Consumer Financing in Pakistan

M.Sheharyar Kaneez Umbreen Baig Fatima Akhter MIF-17 MIF-21 MIF-23

Scope of Presentation

Consumer Financing: Overview Growth of Consumer Financing in Pakistan Categories Some Charts Regulatory Framework for Consumer Financing Shariah Compliant Models of Consumer

Financing Issues and Challenges from Consumer

Perspective Social & Economic Impacts of Consumer

Financing Conclusions & Recommendations

Kaneez Fatima MIF-21

Consumer Financing: Overview

What is “Consumer Financing”?

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

(State Bank of Pakistan)

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

Continued

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 years

According to SBP:

2006 Rs.72.4 – Rs.325 Billion

2007 Reached Rs.354.4 Billions

Categories of Consumer Financing

Personal Loans Auto Finance Housing Finance Credit Cards

Personal Loans

“Loans provided to individuals for the payment of goods, services and expenses”

i.e. A.Cs, Computers,

other Electricity Equipments, Educational Expenses,

Marriage

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.

It is also available for old vehicles but their age should not be more than five years

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.

Different Options For House Financing

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, and Balance Transfer Facility (BTF).

Corporate Cards are not included in this category.

Bank Alfalah Cards

Platinum card

Supplemantory card

Women card

Student card

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

Umbreen AkhterMIF-23

Regulatory frame work

In Pakistan State Bank of Pakistan is the regulatory authority of all banks and Development Finance Institutions (DFIs)

Regulatory Framework for Consumer Financing

SBP is the 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

Regulatory Framework for Consumer Financing

No limits are placed on the margin requirements

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

Regulations For Credit Cards

Receipt of credit cards

Statement of accounts

Unauthorized / wrong transactions

Partial payment by cardholder

Contd….

Due date for payment

Maximum card limit

Classification and provisioning

Regulations For Auto Loans

Prohibition on financing commercial vehicles

Maximum tenure of loan

Minimum down payment

Hypothecation of vehicles

Contd….

Insurance

Repossession of vehicles

Repayment schedule

Financing the purchase of used cars

Regulations For Housing Finance

Maximum per party limit.

Debt-equity ratio.

Maximum tenure of loan.

Mortgage.

Contd….

Evaluation of property

Monitoring of market conditions

Floating rate products

Classification and provisioning

Regulations For Personal Loans

Per party limit Hypothecation Maximum tenure of loan Running / revolving finance Classification and provisioning

Mirza Sheharyar BaigMIF-17

Islamic Ways of Consumer Financing

Housing Finance Arrangements Auto Loans Cards Personal Loans

Housing Finance Arrangements

Murabaha Ijara Muntahia Bittamleek Istisna Diminishing Musharaka

Housing Finance Arrangements

1. Murabaha Based Housing

Long-term House Financing Introduced in Many Islamic Countries Less practicable due to

Price can’t be changed Customer can sell the house Resemblance with interest bearing

transactions

Housing Finance Arrangements

2. Ijara Muntahia Bittamleek Based

Portion, Renovation or Addition Medium-term Financing, 3-7 Years No recourse to lessee Expensive tangible items i.e. electric

equipment, air conditioners

Housing Finance Arrangements

3. Istisna Based Housing Finance Model

Construction of new houses on customer land Construction or renovation of existing house Murabaha or Patallel Istisna Basis Risky because of no guarantee from

customer and sub-contractor

Housing Finance Arrangements

4. Diminishing Musharaka Based Financing

Most commonly used and practical Shirkat-ul-Milk (Joint Ownership) Financed by agreed ratio wholly or partially by

bank Customer pays periodic rental charges along

with price of the units

Housing Finance Arrangements

Continued: Ways of Contracts:

• Renovation or Construction• Customer own land to construct house• To buy completely build house/flat

(Cost of purchased is borne in agreed ratio)

Auto Loans

Car Financing Car Leasing

Auto Loans

Car Financing

“Providing loan to the customer for purchase of a car”

It is done through Car Murabaha

Auto Loans

Car Leasing

“Car remains in the ownership of financier and customer pays the rental charges to financier till the end of the term”

It is done through Car Ijara Scheme

CUSTOMERISLAMIC BANK

The customer approaches the Bank with the request for Ijarah financing and enters into a promise to lease agreement.

The Bank purchases the item required for leasing and receives title of ownership from the vendor

The Bank makes payment to the vendor

VENDOR. .

Agreement-1

Process of Ijarah

CUSTOMERISLAMIC BANK

The Bank leases the asset to the customer after execution of lease agreement.

The customer makes periodic payments as per the contract.

At the end of the tenure customer can purchase the asset from the bank with the help of separate Sale agreement.

VENDOR. .

Agreement-2

Process of Ijarah

Cards

Credit Cards Debit Cards ATM Cards Charge Cards

Cards

Credit Card Allowed in following situations

• Traveling abroad or out of city where cash may not be carried

• Payment on internet• Purchasing valuables• Extreme emergency• Iztirar (Compulsion)

Cards

Debit Cards ATM Cards Charge Cards

“All are allowed and bank can charge a periodic reasonable service charges”

Personal Loans

Motives of Personal Loans

Purchase of Assets Payment of Expenditures

Personal Loans

Purchase of Assets

“Loan is offered under the principles of Murabaha and Ijara Muntahia Bittamleek by Islamic Financial Institutions”

Personal Loans

Payment of Expenditure

Interest-free loan or Qard-e-Hasana Sale and Lease back under Ijara Not consumable items Buy back of Assets (Iztirar) Any type of items Tawarruq (Iztirar) Blue-chip security

Kaneez Fatima MIF-21

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.

Contd…

Umbreen AkhterMIF-23

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.

Contd…

4. Deteriorating quality of service

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

5. Poor information disclosure practice

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

Contd…

6. Lack of consumer education

The technical documents prepared by the banks affects the financial rights of uneducated customers.

Contd…

7. 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

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 i.e. Compounding is not allowed by SBP

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

Contd….

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

Bankers must have a positive attitude towards the customer

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

Contd….

There should be a unified principles of Islamic Finance.

Islam has very flexible finance principles

Question Answer Session