, also declined from Rs61 billion to Rs54.5 billion during the same period a year ago.
Analysts attribute the sharp decline in consumer financing to a number of factors. Since the central bank has been following, tight monetary policy to contain inflation the axe has fallen on private sector credit to maintain money supply growth within reasonable limits. Banks chose to reduce the level of consumer financing in order to accommodate the requirements for productive credit.
They also say there has also been a change in the mindset of borrowers who, in the meantime, have become wary about the sly practices of the financial institutions. In most of the cases, borrowers are not thoroughly informed about the terms of consumer loans and are being harassed for the recovery of loans. A facility that is touted as a kind of blessing turns a misery in most of the cases.
According to some analysts, the decline in consumer financing could turn out to be a positive development for all the stakeholders, including the banks, the borrowers, and the economy as a whole. Reduction in consumer financing will allow the banks to improve their overall recovery rate, reduce temptation to borrow from the banks and purchase durables and teach to match their consumption behavior with their future income streams.
Productive capacity of the economy could increase through diversion of resources from consumption to investment. Besides, import demand for consumer goods would decline and inflationary pressures in the economy could recede somewhat due to preference of savings over consumption.
According to some analysts, credit card and auto loan offers have started pouring - though very slowly. More people are receiving calls and text messages from banks' sales teams offering them new credit cards and auto loans at competitive interest rates. Credit cards and auto loans were a major source of income for many banks, until the economic downturn set in and forced many of them to temporarily shut down their consumer finance divisions.
Many banks - especially smaller ones - have plans of launching consumer finance products during 2011. However, the banks are still very careful in choosing their potential clients in view of the losses they had to suffer due to widespread defaults on credit cards, personal finance, and auto loans.
Unlike past when the banks adopted a rather lenient credit appraisal policy in the race to grab greater market share, the bankers at present are very cautious while extending auto loans and unsecured facilities.
The experience has taught the bankers to be more prudent. Nobody is willing to take risks now. The vast majority of borrowers who had defaulted on their credit card, personal finance, and auto loans may be honest customers but failed in paying back their loans because of economic downturn. The only fallout is that they may not be able to obtain fresh financing from the banks for many years to come because their credit score has been wrecked.
Most banks have trimmed their consumer finance sales teams during the last two years while some went on to close down their credit card, personal finance and auto loan divisions to avoid more defaults due to difficult economic conditions that pushed up price inflation and borrowing costs. The consumer finance credit has been on the decline for the last three years.
Consumer financing has taken a hit in the recent years even in the United States and Europe because of the economic and financial downturn. The banks do not encourage clean lending when the economy is in trouble and jobs are lost. It is time for recovery and consolidation for banks. This is what is happening here in Pakistan. However, the rapid surge in consumer financing during the 2002-08 on the back of availability of liquidity in the banking system and very low interest rates had created a huge data on the credit histories of individual borrowers, which banks can use for safer clean lending in future.
Some see the SBP's recent decision to increase credit card and personal loan limits to Rs5 million from Rs2 million as an effort on its part to encourage consumer financing. According to some analysts, the increase in loan limits will help encourage banks to shift focus from heavy investment in government securities and offer financing to consumers. Still many disagree with this analysis. The current high interest rate environment is not conducive for consumer financing.
The economic conditions are such that fewer people have any appetite for costly credit cards and auto loans than ever before because of job losses, salary cuts and stagnant incomes. However, there is no evidence to support that consumer finance is picking and the chances of default remain higher given the high cost of borrowings and uncertain economic conditions.
Banks are reluctant to give loans even to their corporate customers because of their growing fading risk appetites.