Chapter 12: Consumer Banking

CHAPTER - 12

Consumer Banking

Consumer Banking is the direct execution of transactions between a

bank and its consumers, rather than with corporations or other banks. It
may also be used to refer to a division of a bank dealing with retail
customers and can also be termed as Personal Banking or Retail
Banking.
Services offered include savings and transactional accounts, mortgages,
personal loans, debit cards, and credit cards. The term is generally used
to distinguish these banking services from investment banking,
commercial banking or wholesale banking.

Consumer Banking Products:

Consumer banking products and services are broadly divided into
categories:

Asset Products / Consumer Financing

 Personal Loan
 Credit Card
 Auto Loan
 Home Loan

Liability Products
 Checking Accounts
 Remittance Services
 Debit Card / ATM Card
 Internet Banking
 Electronic Banking
 Online Banking
 Phone Banking

Consumer Financing
The term ‘Consumer Financing’ generally refers to:

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“Any kind of lending to consumers by the banking sector and
financial institutions”.

According to the Prudential Regulations for Consumer Financing (PRCF) of the

State Bank of Pakistan (SBP), consumer financing means:
“Any financing allowed to individuals for meeting their personal, family or
household needs”.

In simple words, it is a type of service that is designed to provide the

individuals with necessary finance for personal purchases ranging from
buying a car, shopping purchases, to buying a house. The concept of
consumer financing is based on the need for an institutional
arrangement that provides consumers with financing support to enhance
their consumption and, as a result, improve their standards of living
while complementing manufacturing and trading activities.

Overview
The banking sector in Pakistan has been robustly engaged in consumer
financing over the last decade or so by introducing a variety of products.
The excess liquidity in banks due to high inflow of remittances after 9/11
stimulated the banks to get into this business.

Since then, it has grown at a very fast rate. The consumer loans reached
Rs.354.4 billion during this period. The banking sector is earning record
profits by charging unrealistic and exceptionally high interest rates. As a
result, despite considerable ratio of non-performing loans, the annual
profitability of banks has reached 76% on annual basis over the last few
years. This is evident from the pre-tax annual profit of all banks, which
was Rs.7 billion in 2000, but jumped to Rs.123.4 billion in 2006.

The competition to acquire maximum share of consumer financing,

exposed the banks to very high risk because of immature consumer
financing market and lack of customer knowledge. This resulted in high
default rates and increase in non-performing portfolio (NPLs), having
adverse effects on profitability. In recent years, deceleration trends are on
the rise consumer financing due to increasing loan default and use of
credit worthiness information by the banks.

Prudential Regulations for Consumer Financing

In Pakistan, all consumer financing are governed by the rules and
regulations set forth by State Bank of Pakistan in Prudential Regulations
for Consumer Financing and Prudential Regulations for House
Financing. These regulations are amended from time to time by SBP to
effectively monitor, regulate and promote consumer financing in the
country. Every bank has to fully comply with these regulations while
designing a consumer financing product. Highlights of these regulations
are as follows:

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Minimum Standards for Consumer Financing Activities

The minimum standards to be observed while carrying out consumer
financing activities include risk management process, such as
identification of repayment source and assessment of customer’s ability
to repay, record of customer’s dealings with banks and the latest
information obtained from CIB about credit worthiness of the customer.
Besides, the PRCF require the banks to obtain written declaration from
the customer containing details of all consumer financing facilities of
other banks availed by the customer. The objective is to help banks avoid
exposure against a person having multiple facilities from different
financial institutions on the strength of sole source of repayment. In
many cases, the banks do not obtain this declaration, and process the
applications with minimum documentation with the aim of profit
maximization. In addition, the internal audit and control system, as well
as, properly equipped and managed accounting and computer systems
are also requisites for processing and management of consumer
financing activities.

Margin Requirements
A noteworthy point is that the regulations do not put any limit on the
margin requirements on consumer financing facilities provided by the
banks. They have been given discretionary powers to decide the margin
requirements after assessing the risk profile of the borrower. However,
the SBP has the authority to fix or reinstate margin requirements on
consumer financing facilities for various purposes, as and when
required. In addition, the restrictions applicable on
corporate/commercial banking have been declared applicable on
consumer financing activities, which would assist the banks to lend in a
secure manner.

Borrower’s Eligibility:
All the banks are required to develop a special programme including the
objective and qualitative parameters for the eligibility of the borrower.
The regulations on credit card have limited the maximum unsecured
limit to a borrower to Rs.500,000. This ceiling also includes the limit
assigned to any supplementary credit cards. The bank is required to
provide the credit card holders a statement of account at monthly
intervals, unless there is no transaction or outstanding balance on the
account since last statement.

Generic Terminology:
General terms that you need to know regarding any bank financing are
as follows:

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Secured Finance
Any financing against which collateral is held by the bank to ensure
payback of the loan. The security may be of any type which bank finds
satisfactory.

Unsecured Finance
Type of financing which is granted without taking any security.

Term Finance
Financing which is granted for a fixed term i.e 1 year, 2 years, 3 years
and so on. Repayment of the loan is done in Equal Monthly Installments
which includes both markup and principal amount. At the end of the
term, all the principal amount and markup stands adjusted.
EMI = Principal Portion + Markup Portion

Running Finance
Running finance is type of finance allowed for one year. The customer
has to pay only the accrued markup every month or every quarter as the
case may be. However, the facility must be Cleaned Up every year. At the
end of one year this facility may be extended for another year or
discontinued on the basis of conduct of account. Running finance is also
known as revolving facility or revolving line of credit.

Types of Collateral
Securities held by banks to secure financing are of various types:
 Liquid Security: Cash Security or Near Cash Security
 Hypothecation: Stock or work in process.
 Pledge: Stock/raw materials
 Mortgage : Immovable Property
 Lien : Movable and Immovable Property

Repayment Capacity
Customer’s ability to service markup and repay the principal amount is
called repayment capacity.

Debt Burden
Debt Burden or Debt Burden Ratio is the proportion of monthly
installment(s) or monthly markup amount to consumer’s total income.

DB = Total Amount of Monthly Payments to All Banks

R
Net Monthly Income of Consumer

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Clean Up
As per the requirements of State Bank of Pakistan, every running finance
facility must be adjusted in full for atleast one day in a year. This is
called clean up of facility.

Non-Performing Loan (NPL)

A loan is nonperforming when payments of interest and/or principal is
past due by 90 days or more and there are other good reasons to doubt
that payments will be made in full.

Provisioning
It is the process of creating provision for bad debts or bad loans. In
Pakistan, the provisioning is done on the basis of loan classification
defined by SBP and such bad debts are called classified loans.

Loan Classification
In common words a classified loan is a loan which is not regular and is
experiencing any problem.
Prudential Regulations of SBP comprehensively covers this topic and SBP
have provided guidelines for banks to report their loans when they are
not behaving regular. Regulation R-11 of PRs deals with the
CLASSIFICATION AND PROVISIONING FOR ASSETS.
There are two types of classification:
i). Time-Based Classification and
ii). Subjective Classification 

Time-Based Classification
In time based its obvious that we have to consider the time period in
order to classify the loan, Annexure III of SME PRs gives the following
time based criteria for classification of loans, on the basis of this
classification the SBP has provided the guidelines to make proper
provisioning of income, details of which are available in PRs.
Time Based classification is different in different sectors, i.e. Agriculture,
Consumer. Check PRs of those sectors for further detail.

Sub-Standard :       Markup or Principal overdue by 90 days or more 

Doubtful :               Markup or Principal overdue by 180 days or more 
Loss:                      Markup or Principal overdue by 365 days or more 

Subjective Classification
In addition to the time-based criteria prescribed in Annexure-III,
subjective evaluation of performing and non-performing credit portfolio
shall be made for risk assessment and, where considered necessary, any
account including the performing account will be classified, and the

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category of classification determined on the basis of time based criteria
shall be further downgraded. Such evaluation shall be carried out on the
basis of credit worthiness of the borrower, its cash flow, operation in
the account, adequacy of the security, inclusive of its realizable value
and documentation covering the advances.
Hence, reason for subjective classification can be anything which shows
some irregularity in the loan and give a hint that loan is attracting
classification. Such classification help banks to make proper provisions
and closely monitor such loans in order to minimize risk and NPLs.

Consumer Financing Issues:

Consumer financing has expanded in Pakistan at an unprecedented
growth rate over the last seven years. The banks have intensively
capitalized upon the demand for consumer financing and earned record
profits within the generous space for credit policy provided by the State
Bank of Pakistan (SBP). This space has further motivated the banks to
get into unsolicited financing by aggressively marketing products even
where no genuine demand exists. Despite that a regulatory framework is
in place, the banks appear to have failed in terms of full compliance with
SBP regulations, and in satisfying majority of their customers against
various service parameters.

Impact on Macroeconomic Scale:

From the macroeconomic standpoint, consumer financing has
significantly contributed to 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, the
manner in which consumer financing is being delivered has seriously
endangered the competitiveness in economy.

High Spreads:
The most important issue is that Pakistan has one of the highest interest
rate spread in the world. An analysis of the interest rate behavior in
Pakistan reveals that the spread has vacillated between 5.95% and
9.58% during the period from 1990 to 2005. In recent years, the spread
has exceeded 7% on the average. High interest rate spread indicates that
competitiveness in the banking sector in Pakistan is either absent or is
very poor.

Weaker Control Over Interest Rates

A cartel-like behavior in banks appears to have taken place within the
policy space provided to the banks by the State Bank of Pakistan. This
issue is largely attributable to weak regulation of interest rates despite
that the State Bank has the powers to control the spread through
monetary policy. While non-operating loans and high administrative
costs could be considered as the major reasons in countries where
spread is high, these cannot be said true of Pakistan because banks are

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earning huge profits at the cost of savings of the depositors. High interest
rate spread is damaging the competitiveness in economy in general, and
in the financial sector in particular. The State Bank should exercise its
powers to determine reasonable rate of returns for the banks as well as
the depositors. As a matter of priority, interest rate spread should be
reduced, at least, to the level of average spread in the South Asian
region.

Variable Interest Rates

Another critical issue is that almost all consumer loans are on the basis
of variable mark up, which has reduced the loan servicing capacity of the
borrowers due to progressive increase in the rates. In addition, the
growth in consumer financing has put great inflationary pressure on the
economy. Acquisition of easy bank credit by the household consumers
has spurred the demand for many essential and luxury items.
Ultimately, the increase in demand has not only escalated the prices of
essential items, but has also stimulated hoarding and black-marketing
thus multiplying the problems for poor consumers. In fact, proliferation
of loans has given rise to new development challenges. For instance, the
need for new roads in metropolitan cities is directly linked with growth in
auto loans provided by the banks.

Lack of Consumer Education:

Lack of consumer education on banking terms and conditions, policies,
rules, and regulations is also a critical factor in securing financial rights.
As the consumer financing portfolio is increasing, quality of related
banking services is becoming a serious issue. Processing delays, service
inefficiencies, unauthorized debits and non-compliance with requirement
of providing monthly bank statements are few examples of poor quality of
banking services. For example, in the first eight months of the operation
of Banking Ombudsman in 2005, about 40% complaints filed with the
Ombudsman related to consumer products, and among these
complaints, 30% were related to credit cards alone.

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