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Rising interest rates under consumer financing remain the daunting task
Personal loans have become an important source of meeting our financial commitments. Be they for acquiring consumer durables to enrich our lives, meet educational needs, marriage, vacation or meet urgent medical needs, consumer loans are being used by millions of Pakistanis in some form or the other. Consumer loans can be broadly classified into two categories:-
- Running finance: The borrower is given an overdraft limit in his/her account and the markup is charged only on the utilized portion and only for the number of days the loan is outstanding. Multiple debits are allowed in the account.
- Demand finance: The borrower is given the full limit in one go and is monthly amortized. No further disbursements are allowed and markup is charged on the diminishing balance method.
Presently the total consumer loan portfolio is 1.1 trillion as of Jan 231. This portfolio has doubled over the last 10 years as prices of consumer goods and property began to rise at an exponential rate in that period.
Consumer loans remain a very viable option for consumer banks due to their markup rates and low probability of default. Normally where a SME or a commercial borrower may be charged KIBOR + 1, the consumer may be charged K+3 or even more. Furthermore, the trouble with business loans is that once a loan gets bad, millions get affected and the recovery actions may take years, however, with consumer loans the type of security is liquid enough to be sold easily with little effort. Additionally, within consumer loans domino effect does not qualify as the ticket size is very small.
In retrospect, the consumer loan sector in Pakistan began to gain momentum in the 90s with the influx of foreign banks entering the Pakistani market and introducing products like credit cards, providing durable goods financing and personal loans to salaried individuals. Later on due to the high default percentage the banking watchdog i.e. the State Bank of Pakistan developed a department called the Credit Information Bureau, their primary task was to keep a borrower-wise record of all loans availed by anyone at any bank across Pakistan. To further safeguard the interest of the depositors, SBP made it mandatory for all banks to upload the outstanding position of the loans disbursed by them on a monthly basis on a portal developed by the CIB. Presently it has become a mandatory requirement for any fresh loan or roll-over of an existing loan to generate an e-CIB which gives an online position of a borrower’s availed loans at any bank along with a last 2-year repayment behavior including any and all payment defaults.
With the recent unprecedented increase in interest rates, the consumer loan sector is facing a huge reduction in fresh applicants. Up to 2018 when interest rates (KIBOR) was roughly around 7%, the consumer finance sector was on the rise. But post 2020 this rate has since doubled to a whopping 23% at present. To add salt, the regulator has decreased the maximum debt burden that a borrower can have on his/her salary from 50% to 40%. All these have resulted in making the lives of the employees working in consumer loans departments a living hell.
But as it says every cloud has a silver lining, various wings of the government are attempting to promote financial inclusion, enhance the lending umbrella and offer subsidized loans to the public. Ministry of Human Rights has taken an initiative towards the development of human capital through the empowerment of women. For this they have proposed the provision of subsidized motor cycle/scooters to the female workforce and/or female students i.e., working women in general, female polio workers, female teachers and female students, etc. Another example is the SBPs subsidized solarv23cv financing to consumers on markup rates of only 6% per annum. This has a 2 pronged benefit, the first being giving additional business to the banks and the second helping in reducing the carbon footprint.
Another major change that has been observed in the consumer financing sector is the sprout of smart financing solutions. Presently more than 290 fintech companies are operating in Pakistan and 14 of them are working in the field of alternative lending. They have used AI and business intelligence tools to develop systems that crunch numbers which not only shortlist prospective borrowers but also market the products, disburse funds and provide recovery mechanisms. In other words, they act as an end-to-end solution. In the recently published Innovation Challenge Facility Guidelines for Digital Financial Services, the State Bank of Pakistan stated that by 2025 the total market share of digital financial services would go beyond $36 billion which would roughly create 4 million employment opportunities.
In order to correct the declining consumer loan portfolio banks have taken measures into their own hands. The instigator of this trend is Meezan Bank who in order to make home loans attractive to customers have offered it at 15.99% fixed for 3 years. This makes them the industry’s cheapest lender for housing finance. NBP and JS have also embarked on similar projects to ensure they stay abreast of the game. With the recent reduction in import duties, it seems that the auto-finance sector may receive a necessary impetus in the right direction as new car sales have plummeted nationwide as car manufacturers rely heavily on financing customers.
The biggest challenge faced by the consumer loan market is the rising interest rates which have decreased the demand for such loans due to a high cost for the borrower. Additionally, many vendors across the country are offering installment plans to bolster their sales and lest we forget the religious reasons that people have for avoiding banking solutions to finance their needs. In order to ensure existence, the consumer loans sector needs to be in the hands of those people who have a track record of transforming banks from a mediocre state to the epitome of financial dominance, however, our banks are spearheaded by those who either do not have the drive for sales growth or have experience of shutting down banks like the ex-foreign bankers, if we continue on a similar trajectory we may never move out of this spiraling staircase of upselling to existing borrowers.
1- https://tradingeconomics.com/pakistan/consumer-credit