Consumer Credit: Need for Major Reforms

by IMRAN MALIK
 

Starting from about 2004 Pakistan along with many other developing countries saw the booming of consumer credit.  The article points to some of the pitfalls of credit fueled consumption and the promotion of consumer financing while overlooking the needs of the agricultural and industrial sectors.  The article also discusses the grievances of borrowers against the banks’ lending and collection practices and recommends that Prudential Regulations related to consumer financing be reviewed so as to promote fair and equitable lending practices.

Daily Dawn: November 03, 2008

Referring to the financial crises in the developed countries, the State Bank governor has observed that there should not be any cause of concern about the stability of the domestic banking in the coming days.

But one should not forget that these are abnormal times the world over. Despite apparent strong fundamentals of our banking sector, the central bank might as well prepare itself for a possible financial crisis, howsoever remote it may appear at the moment. The central bank has already started gradual injection of liquidity. The advisor on finance to the prime minister has initiated action to deal with the looming economic and financial crisis.

Given the external environment, home-grown measures are needed to come out of the difficult situation. One top priority area is the mobilisation of local resources for efficient implementation of our priority projects.

‘Living on credit’ is deeply rooted in the life style of most of the people in the developed world. This ‘fashion’ has been spreading to developing countries. Excessively leveraged and poorly evaluated credits, particularly the sub-prime mortgages have been the root cause of the financial turmoil in the US and other countries. Quality of project appraisal would not be much different in Pakistan.

Without waiting for the reform conditionalities of the IMF or the friendly countries offering assistance, we should critically examine and reform our credit delivery system including guidelines, regulatory oversight and redress complaint mechanism.

Apart from holding substantial investments in corporate equity and debt securities, the banks have large credit exposure to the manufacturing, particularly textile and personal loans or the consumer finance. As on December 31, 2007 the banking sector had total loans of Rs2,613 billion extended to 4.9 million borrowers of which 3.3 million borrowers (nearly two-third of total borrowers) were in the consumer finance segment. Private sector (business) which includes the manufacturing has 1.6 million borrowers. Textile sector, the largest industrial sub-sector, is not in a happy position due to frequent power break-downs, increased cost of energy and raw cotton or yarn.

The SBP’s Banking Sector Quarterly Review, March 2008 shows a consistent increase in the consumer finance though at passive rate for the last few quarters. It has for the first time registered a decline of Rs6 billion, from Rs371 billion as on December 31, 2007 to Rs365 billion as on March 31, 2008, and its share in overall loans contracted by 80 bps to 13 per cent. The internal composition of the consumer finance categories did not witness any major shift, personal loans contributing the largest share of consumer finance, followed by auto and mortgage loans.

According to SBP, the rapid credit growth in recent years has resulted in high credit risk. During March, 08 quarter, non-performing loans (NPLs) increased by Rs18 billion to Rs232 billion. NPLs to loan ratio increased to 7.7 per cent. NPLs of consumer sector increased from 3.2 per cent of loans at end March 2007 to 4.6 per cent at the end March, 2008.

Of particular concern should be the consumer credits which constitute the highest number of individual borrowers. In case of debt defaults, there are fears of severe treatment at the hands of the creditors or their recovery teams. Over a period, these borrowers turn into some sort of destitute and may not have the financial resources nor the legal support to negotiate a fair settlement to get rid of the loan.

Due to the current financial turmoil, the consumer credit borrowers (and their families including the guarantors and their families) are likely to face more difficult times due to further defaults or adverse action by the banks. The government should save these individuals/guarantors (and their families) from possible foreclosures and humiliation. Revolutionary reforms in the consumer credit coupled with remedial measures can save these borrowers.

One view is that credit card, car financing and financing of luxury goods are some of the areas that the banks financed over the past few years instead of the industry which could have brought economic development and employment. The money so obtained was spent or wasted on frivolous consumption. The borrowers mortgaged their future earnings and savings to banks which made huge profits. Finally, the economy was left with the lowest saving rate in the region.

High inflation, particularly in food and energy has badly eaten into the net disposable income of the consumers, some of whom may have availed consumer finance. This will adversely affect borrowers’ ability to timely service consumer loans for housing, credit cards, vehicles, education and other personal needs. The increase in mark- up rates due to recent increases in KIBOR will raise repayment installments for various consumer loans. The purchasing power of their net disposable income has been reduced while loan installments have already increased or would increase shortly. Thus, the probability of their going into default has increased.

The scenario is based on the assumption that the people availing consumer loans are still gainfully employed. However, in case they are unemployed or are on the verge of unemployment, the banks should expect many more defaults. Industry and private businesses are confronted with load-shedding, high energy costs, general inflation and uncertain conditions. These factors are adversely affecting their operations and some of these industries or businesses may resort to lay-offs. The employees with consumer loans will be the worst affected.

The consumer loans in the end make the poor poorer and the rich richer. Loan installments are kept initially low but with floating rates these increase with the passage of time and consume a major part of the income of the borower for years to come. There appears no easy way out for them or their guarantors. The consumers should learn to live within their means.

The Sindh High Court’s two-member division bench while hearing the case of a petitioner, advised the State Bank of Pakistan on October 8, 2008 to provide for mediation between creditor banks and alleged defaulters in the uniform loan recovery policy for the commercial banks being formulated by SBP as earlier asked by the honourable court.

The counsel to SBP had stated that the draft had been sent to the Pakistan Banks’ Association for recommendations. Recourse to alternative dispute resolution should help settle default cases expeditiously without resort to courts or use or threat of force by bank recovery teams. It is suggested that the SBP may share the draft recovery policy with the Consumer Rights Commission of Pakistan and also post it on its website for information of general public as well as consumers.

The SBP may revisit the existing Prudential Regulations and guidelines including system of redressal of consumer grievances. The ministry of finance may constitute a special committee on consumer credit to investigate the whole spectrum of the consumer lending practices and procedures including legal documentation and come up with recommendations for fair and equitable lending. The committee may also make recommendations for resolution of the hopeless situations of the borrowers who find it impossible to service their loans.

(The writer is President/CEO of First Credit and Investment Bank Limited.  The article represents his personal views)