2009 consumer finance thesis
TRANSCRIPT
| 2009 |
| Seminar in Economic Policy Faculty : M.Ashraf JanjuaBy: Shiekh Hammad Amjad Id: 2005-2-50-4862 |
[ Thesis on “Consumer Financing”] |
Analysis of Consumer Financing in Pakistan |
Fall
Table of Content
ACKNOWLEDGEMENT 5
LETTER OF TRANSMITTAL 6
Executive Summary 7
Introduction 9
Background 9
Purpose 9
Objective 9
Main Objectives: 9
Scope & Limitation 9
Assumptions 9
Study Plan 10
Consumer Financing 11
Introduction 11
Defining ‘Consumer Financing’ 11
Key Issues in Consumer Financing: 12
An Overview 12
Objectives of the Study 12
Regulatory Framework for Consumer Financing 13
Prudential Regulations for Consumer Financing 13
Minimum Standards for Consumer Financing Activities 13
Information Disclosure 14
Exposure Limits 14
Margin Requirements 14
Borrower’s Eligibility 15
Insurance Premium 15
Auto Loans 15
House Financing 15
Personal Loans 16
Credit Information Bureau 17
Redress Mechanisms for Consumer Complaints 17
Internal Complaint Units/Sections of Banks 17
Banking Ombudsman 17
Jurisdiction 18
Consumer Protection Department 18
Banking Courts for Recovery of Loans 18
Judges of Baking Courts 19
Powers of Banking Courts 19
Procedure of Banking Courts 19
Growth of Consumer Financing in Pakistan 20
Consumer Finance–Myths and Facts 24
Major Issues and Challenges 25
Issues and Challenges from a Consumer Perspective 30
High Interest Rate Spread 31
Variable Interest Rate 33
Increasing Inflationary Impact 33
Deteriorating Quality of Services 34
Unsolicited Financing 34
Lack of Consumer Education 35
Poor Information Disclosure Practices 35
Loosing Competitiveness in International Trade 35
Intimidating Recovery Practices 36
Weaknesses in Regulatory Framework 37
ATM and Credit Cards 38
ATM and Credit Card Consumption Patterns 38
Reasons for Choice of Bank for Credit Card 38
Credit Card Charges & Terms and Conditions 39
Overall Satisfaction with ATM and Credit Cards 40
Auto Loans 40
Patterns of Access to Auto Loans 40
Factors Affecting the Choice of Bank for Auto Loans 41
Information about Terms and Conditions & Charges 42
Conclusions and Recommendations 43
Interest Rates and Competition in Banking Sector 43
Bibliography 45
*
ACKNOWLEDGEMENT
I am grateful to my course Instructor Mr. Muhammad Ashraf Janjua who provided us guidance and knowledge throughout the lectures, which helped me to evaluate the economic data and analyze it thoroughly. The lectures provided an extremely valuable learning experience for us and actually making me think over the subject. Hopefully this thesis will serve to its best.
I would also like to thank our fellow classmates for making this learning experience a thoroughly productive and enjoyable one.
Thank you,
Shiekh Hammad Amjad
*
LETTER OF TRANSMITTAL
Mr. Muhammad Asraf Janjua
Course instructor
Seminar in Economic Policy
Institute of Business Management
Korangi Creek
Karachi.
Dear Mr. Asraf Janjua,
I am pleased to inform you that the Thesis you assigned for has been completed and is ready for your examination. This thesis as per your instruction has covered all the authentic areas of concern and contains all the relevant information. I would dearly like to thank you for the faith you showed in my capabilities and the encouragement you gave me when assigning the report.
Yours sincerely,
Shiekh Hammad Amjad
*
* Executive Summary
This thesis is a part of my Masters of Business Administration degree. The purpose of this thesis is to explore and analyze the potential of Consumer Banking in Pakistan and to find out the challenges & opportunities faced by Consumer Banking Industry. In this research comparison of consumer financing products and the problems faced by borrowers and lenders have also been identified.
Consumer finance was backed by the SBP to give boost to economic growth through demand-pull pressure. Various instruments of consumer finance have attractions for consumers for reasons that are dictated by personal desires, income constraints, paying capacity, social needs and access to getting loans. Rising interest rates, spiraling service charges and deterioration in quality of service are bringing down the demand for personal loans, credit cards and auto financing. Consumer banking is facing new challenges as a result of interest hikes.
The real beneficiaries of consumer finance are the people who did not have capacity to purchase expensive household items in a single go but could afford them because of consumer finance, the commercial banks that have been earning large interest and huge returns on their investment in consumer finance and the economy that got impetus for growth.
Local banks are preferred by people for general banking services because of their low charges and wide branch network but for consumer banking people prefer foreign banks because of their good customer service and wide range of facilities. Despite of so many changes in consumer financing regulations bank’s customers are still facing hidden charges problem, difficulty in getting consumer loans and not highly satisfied by tenure of consumer loans.
Due to lack of awareness many problems are faced by the banks customers and the industry growth rate is declining. Banks should take steps to promote consumer banking in such a way that the awareness if consumer banking services could be increased and the industry could boost at a high rate. New services need to be introduced and services and banks charges & markup rates should be reduced.
In case economy is to sustain growth through consumer finance as one of the important factors of growth, then income inequalities should be bridged and income level be increased to develop paying capacity of large number of consumers.
* Introduction
* Background
In Pakistan all banks & DFI’s works under the supervision of the State Bank of Pakistan, the four major sectors in which SBP has divided banks operations are Corporate, SME, Agriculture and Consumer. SBP provide regulations according to which all banks should work & continuously keep a track that banks are complying through the regulations or not.
* Purpose
In recent years, Consumer Banking has made tremendous progress and has played a positive role in boosting the economy and in meeting the needs and requirements of the consumers. Whether large or small bank, multinational or local, each one of them is geared towards making its mark in an already competitive environment that is the outcome of consumer banking. The growing economy and further improvements in the level of household income have created many opportunities for consumer banking. In this research the past, present & future of consumer banking will be analyzed.
* Objective
This report will give an overview of the problems in current system of consumer banking from the point of view of both borrowers & lenders and explore the upcoming opportunities in the area of consumer banking.
* Main Objectives:
* Comparison of services by local & foreign banks.
* Problems in current system of consumer banking.
* Solution for problems faced by lenders & borrowers.
* Exploration of opportunities in future.
* Role of consumer banking in Economic Development.
* Scope & Limitation
Issues like, problems in consumer banking due to which some banks temporarily stop consumer financing, why some banks haven’t implemented full fledge consumer banking and what are the opportunities in consumer banking & its effect on economic development will be analyzed.
* Assumptions
* Consumer Banking Industry has a lot of potential to grow.
* Both borrowers and lenders are facing a lot of problems.
* High Interest, wrong policies, lack of education, etc are the factors for decline of consumer banking industry.
* Consumer banking is still a highly profitable banking sector although its facing a lot of problems.
* Study Plan
Section – II of this report is totally based on secondary data consist of an overall view of Pakistan Banking Industry, consumer banking in Pakistan, comparison of consumer financing products of local & foreign banks and brief introduction of few banks which is included in this research.
Section – III of this report consist to research methodology, in which it is explained in detail the method for conducting research, sample, population and tools used for data analysis.
Section – IV of this report consist of Analysis & Findings from our primary and secondary data in included the major party of this section are consumer banking preference, opportunities, challenges, problems of borrowers & lenders in consumer banking industry has been covered.
Section-V of this report consists of recommendation and conclusion bases on our finding & analysis of this whole research.
*
Consumer Financing
* Introduction
Over the last seven years, Pakistan’s banking sector has robustly engaged in consumer financing by unleashing a variety of products such as credit cards, auto loans, housing finance, and personal loans, etc. The unprecedented growth of consumer financing is largely attributed to the liberal economic policies attuned to the principles of free market economy, and huge liquidity available to the banks in the aftermath of 9/11. This environment prompted many banks to make their pie of profits bigger by selling consumer financing products through tactical and persuasive strategies, even where no genuine demand existed. As a result, supply-driven approach and aggressive marketing have further catalyzed the boom.
From a macroeconomic standpoint, consumer financing has considerably contributed to economic turnaround of Pakistan by stimulating consumption and investments. There has been a phenomenal increase in private consumptions due to easy availability of credit from banks. In tandem with this development, a number of problems and challenges have emerged with adverse effects on the national economy as well as the individual consumers. At the macroeconomic level, the boom in consumer financing has demonstrated strong inflationary impact despite stringent monetary policies. Personal and auto loans, for example, have resulted in increased demand for consumer goods, expansion of road networks, and imports of petroleum products. From a consumer’s standpoint, a whole plethora of issues has emerged as a result o unfair profit-earning strategies of banks in absence of consumer awareness about terms and conditions, rules, and regulations, etc.
The main objective is to map and highlight the emerging issues and challenges associated with consumer financing. The emphasis rests on identification of weaknesses in regulatory framework from a
consumer perspective within broader macroeconomic context. This chapter introduces the concept, rationale, objectives, methodology and limitations of the study.
* Defining ‘Consumer Financing’
The term ‘consumer financing’ refers to any kind of lending to consumers by the banking sector and financial institutions. In simple words, it is a 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 Issues in Consumer Financing:
* An Overview
In this study, the term ‘consumer financing’ has been used as it is defined in the Prudential Regulations for Consumer Financing (PRCF) of the State Bank of Pakistan (SBP). According to the Regulations, consumer financing means “any financing allowed to individuals for meeting their personal, family or household needs”. Thus, corporate or commercial consumers are excluded from this definition. Consumer financing is broadly categorized into the following four types of products:
Personal Loans: Personal loans include the loans provided to individuals for the payment of goods, services and expenses, and include ‘running finance’ as well as ‘revolving credit’ to individuals. The running finance is a credit facility established for a specific time limit at variable interest rates whereas revolving credit is a line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. Besides, in revolving credit, the loan is repeatedly available up to a specified amount as periodic repayments are made.
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. According to the PRCF, credit cards include charge cards, debit cards, Stored Value Cards (SVC), and Balance Transfer Facility (BTF). Supplementary credit cards are considered part of the principal borrower according to the Prudential Regulations, whereas Corporate Cards are not included in this category. This study focuses on all these products including Automated Telling Machine (ATM) Cards. ATM Cards were included in the study due to their widespread use by salaried and middle income consumers. The SBP has notified separate Guidelines for Standardization of ATM Operations (GSAO).
* Objectives of the Study
Keeping in view the growth of consumer financing and emergence of issues and challenges associated with it. The main objectives are to:
* Present an objective and fair mapping of the public concerns and regulatory weaknesses related to consumer financing and insurance services in Pakistan;
* Prescribe solutions to address the missing links in regulation and consumer education so that legally enforceable financial rights of the citizens could be promoted and protected;
* Provide thoroughly researched evidence for designing and implementing strategic and practical interventions to strengthen the regulatory mechanism for addressing the grievances in consumer financing and related insurances services;
* Help identify the spheres, both from macro and micro finance standpoints, where consumer education and awareness are lacking; and
* Propose an agenda for reforms on which civil society organizations and the policy community could follow-up for outcome-oriented initiatives for reforms in consumer financing regulations, consumer education, and public grievance redress mechanism.
* Regulatory Framework for Consumer Financing
The State Bank of Pakistan (SBP) is the regulator of all scheduled banks and Development Finance Institutions (DFIs) operating in Pakistan. The regulatory framework for ‘consumer financing’ comprises SBP regulations, orders, policy directives, and its institutions mandated to deal with various aspects of credit banking (e.g. Credit Information Bureau (CIB), Banking Ombudsman, and newly created Consumer Protection Department (CPD), etc). The regulations prescribe minimum standards for consumer financing activities, impose exposure limits on banks, and provide an overall direction for provision of consumer financing services while leaving a lot of policy space to discretion of the banks. Salient features of the regulatory framework for consumer financing are discussed below:
* Prudential Regulations for Consumer Financing
The SBP issued Prudential Regulations for Consumer Financing (PRCF) in the last quarter of 2003, and came into effect on January 1, 2004. Previously, prudential regulations were designed for a predominantly public sector banking system and geared towards wholesale and commercial banking. The objective of PRCF is to carefully monitor and supervise the consumer financing activities of the banks and DFIs by limiting their exposure in terms of equity, devising predefined criteria for the financial institutions undertaking this activity, and encouraging self-regulation through more transparency and greater disclosure. In this respect, disclosure requirements have been prescribed by the SBP.
* Minimum Standards for Consumer Financing Activities
The minimum standards to be observed while carrying out consumer financing activities include risk management process, such as identification of repayment source and assessment of customers’ ability to repay, record of customers’ dealings with banks/DFIs and the latest information obtained from CIB about credit worthiness of the customer.
* Information Disclosure
An important condition in the regulations is with reference to disclosure and ethics. Under the regulations, every bank is obligated to clearly disclose, by publishing in the form of brochures, all important terms, conditions, fees, charges, and penalties for the ease and reference of customers. This pre-requisite is an important step forward by the SBP for protecting customer’s right to information.
However, the manner in which this information is presented by the banks is not very helpful for customers. Most often, the banks do not disclose to the customer all applicable charges. Similarly, technical terms and types of charges used in the statements and information broachers are not fully explained.
Access to information is a critical issue, which has been addressed in the regulations only partially.
* Exposure Limits
The regulations are frequently updated to incorporate the emerging innovative products and risks emanating from them. They link consumer credit exposures of the banks to their track record of Non-Performing Loans (NPLs) and equity.
Moreover, in addition to the required provisioning, the regulations require an additional general reserve of 5% for unsecured and 1.5% for secured consumer loans as additional risk premium so that additional losses incurred could easily be absorbed without taking additional hit on capital. During 2006, the level of compliance by the banks and DFIs was assessed and these institutions were categorized into Largely Compliant, Partially Compliant and Non Compliant with respect to meeting these pre-conditions. Furthermore, to ensure safety and soundness of the bank/DFI itself, the lender is required to ascertain that the total installment of the loan being approved is commensurate with the monthly income and repayment capacity of the borrower. The banks have also been restricted from transferring any classified loan or facility from one category of consumer financing to another.
* Margin Requirements
A noteworthy point is that the regulations do not put any limit on the margin requirements on consumer financing facilities provided by the banks/DFIs. They have been given discretionary powers to decide the margin requirements after assessing the risk profile of the borrower. However, the SBP has the authority to fix or reinstate margin requirements on consumer financing facilities for various purposes, as and when required. In addition, the restrictions applicable on corporate/commercial banking have been declared applicable on consumer financing activities, which would assist the banks to lend in a secure manner.
* Borrower’s Eligibility
All the banks/DFIs are required to develop a special programme including the objective and qualitative parameters for the eligibility of the borrower. The regulations on credit card have limited the maximum unsecured limit to a borrower to Rs.500,000. This ceiling also includes the limit assigned to any supplementary credit cards. The bank is required to provide the credit card holders a statement of account at monthly intervals, unless there is no transaction or outstanding balance on the account since last statement.
* Insurance Premium
The SBP has restrained the banks from charging any amount under the head of “insurance premium” unless written consent of customer is obtained in advance. This regulation relieves the customers by guarding them against forced and undesired insurance premium. However, the monthly statement and insurance premium regulations are not fully honored by the banks.
* Auto Loans
As far as auto loans are concerned, the maximum tenure of loan cannot exceed seven years, while minimum down payment cannot fall below 10% of the value of the vehicle. The banks/DFIs are allowed to extend loan only for the ex-factory tax paid price fixed by the car manufacturers without adding any premium charged by the dealers and/or investors.
The regulations also provide the opportunity of repossession of vehicle. The regulations require the bank to mention a clause of repossession in the loan agreement and publicize the maximum amount of repossession charges in the schedule of charges. Banks are not allowed to finance cars older than five years. Moreover, the banks are also required to keep the customer informed about the repayment schedule and changes made in it from time to time.
Bank Name | MaximumTenure | MaximumLimit | Minimum DownPayment | MaximumInterest Rate |
Soneri Bank | 5 years | Rs. 2 | 15 % | 14 % |
NBP | - | - | - | - |
MCB | 7 years | No limit | 10 % | 15.75% |
UBL | 7 years | 5 Million | 10 % | 15 % |
Habib Metropolitan Bank | 7 years | 3 Million | 15 % | 16.5 % |
Faysal Bank Limited | 5 years | 7 Million | 20 % | 15.99 % |
Average | 6 years | 4.25 Million | 14% | 15.448% |
* House Financing
The regulations related to house financing allow the banks to determine the finance limit, both in urban and rural areas, in accordance with their internal credit policy, credit worthiness and loan repayment capacity of the borrowers. However, the total monthly amortization payments of consumer loans, inclusive of housing finance, are not allowed to exceed 50% of the net disposable income of the prospective borrower. The maximum debt-equity ratio for housing finance has been set 85:15. The maximum time limit for housing finance is 20 years, but the regulations do not prescribe any minimum time limit. Like auto finance, provisions for housing finance have been set as 25%, 50% and 100% for the substandard, doubtful and loss categories, respectively.
Bank Name | MaximumTenure | MaximumLimit | Minimum DownPayment | MaximumInterest Rate |
Soneri Bank | 5 years | Rs. 2 | 15 % | 14 % |
NBP | - | - | - | - |
MCB | 7 years | No limit | 10 % | 15.75% |
UBL | 7 years | 5 Million | 10 % | 15 % |
Habib Metropolitan Bank | 7 years | 3 Million | 15 % | 16.5 % |
Faysal Bank Limited | 5 years | 7 Million | 20 % | 15.99 % |
Average | 6 years | 4.25 Million | 14% | 15.448% |
* Personal Loans
The personal loans cover all loans that individuals avail for the payment of goods, services and expenses. It also includes running finance/ revolving credit to individuals. The SBP has assigned a general clean limit of Rs. 500,000 for all types of personal loans. The prime customers, who have extraordinary strong repayment capacity, can be assigned clean limit beyond Rs. 500,000 but not more than Rs.2 million. The banks are also allowed to offer the loan up to one million, but only when the loan is appropriately secured by tangible security with appropriate margins. The time limit set for such loans is not allowed to exceed five years except for the advances given for educational purposes, which can be extended to
seven years. In case of running/revolving finance the banks are required to ensure that at least 15% of the maximum utilized loan during the year is cleaned up by the borrower for a minimum period of one week, except the banks that require their customers to repay a minimum amount each month and where the aggregate cumulative monthly installments exceed the 15% clean up requirements. Like other consumer financing products, provision for personal loans have also been set as 25%, 50% and 100% for the substandard, doubtful and loss categories, respectively.
Bank Name | Maximum Tenure | Maximum Limit | Maximum Interest Rate |
Soneri Bank Limited | 5 years | 500,000 | 17 % |
NBP | 5 years | 490,000 | 14 % |
MCB | 5 years | 500,000 | 27 % |
UBL | 5 years | 500,000 | 25 % |
Habib Metropolitan Bank | 5 years | 500,000 | 22 % |
Faysal Bank Limited | 5 years | 500,000 | 22 % |
Average | 5 years | 498000 | 21.66% |
* Credit Information Bureau
CIB was established as a part of Banking Surveillance Department in 1992 by the SBP under Section 25(A) of Banking Companies Ordinance, 1962. The Bureau is a repository of credit information of borrowers. The member lending institutions provide credit data of their borrowers to the bureau which consolidates, updates, and stores the same and provides this information to its member institutions in the form of credit worthiness reports (CWR). CIB aids financial institutions to make well informed credit decisions in timely manners minimizing the credit risk. All banks, DFIs, non-bank financial institutions (NBFIs), Modarabas and microfinance banks operating in Pakistan are members of the CIB.
Bank Name | Maximum Limit | Maximum Interest Rate |
Soneri Bank Limited | - | - |
NBP | - | - |
MCB | 500,000 | 35 % pa |
UBL | 500,000 | 37 % pa |
Habib Metropolitan Bank | - | - |
Faysal Bank Limited | - | - |
Average | 500,000 | 36% pa |
* Redress Mechanisms for Consumer Complaints
A multi-tier grievance redress framework exists for dealing with public complaints related to consumer financing products and services. From the standpoint of a complainant’s convenience, the first forum is the bank’s internal complaint redress section. The complainants may also directly approach external administrative and judicial forums including the SBP, Banking Ombudsman and Banking Courts.
* Internal Complaint Units/Sections of Banks
All banks have similar internal complaint redress mechanisms. According to guidelines issued by the SBP, all the banks are required to designate a senior officer to deal with all sorts of complaints either received directly by the bank or referred to by any other source including the SBP. All the banks are required to provide the contact details of the designated person or any change with this reference to SBP. The designated officer or unit/section is entrusted with the responsibility of acknowledging, addressing, handling and investigating all the complaints in fair and prompt manner. In addition, the banks are required to devise a system for redress of complaints.
* Banking Ombudsman
The Federal Government established the Banking Ombudsman in 2005. The principal responsibility of the Ombudsman is to resolve the complaints through mediation and provide an amicable and acceptable solution where conciliation is not possible.
* Jurisdiction
The Banking Ombudsman has been entrusted with the powers and responsibilities to entertain complaints lodged by the customer against the scheduled banks or by a scheduled bank against another bank, and provide the basis for an amicable and acceptable solution after giving hearings to the
complainant and the concerned bank. Moreover, Banking Ombudsman has been given authority to make recommendations, to be communicated to the concerned bank for considering the issue, and in some cases to pass an order against the concerned bank.
In addition, Banking Ombudsman has the authority to call for relevant information necessary for disposal of complaints, receiving evidence on affidavit and issuing commission for examination of witness, given that confidentiality would not be violated.
Bar on Jurisdiction
However, there are some matters which are outside the jurisdiction of Banking Ombudsman including the power to direct banks for giving loans and advances to a complainant. Similarly, the Banking Ombudsman has no authority to consider the complaints regarding the schedule of charges and any other policy matter of banks. Likewise, complaints pertaining to terms and conditions of service of the bank are not accepted by the Banking Ombudsman. Moreover, awarding the damages against banks is not within the jurisdiction of Banking Ombudsman. However, the authority for the compensation of loss suffered by aggrieved persons in pursuit of justice lies with him.
* Consumer Protection Department
Keeping in view the growth in consumer banking and related consumer complaints, SBP has issued a circular on January 30, 2008 for the establishment of new department, namely Consumer Protection Department (CPD). The Department would resolve consumer complaints dealing with banks. All banks and financial institutions would submit complaints and appeals against the orders passed by the Banking Ombudsman to the Consumer Protection Department.
* Banking Courts for Recovery of Loans
Under the Recovery of Finances Ordinance, 2001, the Federal Government has been entrusted with the authority to establish banking courts, appoint judges for each of such courts, and specify the territorial limits to exercise its jurisdiction. For more than one banking courts in the same territorial limit, Federal Government is required to define the territorial limit of each court to exercise its authority. Moreover, High Court has been authorized to transfer a case from one banking court to another, in the same or different territorial limit, for convenience of parties or witnesses. Taking into consideration the Ordinance, Federal Government has established 29 banking courts throughout Pakistan for quick recovery of bank loans from defaulters.
* Judges of Baking Courts
The Federal Government appoints a judge of a banking court for a term of three years, after consulting the Chief Justice of the High Court of the province in which banking court is established. The person appointed as judge of banking court would be a serving or retired District Judge or retired Judge of High Court. Places for banking court to hold its sittings, salary, allowances and terms and conditions of the judges are also decided by the Federal Government. Regarding technical aspects of banking transactions, assistance is provided, if required, to the banking court by amicus curiae having degrees in Commerce and Accountant or Economics or Business Administration, or has completed a course in banking from the institute of bankers, with at least 10 years experience of banking at senior management level. Keeping in view the case, banking court decide the remuneration of the amicus curiae and the party who would pay the remuneration.
According to the Recovery of Finances Ordinance, 2001, the removal of a judge of banking court is decided after consultation with Chief Justice of High Court but judge of banking court, not being a District judge, would resign in writing under his hand addressed to the Federal Government.
* Powers of Banking Courts
In accordance with Recovery of Finances Ordinance, 2001, powers of the banking courts are the same as vested in the civil courts under Code of Civil Procedure, 1908 (Act V) and in case of criminal jurisdiction, it would exercise the powers as vested in a court of session under the Code of Criminal Procedure, 1989 (Act V of 1989). Moreover, banking court is obligated not to take cognizance of any punishable offence except upon a complaint in writing made by a person authorized in this behalf by the financial institution in respect of which the offence was committed. The matters for which procedure has not been provided, the banking courts are required to follow the procedure laid down in the Code of Civil Procedure, 1908 (Act V) and the Code of Criminal Procedure, 1989 (Act V of 1989). Besides, a banking court would be deemed the Court for purposes of the Code of Criminal Procedure, 1898 (Act V of 1898) and its proceedings would be considered judicial proceedings within the section 193 and 228 of Pakistan Penal Code (Act XLV, 1860).
* Procedure of Banking Courts
The customers or financial institutions can file a complaint against any financial institution or the customer, as the case may be, regarding violation of any financial obligation which would be verified on oath. All relevant documents related to grant of finance and the statement of account, which in case of financial institution is to be certified under the Bankers Book Evidence Act, 1981 (XVII of 1981), would be
used to support the complaint and sufficient number of copies of the same documents would also be provided in the banking court.
In case a suit is instituted by the financial institution for recovery of finance, the financial institution is required to provide the details of finance availed by the defendant from the financial institution, amount paid by the defendant to the financial institution with dates of payment, and amount payable by the defendant to the financial institution up to the date of filing of a suit. When a complaint would be presented to banking court, summon through the bailiff or process-server of the banking court would be observed on the defendant. In such cases the complaint would be attached therewith and in all other cases the defendant would be entitled to obtain a copy of the complaint from the office of the banking court without making a written application. The banking court is entitled to ensure the publication of the summons takes place in the newspaper and a wide circulation within its territorial limits. The order of banking court would be final and no other court or authority would have power to revise, review or call, into question any proceeding, judgment, decree or order of banking court, except the Banking Court, on its own accord or on the application of any party, as the case may be, correct any clerical or typographical mistake in any judgment, decree, sentence or order passed by it. In this respect, the SBP would not comment on disputes which have already been heard in the court.
* Growth of Consumer Financing in Pakistan
When Pakistan came into being, the financial system consisting of the commercial banks and the non-bank financial institutions was altered by the nationalization process. All the domestic banks were amalgamated into six major national commercial banks. In addition, a Central Directorate of National Savings (CDNS) was also set up.
The foreign banks, however, were not affected under the policy. The process of consolidation of all banks into six major banks was a serious setback to the banking sector, and economic growth of Pakistan. The banking system was adversely affected by the rapid expansion of branch network within the country, interest rate controls, the system of credit ceilings, subsidized loans, and directed credits and high government borrowing both from banks and national savings schemes.
During the pre-reform period, the financial sector in Pakistan mainly accommodated the financing needs of the government, of public enterprises and of priority sectors. The private sector investment remained modest, and efforts to mobilize savings lacked dynamism of a competitive financial system. Financial intermediaries were insulated from competition in the domestic market through oligopolistic practices and barriers to entry in the sector, and from outside competition through tight restrictions on current and capital accounts transactions. In such an environment, which was typical of many pre-reform
situations, distortions were widespread, interest rates were generally negative in real terms, taxing savers and providing incentives to inefficient investment, credit was rationed based on government determined priorities and excessive regulations hindered the activity of financial intermediation.
Consequently, economic efficiency remained low and growth suffered from relatively low savings and investment rates in the private sector.6 To enhance the efficiency and promote competition among the banks and establish a market-based system of financial intermediation, the Banks (Nationalization) Act, 1974, was revised in 1991. In this regard, the two state owned banks, MCB and ABL, were privatized and the SBP was given the complete autonomy. In the late 1996, the financial structure was on the verge of collapse and the banking losses increased as 90% loans of NCBs and DFIs defaulted. The interest rate spread also increased from 6.02% during 1990-95 to 8% in 1996.
Therefore, in 1997, second phase of banking sector reforms was introduced, which fully liberalized the bank branches and allowed the private banks to grow faster and increase their market shares. The weighted average lending rates increased from 14.4% in 1996 to 14.6% in 1997. Similarly, the weighted average deposit rates increased from 6.4% in 1996 to 6.8% in 1997. However, the interest rate spread decreased nominally (7.8% in 1997) which again increased to 8.8% in 1998. The interest rate spread remained high in Pakistan during 1998-2002, ranging from 8.05% (2000) to 9.58% (2002), which is an indicator of little competition among banks.
Nevertheless, the reforms could not succeed in increasing the efficiency and competition in the banking sector. In the pre-reform period, interest rates were controlled from both sides, with floors on deposit rates and ceilings on lending rates. These controls were motivated by a desire to provide low cost funds to encourage investment, particularly for priority sectors, and to safeguard against their increase. Interest rate spread increased from 3.9% in 1990 to 4.7% in 2000, indicating decreased efficiency. Spread between weighted average lending and deposit rates widened much further, from 2.4% in 1990 to 8.1% in 2000. However, the latter should be interpreted with caution. Therefore, their widening indicated the change from repressed to a liberalized interest rate regime. Moreover, compared with the interest rate spread, the spread between weighted average lending and deposits rates is an inferior indicator of efficiency. This is because the former takes into account lending as well as investment activities, whereas the latter does not. Until the early l990s, many commercial banks working in Pakistan were not providing consumer financing service. Even credit cards were offered to a selected band of customers who needed them not by way of financial support, but as a convenience for paying their bills while traveling abroad. In 2001, the excess in liquidity of the banks due to high inflow of remittances and low interest rates were the main motivations for the banks to get into this business. The abundance of liquidity was a result of high inflow of remittances in the 9/11 aftermath. As a result, the banks aggressively promoted consumer financing through expansion of credit cards, auto loans, house financing, and personal loans with least documentation to earn on the available liquidity.
Consumer Finance refers to lending to individuals by formal financial institutions, for meeting their personal needs. Consumer Finance products cater to the salaried and self-employed segment: essentially those people who can demonstrate an ability to service the loan facility in line with their documented cash flows. Existing players in this area include commercial banks, DFIs, leasing companies and modarabas. The analysis in this article is however based on the consumer finance exposure of the banking sector.
Banks’ consumer finance portfolio has grown at a rapid pace over the last four years or so, and its share in overall credit of the banking system had risen to 13.8 percent by end CY07 from virtually negligible levels, before declining to 12.0 percent by the end of June CY08 (Figure 5.1), constituting 3.6 percent of the GDP (Figure 5.2). Banks now offer a wide range of products under the consumer finance umbrella, such as personal loans, auto loans, credit cards and mortgage finance. The composition and growth of these products in the last few years is shown in Figure 5.3. Notably, growth in this particular asset class has tapered off since the advent of aggressive monetary tightening by the central bank in CY07 and CY08, and emerging pressures on disposable income of the households due to the rising inflation.
While all categories of consumer finance have grown substantially since the inception of this product, the most significant increase has been observed in personal loans, which are generally obtained for meeting different types of consumption needs. While this particular form of financing was available for bank customers even before the formal launch of consumer finance products, these were generally extended by banks on a fully secured basis. Even now, Personal loans extended beyond the specified limits, are fully collateralized. The growing demand for, and interest in, consumer finance however, is not unique to Pakistan, and many of the emerging economies have seen a similar shift in their respective credit portfolios banking sector in Pakistan has undergone a significant transformation in the recent years and has also acted as a catalyst in the revival of the economy. 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. The banks have penetrated into some of the previously underserved areas like consumer finance which has witnessed substantial growth in recent years. This trend was not exceptional in Pakistan, since across many emerging market countries, the growth rate of consumer credit even has outpaced other sectors. The contributing factors behind such a high growth in consumer finance may includes low interest rates, flush of liquidity, product innovation, increased competition, financial liberalization, and growing income level in the back of on going high economic growth. Besides higher return and risk diversification considerations, banks’ may have been taking higher exposures in consumer finance to avail the benefits under Basel II, as consumer finance products relatively require lower capital charge under credit risk (consumer 75 percent and mortgage 35 percent) compared to unrated corporate loans which carry a charge of 100 percent.
It is widely acknowledged 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. However, such potential systemic vulnerabilities in a particular economy can be assessed in the context of the level of consumer finance in terms of total credit and GDP, its trends, composition and structure, major credit provider, level of indebtness of the consumer, effectiveness of regulatory /supervisory/legal framework and adequacy of relevant infrastructure.
In Pakistan, consumer finance has been growing both in absolute and relative terms in recent years. During CY06, consumer loans have witnessed an increase of Rs72.4 billion or 29 percent and reached to Rs325 billion. On the back of persistent higher growth, the share of consumer finance in overall loans has increased to 13.5 percent in CY06 from 9.4 percent in CY04.
Product wise analysis of consumer finance revealed that personal loans carried the highest share i.e. 41 percent followed by auto finance, mortgage loans and credit cards. Though, in rupee terms, the value was not that high, however, in growth terms both credit cards and mortgage loans witnessed the highest growth (see during last couple of years. Consumer durables, which already carried an insignificant share, have further declined in CY06. In value terms, auto loans registered highest increase.
In terms of exposure, the level of indebtness 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 may not pose serious credit risk threats to the banks. However, rising level of consumer’s indebtness on account of personal loans and credit cards, which are considered unsecured lending, warrant attention of the banks management. The analysis of total credit cards issued i.e. 1.5 million and number of borrowers reveals that on an average, each credit card borrower has two cards from different banks. When compared with the total number of bank depositors having deposit size of Rs10, 000 and above, the number of credit card customers is significantly lower i.e. less than 10 percent.
A holistic view of both global as well as regional developments in this area indicates that consumer finance in Pakistan still has significant untapped potential. The proportion of consumer finance in terms of GDP as well as a proportion of overall bank credit is quite low when compared with regional and advanced economies (Figure 5.4)
* Consumer Finance–Myths and Facts
Access to, and growth in, consumer finance carries both social and economic significance for the society. In the absence of such products from the formal banking sector, people used to borrow from money‐lenders in the informal sector at exorbitantly high interest rates. Banks have now facilitated them in acquiring the necessities of life by providing credit against their future incomes and cash flows, at rates far lower than those demanded by players in the informal sector. Since the consumer finance function in itself is quite labor intensive, demand for this product has led the banking sector to employ a significant segment of the active workforce both on full time and part time basis. Banks themselves have also ‐ ‐benefited from the diversification of their credit portfolio, as well as capital savings under the Basel II regime, and consumer finance has brought higher returns and stability in earnings.
However, this phenomenal growth in consumer finance has also raised a debate regarding its downside risks and implications. It is generally perceived that this particular asset product has: (i) given rise to consumerism in Pakistan, which has contributed to the low level of national savings; (ii) fueled inflation; and (iii) led to the rise in speculative activities in asset markets. An analysis of actual facts and figures, however, dispels these notions:
• Consumer Finance has certainly met the individual consumer’s needs for personal expenditures, but in doing so, it has also generated demand for consumer durables and other goods and services which have in turn translated into a chain of economic activities. For the consumer, monthly payments for servicing the loan are a form of forced savings. Rather than promoting consumerism, this product has contributed in enhancing the standard of living of the middle class, which is the back bone of any economy. Moreover, trends in savings of the household sector also do not support the perception of consumerism, as the average saving rate of the household sector is higher in the post 2000 period as ‐compared with the ’90s.
An analysis of inflation dynamics does not support the claim that consumer finance is the reason for the buildup of inflationary pressures in the economy. Core inflation, which is more sensitive to the level of credit and associated increase in demand, has shown quite contained growth over the last few years (Figure 5.5). The recent rise in overall inflation is attributable to factors such as international price shocks, and anomalies in administrative and fiscal policies.
• Personal loan is the only product which is not tied to a specific purpose, and thus could potentially be utilized for speculative transactions in asset markets. However, its potential for spurring speculative activities is limited because of the fact that: (a) given its unsecured nature,2 this loan is priced competitively and is not an attractive funding option for speculators; (b) its main target market is mainly the fixed income / salaried segment of individual customers who are generally risk averse and are not
known to indulge in speculative activities; (c) such loans are relatively smaller in amount (average loan size Rs.200,00) than other categories of consumer finance, whereas speculative transactions in asset markets generally require larger sums of money; (d) the level and annual growth of this particular portfolio is quite small in comparison with other possible contributory factors such as the liquidity generated by increased foreign remittances and reverse capital flight, as well as the easy interest rate regime that prevailed up until a few years back, where disbursed loans for even small corporate entities and businesses could potentially have been miss utilized.
Essentially, consumer finance, if utilized judiciously and within prudent limits, is a handy tool for propelling economic growth, ensuring smooth consumption patterns and improving credit risk diversification. That said, indiscriminate growth in this asset class in an unstable macroeconomic environment, without a corresponding strengthening of risk management systems, could potentially create systemic vulnerabilities.
* Major Issues and Challenges
Bank’s efforts to expand their consumer finance portfolio are mainly faced with challenges emanating from the less than favorable macroeconomic environment. Emerging deterioration in economic fundamentals i.e. rising inflation rate, a certain degree of slowdown in economic activities, etc. has constrained the consumer’s debt servicing capacity (Figure 5.6). This weakness is further intensified by ‐rising interest rates as a consequence of monetary tightening by the central bank which, besides dissuading new customers, have also made the existing debt servicing more costly, given that most of the loans under this asset class are made on a variable, or floating rate basis. An indication of the ‐manifestation of the macroeconomic environment on consumer finance has already started to reflect in the deceleration in its growth rate, and a relative increase in nonperforming loans. The infection ratio has gradually risen to 5.5 percent of the total outstanding credit in H1CY08, though it is still lower than that for the corporate sector at 7.6 and the overall infection ratio of the credit portfolio at 7.7.
The performance of the different components however varies in this regard (Figure 5.7). Mortgage loans, with the lowest infection ratio, have shown relative improvement in disbursements over the last few quarters, while the biggest impact of the macroeconomic environment has been observed on the Credit Card, Personal and Auto loans’ portfolio. Though the overall infection ratio of the consumer finance sector is still lower than that of the corporate and SME sectors, any further deterioration in macroeconomic indicators could pose a serious challenge for those banks with large exposures in consumer finance, due to which they are more vulnerable to the highlighted risks: bank wise data shows that consumer loans are more concentrated in around 10 banks, and have a Herfindahl Hirschman Index (HHI)3 of 0.10 as compared with 0.07 for loans to the corporate sector, 0.08 for SME and 0.07 for the overall loan portfolio. Notwithstanding, since consumer credit is spread over a large number of
borrowers, such risks are widely dispersed. Further comfort is drawn from the fact that results of a stress testing exercise (based on end June CY08 data) conducted on banks’ consumer finance portfolio ‐show that even a rise of 10.0 percentage points in the infection ratio will only reduce the Capital Adequacy Ratio (CAR) of banks by 90 bps. This is because the share of consumer finance in the overall credit extended by banks is still rather low at 12.0 percent.
In recognition of the underlying risks, SBP continues to make concerted efforts to strengthen the regulatory regime, as well as the risk management capacities of banks. The introduction of Prudential Regulations specifically designed to address the risk factors in the consumer finance portfolio in CY03 (Box 5.1), and enhancing the scope of the Credit Information Bureau (CIB) which was first launched in 1992 (Box 5.2) are some important measures implemented to ensure prudent growth of the portfolio. The enhancement in scope of the e CIB database now gives a comprehensive coverage of all borrowers ‐of the banking sector (and some non bank financial institutions) which has helped banks in ensuring that‐ customers are not over leveraged, and that the loan to income ratios are managed more prudently. ‐Furthermore, SBP’s regulations and guidelines on risk management and internal controls effectively delineate the desirable level of internal controls and risk management capacities which the banks have started to implement for their consumer finance operations. Banks are building upon the existing capacities and rapidly improving their risk management expertise in response to regulatory requirements. Their progress along the learning curve suggests that they are now better placed to handle the challenges related to the operations of the consumer finance business.
Though the overall quality of the consumer finance has been good, it has started some weakening. During CY06, the quality of consumer portfolio witnessed some deterioration as NPLs of this sector increased to Rs7.0 billion from Rs3.1 billion in CY05. In terms of loans, this ratio increased to 2.2 percent from 1.2 percent in CY05. Though the infection ratio of the consumer sector is rising, it is still lowest among all the borrowing sectors. Further, this level of 2.2 percent is considerably lower than the weighted average level of general provisioning required to be provided against consumer finance. Product wise, the infection ratio of all the categories remains below 3 percent except that of consumer durables, the share of which is negligible.
This is also evident from the fact that, while the amazing growth in consumer finance has contributed to a surge in banking profitability, it has also raised concerns from certain quarters. The increasing loan infection ratio of this segment does merit some critical inquiry as the stability of the banking sector due to its close proximity with the real sector and its importance as a saving medium is critical for the sustained growth of any economy.
However, it is also imperative to look the share of consumer portfolio in overall context i.e. in terms of total loans or GDP, compare it with the trends in other economies/regional countries, examine key factors like legal and regulatory framework, information sharing arrangement and of course overall macro-economic environment, before taking it as a serious concern.
In Pakistan, despite exceptional growth trend in recent years, consumer finance accounts for less than 14 percent of the total outstanding credit of the banking sector. When compared to the emerging economies, Pakistan still falls below the international norms and is still lower than most of its regional peers. In contrast by 2005, in emerging Asian economies the share of consumer credit was close to 31.4 percent, in mature financial markets it was 41.5 percent and in Latin American economies it was 35.7 percent
Moreover, it would be interesting to know that average quantum of consumer credit to GDP ratio of Pakistan is also quite low i.e. at 5.86 percent in CY06. As for the emerging Asia by 2005, it was around 27 percent and even countries with similar per capita income levels to Pakistan, have relatively higher ratios.
As compared to other sectors, consumer finance has so far shown a very low level of NPLs in Pakistan. In fact at 2.2 percent, the NPL ratio is lower than Corporate (6.5 percent), SME (8.8 percent) and Agriculture (21 percent). This level of NPL of the sub components of consumer credit are considered well within the sustainable limits. In addition, this level is also lower than many countries including Malaysia, Philippines and United States.
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 over the past few years kept up this significant growth in consumer finance. However, the recent inflationary tendencies and the subsequently rising interest rates in response to curb the inflationary pressures may hurt not only the growth of consumer finance in future, but may also impact the repayment capacity of the borrower.
Summing up, the consumer finance though is a growing area of activity in Pakistan, is still smaller in terms of its volume and share. Its present level of infection is low and manageable.
Since the quality of consumer finance has experienced some deterioration, the concern, that if it continues to increase to alarming level it may directly affect the assets quality and profits of the banks, holds some merit considerations. In this respect, cognizant of the riskier nature of this business, SBP has taken prudent stance in supervising and monitoring banks this area of financing, by issuing a separate set of PRs - limiting the exposures in terms of equity, devising a pre-defined criteria for the banks going into this area and implementing a comprehensive and modern CIB reporting. Therefore, so far Pakistan has not depicted any visible signs that banking sector stability is vulnerable due to high exposures in consumer credit as the level is still below the international norms. The banks should nevertheless, remain vigilant to ensure that exposures in consumer finance should be within sustainable limits perfectly inline with their risk appetite.
According to SBP, the consumer loans witnessed an increase of Rs.72.4 billion or 29% and reached Rs.325 billion during 2006, whereas till June 2007, it further increased to Rs.354.4 billions. The share of consumer loans in the overall loans increased to 14.3% till June 2007 from 9.4% in 2004. If we compare the total financial outlay of consumer financing products in December 2006 and June 2007, the portfolio has increased significantly in all products except for consumer durables (Table 1).
Category-wise analysis of consumer financing in rupee terms reveals that personal loans carried the highest share i.e. 40.4% followed by 30.36% of auto loans, 16.39% of mortgage loans and 12.55% of credit cards. However, in growth terms, the credit card category and mortgage loans witnessed highest growth. The number of borrowers has also increased significantly. According to the official estimates, the number of ATM and credit card users is increasing in excess of 50% every year.
The banking sector is earning record profits by charging unrealistic and exceptionally high interest rates. As a result, despite considerable ratio of NPLs, the annual profitability of banks has reached 76% on annual basis over the last few years. The pre-tax annual profit of all banks, which was Rs.7 billion in 2000, jumped to Rs.123.4 billion in 2006 (Chart 1). Experts suggest that banks have achieved present growth rate mainly at the cost of reducing rate of returns to depositors.
In Pakistan, the banking sector is concentrated despite a large number of banks entering the market in the last decade. The top five local banks enjoy 80% of the market share of the banking sector. These banks are charging high lending rates, and passing only a portion of the profit on to their depositors on whose money they make the profits. The banking sector has enjoyed the highest profits in the Asia- Pacific region.
In recent months, some slow down trends are on the rise in consumer financing. For instance, the default rate in the banking sector is rising, which reflects upon the poor risk management. According to the SBP, the total NPLs of the commercial banks rose to Rs.151.9 billion in June 2007 from Rs.142.8 billion in March 2007. A considerable proportion of the NPLs are related to the consumer financing products of the commercial banks. The ratio of these loans for consumer financing sector increased to 2.2% in 2006 from 1.2% in 2005.13 The number of borrowers of mortgage loan and loans for durables has also decreased in 2007 (Table 1).
The statistics reveal that growth in consumer loans slowed down to 6.6% during first seven months of fiscal year 2008 from 10.4% in the preceding year. The growth has declined in all categories of consumer loans, except mortgage loans. The deceleration in the growth of auto finance is attributed to lower demand for automobiles due to increase in prices of locally produced cars, and risk aversions of banks following recovery issues, according to the SBP analysis. The use of credit worthiness reports from CIB has also affected the growth. The mortgage finance, however, depicts a robust growth of 17.6% as compared to 15.5% rise in the corresponding period last year (Table 2). The deceleration, however, does not appear to affect the growth of consumer financing significantly in the long term, given the huge banking profits associated with this business.
* Issues and Challenges from a Consumer Perspective
The consumers as well as the banks are entitled to certain financial rights, which must be protected in an institutional-cum-legal framework, which is capable to strike a balance between rights of both entities independently. The dilemma in Pakistan is that the consumers remain a weaker party vis-à- vis the banking sector, thus balancing the equation in favor of the latter. The market-oriented vision of economic managers has served the banks more favorably than the consumers.
The banking sector has demonstrated capacity to influence the policies, procedures and rules in its favor, as it is better equipped with financial resources, knowledge, technology, and lobbying with the governance machinery. This leverage is leading to emergence of a whole range of problems and grievances, especially in relation to consumer financing, thus negatively affecting the ability of consumers to articulate and protect their financial rights, and access justice if these rights are violated by the banks.
* High Interest Rate Spread
Low interest rate spread is an important indicator of the efficiency and competition in the financial systems and helps in economic growth through increased investments. In the national context, the most
important issue in consumer financing from the standpoint of national economy as well as individual consumers is that Pakistan has one of the highest interest rate spread in the world.
An analysis of the interest rate behavior in Pakistan reveals that the spread has vacillated between 5.95% and 9.58% during the period from 1990 to 2005. This indicates that average deposit rates have been very low, as compared to average lending rates. One could have expected a decrease in spread as a potential gain of competition among the increasing number of banks in the post-2001 period. However, little change has been observed in average spread, which points towards a cartel-like behavior of the banking sector.
If we look at the nominal and real interest rates, it becomes evident that consumers have had suffered a great deal at the hands of banks. From 1990 to 2004, the nominal weighted average lending rate has always been higher than inflation rate. The real lending rates averaged between 1.98% and 9.69%, which means that the banks earned net profits on lending in all these years. In contrast, the average deposit rate was slightly higher than inflation rate in four years only (1999-2002). The real deposit rates were negative in 11 years. It partly explains the impact of inflation on interest rate spread. The banks keep the lending rate high enough to ensure that the real lending rate is almost always positive.
In recent years, the spread has exceeded 7% on the average. The high difference between lending and deposit rates indicates that the depositors are not getting due returns, as compared to huge profits being earned by the banks. Indeed, the lending rates have increased and deposit rates have decreased over the last few years.
In February 2008, the weighted average lending rate was 11.23%whereas the weighted average deposit rate was 4.17% resulting in high interest rate spread to the tone of 7.04%. In terms of average interest rate spread of banks in South Asia, Pakistan has the highest spread. From 2003 to 2005, its average spread has remained between 6.33% and 7.79%. Whereas, during the same period, it ranged between 4.50% and 6.9% in India, 4.34% and 5.99% in Sri Lanka, and between 5.27% and 6.11% in Bangladesh (Table 4).
While the spread is higher in South Asian as compared to other regions, Pakistan stands out distinctively due to huge difference between lending rate and rate of return on deposits. The spread in Pakistan is much higher than average rates in many countries around the world. Chart 2 shows average interest rate spread in 13 countries, which ranges between minimum 1.71% (Japan) and maximum 4.5% (Italy). This is evident from these statistics that average interest rate spread in Pakistan exceeds the regional as
well as international average rates. High interest rate spread indicates that competitiveness in the banking sector in Pakistan is either absent or is very poor. A cartel-like behavior in banks appears to have taken place within the policy space provided by SBP. In April 2006, the present Governor of the SBP had said that banking spread was very high in the county and termed it an inefficiency of banks. In December 2006, she said that spreads were high because the sector was not facing competition and it was hurting the economy. However, she said that time was yet to come when SBP should exercise its powers.
This issue is largely attributable to weak SBP regulation of interest rates despite that it has the powers to bring down the spread through monetary policy. While non-operating loans and high administrative costs could be considered as the major reasons in countries where spread is high. These reasons cannot be said true of Pakistan because banks are earning huge profits at the cost of savings of the depositors.
* Variable Interest Rate
A variable interest rate moves up and down based on factors including changes in the rate paid on bank certificates of deposit or treasury bills. From a consumer’s standpoint, it makes a huge difference whether the bank is charging variable or fixed rate on credit. If a consumer enters into an agreement with the bank on the basis of fixed interest rate, the bank cannot change the overall payable interest during the entire tenure even if interest rates go up in the market. In contrast, when the interest rate is variable, the bank ties the rate with an index. The interest payable by the consumer varies as the index changes.
In Pakistan, almost all consumer loans are on the basis of variable mark up rates. This policy is attributed to two reasons. First, variable rates are in the larger interest of banks due to high probabilities of increase in rates in the future. Second, a long term debt market has yet to be developed to provide term funding to the banks. However, banks also offer loans in which borrowers are given the choice of fixed or variable mark up. If the borrower chooses fixed mark up, the rate offered is generally higher than the variable mark up rate at the time of the contract. Therefore, borrowers most often choose variable mark up, without realizing their future financial liability, in the hope that the rates will fall in the future. This has seriously affected the loan servicing capacity of the borrowers with deleterious effects on their savings.
Some countries have determined fixed or variable interest rate for each sector depending on specific needs. In the United States, for example, the interest rates on education loans were changed from variable rates to fixed rates in 2002. In addition, there are examples of discount periods for variable
interest rates. Such practices need to be introduced and scaled up in Pakistan in order to serve the interests of small borrowers.
* Increasing Inflationary Impact
A crucial issue that links with the increasing consumer financing is the inflation rate. Acquisition of easy bank credit by the household consumers has spurred the demand for many essential and luxury items. Ultimately, the increase in demand has not only escalated the prices of essential items, but has also stimulated hoarding and black-marketing thus multiplying the problems for poor consumers. Similarly, the demand for road networks and fuel imports has increased due to growth in auto financing. These developments have an overall inflation impact, which is affecting the purchasing capacities of the poor.
* Deteriorating Quality of Services
As the consumer financing portfolio is increasing, quality of related banking services is becoming a serious issue. Processing delays, service inefficiencies, unauthorized debits and non-compliance with requirement of providing monthly bank statements are few examples of poor quality of banking services. Other issues such as non-transparent advertisements, violation of agreed terms and conditions, levy of unjustifiable charges, and arduous complaint redress mechanism, etc. also reflect upon the poor quality of consumer services.
The press frequently reports such complaints, which speak of the issues in quality of banking services. For example, some banks are involved in charging late payments penalties despite payment on time. Similarly, many credit card users complain about service charges appearing on their credit statements, which make no sense to anybody. The number of complaints is increasing every year. For example, in the first eight months of the operation of Banking Ombudsman in 2005, about 40 per cent complaints filed with the Ombudsman were related to consumer products, and among these complaints, 30 per cent were related to credit cards alone.
In 2006, Banking Ombudsman received 215 complaints out of which 18 were rejected, 71 were declined and 90 complaints were granted. There were 36 complaints related to internal banking fraud scam, still being investigated by the Banking Ombudsman. The complaints received at Banking Ombudsman were related to service rules, service inefficiency, and loan remission of mark-up waiver, frauds and consumer products including ZTBL loans. However, it is observed that percentage of complaints received regarding consumer products including ZTBL loans was 46%, much higher than other type of complaints received. The complaints related to consumer products included credit cards, small loans Inc ZTBL, auto loans,
undertake mark up, processing delays and ATM’s complaints. Magnitude of credit card complaints was much more than all other complaints, nearly 40% of total complaints.
* Unsolicited Financing
Aggressive marketing campaigns launched by the banks are targeting the consumers and repeatedly encouraging them to purchase a loan or credit card. In some cases, the banks have gone to an extent where a consumer who has not even applied for a loan, is informed through telephonic call that the bank has approved a loan for him. Misleading phone calls are made to the consumers who are misled by false promises; they succumb to attractive offers and later discover that the commitments and assurances held at sign up stage were not being honored. The supply driven approach is creating artificial consumerism on one hand, and is limiting the choices for consumers, on the other.
For example, auto leasing makes a fit case of banking sector’s dominance over customers. A car lessee, for instance, is bound to insure the car from an insurance company of the bank’s choice.
* Lack of Consumer Education
The issue of consumer education is equally important. Most of the bank users do not have enough understanding of the very basic rules and terms and conditions. Another problem is that the documents prepared by banks are usually technical and the information which may affect financial rights of the consumers is never stated clearly and plainly in these documents.
Indeed, the SBP and other scheduled banks have excluded consumers as a legitimate stakeholder in formulation of, or any change in policies and procedures. There is a need to focus on public awareness about the financial rights of the citizens, and the forums available to them for accessing justice, if these rights are violated.
* Poor Information Disclosure Practices
Although PRCF require the banks to ensure transparency through disclosure, access to information related to consumer financing remains a critical issue. A strong culture of secrecy prevails in the banks, as they avoid providing even ordinary and insensitive data. Apart from reporting requirements laid down in the SBP regulations and contracts, there is no law in Pakistan, which entitles the consumers to access information from private banks as a legal right. The existing freedom of information laws are applicable to only public sector banks, and do not extend to private banks and DFIs.
* Loosing Competitiveness in International Trade
Banking sector has assumed greater importance due to liberalization of trade under the General Agreement on Trade in Services (GATS).
Pakistan has opened up the financial sector and made a number of commitments under GATS without performing any Economic Needs Test (ENT). The impact of such decisions needs to be ascertained keeping in view the contribution of financial services in services trade.
The imports of financial services have remained substantially higher than exports. Estimates suggest that the imports in financial services were US$ 77 million in 2003-04 and 2004-05, and US$133 million in 2005- 06. In comparison, exports in financial services stood at US $21 million, US$ 39 million, and US$ 70 million during the same years.
The challenge for Pakistan is to increase exports in financial services in a manner that has least impact on low income customers. Given the huge spread in interest rates, the local banks have no incentive to improve internal efficiencies to become competitive in the international market. Therefore, urgent steps including reduction in spread need to be taken to create competitive financial environment in Pakistan.
* Intimidating Recovery Practices
Recovery of dues from borrowers is the responsibility of the ‘collection department’. However, when a borrower does not clear all his dues, the case is transferred to the loan recovery department. Legally, under Section 15 (sub-section 2) of the Financial Institutions (Recovery of Finances) Ordinance, 2001, the banks are required to send three legal notices to the borrowers for payment of dues within the specified time periods. If the borrower fails to pay the dues even after third legal notice, only then the bank has the authority (under sub-section 4 of section 15) to sell the property of the mortgagor, without the intervention of any court, which was kept on mortgage as a security for the bank.
Keeping aside the law, the banks have constituted recovery teams comprising thugs who use strong-arm tactics to harass the borrower and make threatening calls. Despite the fact that bank’s recovery teams have no legal authority to visit the borrower’s residence; sometimes, recovery teams reach the borrower’s house to intimidate and pressurize them for payment of dues. In some instances, they
illegally coerce and misbehave the borrowers, and, in desire of earning more commission, cross the limits by abusing, brutally beating, showing guns, locking in the house and threatening to dreadful consequences.
Second annual report (2006) of the Banking Ombudsman stated a rise in the unrestrained action by the debt collectors; cases have also come to light where innocent people have been accost and maltreated as well as cases where borrowers with up-to-date payments needlessly harassed.
The report mentioned that in most countries, debt collection is regulated by the law. In the US, to prohibit certain methods of debt collection and treat borrowers fairly, the “Fair Debt Collection Practices Act” was incorporated in the “Consumer Credit Protection Act” in 1977. According to Banking Ombudsman Report (2006), some banks in Pakistan have developed guidelines applicable to debt collection but these are not strictly followed by external recovery agencies engaged for the purpose. To protect consumers from abuse by debt collectors, it was recommended that Pakistan Banks Association be asked by SBP to draft suitable set of instruction for compliance by external debt collection agencies.
* Weaknesses in Regulatory Framework
The frequent violation of financial rights of the consumers is attributed, mainly, to weaknesses in the regulatory framework governing the banking sector, and low level of consumer education about the relevant policies and rules. The existing regulations do not capture the full range of problems being faced by the users of consumer financing services. For example, the regulations do not restrict the banks to levy unjustified service charges such as high fee on depositing cash in one’s own account. Another case in point is the Credit Worthiness Reports maintained by the Credit Information Bureau (CIB). According to the rules, these reports are confidential documents for the borrowers, and amount to denial of the right to one’s own personal information.
On the top of it, whatever regulations exist, they are yet to be fully implemented. As a matter of fact, the banks enjoy a great degree of freedom for formulating their own policies and procedures regarding credit cards, automated services, loans, interest rates, etc., which suit their interests best. These missing links, if not abridged adequately, would continue to harm the interest of the consumers on one hand, and affect the potential of banks to serve as a strong base of economy in the longer term, on the other hand.
* ATM and Credit Cards
Credit cards include any card that a customer can use to make payments on credit, whereas ATM cards are debit or cash cards used for transactions on bank account using cash machines. The use of ATM and credit cards has increased manifold in Pakistan. Estimates suggest that about 2 million credit cards are currently on issue compared with around 500,000 during 2002. According to the official estimates, the number of ATM and credit card users is increasing in excess of 50% every year.
The SBP has notified separate guidelines for ATM, whereas credit cards have been covered in Prudential Regulations for Consumer Financing. Keeping in view the increase in users of ATM and credit cards, CRCP conducted a survey of card users in Rawalpindi, Islamabad and Karachi. In total, 124 interviews were conducted. Only those customers were interviewed who were currently using or had previously used at least one of the ATM or credit card. Findings of the survey are presented below.
* ATM and Credit Card Consumption Patterns
According to the survey, most the respondents were using both ATM as well as credit cards. The percentage of ATM users (87.4 %) is higher than that of credit card users (74.3%). About 14.8% respondents said that they used a credit card previously, whereas 10.9% were those whose applications for credit card were rejected by their bank on count of failure to meet minimum salary requirement or bad credit worthiness. On the average, the data reflects that the propensity of using ATM cards is greater than credit cards. The proportion of the respondents whose applications were rejected and those who were previously using the cards are similar.
* Reasons for Choice of Bank for Credit Card
Most of the users chose their current bank due to multiple reasons.
A majority (65.5%) said that they had been approached by the bank to use the card. In contrast, a far less percentage was using the credit cards of the bank due to low or no annual fee or larger network of the banks. As many as 58.6% of the respondents was using credit card primarily due to easy installments for their credit repayments. Suitability of terms and conditions was the third largest reason for choosing a particular bank for credit card. This indicates that majority of the banks are involved in aggressive marketing of credit cards.
* Credit Card Charges & Terms and Conditions
Prior to signing an application form for a credit card, prospective clients have the right to be provided with relevant information such as terms and conditions, schedule of charges, and brochures either in English or Urdu, or both.
However, consumers complain that they do not receive enough information to make an informed choice. According to the survey, a very low percentage of current credit card users received the document in both languages and a negligible proportion received it in Urdu. About 8o% applicants are not provided Schedule of Charges, which indicates the high tendency in banks to hide information.
All banks levy a variety of charges (annual fee, processing fee, collection charges, late payment charges, over limit fee, transaction charges, credit shield, etc) on credit card users. Generally, the bank officers inform the applicant about major charges such as processing fee, mark up and annual fee.
According to the survey, 75% of the respondents who are currently using credit card were provided information about processing fee while 64% were informed about late payment charges, as far as provision of written information about these charges is concerned. A relatively low percentage of respondents were also informed about collection and service charges, which stand at 60% and 54% respectively.
According to the survey, 51.8% of the respondents were informed about the annual fee; this percentage is slightly more than that of respondents who were provided with written information. Overall, 54.5% of the respondents using credit card were informed about applicable charges.
Of these, 33.8% were provided with written information and 20.7% were verbally informed. On the average, percentage of the respondents received information about annual fee, processing fee, collection charges and late payment charges where more respondents were provided with written information about applicable charges and a comparatively less percentage was informed verbally. However, a very low proportion of respondents were informed about finance charges, federal excise duty, over limit fee, and credit protection and transaction charges.
* Overall Satisfaction with ATM and Credit Cards
As many as 79.4% respondents using the ATM cards are dissatisfied. As for the respondents using ATM card, 11.8% are undecided in their opinion, whereas a nominal percentage of the respondents is satisfied and not a single respondent is highly satisfied. Comparatively, most of the credit card users are undecided in their opinion with a percentage of 51.9%. Only 19.2% respondents are highly satisfied while 15.4% are satisfied. However, level of dissatisfaction is low. So, on the average, there is a high level of dissatisfaction.
* Auto Loans
Auto financing has the second largest share in total consumer financing portfolio in Pakistan. According to the data compiled by Baking Surveillance Department of SBP, 30.36% of consumer financing comprised of auto financing and leasing products by mid 2007. At the same time, the total number of auto loan borrowers has exceeded 0.26 million.
From a macroeconomic standpoint, the growth in auto loans has put great pressure on the economy by increasing the demand for extension of road networks as well as fuel imports. In fiscal year 2008, the annual growth of auto loans has decreased to 6.6% from 8.0% in 2007 during the months of July to January. The deceleration is attributed to increase in prices of locally manufactured cars. Increasing ratio of auto loan default is also a critical factor in moving the banks to adopt a cautious approach.
CRCP conducted a survey of bank customers who are currently using at least one auto loan or had availed an auto loan in the past. The customers whose applications for auto loan were rejected were also included in the survey. In total, 99 customers were interviewed. Out of a sample of 30 branches of 15 banks, 22 branches were providing auto loans. The survey covered only these selected bank branches at Rawalpindi, Islamabad, and Karachi. Findings of the survey are presented in the following sections.
* Patterns of Access to Auto Loans
There are two types of auto loans being offered by the banks: car leasing and car financing. Car financing is a type of loan in which car is registered under the name of borrower and is mortgaged to the bank as long as the consumer pays off the amount borrowed from the bank. In case of car lease, the car is registered in the name of the Bank and the original papers are also in the name of the bank. Most of the banks offer car financing instead of leasing. As compared to individual loans, a higher interest rate is charged on consumer financing.
With reference to different types of auto loan, survey revealed that the percentage of respondents whose applications for new car financing were rejected is higher (24%) than the borrowers who are currently availing car finance facility (14%). Similarly, the respondents whose applications for new car leasing were rejected is also quite high (12%), but it is lower than current users of car leasing. In comparison, the number of respondents who avail used car financing is very low. More respondents are using brand new car leasing than brand new car financing.
The tenure of auto loans varies from one to five years. Some banks have fixed a minimum tenure of auto loans. A telephonic survey conducted, revealed that Askari, HMP, Soneri and ABN Amro have fixed the minimum tenure at one year, whereas Dawood Islamic Bank and KASB have the minimum tenure as high as 3 years.
As Chart 1 shows that a high percentage of respondents were those whose applications for auto financing or leasing were rejected. The ratio of rejected applications is higher for car financing, as compared to car leasing.
Out of the total respondents whose applications for auto loan were rejected, 51.0% and 44.7% applications were rejected due to bad credit worthiness and income below the bank’s desired limit, respectively. In some cases, the bank did not give any reason for rejection of application. This percentage stands at 34.8% whereas 27.7% respondents were unable to provide the required documents.
* Factors Affecting the Choice of Bank for Auto Loans
The factors that influence the decision of borrowers to choose a particular bank for availing auto loan are legion. Suitability of terms and conditions is cited by nearly 59% respondents as the single largest reason for selection of bank from which they have borrowed the auto loan. A considerable proportion comprising 35% respondents chose the bank because they were approached by the bank officer to avail the auto loan. Mark up rate and quality of bank services stand out to be the third and fourth main reasons for selection of bank for auto loan.
* Information about Terms and Conditions & Charges
Before signing the contract, almost all the respondents received the terms and conditions, and draft contract in English, whereas a nominal percentage received these documents in both languages (English and Urdu). Besides, quarter of the respondents received the information brochures in both languages and the remaining 69% received the document in English.
Concerning verbal information about the applicable charges, high percentage of the respondents was informed about the prepayment penalty and other charges, whereas the ratio of respondents for these charges is nominal with regard to written information.
The overall ratio of written information stands at 36.6%, whereas less percentage of the respondents was verbally informed. On the average, 59% of the respondents were informed about applicable charges by the bank officer.
Mark up on auto loan is a critical decision factor for borrowers. Telephonic survey of banks about mark up rate on auto loans and found that it ranges between 14% and 16% for many banks. The rate varies according to the tenure and type of the loan.
The most common problems faced by auto loan borrowers include levy of late fee payment despite timely payment and imposition of prepayment penalty. About 29% respondents were of the view that their bank most often levied late payment fee even when they had paid the installments in time. A few respondents commented that when they asked the bank to reverse the charges, the bank officer promised that the charges would be reversed but it never happened.
* Conclusions and Recommendations
Consumer financing has expanded in Pakistan at an unprecedented growth rate over the last seven years. The banks have intensively capitalized upon the demand for consumer financing and earned record profits within the generous space for credit policy provided by the State Bank of Pakistan (SBP). This space has further motivated the banks to get into unsolicited financing by aggressively marketing products even where no genuine demand exists. Despite that a regulatory framework is in place, the banks appear to have failed in terms of full compliance with SBP regulations, and in satisfying majority of their customers against various service parameters.
At the macroeconomic level, consumer financing has significantly contributed to economic turnaround by stimulating consumption and investments. There has been a phenomenal increase in private consumptions due to easy availability of credit from banks. However, in tandem with this development, the manner in which consumer financing is being delivered has seriously jeopardized the competitiveness in economy. A cartel-like pattern appears to have emerged in the banks, given that interest rate spread is among the highest in the world.
Moreover, consumer financing has significant impact on inflation, which is rising sharply. In face of the economic challenges facing Pakistan, the SBP can no longer afford to overlook the state of poor competition in the financial sector.
From a consumer perspective, 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 on loans. Depositors are not getting due returns due to high difference between lending and deposit interest rates. Further, the volume of consumer complaints is rising day by day due to processing delays, service inefficiencies, hidden charges, and poor disclosure practices. Lack of consumer education on banking terms and conditions, policies, rules, and regulations is also a critical factor in securing financial rights. Based on the analysis, the study makes the following recommendations:
* Interest Rates and Competition in Banking Sector
High interest rate spread is damaging the competitiveness in economy in general, and in the financial sector in particular. Further, huge profit margins of banks at the cost of depositors’ savings cannot be justified on any ground whatsoever. The SBP should exercise its powers to determine reasonable rate of returns for the banks as well as the depositors. As a matter of priority, interest rate spread should be reduced, at least, to the level of average spread in the South Asian region. The average spread in India, Sri Lanka and Bangladesh is less than 6%.
Presently, almost all consumer loans are on the basis of variable mark up. It should be mandatory for all banks to offer both fixed as well as variable mark up on consumer loans. If a borrower chooses fixed mark up, it should not exceed the market rate current at the time of the signing of agreement.
The banks should introduce discounted variable rates for fixed periods. The small borrowers should be provided opportunities to pay interest on loan at a lower level than the standard variable rate.
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