Rapid growth in the consumer finance portfolio of the banking sector in recent times has generated a preceding debate, substantially critical of its alleged part in converting consumption-less financially literate customers. This story aims to explore some of these perceptions, the present data in perspective, while taking into account the high perceptivity of these loans to add interest rate dynamics. Notably, the banking sector in Pakistan is under-leveraged by global standards and emergent risks are well-managed by the banking sector.
In the early period when the concept of banking wasn’t well known, people, generally in rural areas used to borrow money from unlicensed lenders on partial terms and at an emulsion interest of veritably high rate. Farmers had to adopt money from landlords to meet their financial requirements, which were primarily driven by the interest of lenders. Hardly, they could repay the loan during their continuance due to the high rate of compound interest. Still, over the recent decades, a large number of foreign bank branches operating in the country have been offering a variety of financial products; with the expansion and growth of the banking industry, which touched off an openness to particular loans, have instated the consumer finance market.
Achievement
Consumer finance is an established financial product across the globe, particularly in mature economies, where it constitutes a significant portion of banks’ lending portfolios. Emulating the experience of various foreign banks that had a head-start in this area, domestic private banks have exhibited remarkable adeptness in adopting new procedures for credit risk assessment, setting up the requisite policy and collections units, and upgrading the scope of their IT-based systems. In doing so, they successfully introduced several innovative products for the individual consumer segment.
Providing access to purchasing power to the middle-class consumer has been the most significant achievement of this product class. Not only have people been able to raise their standard of living by purchasing various consumption goods, which were previously treated as luxuries in reach of only a few, demand for these goods has also led the manufacturing sector to expand its capacity, such that both backward and forward linkages have contributed to the expansion in economic activities. Banks’ auto loans product and loans for consumer durable, for instance, have been instrumental in this aspect. Though still small in proportion, the rising demand for mortgage finance reflects the individual consumer’s need and financial capacity to acquire private ownership of housing units. Hence in promoting their consumer financing products, banks have played their due role in promoting economic development in the country.
Admiration
From the banking sector perspective, consumer loan history is fairly now about 10 to 15 years and includes schemes similar as auto loans, credit cards, house loans, and particular handling finance by the loaning enterprises and by some institutions. Over the last ten years, Pakistan’s banking sector has mainly promoted consumer finance by unleashing a wide range of products. This unknown growth of consumer finance is largely attributed due to the profitable policy liberalization attuned to the principles of free market economy, and a vacuity of huge liquidity to the banks in the aftermath of 9/11. In the Pakistani banking sector, still, the elaboration of the consumer loan portfolio is further a recent phenomenon, as banks have traditionally concentrated on advancing to the corporate sector and public sector entities. While many prominent foreign banks took the lead in introducing credit cards during the mid-90s, their accomplishment was limited to the top league of salaried class and businessmen.
Alternatively, a combination of other factors is responsible for the widespread popularity of consumer loans in recent times the financial liberalization process over the last decade or so, has led to the creation of a banking system that is largely possessed and operated by the private sector, and is free to allocate resources to respond the market demand. Secondly, the influx of liquidity in the banking sector since FY02 motivated banks to outreach its venture into preliminarily untapped areas, and third, the easy financial policy station of the central bank from FY02 to FY05 provided customers flexible financing options with competitively lower rates than before. Foreign banks apparently paid the best intention to exploit such opportunities and, sooner or later, domestic private banks that have exhibited remarkable adeptness in adopting new procedures for credit risk assessment, setting up the requisite policy and collections units, and upgrading the scope of their IT-based systems. In doing so, they successfully introduced several innovative products for the individual consumer segment.
Access to credit
Access to credit is important for economic growth, creates employment and flexible consumption of households. It is also an important factor in increasing the incidence of financial inclusion, a concept that implies exclusivity through easily accessible and affordable financial services for all businesses and households. Besides credit, these services include remittances, insurance and savings among others. The focus of financial inclusion is entirely on the formal provision of these services by financial institutions that are regulated by the state.
On the demand side, the consumer, who previously did not have access to bank credit without sufficient cash inflow, responded well to these initiatives. In a way, providing such access that leads to purchasing power to the middle-class consumer has been the most significant achievement of this product class. It allows people to raise their living standards by enabling them to afford various consumption goods, which previously might have been out of their reach. Most importantly, it cut out the fine line of luxury, creating an overall demand for goods that were treated as luxuries. Hence, this also led the manufacturing sector to expand its capacity, achieving a scale economy and consuming its benefits.
Similarly, a lot of other socioeconomic development and consequences can be noted due to further consumer financing; certainly, banks have played their due role in promoting economic development in Pakistan. From an economic perspective, there is a tension that lies between creditability and capability. Consumer financing always appears worthwhile to take on, however, without a sound policy and an ability to repay, it might backfire on the consumer.
Bank’s consumer finance portfolio has grown at a rapid pace over the last four years or so, and its share in the overall credit of the banking system had risen to 13.8 percent by the end of CY07 from virtually negligible levels, before declining to 12.0 percent by the end of June CY08 constituting 3.6 percent of the GDP. 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. Notably, growth in this particular asset class has narrowed off since the arrival of aggressive monetary tightening by the central bank in CY07 and CY08, and emerging pressures on the 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.
Myths and facts
Access and growth in consumer finance hold both social and economic importance and consequences for 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 provided them in getting the prerequisites of life by providing credit against their future incomes and cash flows, at rates way lower than those demanded by 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 a full‐time and part-time basis. Banks themselves have also gained from the heterogeneity of their credit portfolio, as well as capital savings, and consumer finance has brought higher returns and firmness 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, dispel these notions:
- Consumer finance has assuredly met the individual consumer’s needs for personal expenditures, but in doing so, it has also generated demand for consumer durables and other goods & 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.
- An analysis of inflation dynamics does not support the claim that consumer finance is the reason for the build-up of inflationary pressures in the economy. Core inflation, which is more sensitive to the level of credit and associated increases in demand, has shown quite contained growth over the last few years. The recent rise in overall inflation is attributable to factors such as international price shocks, and anomalies in administrative and fiscal policies.
- A 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 conjectural activities is limited because of the fact that: (a) given its unsecured nature, 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 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; (d) the level and annual growth of this 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 wrecked. Essentially, consumer finance, if utilized judiciously and within sagacious limits, is a handy tool for pushing forward economic growth, ensuring smooth consumption patterns and improving credit risk diversification.
Borrowing among Pakistani adults
Three demand-side datasets are available to analyze patterns and borrowing behavior in Pakistan. The Access to Finance Survey (A2F) was sponsored by the State Bank of Pakistan (SBP), with a sample size of 10,000 respondents (ages 18 and above) this survey is representative at the national and sub-national level. The latest part of the survey was done in 2015.
Financial Inclusion Insights Survey (FII) is sponsored by Bill and Melinda Gates Foundation (BMGF). This is a longitudinal survey covering 6,000 individuals aged 15 and over. The survey has been conducted with a yearly frequency starting from the year 2013 till 2017. Like A2FS, the survey is representative at the national and provincial level, however, due to limitations within the sample size, data captured for KP and Baluchistan need to be interpreted with caution.
World Bank’s Global Findex Survey (Findex) is conducted every three years. So far, three survey waves have been completed in Pakistan, i.e. 2011, 2014 and 2017. 1,000 individuals aged 15 and over were interviewed for this survey in each wave and the data captured is representative only at the national level.
The proportion of total borrowers varies significantly and ranges between 7% – 48%, across different waves of the aforementioned demand-side surveys. As per recent readings, 35% of the participants under Findex (2017) reported having borrowings, while FII (2017) and A2F (2015) reported it at 15% and 17%, respectively. The variance is mainly due to the different approaches used by each survey to define what constitutes borrowing.
In terms of provinces, A2F reports the highest number of borrowers in Sindh (37%) followed by Balochistan (20%). In Punjab, the largest province of Pakistan, this threshold is surprisingly low as only 12% of the respondents said to have borrowed (formally or informally) in the last 12 months. Khyber Pakhtunkhwa (KP), has the lowest level of borrowing incidence (5% of households).
Across all the provinces, the majority of the participants reported using borrowings to buy food items and ration. The other two most quoted reasons were using credit to pay for emergency costs or for other future events (this can include, house building, child education etc.). According to the Household Integrated Economic Survey (HIES), average monthly savings per household is estimated at Rs4,000, depicting a constrained availability of resources to pay for any major emergency expenses or planned future consumption.
Further analysis of A2F datasets reveals that the majority of the borrowing population prefers to have a monthly frequency for loan payments, reinstating the possibility of reliance on store credit for monthly consumption.
Problem area with borrowing
According to SBP, consumer loans witnessed an increase of Rs72.4 billion or 29% and reached Rs325 billion during 2006, whereas, till June 2007, it further increased to Rs354.4 billion. 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 durable.
Despite the many positive developments associated with consumer finance, its role in promoting consumerism in Pakistan has generated a debate, with mostly negative connotations.
Pakistan has witnessed phenomenal growth in consumer finance over the last seven years. Most commercial banks are involved in consumer lending through one or more financing modes, as it has become a very lucrative business due to high spread and variable interest rates. The increase in consumer financing has come with many challenges facing the national economy as well as individual borrowers.
During the per-reform period, the financial sector in Pakistan mainly accommodated the financing needs of the government, public enterprises and priority sectors. Consequently, economic efficiency remained low and growth suffered from relatively low savings and investment rates in the private sector. To enhance efficiency and promote competition among the banks and establish a market-based system of financial intermediation, the Banks (Nationalization) Act, of 1974, was revised in 1991. Until the early l990s, many commercial banks working in Pakistan were not providing consumer-financing services.
While it is important to understand why people borrow, it is equally useful to explore the reasons that inhibit potential borrowers from borrowing. This part of the behavioral attribute completes the demand-side credit dynamic. One key reason for not borrowing (irrespective of gender) is the lack of a credible credit history. This issue is widely acknowledged in the formal market and it is expected that locally domiciled credit bureaus with their expanding databases will help address this market failure.
Suggestions:
- High-interest rate widening is damaging the competitiveness of the 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 rates 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%.
- The rising volume of public complaints stipulates that banks are not fully abided by existing SBP regulations. The mechanism for the imposition of regulations needs to be strengthened. Also, the banks should be penalized for non-compliance with mandatory requirements.
- Aggressive marketing and unsolicited financing is promoting unnecessary private consumption at the cost of consumer savings. The SBP regulations should discourage this approach. Unsolicited financing through personal loans, auto loans, credit cards, etc. should be forbidden. Nevertheless, banks should have the right to offer products through transparent advertising.
- Comparative information is not available to the consumers to make informed choices. If a consumer is interested to find out the bank with the lowest mark up on the personal loan, for instance, consolidated bank-wise data is not available in Pakistan. As a result, the consumer has to rely on misleading advertisements and false promises from banks. The SBP should prepare and advertise bank-wise consolidated data in the form of charts and tables for the public in Urdu and local languages so that they are able to choose a bank on the basis of reliable information. This practice would help promote competition among the banks and create an incentive for improving efficiency and the quality of services.
- The complaint procedure is lengthy. The normal time allowed to banks, the Banking Ombudsman and in case of appeal, the SBP for redress of a consumer complaint aggregates to about 4 months. If a consumer has to go through the judicial process against the SBP‘s decision, then it might take even longer. The number of days for redress of complaints should be reduced.
- The SBP regulations should bind the banks to explain ALL applicable charges on consumer loans before signing the contract. Banks fix different types of charges on credit cards and loans as a percentage as well as a minimum amount and charge to the customer whichever is higher. For instance, some banks charge Rs.500 or 3% of cash advance amount on credit cards, whichever is higher. If the cash advance amount to be paid by the customer at the rate of 3% is less, then the bank would charge Rs.500, instead of 3%. This practice is unfair and should be abolished immediately. The bank should either charge a fee or only a percentage.
- The problems in interest rate spread and service delivery notwithstanding, consumers have benefited a lot from the consumer-financing sector. A large number of people have been able to meet their real needs by accessing credit from the banks. Therefore, steps need to be taken for the sustainability of this sector. This requires the banks to develop database lending strategies to manage the risks associated with this sector.
Conclusion
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 the majority of their customers against various service parameters.
At the macroeconomic level, consumer financing has importantly contributed to economically stimulating consumption and investments. There has been a rampant increase in private consumption due to the unexacting availability of credit from banks. Moreover, consumer financing has a significant impact on inflation, which is rising sharply. In the 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 the 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.