Consumer Finance

Consumer Financing in Pakistan

By: Haris Mehmood Umair Shakeel Shahid Aslam

Definition
The division of retail banking that deals with lending money to consumers. This includes a wide variety of loans, including credit cards, mortgage loans, and auto loans.

Consumer Financing: Overview

What is consumer Financing?

Any financing allowed to individuals for meeting their personal, family or household needs.

Type of service that is designed to provide the individuals with necessary finance for personal purchases ranging from buying a car, shopping purchases, to buying a house.
The concept of consumer financing is based on the need for an institutional arrangement that provides consumers with financing support to enhance their consumption and, as a result, improve their standards of living.

KEY PLAYERS
United Bank Limited Habib Bank Limited Bank Al Habib Limited Bank Islami Burj Bank Modarbas Companies.

Categorized into 4 types

1.

Personal loans: loans provided to individuals for the payment of goods, services and expenses, Auto loans: Auto loans include any loans used to purchase a vehicle for personal use. The loans borrowed to purchase vehicles for commercial or corporate use are not included in this category. Housing Finance: Housing finance includes the loan, which is provided to individuals for the purpose of purchasing or improving a residential house, or apartment, or land. This category also includes loans for a combination of housing activities such as loans for purchase of land plus construction. Credit Cards: Credit cards include any card, which a customer can use to borrow credit from a bank. Credit cards include charge cards, debit cards, Stored Value Cards (SVC), and Balance Transfer Facility (BTF). Corporate Cards are not included in this category.

2.

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Growth of Consumer Financing in Pakistan

Until the early 1990s, consumer financing was not offered by commercial banks Credit cards were offered to only a selected band as a convenience for bill payments and not for financial support In 2001, excess in liquidity of the banks due high inflow of remittances in the 9/11 aftermath and low interest rates motivated banks to enter into consumer financing business As a result, Banks aggressively promoted consumer financingcredit cards, auto loans, house financing and personal loans with least documentation Unprecedented growth rate over the last 7 years According to SBP:

2006

Rs.72.4 Rs.325 Billion

2007

Reached Rs.354.4 Billions

Banks are making abnormal profits after the emergence of consumer financing.

Regulatory Framework for consumer financing

State Bank of Pakistan (SBP) regulator of all banks and Development Finance Institutions (DFIs) For redress of consumer grievances comprises of both administrative and judicial institutions. Banks are obligated to clearly disclose Margin Requirements no limits are placed on the margin requirement SBP has restrained banks from charging any Insurance Premiums Banks are not allowed to finance older than 5 years cars and must keep the customer informed of payment schedules and any changes

Issues and Challenges from Consumer Perspective

1. High Interest Rate: In Pakistan the spread has vacillated between 5.95% and 9.58% during the period from 1990 to 2005. 2. Variable Interest Rate According to the annual report of the banking ombudsman, in Pakistan almost all consumer loan are on the basis of variable mark up rates. 3. Increasing Inflationary impact Acquisition of easy bank credit by the household consumers has spurred the demand for many essential and luxury items.

Contd
4.

Deteriorating quality of service

As the consumer financing portfolio is increasing quality of related bank services is becoming a serious issue.

5.

Lack of consumer education

The technical documents prepared by the banks affects the financial rights of uneducated customers. Table No.2

6.

Poor information disclosure practice

There is no law in Pakistan, which entitles the consumers to access information from the private banks as a legal right.

Contd
7.
Intimidating recovery practices:
Banks recovery team reaches the borrower house to pressurize them for payment of dues without any legal authority
8.

Weaknesses in regulatory framework:

The banks formulates their own policies and procedures which suits their interests best

9.

Unsolicited Financing
Aggressive marketing campaigns launched by the banks are targeting the costumers and encouraging them to purchase a loan or credit. Source: Consumer financing in Pakistan: Issues, Challenges, and way Forward published by CRCP

Social & Economic Impacts of Consumer Financing

Increased consumption > increased output / Inflationary Pressure (Demand-Pull Inflation) Increased dependence on foreign loans Lack of infrastructure to absorb and manage the increased number of cars on the road due to easy auto financing Spending beyond their means behavior results in burdening the economy and society Negative Saving-Investment gap as a result of spend now, save later behavior in developing nations Its beneficial for those who have the prerequisite responsibility, maturity and financial literacy to manage their finances.

Conclusions & Recommendations

High Interest rate spread should be reduced to increase competition in the banking sector SBP Regulations regarding consumer financing should be enforced strictly to decrease the high profit margins of the banks at the expense of the depositors Unsolicited financing should be discouraged to avoid unnecessary private consumption at the cost of consumer savings SBP should bind banks to explain ALL applicable charges on consumer loans before signing the contracts

Consumer Education: comparative information should be made available Latest copy of terms, conditions, & schedule of charges should be provided to applicants in the language of their understanding

Question-Answer Session