Consumer finance under covid-19

In the first quarter of 2020, the world was faced with Covid-19 pandemic. Globally, factories were shut down, trade was severely disrupted, stock markets crashed, airports all over the world were deserted, and businesses remained closed to contain the coronavirus outbreak. Investors have started becoming concerned about their money invested in companies. Economies around the world have been experiencing an economic decline similar to the great depression of 1930s. The Covid-19 pandemic has created unprecedented recessionary impact on global GDP.

The role of central banks

Central banks across the world are responsible for maintaining price stability as their prime objective, along with safeguarding the stability of the financial system. The ultimate objective of an effective monetary policy is low and stable inflation, which is prerequisite for sustainable economic growth. It ensures confidence of the individuals and businesses to make rational economic decisions relating to consumption, saving and investment, which have spillover effect on economic growth and employment opportunities in long run, thus improving overall economic welfare of the country.

Importance of an efficient financial system in economic growth

A sound and efficient financial system plays a vital role in economic growth and development of the country. In fact, it helps to convert savings into investment. It provides a secure platform for carrying out economic transactions and helps in a smooth and quick transmission of changes in monetary policy stance to the real economy. The Covid-19 pandemic has triggered an unprecedented human and health crisis. In an attempt to contain the spread of the virus, necessary measures, including lockdowns and social distancing, have restricted the economic activity, which in turn, may have implications for financial stability. In the wake of Covid-19 outbreak, market volatility spiked and borrowing costs have soared, particularly in risky credit markets. Emerging and frontier markets have witnessed the sharpest portfolio flow reversal on record.

Consequently, it has increased the risk that borrower’s inability to service their debts would put pressure on banks, leading to strains on credit markets.Thus, within three months, the 2020 outlook has shifted from the expected growth of more than 3 per cent globally to a sharp contraction of negative 3 per cent, much worse than the output loss seen during the 2008-09 global financial crisis. An extended period of disruption in the financial market may lead to a credit crunch for non-financial borrowers, further intensifying the economic downturn.

Weakening economic activity and increased downside risks stricken by the outbreak of Covid-19 have prompted the countries across the globe to take swift actions. In this regard, central banks globally have taken bold and decisive actions by easing monetary policy and using unconventional monetary policy tools, including assets purchases and providing liquidity to the financial system in an effort to lean against the tightening in financial conditions and maintain the flow of credit to the economy. Policy rates are now near zero in many advanced economies.

Economic situation

Before the outbreak of Covid-19, there were signs of recovery in Pakistan’s economy primarily reflecting the cumulative effect of stabilization and regulatory measures taken during the current financial year. Inflation has started to fall after reaching its peak in January 2020. This improvement is now subject to risks arising from the global and the domestic spread of Covid-19. State Bank of Pakistan (SBP) has on public and economy. The focus growth and employment and ensuring the stability of the banking and payment system.

Overall economic growth in Pakistan contracted to (-) 0.47% in 2019-20 when it already had weak economic growth of just 1.9 percent in the prior year. The Covid-19 further compounded long-standing challenges, especially in the industrial and services sector. However, due to the timely intervention of the government (economic stimulus package), the economy turned back to revival path.

Pakistan’s consumer finance

Consumer Credit in Pakistan averaged Rs 444,080.32 million from 2006 until 2021, reaching an all-time high of Rs 902,382 million in July of 2021 and a record low of Rs 282,406 million in April of 2012. Consumer finance is an established financial product across the globe, particularly in mature economies, where it constitutes a significant portion of banks’ lending portfolios. In the Pakistani banking sector, however, the evolution of the consumer financing portfolio is a more recent phenomenon, as banks have traditionally focused on lending to the corporate sector and public sector entities. While two prominent foreign banks took the lead in introducing credit cards in the banking sector in the mid‐‘90s, their outreach was limited to the top‐tier of salaried customers and businessmen.

During Jul-Mar FY2020 demand for consumer financing credit remained subdued at Rs 15.5 billion (growth of 2.9%) as compared to Rs 43 billion (growth of 9% per cent) in the same period of last year. Consumers perceived current fiscal year to be challenging to spend for house building, consumer durable, auto financing and others as overall consumer confidence remained weak with the rising inflation. Consumer financing for transport, credit cards and household durable items decelerated to Rs. 3.2 billion, Rs 2.4 billion and Rs. 1.1 billion, respectively, during the period under review. The decline in consumer credit is the obvious outcome of the demand management policies being followed in the period under review. Consumer financing for house building and other shows a negative growth of 6.1% and 19.8%, respectively.

Role of Pakistan’s banking industry

Emulating the experience of various foreign banks who 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. On the demand side, the consumer, who previously did not have access to bank credit without sufficient liquid collateral, responded well to these initiatives.

The factors responsible for the widespread popularity of consumer finance in recent years are:

  1. The financial liberalization process over the last decade has led to the creation of a banking system which is largely owned and operated by the private sector. Moreover, it is free to allocate resources in response to the demands of a market based mechanism.
  2. The influx of liquidity in the banking sector since FY02 motivated banks to diversify and expand their earnings base by venturing into previously untapped areas.
  3. The easy monetary policy stance of the central bank from FY02 to FY05 provided eligible customers with financing options at historically low rates to meet their consumption demand.
Role of consumer financing in economic development

In this backdrop, consumer finance has emerged as one of the most promising asset products for banks.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 durables, 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.

Steps taken by SBP

To provide oxygen to near-to-die industry, the State Bank of Pakistan has promptly taken the following steps:

  1. Increased the regulatory limit on extension of credit to SMEs by 44% from Rs 125 million to Rs 180 million
  2. Relaxation of the debt burden ratio for consumer loans from 50% to 60% which will accommodate almost 2.3 million individuals
  3. Allowing banks to defer clients’ payment of principal on loan obligations by one year
  4. Relaxation of regulatory criteria for restructured/rescheduled loans for borrowers whorequire relief beyond the extension of principal repayment for one year.
  5. Margin call requirement of 30% vis-à-vis banks’ financing against listed shareshas been significantly reduced to 10%

In addition, the SBP has introduced a number of measures and some concessional refinance schemes to address both the demand and supply side conditions for businesses such as Temporary Economic Refinance Facility (TERF), Refinance Facility for Combating COVID-19 (RFCC) and Refinance Scheme for Payment of Wages and Salaries to the Workers and Employees of Business Concerns. All these measures are aimed at facilitating the businesses to remain afloat during the crisis times. On the demand side, a cumulative reduction of 525 bps in the policy rate is expected to address the high cost of borrowing issue.

To promote and develop housing finance in Pakistan, SBP hasundertaken following initiatives:

  1. The regulatory relaxations allowed in the area of low-cost housing finance
  2. removal of general reserve requirement, increase in loan to value ratio, lowering of risk
  3. Weights, exemption from exposure limit on real estate etc.
  4. To facilitate availability of long-term affordable funding for housing to special segments
  5. For society e.g. Widows, Transgender, special persons
  6. Against subsidized low cost housing financing by banks/DFIs (conventional and Islamic)
  7. Assigned targets for overall housing finance portfolio to banks and targets for low cost
  8. Housing for special segments to both banks and HBFCL

Bank/DFI’s exposure in housing finance was excluded from calculating the real estate exposure limit i.e. 10 per cent of the aggregate of advances and investments excluding investments in government securities.

Way forward

Initially, the State Bank of Pakistan (SBP) increased the policy rate to absorb the inflationary pressure in July, FY2020. The move resulted in lower credit demand from the private sector, which slowed down the economic activities. While domestic production and retail trade were adversely affected by the stabilization efforts, they received a major blow when the businesses were shut down amid lockdown to control the Covid-19.

The SBP has also introduced various measures to lessen the impact on public and economy. It is expected that these measures will revitalize the economy.

The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Nazir Shaikh can be reached at [email protected]

Check Also

A brief review of ‘Buy Now, Pay Later’ model

A brief review of ‘Buy Now, Pay Later’ model

Pakistan used to be one of the most often overlooked countries when it comes to …

Leave a Reply