Consumer Financing in Pakistan

By:Javeria A. Cheema

Sabahat NasirSamia Arif

Consumer Financing: Overview

What is “consumer Financing”?

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

Type of service that is designed to provide the individuals with necessary finance for personal purchases ranging from buying a car, shopping purchases, to buying a house.

The concept of consumer financing is based on the

need for an institutional arrangement that provides consumers with financing support to enhance their consumption and, as a result, improve their standards of living.

Growth of Consumer Financing in Pakistan

Until the early 1990s, consumer financing was not offered by commercial banks

Credit cards were offered to only a selected band as a convenience for bill payments and not for financial support

In 2001, excess in liquidity of the banks due high inflow of remittances in the 9/11 aftermath and low interest rates motivated banks to enter into consumer financing business

As a result, Banks aggressively promoted consumer financing- credit cards, auto loans, house financing and personal loans with least documentation

Unprecedented growth rate over the last 7 yearsAccording to SBP:

2006 Rs.72.4 – Rs.325 Billion

2007 Reached Rs.354.4 Billions

Categorized into 4 types

1. Personal loans: loans provided to individuals for the payment of goods, services and expenses,

2. 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.

3. 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.

4. Credit Cards: Credit cards include any card, which a customer can use to borrow credit from a bank. Credit cards include charge cards, debit cards, Stored Value Cards (SVC), and Balance Transfer Facility (BTF). Corporate Cards are not included in this category.

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

Regulatory Framework for consumer financing State Bank of Pakistan (SBP) regulator of all banks and Development

Finance Institutions (DFIs)

For redress of consumer grievances comprises of both administrative and judicial institutions.

Banks are obligated to clearly disclose

Margin Requirementsno limits are placed on the margin requirement

SBP has restrained banks from charging any “Insurance Premiums”

Banks are not allowed to finance older than 5 years cars and must keep the customer informed of payment schedules and any changes

Issues and Challenges from Consumer Perspective

1. High Interest Rate:In Pakistan the spread has vacillated between 5.95%

and 9.58% during the period from 1990 to 2005.

2. Variable Interest RateAccording to the annual report of the banking

ombudsman, in Pakistan almost all consumer loan are on the basis of variable mark up rates.

3. Increasing Inflationary impactAcquisition of easy bank credit by the household

consumers has spurred the demand for many essential and luxury items.

Cont’d…4. Deteriorating quality of service

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

5. Lack of consumer educationThe technical documents prepared by the banks affects the financial rights of uneducated customers. Table No.2

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

Cont’d7. Intimidating recovery practices:

Banks recovery team reaches the borrower house to pressurize them for payment of dues without any legal authority

8. Weaknesses in regulatory framework: The banks formulates their own policies and procedures which

suits their interests best

9. Unsolicited Financing

Aggressive marketing campaigns launched by the banks are targeting the costumers and encouraging them to

purchase a loan or credit.

Source: Consumer financing in Pakistan: Issues, Challenges, and way Forward published by CRCP

Social & Economic Impacts of Consumer Financing Increased consumption > increased output / Inflationary Pressure

(Demand-Pull Inflation)

Increased dependence on foreign loans

Lack of infrastructure to absorb and manage the increased number of cars on the road due to easy auto financing

Spending beyond their means behavior results in burdening the economy and society

Negative Saving-Investment gap as a result of spend now, save later behavior in developing nations

It’s beneficial for those who have the prerequisite responsibility, maturity and financial literacy to manage their finances.

Conclusions & Recommendations High Interest rate spread should be reduced to increase

competition in the banking sector

SBP Regulations regarding consumer financing should be enforced strictly to decrease the high profit margins of the banks at the expense of the depositors

Unsolicited financing should be discouraged to avoid unnecessary private consumption at the cost of consumer savings

SBP should bind banks to explain ALL applicable charges on consumer loans before signing the contracts

Consumer Education: comparative information should be made available Latest copy of terms, conditions, & schedule of charges should

be provided to applicants in the language of their understanding

Question-Answer Session