The evil of consumer financing

The banking sector in Pakistan has robustly been engaged in consumer financing by unleashing a variety of products such as credit cards, auto loans, housing finance, personal loans, etc. Consumer financing was introduced for the first time in Pakistan around 1990 by Citibank (a foreign bank) and it immediately turned out to be a huge success. Emulating this success, many local as well as foreign banks introduced lucrative financing schemes for all and sundry in Pakistan. These schemes were so alluring that people started availing them without understanding the repercussions.
From a macroeconomic standpoint, consumer financing has significantly contributed to the economic turnaround of Pakistan by stimulating consumption and investments. There has been a phenomenal increase in private consumptions due to easy availability of credit from banks. However, in tandem with this development, this particular financing 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.
From a consumer perspective, the financing has been helpful in improving the quality of life of people who have the capacity of servicing the loans. However, this capacity is now deteriorating due to high interest rate spread (in recent years, the spread has exceeded seven per cent on average and has now reached 13-14 per cent) and variable interest rates on loans. High interest rate spread is damaging competitiveness in the economy in general, and in the financial sector in particular. A cartel-like behavior in banks has taken place within the policy space provided to them by the central bank, the State Bank of Pakistan (SBP).
The volume of consumer complaints is consistently rising due to processing delays, service inefficiencies, hidden charges and poor disclosure practices. Consumers are told that they have to pay to the bank a mark-up of up to 12 per cent on financing; however, under the garb of hidden charges the mark-up goes up to an astounding 36 per cent per annum! Gas stations and shops earn an extra 0.2 per cent to 0.4 per cent profit on any amount charged on credit cards without the knowledge of the consumer — a prime example of poor disclosure by banks. Intriguingly, banks have no objection to such profits earned by gas stations or shops.
In a report on the winding up of a bank, Lord Bingham (of the BCCI shut-down fame) attributed the bank’s failure to the “incompetence and errors of unsophisticated immature venturing into highly technical and sophisticated markets”. Incompetence, like in all other fields in Pakistan, is the chief protagonist in creating unnecessary hurdles in consumer financing as well. People are recruited without proper knowledge and experience in banks. Often they are not even trained enough to effectively communicate information to consumers. Uneducated consumers fail to understand their rights and obligations contained in technical documents prepared by the banks as approximately 85 per cent of these documents are in English. The sad part is that consumers are getting heavily penalised for this insensitive approach.
Most of the banks in Pakistan are unaware as to how to settle outstanding consumer loans as no guidelines are available for such settlements. Those consumers who are able to settle their outstanding loans towards banks suffer from the fact that banks don’t update their records and their names remain with the Credit Information Bureau (a repository of credit information of borrowers established by SBP) as defaulters for years. Individuals don’t have access to their own credit worthy reports as they are marked confidential in accordance with SBP rules. Ironically, banks and financial institutions can access these reports as and when they like.
Although SBP has introduced a regulatory framework for consumer financing, it is extremely sketchy as it only provides an overall direction for consumer financing services. The loopholes in the regulatory framework have left a lot of policy space to discretion of the banks, which they have exploited to their own advantages. There is no structure for recoveries for which reason bank recovery teams literally break into the consumers’ houses and pressurise them for payment of dues without any legal authority. This unprecedented approach has even pushed some to suicide.
Essentially, indiscriminate and unmanageable growth in consumer financing, in an unstable macroeconomic environment like Pakistan, without a corresponding strengthening of risk management systems, is not only making people spend more than they earn, but is also completely exposing vulnerabilities that exist in the banking system.

Asaf Kamal is a Lahore based banker; Bilal Hussain is an advocate, Lahore High Court