consumer finance report 29.07

Consumer Financing in Pakistan:

Issues, Challenges and Way Forward

Consumer Financing in Pakistan: Issues, Challenges and Way Forward

ISBN: 978-968-8525-30-9 Published by Consumer Rights Commission of Pakistan (CRCP) P.O. Box: 1379, Islamabad, Pakistan Tel No: +92-51-111-739-739 Fax No: +92-51-2825336 E-mail: [email protected] Website: www.crcp.org.pk ©2008 Consumer Rights Commission of Pakistan Sponsored by: The Asia Foundation, Pakistan Reproduction is authorized, except for commercial purposes, provided the source is acknowledged.

Consumer Financing in Pakistan: Issues, Challenges and Way Forward 74

Acknowledgements

The study was designed and executed by a core research team comprising Mr. Mazhar Siraj, Mr. Ahmed Mukhtar, Ms. Rabia Shabbir, Mr. Riaz Ahmed, and Ms. Rizwana Shabbir. Mr. Abrar Hafeez, Secretary General Consumer Rights Commission of Pakistan and Dr. Salman Humayun, Director Institute of Social and Policy Sciences (I-SAPS) provided technical inputs at the stages of design and data analysis. CRCP appreciates the commitment and inputs of all these individuals as well as the field team. We are also thankful to the State Bank of Pakistan (SBP), selected schedule banks, and the individual borrowers for providing necessary information in interviews and in response to our formal information requests. CRCP is thankful to The Asia Foundation, Pakistan for providing financial as well as technical support for this study. We are grateful to Mr. Jon L. Summers, Country Representative, Mr. Zahid Elahi, Mr. Shahnawaz Mahmood, and Ms. Faiza Inayat from The Asia Foundation for their valuable insights for improvement of the study design, data analysis, and reporting. Thanks are due to Ex-Country Representative of the Foundation, Mr. Hamid Sharif, for his useful insights at the initial stages of the research.

The draft report was sent to a number of think tanks for comments and suggestions. We received very useful suggestions from Social Policy and Development Centre (SPDC), Competition Commission of Pakistan (CCP), The Network for Consumer Protection, and Delhi-based non-governmental think tank, Consumer Unity & Trust Society (CUTS). CRCP appreciates the cooperation of Dr. Khalida Ghaus and the review team from SPDC, Dr. Joseph Wilson from CCP, and Mr. George Cheriyan, Mr. Rajeev D. Mathur and Mr. Pradeep S. Mehta from CUTS. Their inputs helped us to beef up the analysis presented in the report.

Table of Contents

Table of Contents

Acknowledgements .......................................................................... ii

Acronyms……. .................................................................................. I

Foreword……...................................................................................II

Executive Summary ....................................................................... III

CHAPTER 1

Introduction ................................................................................... 29

1.1 Defining ‘Consumer Financing’ ..................................30

1.2 Objectives of the Study ................................................31

1.3 Methodology ................................................................32

1.3.1 Literature Review................................................ 32

1.3.2 Surveys of Borrowers and Banks ........................ 33

1.3.3 Key Informant Interviews ................................... 34

1.3.4 Short Stories ........................................................ 34

1.4 Limitations ...................................................................35

Chapter 2

Regulatory Framework for Consumer Financing ....................... 37

2.1 Prudential Regulations for Consumer Financing .........38

2.2 Guidelines for Standardization of ATM Operations ....42

2.3 Guidelines for Dealing with Customer Complaints .....43

2.4 Credit Information Bureau ...........................................44

2.5 Redress Mechanisms for Consumer Complaints .........45

2.5.1 Internal Complaint Units/Sections of Banks....... 45

2.5.2 Banking Ombudsman.......................................... 46

2.5.3 Consumer Protection Department ....................... 48

2.5.4 Banking Courts for Recovery of Loans .............. 48

2.6 The Financial Institutions (Recovery of Finances) Ordinance, 2001 ...........................................................50

2.7 The Payment Systems and Electronic Fund Transfers Act, 2007 ......................................................................53

2.8 The Competition Ordinance, 2007 ...............................54

Chapter 3

Key Issues in Consumer Financing:An Overview ....................... 57

3.1 Growth of Consumer Financing in Pakistan ................58

3.2 Issues and Challenges from a Consumer Perspective ..63

3.2.1 High Interest Rate Spread ................................... 63

3.2.2 Variable Interest Rate ......................................... 66

3.2.3 Increasing Inflationary Impact ............................ 67

3.2.4 Deteriorating Quality of Services ....................... 67

3.2.5 Unsolicited Financing ......................................... 69

3.2.6 Lack of Consumer Education.............................. 69

3.2.7 Poor Information Disclosure Practices ............... 70

3.2.8 Loosing Competitiveness in International Trade 71

3.2.9 Intimidating Recovery Practices ......................... 72

3.2.10 Weaknesses in Regulatory Framework ............... 73

Table of Contents

Chapter 4

ATM and Credit Cards .................................................................. 74

4.1 ATM and Credit Card Consumption Patterns ..............75

4.2 Reasons for Choice of Bank for Credit Card ...............76

4.3 Credit Card Charges & Terms and Conditions ............76

4.4 Time Taken for Processing of Applications for ATM and Credit Cards ..........................................................78

4.5 Common Problems faced by ATM Users ....................80

4.6 Common Problems faced by Credit Card Users ..........81

4.7 Regular Statements and Updates .................................81

4.8 Registration of Complaints ..........................................83

4.9 Nature of Complaints ...................................................84

4.10 Response Time .............................................................84

4.11 Overall Satisfaction with ATM and Credit Cards........85

Chapter 5

Auto Loans ................................................................................... 86

5.1 Patterns of Access to Auto Loans ................................87

5.2 Factors Affecting the Choice of Bank for Auto Loans 89

5.3 Information about Terms and Conditions & Charges ..89

5.4 Delays in Application Processing ................................91

5.5 Duration for Car Delivery after Approval of Loan Application ...................................................................93

5.6 Regular Updates ...........................................................94

5.7 Premature Full Payment ...............................................94

5.8 Registration of Complaints against Banks ...................95

5.9 Nature of Complaints ...................................................96

5.10 Time Consumed in Resolution of Complaints .............96

5.11 Satisfaction with Redress of Complaints .....................97

5.12 Problems related to Auto Insurance .............................97

5.13 Overall Satisfaction with Auto Loan Services .............98

Chapter 6

Personal Loans ................................................................................ 99

6.1 Patterns of Access to Personal Loans ........................100

6.2 Factors Affecting the Choice of Bank. ......................101

6.3 Information about Charges & Terms and Conditions 102

6.4 Time Taken for Processing of Loan Application .......104

6.5 Regular Updates .........................................................105

6.6 Registration of Complaints ........................................106

6.7 Nature of Complaints .................................................107

Chapter 7

House Financing ............................................................................ 109

7.1 Patterns of Access to House Financing ......................110

7.2 Factors Affecting the Choice of Bank .......................111

7.3 Information about Terms and Conditions & Charges 112

7.4 Delays in Processing of Application ..........................114

7.5 Duration of Loan Disbursement after Approval of Application .................................................................116

Table of Contents

7.6 Provision of Updated Information .............................116

7.7 Registration of Complaints against Banks .................117

7.8 Nature of Complaints .................................................117

7.9 Time Consumed in Resolution of Complaints ...........118

7.10 Problems Related to Housing Insurance ....................118

7.11 Satisfaction with Redress of Complaints ...................119

7.12 Overall Satisfaction with House Financing ...............120

Chapter 8

Conclusions and Recommendations ............................................ 121

8.1 Interest Rates and Competition in Banking Sector ....122

8.2 Compliance with SBP Regulations ............................123

8.3 Transparency and Access to Information related to Consumer Financing Products and Services ..............123

8.4 Consumer Education ..................................................124

8.5 Complaint Redress Mechanism .................................125

8.6 Bank Charges .............................................................125

8.7 ATM ………………………………………………...126

8.8 Sustainability of Consumer Financing Sector............126

Bibliography ................................................................................. 127

Annex I List of Selected Banks ............................................ 129

Annex II List of Interviews .................................................... 130

Annex III List of Banking Courts .......................................... 131

Annex IV List of Tables .......................................................... 132

Annex V List of Charts .......................................................... 134

Annex VI List of Boxes ............................................................ 135

Glossary…….. ............................................................................... 136

Consumer Financing in Pakistan: Issues, Challenges and Way Forward I

Acronyms

ATM Automatic Teller Machine

BSD Banking Surveillance Department

BTF Balance Transfer Facility

CFC Card Facilitation Centre

CIB Credit Information Bureau

CPD Consumer Protection Department

CRCP Consumer Rights Commission of Pakistan

CWR Credit Worthiness Report

DFI Development Finance Institutions

EFT Electronic Funds Transfer

GDP Gross Domestic Product

GSAO Guidelines for Standardization of ATM Operations

LPB Local Private Bank

MCB Muslim Commercial Bank

NBFI Non-Bank Financial Institution

NPL Non-Performing Loan

PRCF Prudential Regulations for Consumer Financing

PSCB Public Sector Commercial Bank

PSD Payment System Department

SBP State Bank of Pakistan

SVC Stored Value Card

TAF The Asia Foundation

NBP National Bank of Pakistan

HSBC Hong Kong and Shanghai Banking Corporation

HMBL Habib Metropolitan Bank

FWBPL First Women Bank of Pakistan

EGIB Emirates Global Islamic Bank

ACB Askari Commercial Bank

ABL Allied Bank Limited

Consumer Financing in Pakistan: Issues, Challenges and Way Forward II

Foreword

This study is the result of research undertaken by Consumer Rights Commission of Pakistan (CRCP) and The Asia Foundation (TAF). It presents a critical analysis of the regulatory framework for consumer financing, emerging issues from micro and macro standpoints, and the nature and magnitude of consumer grievances. Drawing on secondary data sources and user surveys, the study is one-of-its kind as it covers all main consumer financing products including credit cards, car financing and leasing, personal loans, and house financing. It provides evidence-based proposals for designing and implementing strategic and practical interventions to strengthen the regulatory mechanism for strengthening the consumer financing sector in Pakistan.

I can hardly overemphasize the significance of this study, given the unprecedented growth in consumer financing over the last few years. On one hand, consumer financing has made significant contribution in terms of increased consumption and investments, and on the other hand, it tends to jeopardize the competitiveness in economy. The fact that Pakistan has one of the highest interest rate spread in the world indicates that competitiveness in the banking sector is very poor. In recent years, the spread has exceeded 7% on the average. This situation calls for reduction in operational costs and effective exercise of regulatory powers to determine reasonable rate of returns for the banks as well as the depositors. In addition, the growth in consumer financing is creating inflationary pressure on the economy. The study urges the decision-makers to take practical steps for realigning the consumer financing sector in line with macroeconomic discipline.

The study also concentrates on issues in consumer awareness on banking terms and conditions, policies, rules, and regulations as a critical factor in securing financial rights. As the consumer financing portfolio is increasing, unsolicited banking, processing delays, service inefficiencies, unauthorized debits, etc. are emerging as main problems for the users of consumer financing products. Better consumer education and improved access to information are central to address these problems, in addition to strengthening the regulatory framework.

I hope that the readers would find this study useful and interesting. It is expected that the recommendations would attract the civil society organizations and the policy community to take outcome-oriented initiatives for reforms in regard to banking regulations and public grievances in the baking sector in general, and in consumer financing, in particular.

Mian Abrar Hafeez Secretary General

CRCP


Executive Summary

The banking sector in Pakistan has been robustly engaged in consumer financing over the last seven years by unleashing a variety of products. The excess liquidity in banks due to high inflow of remittances in the 9/11 aftermath stimulated the banks to get into this business. Since then, it has swelled at an unprecedented growth rate. The consumer loans reached Rs.325 billion during 2006, whereas till June 2007, they further increased to Rs.354.4 billion. 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. In recent months, deceleration trends are on the rise consumer financing due to increasing loan default and use of credit worthiness information by the banks.

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 jeopardized the competitiveness in economy. 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. A cartel-like behaviour 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 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.

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

Executive Summary

Consumer Financing in Pakistan: Issues, Challenges and Way Forward IV

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.

From a consumer perspective, consumer financing has been helpful in improving the quality of life of the people who have the capacity of servicing the loans. However, there is mounting evidence that this capacity is deteriorating due to high spread and variable interest rates on loans. Depositors are not getting due returns due to high difference between lending and deposit interest rates. Further, the volume of consumer complaints is rising day by day due to processing delays, service inefficiencies, hidden charges, and poor disclosure practices. 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.


CHAPTER 1

Introduction

Key Issues in Consumer Financing: An Overview


Introduction Over the last seven years, Pakistan’s banking sector has robustly engaged in consumer financing by unleashing a variety of products such as credit cards, auto loans, housing finance, and personal loans, etc. The unprecedented growth of consumer financing is largely attributed to the liberal economic policies attuned to the principles of free market economy, and huge liquidity available to the banks in the aftermath of 9/11. This environment prompted many banks to make their pie of profits bigger by selling consumer financing products through tactical and persuasive strategies, even where no genuine demand existed. As a result, supply-driven approach and aggressive marketing have further catalyzed the boom.

From a macroeconomic standpoint, consumer financing has considerably 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. In tandem with this development, a number of problems and challenges have emerged with adverse effects on the national economy as well as the individual consumers. At the macroeconomic level, the boom in consumer financing has demonstrated strong inflationary impact despite stringent monetary policies. Personal and auto loans, for example, have resulted in increased demand for consumer goods, expansion of road networks, and imports of petroleum products. From a consumer’s standpoint, a whole plethora of issues has emerged as a result o unfair profit-earning strategies of banks in absence of consumer awareness about terms and conditions, rules, and regulations, etc.

In this context, Consumer Rights Commission of Pakistan (CRCP) has undertaken this research with financial support of The Asia Foundation. The main objective is to map and highlight the emerging issues and challenges associated with consumer financing. The emphasis rests on identification of weaknesses in regulatory framework from a consumer perspective within broader macroeconomic context. This chapter introduces the concept, rationale, objectives, methodology and limitations of the study.

1.1 Defining ‘Consumer Financing’

The term ‘consumer financing’ refers to any kind of lending to consumers by the banking sector and financial institutions. 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.1

1 A.B. Shahid, ‘Consumer Finance: What are its Chances of Success?’ Pakistan Economist. March

10-16, 2003. http://www.pakistaneconomist.com/database1/cover/c2003-14.asp

At the

macroeconomic

level, the boom

in consumer

financing has

demonstrated

strong

inflationary

impact despite

stringent

monetary

policies.



In this study, CRCP has used the term ‘consumer financing’ as it is defined in the Prudential Regulations for Consumer Financing (PRCF) of the State Bank of Pakistan (SBP). According to the Regulations, consumer financing means “any financing allowed to individuals for meeting their personal, family or household needs”.2 Thus, corporate or commercial consumers are excluded from this definition.

Consumer financing is broadly categorized into the following four types of products:

Personal Loans: Personal loans include the loans provided to individuals for the payment of goods, services and expenses, and include ‘running finance’ as well as ‘revolving credit’ to individuals. The running finance is a credit facility established for a specific time limit at variable interest rates whereas revolving credit is a line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. Besides, in revolving credit, the loan is repeatedly available up to a specified amount as periodic repayments are made.

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.

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.

Credit Cards: Credit cards include any card, which a customer can use to borrow credit from a bank. According to the PRCF, credit cards include charge cards, debit cards, Stored Value Cards (SVC), and Balance Transfer Facility (BTF). Supplementary credit cards are considered part of the principal borrower according to the Prudential Regulations, whereas Corporate Cards are not included in this category.

This study focuses on all these products including Automated Telling Machine (ATM) Cards. ATM Cards were included in the study due to their widespread use by salaried and middle income consumers. The SBP has notified separate Guidelines for Standardization of ATM Operations (GSAO). CRCP has used the definitions of these terms as given in the PRCF and GSAO.

1.2 Objectives of the Study

Keeping in view the growth of consumer financing and emergence of issues and challenges associated with it, CRCP has developed this study using a consumer lens. The main objectives are to

2 State Bank of Pakistan, Prudential Regulations for Consumer Financing. Part A: Definitions. 2003.

The running

finance is a

credit facility

established for a

specific time

limit at variable

interest rates

whereas

revolving credit

is a line of credit

where the

customer pays a

commitment fee

and is then

allowed to use

the funds when

they are needed.



• Present an objective and fair mapping of the public concerns and regulatory weaknesses related to consumer financing and insurance services in Pakistan;

• Prescribe solutions to address the missing links in regulation and consumer education so that legally enforceable financial rights of the citizens could be promoted and protected;

• Provide thoroughly researched evidence for designing and implementing strategic and practical interventions to strengthen the regulatory mechanism for addressing the grievances in consumer financing and related insurances services;

• Help identify the spheres, both from macro and micro finance standpoints, where consumer education and awareness are lacking; and

• Propose an agenda for reforms on which civil society organizations and the policy community could follow-up for outcome-oriented initiatives for reforms in consumer financing regulations, consumer education, and public grievance redress mechanism.

1.3 Methodology

This study is based on literature review, primary data collected through surveys of borrowers and banks, information collected from key informant interviews and short stories on selected issues. In the following paragraphs, a brief description of each of these methods is provided.

1.3.1 Literature Review

A comprehensive literature review was undertaken at the initial stage of the research. This included a critical review of relevant rules, regulations, guidelines and policies of SBP. Main documents reviewed included (i) Prudential Regulations for Consumer Financing, (ii) Guidelines for Standardization of ATM Operations, (iii) Guidelines for Dealing with Customer Complaints, (iv) Credit Information Bureau Rules and Regulations, (v) The Financial Institutions (Recovery of Finances) Ordinance, 2001, and (vi) Payment Systems and Electronic Fund Transfer Act, 2007. In addition, complaint redress procedures of banks, SBP, Banking Courts, and Banking Ombudsman were also reviewed.

In addition to the regulations, guidelines, policies, etc., secondary sources including research papers, reports, publications, and articles developed by various institutions and individual authors were also consulted to substantiate the findings of the study. Relevant studies conducted in other countries such as India and Bangladesh were also reviewed.



Findings of the review are presented in chapters 2 and 3.

1.3.2 Surveys of Borrowers and Banks

CRCP conducted surveys of borrowers and banks in Rawalpindi, Islamabad, and Karachi. Data about the nature of public grievances and concerns was collected through exit interviews of borrowers of 15 scheduled banks. The banks were selected using stratified systematic sampling technique. This method was chosen for two reasons: First, it provided unbiased parameters for selection of the banks, and thus possibility of interference of personal preferences was eliminated. Repetition of the sampling procedure by any person would produce the same list of banks. Second, this method improves the accuracy of estimation by focusing on all important subgroups. An explanation of the procedure applied is provided below:

CRCP collected the list of all banks from Quarterly Performance Review of the Banking System (June 2007). Later, the list was updated keeping in view the merger of Prime Commercial Bank with the ABN Amro and merger of PICIC Commercial Bank with the NIB Bank. In the final list, all commercial banks were divided into three strata/groups namely Public Sector Commercial Banks (PSCBs), Local Private Banks (LPBs) and Foreign Banks (FBs). These strata were mutually exclusive and every bank in the list was assigned to only one stratum/group. In addition, the strata were also collectively exhaustive, as no bank was excluded from the list. Out of total banks, a representative sample consisting of 15 banks (representing 42.8% of all banks) was selected. List of selected banks is given in Annex I.

The sample was chosen from each stratum in proportion to their original ratio in the list of banks. To make the selection of sample objective and representative, the list of banks was arranged in alphabetical order after eliminating the commonly used terms such as ‘the’, ‘the bank’, ‘bank of’, etc. Finally, every n

th bank was selected systematically from each stratum, where n was the sampling interval. It was calculated as follows:

n (Sampling interval): Total number of banks in the stratum/ sample size of that stratum

For example, the interval for Public Sector Commercial Banks was (4/2=2)2. After finding the interval, the first bank of each stratum was selected as the random starting point.

After selection of the 15 banks, two branches of each bank were identified for interviews of borrowers. Thus, a total of 30 branches were covered in the survey. The initial idea was to select one urban and one rural branch of each bank. However, branches of most of the banks were located in urban areas only. Where rural branches existed, majority of these did not deal with any consumer financing product. As a result, only four rural branches could be included in the study. In total, 408 borrowers of these branches were interviewed using a detailed structured



questionnaire. There were separate sections for each of the four consumer financing products. In each section, questions on a range of consumer issues were asked.

After incorporating comments of experts, the final questionnaire was coded and formatted. After finalization of the questionnaire, it was pre-tested on a select group of bank customers. Then, a team of five enumerators was selected. The project team conducted a full-day training of the enumerators covering data collection techniques, item-by-item explanation of the questionnaire, and data editing in the field. A Field Supervisor was appointed from within the core team of CRCP to monitor the data collection. Filled-in questionnaires were collected on daily basis and edited by Data Editor. Data Entry Operators entered the data on daily basis using a data entry program developed in MS Excel and Visual Basics. The data were processed in SPSS according to a tabulation plan. The analysis was undertaken by a team of professionals.

In addition to the exit interviews, CRCP conducted survey of banks through physical visits and telephone. The objective was to collect updated information about various types of charges applicable on personal loans, auto loans, housing finance and credit cards.

Findings of the surveys are presented in chapters 4 to 7.

1.3.3 Key Informant Interviews

Ten key informant interviews were conducted with bankers, economists, academic experts, journalists, and consumers. These interviews helped us to identify shortcomings in the regulatory framework, common problems faced by the customers of consumer banking and inadequacies in the practices of the banking sector. Information collected through the interviews has been included in relevant sections of chapters 2 to 7.

List of people interviewed is attached as Annex II.

1.3.4 Short Stories

A number of short stories on grievances and experiences of individual borrowers and banking practices were prepared. Initially, the research team decided to develop stories on the basis of information provided by an aggrieved customer of any bank, but during this attempt, we realized that mostly customers do not keep complete record of their transactions. Therefore, it was next to impossible to provide thoroughly researched evidence. The team therefore decided to develop short stories based on personal experiences of individuals and collect case studies from other organizations and grievance redress forums working on similar issues such as The Network for Consumer Protection and Banking Ombudsman. The short stories are presented in different chapters in boxes.



1.4 Limitations

The study has been developed with a broad range of audience in mind. Consumers, bankers, economic managers, parliamentarians, researchers and civil society organizations are its main target groups. Particular focus rests on highlighting issues from a consumer perspective for general audience. Therefore, we have tried to avoid technical terms as much as possible. The terms most frequently used have been explained in relevant sections of the study.

The study covers consumer financing products being provided by the commercial banks only. The analysis does not focus on consumer financing by the DFIs. Similarly, the issues related to insurance are covered only to the extent they are related with consumer financing.

Chapters 4 to 7 are based on data collected through exit interviews and telephonic survey of selected 15 banks located in three cities, i.e. Rawalpindi, Islamabad, and Karachi. The views expressed in these chapters are those of a fairly broad group of users of personal loans, auto loans, housing finance and credit cards including ATM. The geographical limitation draws on the assumption that, given the similar characteristics of consumer financing products, and similar rules and procedures across branches of a given bank, there would be little differences in the nature of borrower’s grievances and experiences in various cities.

The survey proved to be the most challenging task because it was not possible for the survey team to access the database for selection of customers for interviews due to the banks’ restrictive policies. In Karachi, for example, the banks refused to allow the interviewers to conduct interviews within the bank’s premises. Therefore, the alternative strategy was to stand outside the main door, and interview the borrowers coming out of the bank. This approach made the task of interviewing the users of credit cards easier. However, the ratio of people who used auto loans, house finance and personal loans was very low, as they did not frequently visit the banks. Fallout of this strategy was that some customers did not give enough time for interviews. Therefore, CRCP had to conduct additional number of interviews to replace the partly filled-in questionnaires.

Another major constraint was that the banks did not provide banks desired information for analysis. CRCP requested the SBP and selected commercial for data such as total financial outlay and number of customers of credit cards, personal loans, auto financing and mortgage loans, information brochures about these products, and schedule of charges, etc. In response to our letters, the SBP provided only limited data and advised to contact each bank instead for bank-wise data. At the same time, when the banks were requested to provide the required data, none of them responded despite repeated phone calls and reminders, except three banks. Therefore, bank-specific information was collected through personal visits and telephonic survey.

The banks did

not provide

banks desired

information for

analysis.

When the banks

were requested

to provide the

required data,

none of them

responded

despite repeated

phone calls and

reminders,

except three

banks.



Lastly, this study is primarily concerned with highlighting the major issues in consumer financing from macro and microeconomic standpoints. The report does not aim to identify trends and issues during a particular year, and therefore, does not offer longitudinal analysis in a time series. Efforts, however, have been made to include latest data from reliable sources. Chapter 3 presents an analysis of secondary data covering the period from 1990 to 2008, although most of the data is concerned with years since 2001.



Chapter 2

Regulatory Framework for Consumer

Financing



Regulatory Framework for Consumer

Financing The State Bank of Pakistan (SBP) is the regulator of all scheduled banks and Development Finance Institutions (DFIs) operating in Pakistan. The regulatory framework for ‘consumer financing’ comprises SBP regulations, orders, policy directives, and its institutions mandated to deal with various aspects of credit banking (e.g. Credit Information Bureau (CIB), Banking Ombudsman, and newly created Consumer Protection Department (CPD), etc). The regulations prescribe minimum standards for consumer financing activities, impose exposure limits on banks, and provide an overall direction for provision of consumer financing services while leaving a lot of policy space to discretion of the banks. The mechanism for redress of consumer grievances related to credit cards, ATM, personal loans, housing finance and auto loans comprises of both administrative and judicial institutions. In the first place, banks have put in place internal complaint redress procedures. Where the consumers are not satisfied or are not heard by the bank, they can approach the Banking Ombudsman. Separate banking courts have also been established for dealing with loan recovery issues.

Salient features of the regulatory framework for consumer financing are discussed below:

2.1 Prudential Regulations for Consumer Financing

The SBP issued Prudential Regulations for Consumer Financing (PRCF) in the last quarter of 2003, and came into effect on January 1, 2004. Previously, prudential regulations were designed for a predominantly public sector banking system and geared towards wholesale and commercial banking. The objective of PRCF is to carefully monitor and supervise the consumer financing activities of the banks and DFIs by limiting their exposure in terms of equity, devising predefined criteria for the financial institutions undertaking this activity, and encouraging self-regulation through more transparency and greater disclosure. In this respect, disclosure requirements have been prescribed by the SBP.

Pre-operation Requirements

According to the regulations, the pre-operation requirements for undertaking consumer financing activities include preparation of a comprehensive consumer credit policy duly approved by the Board of Directors of the banks and DFIs, establishment of separate risk management capacity staffed by expert and experienced personnel, development of a specific program for every type of consumer financing activity, development and implementation of efficient computer-based Management Information System (MIS) capable of generating periodical reports, development of comprehensive recovery procedures for the delinquent consumer loans, preparation of standardized set of borrowing and recourse documents, and acquiring membership of at least one credit information bureau.

The mechanism

for redress of

consumer

grievances

related to credit

cards, ATM,

personal loans,

housing finance

and auto loans

comprises of

both

administrative

and judicial

institutions.



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 customers’ ability to repay, record of customers’ dealings with banks/DFIs 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.

Information Disclosure

An important condition in the regulations is with reference to disclosure and ethics. Under the regulations, every bank is obligated to clearly disclose, by publishing in the form of brochures, all important terms, conditions, fees, charges, and penalties for the ease and reference of customers. This pre-requisite is an important step forward by the SBP for protecting customer’s right to information. However, the manner in which this information is presented by the banks is not very helpful for customers. Most often, the banks do not disclose to the customer all applicable charges. Similarly, technical terms and types of charges used in the statements and information broachers are not fully explained. Access to information is a critical issue, which has been addressed in the regulations only partially.

Exposure Limits

The regulations are frequently updated to incorporate the emerging innovative products and risks emanating from them. They link consumer credit exposures of the banks to their track record of Non-Performing Loans (NPLs) and equity. Exposure limits have been set on part of both the borrowers and lenders. According to regulations, banks are limited to a maximum consumer credit exposure of 10 times of their equity provided that the ratio of their classified consumer loans to total loans is below 3%. However, if it is higher, the exposure limit is accordingly reduced. For example, for the ratio at 3-5%, the maximum limit reduces to 6 times of the equity and for up to and above 10%, it is reduced to merely 2 times of the equity. This linkage ensures that the total exposure

Every bank is

obligated to

clearly disclose,

by publishing in

the form of

brochures, all

important terms,

conditions, fees,

charges, and

penalties for the

ease and

reference of

customers.



to consumer credit remains within limits and is tied further to the bank’s risk mitigation ability.3

Moreover, in addition to the required provisioning, the regulations require an additional general reserve of 5% for unsecured and 1.5% for secured consumer loans as additional risk premium so that additional losses incurred could easily be absorbed without taking additional hit on capital. During 2006, the level of compliance by the banks and DFIs was assessed and these institutions were categorized into Largely Compliant, Partially Compliant and Non Compliant with respect to meeting these pre-conditions. Furthermore, to ensure safety and soundness of the bank/DFI itself, the lender is required to ascertain that the total instalment of the loan being approved is commensurate with the monthly income and repayment capacity of the borrower. The banks have also been restricted from transferring any classified loan or facility from one category of consumer financing to another.

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/DFIs. 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/DFIs 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.

Insurance Premium

The SBP has restrained the banks from charging any amount under the head of “insurance premium” unless written consent of customer is obtained in advance. This regulation relieves the customers by guarding them against forced and undesired insurance premium. However, the monthly statement and insurance premium regulations are not fully honoured by the banks.

3 Banking Surveillance Department, The Banking System Review, 2006 , State Bank of Pakistan.

p.28-29.

The SBP has

restrained the

banks from

charging any

amount under

the head of

“insurance

premium” unless

written consent

of customer is

obtained in

advance.



Auto Loans

As far as auto loans are concerned, the maximum tenure of loan cannot exceed seven years, while minimum down payment cannot fall below 10% of the value of the vehicle. The banks/DFIs are allowed to extend loan only for the ex-factory tax paid price fixed by the car manufacturers without adding any premium charged by the dealers and/or investors. The regulations also provide the opportunity of repossession of vehicle. The regulations require the bank to mention a clause of repossession in the loan agreement and publicize the maximum amount of repossession charges in the schedule of charges. Banks are not allowed to finance cars older than five years. Moreover, the banks are also required to keep the customer informed about the repayment schedule and changes made in it from time to time.

House Financing

The regulations related to house financing allow the banks to determine the finance limit, both in urban and rural areas, in accordance with their internal credit policy, credit worthiness and loan repayment capacity of the borrowers. However, the total monthly amortization payments of consumer loans, inclusive of housing finance, are not allowed to exceed 50% of the net disposable income of the prospective borrower. The maximum debt-equity ratio for housing finance has been set 85:15. The maximum time limit for housing finance is 20 years, but the regulations do not prescribe any minimum time limit. Like auto finance, provisions for housing finance have been set as 25%, 50% and 100% for the substandard, doubtful and loss categories, respectively.

Personal Loans

The personal loans cover all loans that individuals avail for the payment of goods, services and expenses. It also includes running finance/ revolving credit to individuals. The SBP has assigned a general clean limit of Rs.500,000 for all types of personal loans. The prime customers, who have extraordinary strong repayment capacity, can be assigned clean limit beyond Rs.500,000, but not more than Rs.2 million. The banks are also allowed to offer the loan up to one million, but only when the loan is appropriately secured by tangible security with appropriate margins.

The time limit set for such loans is not allowed to exceed five years except for the advances given for educational purposes, which can be extended to seven years. In case of running/revolving finance the banks are required to ensure that at least 15% of the maximum utilized loan during the year is cleaned up by the borrower for a minimum period of one week, except the banks that require their customers to repay a minimum amount each month and where the aggregate cumulative monthly instalments exceed the 15% clean up requirements. Like other consumer financing products, provision for personal loans have also been set as 25%, 50% and 100% for the substandard, doubtful and loss categories, respectively.

Banks are not

allowed to

finance cars

older than five

years. Moreover,

the banks are

also required to

keep the

customer

informed about

the repayment

schedule and

changes made in

it from time to

time.



2.2 Guidelines for Standardization of ATM Operations

ATM is among the most important e-banking delivery channels in Pakistan. It is becoming increasingly popular, as it facilitates accountholders to withdraw fast cash anytime, inquire balance, and transfer funds throughout the year. The SBP has issued separate guidelines for all the commercial banks and switch operators in order to curtail any inconvenience to the users of ATM services. The guidelines require the banks having ATMs to carry out cash balancing and reconciliation on every working day at the time fixed by their Head Office, other than the peak hours.

According to the guidelines, a process of “automatic credit” is to be carried out on the basis of verified individual transactions in which a customer’s account has been debited without any cash disbursement. Moreover, the process of “automatic credit” is to be completed within the timeframe ranging from one to seven business days, depending on the manner of execution of transaction by a cardholder of a bank. In order to facilitate the customers and meet the objectives of the ATM, banks are also required to develop a detailed documented procedure for automatic credit and carry out training of relevant staff members. The guidelines necessitate Card Facilitation Centre (CFC) in every bank. CFC is a unit responsible for managing e-banking channels and maintaining database of cases (resolved/unresolved) of its own customers and balance in suspense account. In this regard, every branch ought to report to CFC the details of claims settled, outstanding claims and balance suspense account on daily basis, to enable quick response of queries.

It is mandatory for all the banks to identify at least two key personnel of CFC, who would be responsible for responding to the queries of customers, and their contact details are to be made available on website of the bank. Furthermore, customer must be informed in writing about the amount credited to his/her account by the issuing bank. Besides, the customers are not to be charged for minimum balance when their account has been debited without cash disbursement and time for which the amount remains payable. For providing secondary evidence to satisfy the customer against cash claims, banks are required to install external camera in ATM cabins in a way that PIN may not be captured.

Moreover, the guidelines obligate all banks to report details regarding the nature of transactions (automatic credit, claims processed or outstanding balance (suspense ATM cash), and total number and amount of actual transactions to the SBP’s Payment Systems Department (PSD). In addition, every bank is required to develop a numbering sequence for complaints and every complainant is to be issued a reference number. These guidelines are applicable only on cards used on ATM machines for local currency transactions, which are carried out in Pakistan.

The guidelines

necessitate Card

Facilitation

Centre (CFC) in

every bank.

Every branch

ought to report

to CFC the

details of claims

settled,

outstanding

claims and

balance

suspense

account on daily

basis, to enable

quick response

of queries.



2.3 Guidelines for Dealing with Customer Complaints

Keeping in view the complaints received by the SBP regarding financial losses, damage to the businesses, and delayed response of banks, the SBP has issued guidelines for dealing with the customer complaints. SBP observed that due to absence of proper mechanism for resolution of public grievances, the banks are unable to respond to the customer complaints promptly and efficiently. Therefore, these minimum guidelines require every bank and financial institution to designate a senior officer to deal with all sorts of complaints, whether they are received directly by the bank or referred to by other institutions including the SBP. All banks are obligated to provide contact details of such designated officials or any change with this reference to the SBP.

According to the guidelines, the person and the unit/section appointed for this purpose is responsible for acknowledging, addressing, handling and investigating all the complaints in a fair and prompt manner. The reply to the complaints ought to be clear and indicate the reasons of the decisions taken. The complaint unit is also required to identify complaints of recurring nature for taking immediate corrective measures in the related area. In addition, the unit has been guided to monitor and analyse the status and data of complaints for improving the system. Every bank or financial institution is also required by the guidelines to submit a regular report about the complaints to the management of the bank or financial institution for review.

What is a Grievance?

‘Grievance’ may be defined as a formal statement of complaint generally against an authority, or an institution. Most often, organizations establish a body or designate an officer who deals with complaints of the clients. Such a body plays important role for identification, intervention and resolution of issues that have the potential of becoming a grievance. When the circumstances do not allow prior resolution of issues and a grievance takes place, the redress forum is responsible for initiating a grievance redress process. The aim is to protect the citizens’ right to raise a genuine issue, lodge a complaint for a grievance, and have the grievance redressed in a timely manner.

The response time for the complaints has been fixed at 10 days under the guidelines. However, an interim reply can also be sent to the complainant explaining the reasons for delay, but the final reply is to be transmitted within 45 working days. Like other departments of the bank, the complaints department/unit is also required to be regularly audited by internal auditors to check the effectiveness and performance of the unit.

For raising awareness among the customers about the grievance redress procedure and complaint unit, the banks and DFIs are required to prepare a leaflet indicating the procedure for lodging a complaint and its resolution, and post the same on the notice boards at each of their branch/office and on the website. Besides, a copy of the leaflet is to be

The reply to the

complaints

ought to be clear

and indicate the

reasons of the

decisions taken.

The complaint

unit is also

required to

identify

complaints of

recurring nature

for taking

immediate

corrective

measures in the

related area.



supplied to customer upon request. Moreover, the bank staff is to be provided appropriate training to enhance their skills so that an employee who is not directly involved with the complaint unit may investigate a complaint, if required.

The guidelines specify that the complaints forwarded by the SBP would be handled by the person who is the contact person for SBP in this regard. Whereas, the SBP would check the performance, effectiveness and function of the complaint section and strict actions would be taken against the bank or DFI and the concerned staff members for non-compliance with the procedures or mishandling of complaints.

2.4 Credit Information Bureau

CIB was established as a part of Banking Surveillance Department in 1992 by the SBP under Section 25(A) of Banking Companies Ordinance, 1962. The Bureau is a repository of credit information of borrowers. The member lending institutions provide credit data of their borrowers to the bureau which consolidates, updates, and stores the same and provides this information to its member institutions in the form of credit worthiness reports (CWR). CIB aids financial institutions to make well informed credit decisions in timely manners minimizing the credit risk. All banks, DFIs, non-bank financial institutions (NBFIs), Modarabas and microfinance banks operating in Pakistan are members of the CIB.

Confidential Credit Worthiness Reports

Mr. Zahid Ali, an accountholder of the Standard Chartered Bank, sent a letter to the Director CIB on April 16, 2007 requesting him to provide a copy of his Credit Worthiness Report. On April 25, 2007, he was informed by CIB that the report was a confidential document, and could not be provided to the individuals and corporations. Mr. Zahid Ali approached Consumer Complaint and Redress Forum (CCRF) of CRCP.

On receiving the details, CRCP reviewed the relevant SBP rules and noted that they do not allow CWR to provide a copy of the CIB to individual borrowers. However, the information on CIB website indicated that SBP was considering revising the rules, but no timeframe was set for this purpose. Keeping this in view, CRCP wrote a letter to the Director CIB on May 2, 2007 and emphasized that the report should not be treated as confidential, as every citizen has a right to access personal financial information, and get it corrected if there are errors or omissions. CRCP requested that concerned office of SBP should set a timeframe by which the rules shall be amended.

In response, Banking Surveillance Department informed CRCP that the credit information was deemed confidential and shall not be disclosed or published except with the prior permission of SBP. Under Section 25(A) of the Banking Companies Ordinance, 1962, no court, tribunal or other authority including an officer of Government shall require the SBP or any banking company to disclose any information furnished to, or supplied by, the SBP unless the rules are amended.

CIB aids

financial

institutions to

make well

informed credit

decisions in

timely manners

minimizing the

credit risk.



According to the SBP rules, CWRs are confidential documents for individual borrowers. A credit cardholder, for instance, has no right to access his own CWR, whereas the member banks and financial institutions can access the report. This practice amounts to denial of the right to one’s own personal information.

2.5 Redress Mechanisms for Consumer Complaints

A multi-tier grievance redress framework exists for dealing with public complaints related to consumer financing products and services. From the standpoint of a complainant’s convenience, the first forum is the bank’s internal complaint redress section. The complainants may also directly approach external administrative and judicial forums including the SBP, Banking Ombudsman and Banking Courts.

2.5.1 Internal Complaint Units/Sections of Banks

All banks have similar internal complaint redress mechanisms. According to guidelines issued by the SBP, all the banks are required to designate a senior officer to deal with all sorts of complaints either received directly by the bank or referred to by any other source including the SBP. All the banks are required to provide the contact details of the designated person or any change with this reference to SBP. The designated officer or unit/section is entrusted with the responsibility of acknowledging, addressing, handling and investigating all the complaints in fair and prompt manner. In addition, the banks are required to devise a system for redress of complaints. The guidelines require that reply to the complainant ought to be clear, and rationale indicating the reasons of the decision being taken should be given. The designated officer or the complaint unit/section is required to identify the complaints of recurring nature for taking immediate action in the respective area. Moreover, the unit/section should also monitor the status of complaints received, and analyze the data for improving the system. All banks are obliged to submit a regular report to the management for review, containing information regarding the volume and type of the complaints received.

According to the SBP guidelines, the response time for a consumer complaint is 10 working days. However, if a complaint requires further investigation, an interim reply should be sent indicating the reasons for the delay in response. The final response must be forwarded within 45 working days. Moreover, to check the performance, efficiency and utility of complaint unit, internal auditors are responsible to conduct the regular audit.

For raising awareness among the customers about the grievance redress procedure and complaint unit, the Banks and DFIs are required to prepare a leaflet indicating the procedure for lodging and resolution of complaints, and post the same on notice boards at each of their branch/office and also on the website. Furthermore, banks are also required to provide a copy of the leaflet to customers upon request.

The response

time for a

consumer

complaint is 10

working days.

However, if a

complaint

requires further

investigation,

the final

response must

be forwarded

within 45

working days.



All the banks and DFIs are required to provide appropriate training to their staff dealing with complaints for speedy resolution of complaints. The complaints forwarded by SBP have to be handled by the designated officer who is also the contact person for SBP in this regard. The SBP checks the performance, effectiveness and functioning of the complaint unit and action is taken against the bank and concerned staff members for non-compliance of instructions and negligence in handling complaints.

2.5.2 Banking Ombudsman

The Federal Government established the Banking Ombudsman in 2005. The principal responsibility of the Ombudsman is to resolve the complaints through mediation and provide an amicable and acceptable solution where conciliation is not possible.

Jurisdiction

The Banking Ombudsman has been entrusted with the powers and responsibilities to entertain complaints lodged by the customer against the scheduled banks or by a scheduled bank against another bank, and provide the basis for an amicable and acceptable solution after giving hearings to the complainant and the concerned bank. Moreover, Banking Ombudsman has been given authority to make recommendations, to be communicated to the concerned bank for considering the issue, and in some cases to pass an order against the concerned bank. To improve the service standards and effectiveness, and remove the generalized systematic deficiencies, the Banking Ombudsman can recommend procedural improvements. SBP can inquire the banks involved in violation of laws and regulations on recommendation of the Ombudsman.

The authority and powers of Banking Ombudsman have been specified for private and public sector banks. In relation to all banks, Banking Ombudsman has been given the authority to entertain the complaints regarding bank’s failure to act in accordance with the laws, regulations, policy directives and guidelines, which are time to time issued by SBP and inquire the delays or fraud in relation to the payment or collection of cheques, drafts or transfer of funds. Moreover, the Banking Ombudsman has also been allowed to consider the complaints regarding fraudulent or unauthorized withdrawal or debit entries in accounts, complaints from exporters or importers, complaints related to banking services and obligations including letters of credit, complaints from holders of foreign currency accounts, whether maintained by residents or non-residents, complaints relating to remittances to or from abroad and relating to payment of utility bills.

A noteworthy characteristic of the Baking Ombudsman is that it has some special powers, which do not apply to the private banks. The responsibilities of entertaining the complaints pertaining to corruption, negligence of duties by bank officers in dealing with customer and excessive delay in taking decisions can be exercised only in respect of public sector banks.

The

responsibilities

of entertaining

the complaints

pertaining to

corruption,

negligence of

duties by bank

officers in

dealing with

customer and

excessive delay

in taking

decisions can be

exercised only in

respect of public

sector banks.



In addition, Banking Ombudsman has the authority to call for relevant information necessary for disposal of complaints, receiving evidence on affidavit and issuing commission for examination of witness, given that confidentiality would not be violated.

Bar on Jurisdiction

However, there are some matters which are outside the jurisdiction of Banking Ombudsman including the power to direct banks for giving loans and advances to a complainant. Similarly, the Banking Ombudsman has no authority to consider the complaints regarding the schedule of charges and any other policy matter of banks. Likewise, complaints pertaining to terms and conditions of service of the bank are not accepted by the Banking Ombudsman. Moreover, awarding the damages against banks is not within the jurisdiction of Banking Ombudsman. However, the authority for the compensation of loss suffered by aggrieved persons in pursuit of justice lies with him.

Complaint Procedure

The complaint handling process of Banking Ombudsman is centralized at the Karachi Secretariat. The complainant is required to file a complaint to the bank in writing stating the intention to refer the matter to the Banking Ombudsman if matter would not be resolved satisfactorily. The bank is required to resolve the complaint within 45 days, otherwise the complainant can file the case to Banking Ombudsman on the complaint form duly completed, signed and attested by an Oath Commissioner, attached to the letter of complaint. Moreover, the complainants are required to make sure that copies of all documents and relevant correspondence with the bank are also attached along with the form and letter of complaint.

The Banking Ombudsman entertains those complaints, which are filed by a customer against scheduled bank or by a scheduled bank against any other bank. Further, the rejected complaints, which have not been barred by time or have not been destroyed by the bank, are also entertained by the Banking Ombudsman. In this regard, the complainant has to send all related correspondence along with the complaint form without giving 45 days notice to the concerned bank.

When a complaint is lodged to the Banking Ombudsman, first all procedural requirements are confirmed and both parties may be required to provide additional information, if necessary. Informal complaints (i.e. walk in, e-mail, copies of letters or via telephone) are resolved by providing procedural guidance to complainant. In case of formal complaints, the banks are formally informed where necessary. Regarding informal complaints, the law allows to entertain only those complaints, which have been filed directly to Banking Ombudsman and made under oath.

The Banking Ombudsman may also visit the concerned bank to examine their books, procedures and processes relating to complaints. The case is

The Banking

Ombudsman has

no authority to

consider the

complaints

regarding the

schedule of

charges and any

other policy

matter of banks.



closed if found unjustified. However, if a case is found to be genuine, then it would be resolved through mediation. The situation where conciliation is not possible, the Banking Ombudsman passes an order asking the bank to rectify the situation or compensate the loss of aggrieved.

The Banking Ombudsman solves the complaint within two months. However, some complaints may take longer to resolve if they are complex or information and copies of documents are not provided by the complainant. Therefore, a complainant is required to make sure that the complaint form has been filled in with clarity and copies of all the relevant documents are attached.

The Right to Appeal

The law provides the right to appeal to parties, the complainant and the bank. A complainant, dissatisfied with the decision of Banking Ombudsman, has the right to appeal to the Governor SBP within 30 days from the date of order of the Ombudsman. Moreover, a complainant, dissatisfied with the decision of SBP, has also been given the right to go to a court of law. However, the Ombudsman’s decision would be final, operative and binding upon the bank, if no appeal is filed or SBP does not uphold the appeal.

Several changes have been made in the Banking Companies Ordinance, 1962 through the Finance Act, 2007 empowering the Banking Ombudsman to issue commission for the examination of witnesses. In consideration of the changes, Banking Ombudsman does not entertain those cases, which have already been decided or handled by the SBP. The time allowed to banks, to send the complaint to the Banking Ombudsman if not resolved, is reduced to 45 days from three months. Earlier, there was no time limit for disposal of an appeal filed with SBP against any order by the Banking Ombudsman, which has now been limited to 60 days. Unless an appeal is referred to the Governor SBP, the time limit for implementation of an order passed by the Banking Ombudsman has been increased to 40 days and submission of compliance report is compulsory, which was not required previously.

2.5.3 Consumer Protection Department

Keeping in view the growth in consumer banking and related consumer complaints, SBP has issued a circular on January 30, 2008 for the establishment of new department, namely Consumer Protection Department (CPD). The Department would resolve consumer complaints dealing with banks. All banks and financial institutions would submit complaints and appeals against the orders passed by the Banking Ombudsman to the Consumer Protection Department.

2.5.4 Banking Courts for Recovery of Loans

Under the Recovery of Finances Ordinance, 2001, the Federal Government has been entrusted with the authority to establish banking

A complainant,

dissatisfied with

the decision of

SBP, has been

given the right to

go to a court of

law. However,

the

Ombudsman’s

decision would

be final,

operative and

binding upon the

bank, if no

appeal is filed or

SBP does not

uphold the

appeal.



courts, appoint judges for each of such courts, and specify the territorial limits to exercise its jurisdiction. For more than one banking courts in the same territorial limit, Federal Government is required to define the territorial limit of each court to exercise its authority. Moreover, High Court has been authorized to transfer a case from one banking court to another, in the same or different territorial limit, for convenience of parties or witnesses. Taking into consideration the Ordinance, Federal Government has established 29 banking courts throughout Pakistan for quick recovery of bank loans from defaulters.

Judges of Baking Courts

The Federal Government appoints a judge of a banking court for a term of three years, after consulting the Chief Justice of the High Court of the province in which banking court is established. The person appointed as judge of banking court would be a serving or retired District Judge or retired Judge of High Court. Places for banking court to hold its sittings, salary, allowances and terms and conditions of the judges are also decided by the Federal Government.

Regarding technical aspects of banking transactions, assistance is provided, if required, to the banking court by amicus curiae having degrees in Commerce and Accountant or Economics or Business Administration, or has completed a course in banking from the institute of bankers, with at least 10 years experience of banking at senior management level. Keeping in view the case, banking court decide the remuneration of the amicus curiae and the party who would pay the remuneration.

According to the Recovery of Finances Ordinance, 2001, the removal of a judge of banking court is decided after consultation with Chief Justice of High Court but judge of banking court, not being a District judge, would resign in writing under his hand addressed to the Federal Government.

Powers of Banking Courts

In accordance with Recovery of Finances Ordinance, 2001, powers of the banking courts are the same as vested in the civil courts under Code of Civil Procedure, 1908 (Act V) and in case of criminal jurisdiction, it would exercise the powers as vested in a court of session under the Code of Criminal Procedure, 1989 (Act V of 1989). Moreover, banking court is obligated not to take cognizance of any punishable offence except upon a complaint in writing made by a person authorized in this behalf by the financial institution in respect of which the offence was committed. The matters for which procedure has not been provided, the banking courts are required to follow the procedure laid down in the Code of Civil Procedure, 1908 (Act V) and the Code of Criminal Procedure, 1989 (Act V of 1989). Besides, a banking court would be deemed the Court for purposes of the Code of Criminal Procedure, 1898 (Act V of 1898) and its proceedings would be considered judicial proceedings within the section 193 and 228 of Pakistan Penal Code (Act XLV, 1860).

Taking into

consideration

the Ordinance,

Federal

Government has

established 29

banking courts

throughout

Pakistan for

quick recovery

of bank loans

from defaulters.



Procedure of Banking Courts

The customers or financial institutions can file a complaint against any financial institution or the customer, as the case may be, regarding violation of any financial obligation which would be verified on oath. All relevant documents related to grant of finance and the statement of account, which in case of financial institution is to be certified under the Bankers Book Evidence Act, 1981 (XVII of 1981), would be used to support the complaint and sufficient number of copies of the same documents would also be provided in the banking court.

In case a suit is instituted by the financial institution for recovery of finance, the financial institution is required to provide the details of finance availed by the defendant from the financial institution, amount paid by the defendant to the financial institution with dates of payment, and amount payable by the defendant to the financial institution up to the date of filing of a suit. When a complaint would be presented to banking court, summon through the bailiff or process-server of the banking court would be observed on the defendant. In such cases the complaint would be attached therewith and in all other cases the defendant would be entitled to obtain a copy of the complaint from the office of the banking court without making a written application. The banking court is entitled to ensure the publication of the summons takes place in the newspaper and a wide circulation within its territorial limits.

The order of banking court would be final and no other court or authority would have power to revise, review or call, into question any proceeding, judgement, decree or order of banking court, except the Banking Court, on its own accord or on the application of any party, as the case may be, correct any clerical or typographical mistake in any judgement, decree, sentence or order passed by it. In this respect, the SBP would not comment on disputes which have already been heard in the court.

A list of banking courts working in various districts is attached as Annex III.

2.6 The Financial Institutions (Recovery of Finances)

Ordinance, 2001

To tackle the problem of non-performing loans, a multi-track strategy was adopted by the SBP, which included enacting new laws, creation of institutions to pursue recovery of bad loans, and an incentive package for genuine cases (rescheduling of loans of those borrowers who were unable to pay due to economic constraints). Specifically, a new law, “The Financial Institutions (Recovery of Finance) Ordinance 2001” was promulgated. The new recovery law provided a mechanism for expeditious recovery of stuck up loans, e.g., the law provided a comprehensive procedure for the foreclosure and sale of mortgaged property without the interventions of a court of law, and automatic

The SBP would

not comment on

disputes, which

have already

been heard in

the court.



transfer of all cases pending in any other courts to the banking courts for their early resolution.4

Under the new legislation, banks may recover debt through summary procedure, and sell mortgaged property without intervention of the court. While this has generally had a positive effect on borrowers’ attitude, creditors have been reluctant to use the summary procedures, citing inability to register mortgaged property in the name of the new owners and cases where borrowers have been able to obtain injunctions to stop the sale.5

According to the Ordinance, a "customer" is a person to whom finance has been extended by a financial institution and includes a person on whose behalf a guarantee or letter of credit has been issued by a financial institution, as well as, a surety or an indemnifier. This definition of the term customer is specific with reference to the Ordinance and it does not include the depositors or account holders of the bank. Generally, the definition covers all the customers who are using any consumer financing product or service of the bank, but the definition is not limited to it as corporate finance customers also fall under the same definition.

Under the Ordinance, the customer is duty bound to fulfil his/her obligations to the financial institutions and upon failure to do so would be liable to pay for the period from the date of his default till realization of the cost of funds of the financial institution as certified by the SBP from time to time. This payment would be apart from such other civil and criminal liabilities that he may incur under the contract or rules or any other law for the time being in force. However, it is a note worthy point that the Ordinance does not clearly and specifically mention the duties and responsibilities of financial institutions with reference to payment procedures and charges to be incurred on the extended amount.

For dealing with the cases and disputes related to the recovery of finance, the Ordinance provides for the establishment of separate Banking Courts and appointment of judges in each such Court by the Federal Government. In case the Government establishes more than one Banking Courts, it is required to specify in the notification the territorial limits within which each of the Banking Courts shall exercise its jurisdiction.

Furthermore, whenever Banking Court requires assistance in technical aspects of banking transactions it can hire services of a technical expert - named as amicus curiae in the Ordinance - who has at least ten years of relevant experience at senior management level in a reputed financial institution or the SBP. The pre-defined qualifications for the technical expert include; a degree in Commerce and Account or in Economics; or a degree in Business Administration; or a course (successfully completed) in

4 Dr Shamshad Akhtar, Governor of the State Bank of Pakistan. ‘Pakistan’s banking sector–the need

for second tier of reforms’. Address at the Pakistan Banking Association, London, 12 November 2006.

5 Ishrat Hussain. Governor of the State Bank of Pakistan. ‘Banking Sector Reforms in Pakistan’. The

Business People’s Magazine. January 2005.

The Ordinance

does not clearly

and specifically

mention the

duties and

responsibilities

of financial

institutions with

reference to

payment

procedures and

charges to be

incurred on the

extended

amount.



banking from the Institute of Bankers, Pakistan. Remuneration of the amicus curiae, and the party or parties by whom it will be payable, is to be determined by the Banking Court, keeping in view the circumstances of each case.

Clause 7 of the Ordinance outlines the powers of Banking Courts. The Courts in exercise of its civil jurisdiction would possess all the powers vested in a Civil Court under the Code of Civil Procedures, 1908. Whereas, in the exercise of its criminal jurisdiction, the Court would try offences punishable under this Ordinance and shall, for this purpose have the same powers as are vested in a Court of Sessions under the Code of Criminal Procedure, 1898. However, the Ordinance states that Banking Court shall not take cognizance of any offence punishable under this Ordinance except upon a complaint in writing made by a person authorized in this behalf by the financial institution in respect of which the offence was committed.

Furthermore, according to sub-section 3 of Clause 7 all proceedings before a Banking Court shall be deemed to be judicial proceedings within the meaning of sections 193 and 228 of the Pakistan Penal Code (Act XLV of 1860), and a Banking Court shall be deemed to be a Court for purposes of the Code of Criminal Procedure, 1898 (Act V of 1898). With the promulgation of this Ordinance all previous proceedings pending with a Banking Court which was established under the Banking Companies (Recovery of Loans, Advances, Credits and Finances) Act, 1997 were transferred to the Banking Court having jurisdiction under this Ordinance. The proceedings of all such transferred cases were to be continued from the stage which the proceedings had reached prior to their transfer.

For instituting a suit in the Banking Court the afflicted party/person, whether it be the financial institution or the customer, is required to present a complaint which is verified on oath. The complaint is to be supported by the statement of account and other relevant documents and copies of the complaint and relevant documents are to be provided in sufficient numbers so that there is one set of copies for each defendant and one extra copy. The Ordinance outlines some important documents to be presented by the financial institution for filing a complaint. In response to the complaint the Court issues summon in a prescribed form under the Code of Civil Procedure, 1908. After receiving the summon, the defendant would be entitled to defend the suit only after obtaining leave from the Banking Court. The application for leave to defend is to be submitted before the Court within thirty days of the receipt of the summon. However, failure to obtain leave would mean that allegations of fact in the complaint are admitted and the Court may pass a degree in favour of the plaintiff.

A suit in which leave to defend has been granted to the defendant is to be disposed of within ninety days from the day on which leave was granted. In case proceedings continue beyond the said period and the delay is attributed to the defendant, he/she would be required to furnish security in such amount as the Banking Court deems fit. Suits before the Banking Courts

The Banking

Court shall not

take cognizance

of any offence

punishable under

this Ordinance

except upon a

complaint in

writing made by

a person

authorized in this

behalf by the

financial

institution in

respect of which

the offence was

committed.



are to be heard regularly, as expeditiously as possible. The adjournment of any case in the Banking Court is not to be allowed for more than seven days, except in extraordinary circumstances and for reasons to be recorded.

As far as default of mortgaged property is concerned the defaulter would be served a notice by the bank/DFI demanding payment of the outstanding amount within fourteen days from service of the notice. If the mortgagor fails to act in accordance with the notice the bank/DFI would serve second notice of demand with fourteen days duration. If the customer continues to default after second notice then the bank/DFI would send the final notice demanding the payment within thirty days form service of the final notice. After expiry of the due date given in final notice, the bank/DFI possesses the right to sell the mortgaged property or any part thereof by public auction without the intervention of any court. An important feature of the Ordinance is that it confers discretionary powers to the FI for participating in the public auction and purchasing the property at the highest bid obtained in the public auction.

The Ordinance specifically defines and categorises offences such as dishonesty, fraudulent misrepresentation and breach. The fines and costs given in the Ordinance include payment of costs of all or any proceeding under the Ordinance; and payment of compensation to an aggrieved party. There is also provision in the Ordinance for appeal against the judgment, decree, sentence, or final order passed by the Banking Court. The appeal is to be made with the High Court within thirty days of such judgment, decree, sentence or final order of the Court. However, clause of indemnity specifies that no suit, prosecution or other legal proceeding can take place against the Federal Government or Banking Court or a bank/DFI or any person for anything which is done or intended to be done in good faith under the Ordinance. The Ordinance gives powers to the Federal Government for formulation of rules under the Ordinance or removal of difficulty arising in giving affect to any provision of the Ordinance, by notification in the Official Gazette.

2.7 The Payment Systems and Electronic Fund

Transfers Act, 2007

With the rapid development in technology, like other spheres of human life business and trade are also no more limited to traditional modes of delivery of products and services, as well as, purchase and payments in cash. A person sitting at one place can buy any product from another place through internet and can pay through secured online electronic channels like credit cards. Many countries around the world have formulated laws, rules and documentation procedures for secure fund transfer through electronic means.

The Government of Pakistan promulgated the Payment Systems and Electronic Fund Transfers Act, 2007 in order to encourage documentation of economy, supervise and regulate such payments and fund transfers, provide standards for protection of the consumer and to

The Ordinance

confers

discretionary

powers to the FI

for participating

in the public

auction and

purchasing the

property at the

highest bid

obtained in the

public auction.



determine respective rights and liabilities of the financial institutions and other services providers, and their consumers and participants. The Act is aimed at providing regulatory framework for the electronic fund transfer services. Under the Act, the SBP has the authority to designate a payment system as a designated a payment system and/or revoke designation of a designated payment system.

Under the Act, the SBP is also empowered to issue rules, guide lines, circulars, by-laws or directions as it may consider appropriate. A bank, financial institution, clearing house, service provider or any person authorized by the SBP to transact business under the Act and providing funds transfer facility is required to retain complete record of electronic transactions in electronic form and ensure secure means of transfer consistent with international standards. Clause 8 and 9 of the Act describe the reasons for disqualification of staff of a designated payment system and its effects respectively. According to the Act, the operator of a designated payment system is obligated to establish adequate governance arrangements which are effective, accountable and transparent or which may be required by the SBP to ensure the continued integrity of such system.

The SBP is empowered under the Act to nominate one or more clearing house to provide clearing or settlement services for a payment system and to formulate ‘settlement rules’ relating thereto. Besides, certain conditions have been imposed in the Act for the issuance of a designated payment instrument. The financial institutions and other institutions providing Electronic Funds Transfer (EFT) facilities are required to ensure that secure means are used for transfer of funds which are compliant with current international standards. In respect of each EFT initiated by a consumer, the financial institution holding such consumer’s account is required to provide documentary proof to the consumer of such transfer.

The Act further requires the financial institution to provide periodic statement of account to each consumer in respect of each electronically accessible account. It also lays down the procedures to be followed in case of errors or omission in electronic fund transfer (EFT) and the respective liabilities of the financial institutions and consumers in such circumstances. Under the Act, a consumer may also complain to the SBP regarding EFT in case of not being satisfied with the outcome of a complaint made to financial institution without prejudice to any right to seek any other remedy under the law.

2.8 The Competition Ordinance, 2007

The Government of Pakistan, in a bid to strengthen the competition policy and law, constituted Competition Commission of Pakistan. The Commission is responsible for promotion of competition and fair trade practices. The legal mandate comes from the Competition Ordinance, 2007. All regulated sectors, including the banking sector, fall within the purview of the Ordinance.

According to

the Act, the

operator of a

designated

payment system

is obligated to

establish

adequate

governance

arrangements

which are

effective,

accountable and

transparent or

which may be

required by the

SBP to ensure

the continued

integrity of such

system.



Section 4 and 10 of the Ordinance are particularly relevant in the context of banking sector, as they deal with prohibited agreements and deceptive market practices. Section 4 lays down that no undertaking or association of undertaking shall enter into any agreements or, in the case of an association of undertakings, shall make a decision in respect of the production, supply, distribution, acquisition or control of goods or the provision of services which have the object or effect of preventing, restricting or reducing competition within the relevant market unless exempted under the ordinance. Such agreements includes, but are not limited to fixing the purchase or selling price or imposing any other restrictive trading conditions with regard to the sale or distribution or any goods or the provision of any services. Such agreements also include those, which involve dividing or sharing of markets for goods or services, whether by territories, by volume of sales or purchases, by type of goods or services sold or by any other means; fixing or setting the quantity of production, distribution or sale with regard to any goods or the manner or means of providing any services; limiting technical development or investment with regard to the production, distribution or sale of any goods or the provision of any service; or collusive tendering or bidding for sale, purchase or procurement of any goods or services; applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a disadvantage; and make the conclusion of contractors subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usages, have no connection with the subject of such contract. Section 10 of the Competition Ordinance 2007 prohibits deceptive marketing practices (which are common in the banking sector). The law provides that no undertaking shall enter into deceptive marketing practices. The deceptive marketing practices shall be deemed to have been restored to or continued to or continued if an undertake restores to the distribution of false or misleading information that is capable of harming the business interests of another undertaking; the distribution of false or misleading information to consumers, including the distribution of information lacking a reasonable basis, related to the price, character, method or place of production, properties, suitability for use, or quality of goods; false or misleading comparison of goods in the process of advertising or packing; fraudulent use of another’s trademark, firm name, or product labelling or packing.

The above review indicates that a number of mechanisms exist for dealing with public complaints and concerns that are associated with consumer financing. Still, the number of complaints is rising every year. While this trend can be measured in proportion to the increasing number of borrowers and overall consumer financing portfolio, lack of consumer education and weaknesses in the grievance redress mechanism are among the major reasons for rising customer dissatisfaction. The Banking Ombudsman is a case in point. The complex complaint

The complex

complaint

procedure and

limited powers

of the

Ombudsman do

not provide an

incentive to

many aggrieved

customers to

approach this

forum against

banks.



procedure and limited powers of the Ombudsman do not provide an incentive to many aggrieved customers to approach this forum against banks. The regulatory framework needs to be reformed keeping in view the emerging issues and challenges in consumer financing.



Chapter 3

Key Issues in Consumer Financing:

An Overview



Key Issues in Consumer Financing:

An Overview

Pakistan has witnessed phenomenal growth of consumer financing products and services over the last seven years. Most of the commercial banks are involved in consumer lending through one or more financing modes, as it has become very lucrative business due to high spread and variable interest rates. The increase in consumer financing has come with many challenges facing the national economy as well as the individual borrowers. This chapter provides an overview of the growth of consumer financing in Pakistan, and outlines major issues and challenges associated with it.

A caveat needs to be made here. This chapter does not aim to identify trends and issues during a particular period, and therefore, does not offer longitudinal analysis in a time series. The following analysis is based on a review of secondary data with focus on the years since 2001. An effort has been made to concentrate on the latest data dealing with the last three fiscal years since 2006.

3.1 Growth of Consumer Financing in Pakistan

When Pakistan came into being, the financial system consisting of the commercial banks and the non-bank financial institutions was altered by the nationalization process. All the domestic banks were amalgamated into six major national commercial banks. In addition, a Central Directorate of National Savings (CDNS) was also set up. The foreign banks, however, were not affected under the policy. The process of consolidation of all banks into six major banks was a serious setback to the banking sector, and economic growth of Pakistan. The banking system was adversely affected by the rapid expansion of branch network within the country, interest rate controls, the system of credit ceilings, subsidized loans, and directed credits and high government borrowing both from banks and national savings schemes.

During the pre-reform period, the financial sector in Pakistan mainly accommodated the financing needs of the government, of public enterprises and of priority sectors. The private sector investment remained modest, and efforts to mobilize savings lacked dynamism of a competitive financial system. Financial intermediaries were insulated from competition in the domestic market through oligopolistic practices and barriers to entry in the sector, and from outside competition through tight restrictions on current and capital accounts transactions. In such an environment, which was typical of many pre-reform situations, distortions were widespread, interest rates were generally negative in real terms, taxing savers and providing incentives to inefficient investment, credit was rationed based on government determined priorities and excessive regulations hindered the activity of financial intermediation.

During the pre-

reform period,

the financial

sector in

Pakistan mainly

accommodated

the financing

needs of the

government, of

public

enterprises and

of priority

sectors.



Consequently, economic efficiency remained low and growth suffered from relatively low savings and investment rates in the private sector.6

To enhance the efficiency and promote competition among the banks and establish a market-based system of financial intermediation, the Banks (Nationalization) Act, 1974, was revised in 1991. In this regard, the two state owned banks, MCB and ABL, were privatized and the SBP was given the complete autonomy. In the late 1996, the financial structure was on the verge of collapse and the banking losses increased as 90% loans of NCBs and DFIs defaulted. The interest rate spread also increased from 6.02% during 1990-95 to 8% in 1996.

Therefore, in 1997, second phase of banking sector reforms was introduced, which fully liberalized the bank branches and allowed the private banks to grow faster and increase their market shares. The weighted average lending rates increased from 14.4% in 1996 to 14.6% in 1997. Similarly, the weighted average deposit rates increased from 6.4% in 1996 to 6.8% in 1997. However, the interest rate spread decreased nominally (7.8% in 1997) which again increased to 8.8% in 1998. The interest rate spread remained high in Pakistan during 1998-2002, ranging from 8.05% (2000) to 9.58% (2002), which is an indicator of little competition among banks. Nevertheless, the reforms could not succeed in increasing the efficiency and competition in the banking sector.

In the pre-reform period, interest rates were controlled from both sides, with floors on deposit rates and ceilings on lending rates. These controls were motivated by a desire to provide low cost funds to encourage investment, particularly for priority sectors, and to safeguard against their increase. Interest rate spread increased from 3.9% in 1990 to 4.7% in 2000, indicating decreased efficiency. Spread between weighted average lending and deposit rates widened much further, from 2.4% in 1990 to 8.1% in 2000. However, the latter should be interpreted with caution. Therefore, their widening indicated the change from repressed to a liberalized interest rate regime. Moreover, compared with the interest rate spread, the spread between weighted average lending and deposits rates is an inferior indicator of efficiency. This is because the former takes into account lending as well as investment activities, whereas the latter does not.7

Until the early l990s, many commercial banks working in Pakistan were not providing consumer financing service. Even credit cards were offered to a selected band of customers who needed them not by way of financial support, but as a convenience for paying their bills while travelling abroad. In 2001, the excess in liquidity of the banks due to high inflow of remittances and low interest rates were the main motivations for the

6 Muhammad Arshad Khan, and Sajawal Khan, Financial Sector Restructuring in Pakistan Pakistan

Institute of Development Economics Islamabad (PIDE), August 2007, MPRA Paper No.4141. 7 State Bank of Pakistan, Pakistan: Financial Sector Assessment 1990 -2000 Research

Development Department SBP

The consumer

loans witnessed

an increase of

Rs.72.4 billion

or 29% and

reached Rs.325

billion during

2006, whereas

till June 2007, it

further

increased to

Rs.354.4

billions.



banks to get into this business. The abundance of liquidity was a result of high inflow of remittances in the 9/11 aftermath. As a result, the banks aggressively promoted consumer financing through expansion of credit cards, auto loans, house financing, and personal loans with least documentation to earn on the available liquidity.

According to SBP, the consumer loans witnessed an increase of Rs.72.4 billion or 29% and reached Rs.325 billion during 2006, whereas till June 2007, it further increased to Rs.354.4 billions. The share of consumer loans in the overall loans increased to 14.3% till June 2007 from 9.4% in 2004. If we compare the total financial outlay of consumer financing products in December 2006 and June 2007, the portfolio has increased significantly in all products except for consumer durables (Table 1).

Table 1: Consumer Financing Portfolio of Banks (December 2006 and

June 2007)

Year Portfolio Credit

Cards

Auto

Loans

Consumer

Durables

Mortgage

Loan

Other

Personal

Loans

Total

December 2006

Amount (Rs. in Million)

39,243.1 104,057.2 1,301.5 49,245.4 131,324.2 325,171.4

No. of Borrowers

1,207,885 253,097 59,082 24,313 1,310,371 2,689,736

June 2007

Amount (Rs. in Million)

44,460.5 107,575.7 1,003.6 58,052.2 143,286.0 354,378.1

No. of Borrowers

1,615,569 265,876 55,139 24,007 1,383,847 3,211,117

Source: State Bank of Pakistan (Communication with CRCP, November 16, 2007)

Category-wise analysis of consumer financing in rupee terms reveals that personal loans carried the highest share i.e. 40.4% followed by 30.36% of auto loans, 16.39% of mortgage loans and 12.55% of credit cards. However, in growth terms, the credit card category and mortgage loans witnessed highest growth.8 The number of borrowers has also increased significantly. According to the official estimates, the number of ATM and credit card users is increasing in excess of 50% every year.9

8 Banking Surveillance Department (BSD), Quarterly Performance Review of the Banking System:

June 2007, State Bank of Pakistan, P. 9-10. 9 Government of Pakistan, Economic Survey of Pakistan 2006-07. p.97.



Chart 1: Share of Products in Total Consumer Financing Portfolio

40.40%

16.39%

30.36%

12.55%

Personal Loans Mortgage Loans Auto Loans Credit Cards

Source: Banking Surveillance Department, Quarterly Performance Review of the

Banking System. June 2007.

The banking sector is earning record profits by charging unrealistic and exceptionally high interest rates. As a result, despite considerable ratio of NPLs, the annual profitability of banks has reached 76% on annual basis over the last few years.10 The pre-tax annual profit of all banks, which was Rs.7 billion in 2000, jumped to Rs.123.4 billion in 2006 (Chart 1). Experts suggest that banks have achieved present growth rate mainly at the cost of reducing rate of returns to depositors.11

Chart 2: Rise in Pre-Tax Annual Profits of Banks in Pakistan

7

123.4

0

20

40

60

80

100

120

140

Rs. in

billio

n

2000 2006

Year

Source: Economist. January 28-February 3, 2008.

In Pakistan, the banking sector is concentrated despite a large number of banks entering the market in the last decade. The top five local banks enjoy 80% of the market share of the banking sector. These banks are charging high lending rates, and passing only a portion of the profit on to their depositors on whose money they make the

10 Ibid. p.96. 11 Tariq Ahmed Saeedi, ‘Consumer Financing: Fine Line Drawn between Haves and Have-Not’.

Economist. January 28-February 3, 2008.

The top five

local banks

enjoy 80% of the

market share of

the banking

sector. These

banks are

charging high

lending rates,

and passing only

a portion of the

profit on to their

depositors on

whose money

they make the

profit.



profits. The banking sector has enjoyed the highest profits in the Asia- Pacific region. In recent months, some slow down trends are on the rise in consumer financing. For instance, the default rate in the banking sector is rising, which reflects upon the poor risk management. According to the SBP, the total NPLs of the commercial banks rose to Rs.151.9 billion in June 2007 from Rs.142.8 billion in March 2007.12 A considerable proportion of the NPLs is related to the consumer financing products of the commercial banks. The ratio of these loans for consumer financing sector increased to 2.2% in 2006 from 1.2% in 2005.13 The number of borrowers of mortgage loan and loans for durables has also decreased in 2007 (Table 1).

The statistics reveal that growth in consumer loans slowed down to 6.6% during first seven months of fiscal year 2008 from 10.4% in the preceding year. The growth has declined in all categories of consumer loans, except mortgage loans. The deceleration in the growth of auto finance is attributed to lower demand for automobiles due to increase in prices of locally produced cars, and risk aversions of banks following recovery issues, according to the SBP analysis. The use of credit worthiness reports from CIB has also affected the growth. The mortgage finance, however, depicts a robust growth of 17.6% as compared to 15.5% rise in the corresponding period last year (Table 2). The deceleration, however, does not appear to affect the growth of consumer financing significantly in the long term, given the huge banking profits associated with this business.

Table 2: Growth in Consumer Financing (July-January 2007 and 2008)

Source: State Bank of Pakistan. Second Quarterly Report for FY 08.

12 Dawn, October 9, 2007. 13 BSD, June 2007. p.25.

Portfolio Fiscal Year

2007 2008

Mortgage Loans 15.5 17.6

Credit Cards 19.2 6.9

Auto Finance 8.0 6.0

Personal Loans 7.9 3.0

All 10.4 6.6

The statistics

reveal that

growth in

consumer loans

slowed down to

6.6% during first

seven months of

fiscal year 2008

from 10.4% in

the preceding

year.



3.2 Issues and Challenges from a Consumer

Perspective

The consumers as well as the banks are entitled to certain financial rights, which must be protected in an institutional-cum-legal framework, which is capable to strike a balance between rights of both entities independently.14 The dilemma in Pakistan is that the consumers remain a weaker party vis-à-vis the banking sector, thus balancing the equation in favor of the latter. The market-oriented vision of economic managers has served the banks more favorably than the consumers.

The banking sector has demonstrated capacity to influence the policies, procedures and rules in its favour, as it is better equipped with financial resources, knowledge, technology, and lobbying with the governance machinery. This leverage is leading to emergence of a whole range of problems and grievances, especially in relation to consumer financing, thus negatively affecting the ability of consumers to articulate and protect their financial rights, and access justice if these rights are violated by the banks.

3.2.1 High Interest Rate Spread

Low interest rate spread is an important indicator of the efficiency and competition in the financial systems and helps in economic growth through increased investments. In the national context, the most important issue in consumer financing from the standpoint of national economy as well as individual consumers 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. This indicates that average deposit rates have been very low, as compared to average lending rates. One could have expected a decrease in spread as a potential gain of competition among the increasing number of banks in the post-2001 period. However, little change has been observed in average spread, which points towards a cartel-like behavior of the banking sector.

If we look at the nominal and real interest rates, it becomes evident that consumers have had suffered a great deal at the hands of banks. From 1990 to 2004, the nominal weighted average lending rate has always been higher than inflation rate. The real lending rates averaged between 1.98% and 9.69%, which means that the banks earned net profits on lending in all these years. In contrast, the average deposit rate was slightly higher than inflation rate in four years only (1999-2002). The real deposit rates were negative in 11 years. It partly explains the impact of inflation on interest rate spread. The banks keep the lending rate high enough to ensure that the real lending rate is almost always positive.

14 These rights include, for example, access to accurate information, fair credit billing and reporting,

fair debt collection practices, right to financial privacy, right to complaint filing and redress, etc.

In, Pakistan, the

spread has

vacillated

between 5.95%

and 9.58%

during the

period from

1990 to 2005.



Table 3: Interest Rate Behaviour in Pakistan

Source: SBP Annual Reports (Various Issues). Compiled by Muhammad Arshad Khan and Sajawal Khan in ‘Financial Sector Restructuring in Pakistan’. PIDE. August 2007.

In recent years, the spread has exceeded 7% on the average. The high difference between lending and deposit rates indicates that the depositors are not getting due returns, as compared to huge profits being earned by the banks. Indeed, the lending rates have increased and deposit rates have decreased over the last few years.

Chart 3: Weighted Average Lending and Deposit Rates in February 200815

11.23

4.17

7.06

0

2

4

6

8

10

12

Pe

rce

nta

ge

Average Lending

Rate

Average Profit on

Deposits

Spread

Source: State Bank of Pakistan, 2008.

15 The weighted average rates are for outstanding loans and deposits including zero mark up.

Year Inflation

Rate

Weighted average

Lending Rate

Weighted average

Deposit Rate

Interest Rate

Spread

Nominal Real Nominal Real Nominal Real

1990-95 10.57 12.55 1.98 6.53 -4.05 6.02 5.95

1996 10.8 14.4 3.6 6.4 -4.4 8.00 8.00

1997 11.8 14.6 2.8 6.8 -5.0 7.8 7.8

1998 7.8 15.6 7.8 6.8 -1.0 8.8 8.8

1999 5.7 14.8 9.1 6.5 0.8 8.3 8.3

2000 3.6 13.52 10.9 5.47 1.9 8.05 9.00

2001 4.4 13.61 9.21 5.27 0.87 8.34 8.34

2002 3.5 13.19 9.69 3.61 0.11 9.58 9.58

2003 3.1 9.40 6.3 1.61 -1.49 7.79 7.79

2004 4.6 7.28 2.68 0.95 -3.65 6.33 6.33

2005 9.3 8.81 -0.49 1.37 -7.93 7.44 7.44

In February

2008, the

weighted

average lending

rate was 11.23%

whereas the

weighted

average deposit

rate was 4.17%

resulting in high

interest rate

spread to the

tone of 7.04%.



In February 2008, the weighted average lending rate was 11.23% whereas the weighted average deposit rate was 4.17% resulting in high interest rate spread to the tone of 7.04%. In terms of average interest rate spread of banks in South Asia, Pakistan has the highest spread. From 2003 to 2005, its average spread has remained between 6.33% and 7.79%. Whereas, during the same period, it ranged between 4.50% and 6.9% in India, 4.34% and 5.99% in Sri Lanka, and between 5.27% and 6.11% in Bangladesh (Table 4).

Table 4: Average Interest Rate Spread in South Asia (2003-05) 16

Year Pakistan India Sri Lanka Bangladesh

2003 7.79 6.09 4.34 6.11

2004 6.33 5.17 4.4 5.27

2005 7.44 4.50 5.99 5.38

Sources: (1) SBP Annual Reports (2) Shamim Ahmed and Ejazul Islam, Policy Analysis Unit, Bangladesh Bank

Head Office, Bangladesh, July 2006

While the spread is higher in South Asian as compared to other regions, Pakistan stands out distinctively due to huge difference between lending rate and rate of return on deposits. The spread in Pakistan is much higher than average rates in many countries around the world. Chart 2 shows average interest rate spread in 13 countries, which ranges between minimum 1.71% (Japan) and maximum 4.5% (Italy). This is evident from these statistics that average interest rate spread in Pakistan exceeds the regional as well as international average rates.

High interest rate spread indicates that competitiveness in the banking sector in Pakistan is either absent or is very poor. A cartel-like behaviour in banks appears to have taken place within the policy space provided by SBP.17 In April 2006, the present Governor of the SBP had said that banking spread was very high in the county and termed it an inefficiency of banks. In December 2006, she said that spreads were high because the sector was not facing competition and it was hurting the economy.18 However, she said that time was yet to come when SBP should exercise its powers.

16 For India, deposit and prime lending rates are the mid-points of the range where the rates relate to

five major banks. Moreover, deposit rates are for more than one year maturity. Bangladesh, Pakistan, and Sri Lanka figures are weighted average. The interest rate for Pakistan has been taken from Table 3 above.

17 A case in point is the warning issued by Competition Commission of Pakistan (CCP) to the banks in February 2008 for fixing 4% interest rate for small accountholders of Enhanced Saving Accounts Scheme.

18 The News, March 6, 2008.

In terms of

average interest

rate spread of

banks in South

Asia, Pakistan

has the highest

spread. From

2003 to 2005, its

average spread

has remained

between 6.33%

and 7.79%.



Chart 4: Nine Year Average Interest Rate Spread of 14 Countries19

1.71

1.9

2

2.1

2.4

2.5

2.8

3

3.5

3.6

3.9

4.4

4.5

8.15

0 1 2 3 4 5 6 7 8 9

Japan

Netherlands

Canada

U.K.

Spain

Norway

U.S.

Switzerland

Finland

France

Singapore

Australia

Italy

Pakistan

Co

un

trie

s

Spread (Percent)

Sources: (1) World Economic Forum, Global Competitiveness Reports (1997 to 2005- 06)

(2) SBP Annual Reports

This issue is largely attributable to weak SBP regulation of interest rates despite that it has the powers to bring down 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 reasons cannot be said true of Pakistan because banks are earning huge profits at the cost of savings of the depositors.

3.2.2 Variable Interest Rate

A variable interest rate moves up and down based on factors including changes in the rate paid on bank certificates of deposit or treasury bills. From a consumer’s standpoint, it makes a huge difference whether the bank is charging variable or fixed rate on credit. If a consumer enters into an agreement with the bank on the basis of fixed interest rate, the bank cannot change the overall payable interest during the entire tenure even if interest rates go up in the market. In contrast, when the interest rate is variable, the bank ties the rate with an index. The interest payable by the consumer varies as the index changes.

In Pakistan, almost all consumer loans are on the basis of variable mark up rates.20 This policy is attributed to two reasons. First, variable rates are in the larger interest of banks due to high probabilities of increase in rates in the future. Second, a long term debt market has yet to be developed to provide term funding to the banks. However, banks also offer loans in which borrowers are given the choice of fixed or variable mark up. If the borrower chooses fixed mark up, the rate offered is generally higher than the variable mark up rate at the time of the contract. Therefore, borrowers most often choose variable mark up, without realizing their future financial liability, in the hope that the rates

19 For Pakistan, the nine-month weighted average has been calculated from Table 3 in this chapter. 20 Annual Report of the Banking Ombudsman, 2006

High interest

rate spread

indicates that

competitiveness

in the banking

sector in

Pakistan is

either absent or

is very poor.



will fall in the future. This has seriously affected the loan servicing capacity of the borrowers with deleterious effects on their savings.

Some countries have determined fixed or variable interest rate for each sector depending on specific needs. In the United States, for example, the interest rates on education loans were changed from variable rates to fixed rates in 2002. In addition, there are examples of discount periods for variable interest rates. Such practices need to be introduced and scaled up in Pakistan in order to serve the interests of small borrowers.

3.2.3 Increasing Inflationary Impact

A crucial issue that links with the increasing consumer financing is the inflation rate. 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. Similarly, the demand for road networks and fuel imports has increased due to growth in auto financing. These developments have an overall inflation impact, which is affecting the purchasing capacities of the poor.

3.2.4 Deteriorating Quality of Services

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. Other issues such as non-transparent advertisements, violation of agreed terms and conditions, levy of unjustifiable charges, and arduous complaint redress mechanism, etc. also reflect upon the poor quality of consumer services.

The press frequently reports such complaints, which speak of the issues in quality of banking services. For example, some banks are involved in charging late payments penalties despite payment on time. Similarly, many credit card users complain about service charges appearing on their credit statements, which make no sense to anybody. The number of complaints is increasing every year. For example, in the first eight months of the operation of Banking Ombudsman in 2005, about 40 per cent complaints filed with the Ombudsman were related to consumer products, and among these complaints, 30 per cent were related to credit cards alone.21

21 Annual Report of the Banking Ombudsman, 2005, p.6.

In Pakistan,

almost all

consumer loans

are on the basis

of variable mark

up rates. This

has seriously

affected the loan

servicing

capacity of the

borrowers with

deleterious

effects on their

savings.



Table 5: Consumer Complaints against Banks in 2006

No. Name of Bank Complaints

Received Branches

Complaints per

Brach

1 Citibank 56 14 4.00

2 ABN Amro Bank 16 8 2.00

3 SME Bank Ltd. 9 7 1.29

4 Union Bank Ltd. 62 53 1.17

5 Standard Chartered Bank 49 46 1.07

6 JS Bank 3 4 0.75

7 Bank Al-falah Ltd. 30 97 0.31

8 The Punjab Provincial Co-operative Bank 48 158 0.30

9 Zarai Taraqiati Bank Ltd. 91 342 0.27

10 Atlas Bank Ltd. 1 4 0.25

11 Askari Commercial Bank Ltd. 16 75 0.21

12 Industrial Development Bank of Pakistan 3 19 0.16

13 Mybank 8 51 0.16

14 United Bank Ltd. 143 1056 0.14

15 KASB Bank 3 25 0.12

16 National Bank of Pakistan 156 1316 0.12

17 Crescent Commercial Bank 2 17 0.12

18 First Women Bank Ltd. 4 42 0.10

19 Faysal Bank 5 53 0.09

20 Soneri Bank 5 53 0.09

21 Habib Bank Ltd. 131 1457 0.09

22 NIB Bank 12 0.08

23 Prime Commercial Bank 4 50 0.08

24 MCB Bank Ltd. 67 969 0.07

25 Allied Bank Ltd. 50 749 0.07

26 The Bank of Punjab 14 254 0.06

27 Bank Al-Habib Ltd. 4 75 0.05

28 Meezan Bank 1 23 0.04

29 PICIC Commercial Bank 3 101 0.03

30 Saudi Pak Commercial Bank 1 39 0.03

31 Habib Metropolitan Bank 1 68 0.01

Source: Annual Report of Banking Ombudsman, 2006



In 2006, Banking Ombudsman received 215 complaints out of which 18 were rejected, 71 were declined and 90 complaints were granted. There were 36 complaints related to internal banking fraud scam, still being investigated by the Banking Ombudsman. The complaints received at Banking Ombudsman were related to service rules, service inefficiency, loan remission of mark-up waiver, frauds and consumer products including ZTBL loans. However, it is observed that percentage of complaints received regarding consumer products including ZTBL loans was 46%, much higher than other type of complaints received.

The complaints related to consumer products included credit cards, small loans Inc ZTBL, auto loans, undertake mark up, processing delays and ATM’s complaints. Magnitude of credit card complaints was much more than all other complaints, nearly 40% of total complaints.

Chart 5: Types of Consumer Complaints in 2006

Processing Delay

Undue mark-up

ATM’s

Auto Loans

Small loans inc ZTBL

Credit Cards

0% 5% 10% 15% 20% 25% 30% 35% 40%

Source: Annual Report of Banking Ombudsman, 2006

3.2.5 Unsolicited Financing

Aggressive marketing campaigns launched by the banks are targeting the consumers and repeatedly encouraging them to purchase a loan or credit card. In some cases, the banks have gone to an extent where a consumer who has not even applied for a loan, is informed through telephonic call that the bank has approved a loan for him. Misleading phone calls are made to the consumers who are misled by false promises; they succumb to attractive offers and later discover that the commitments and assurances held at sign up stage were not being honored. The supply-driven approach is creating artificial consumerism on one hand, and is limiting the choices for consumers, on the other. For example, auto leasing makes a fit case of banking sector’s dominance over customers. A car lessee, for instance, is bound to insure the car from an insurance company of the bank’s choice.

3.2.6 Lack of Consumer Education

The issue of consumer education is equally important. Most of the bank users do not have enough understanding of the very basic rules and terms

Indeed, the SBP

and other

scheduled banks

have excluded

consumers as a

legitimate

stakeholder in

formulation of,

or any change in

policies and

procedures.



and conditions. Another problem is that the documents prepared by banks are usually technical and the information which may affect financial rights of the consumers is never stated clearly and plainly in these documents. Indeed, the SBP and other scheduled banks have excluded consumers as a legitimate stakeholder in formulation of, or any change in policies and procedures. There is a need to focus on public awareness about the financial rights of the citizens, and the forums available to them for accessing justice, if these rights are violated.

3.2.7 Poor Information Disclosure Practices

Although PRCF require the banks to ensure transparency through disclosure, access to information related to consumer financing remains a critical issue. A strong culture of secrecy prevails in the banks, as they avoid providing even ordinary and insensitive data. Apart from reporting requirements laid down in the SBP regulations and contracts, there is no law in Pakistan, which entitles the consumers to access information from private banks as a legal right. The existing freedom of information laws are applicable to only public sector banks, and do not extend to private banks and DFIs.

Information Disclosure Practices of Banks

As a part of the study at hand, CRCP wrote a letter to the Governor of State Bank of Pakistan on November 6, 2007 and requested information about total number of customers, total financial outlay of credit cards, personal loans, auto financing and mortgage loans for each scheduled bank. The SBP responded on November 16, 2007 and provided break-up of consumer finance (Table 1, Chapter 2). CRCP again wrote a letter to SBP requesting bank-wise data. In response, the SBP informed CRCP that it was not in a position to provide the bank-wise data; CRCP should contact the banks/DFIs instead.22

Keeping with the advice from SBP, CRCP wrote letters to all the selected 15 banks on January 2-3, 2008 requesting the same information. None of the banks responded to the information requests except Emirates Global Islamic Bank Ltd. On February 1, 2008, CRCP sent reminders to the remaining 14 banks. In response, only two banks returned. Dawood Islamic Bank Ltd provided the total number of customers and total portfolios of consumer financing products, whereas ABN Amro regretted to provide the information requested by CRCP.

Having received poor response from the banks, CRCP sent its team members to the banks to collect information personally. Only 7 banks provided schedule of charges whereas some banks advised that head office should be approached for this purpose. Out of 15 selected banks, 11 banks have made schedule of charges available on their websites as well.

22 Letter No. BSD/SU-33/301/3488/2007 dated December 6, 2007

Apart from

reporting

requirements

laid down in the

SBP regulations

and contracts,

there is no law

in Pakistan,

which entitles

the consumers to

access

information from

private banks as

a legal right.



3.2.8 Loosing Competitiveness in International Trade

Banking sector has assumed greater importance due to liberalization of trade under the General Agreement on Trade in Services (GATS). Pakistan has opened up the financial sector and made a number of commitments under GATS without performing any Economic Needs Test (ENT). The impact of such decisions needs to be ascertained keeping in view the contribution of financial services in services trade. The imports of financial services have remained substantially higher than exports. Estimates suggest that the imports in financial services were US$ 77 million in 2003-04 and 2004-05, and US$133 million in 2005-06. In comparison, exports in financial services stood at US $21 million, US$ 39 million, and US$ 70 million million during the same years. 23

Banking Cartel and Competition

The Pakistan Banks’ Association (PBA) advertised on 5 November 2007 in the daily press that “under the auspicious of Pakistan Banks’ Association, all schedule banks introduced the Enhanced Saving Account (ESA)” for all saving accounts with a maximum deposit of Rs.20,000. Under the ESA, small accountholder will get a fixed interest of 4% annually. The Competition Commission of Pakistan took notice of the advertisement and issued notices to PBA and 41 banks under Section 30 of the Competition Ordinance, 2007 calling for explanation for jointly introducing a financial product and fixing profit rates, which prima facie violated Section 4 of the Ordinance. On April 10, 2008, the Commission issued its order against the bank cartel requiring PBA to desist from collusive price-fixing and imposed a penalty of Rs.30 million on it and Rs.25 million each on seven leading banks (Copy of order available at http://www.mca.gov.pk/Downloads/Order_of_Banks.pdf. Such interventions can promote fair competition in the market for small depositors thereby giving them a choice to opt for banks offering high profit rates and low lending rates.

Courtesy: Competition Commission of Pakistan

The challenge for Pakistan is to increase exports in financial services in a manner that has least impact on low income customers. Given the huge spread in interest rates, the local banks have no incentive to improve internal efficiencies to become competitive in the international market. Therefore, urgent steps including reduction in spread need to be taken to create competitive financial environment in Pakistan.

23 Abid A. Burki and S.M. Turab Hussain, Opportunities and Risks for Liberalizing Trade in

Pakistan. LUMS and ICTSD, 2007.

Given the huge

spread in

interest rates,

the local banks

have no

incentive to

improve internal

efficiencies to

become

competitive in

the international

market.



3.2.9 Intimidating Recovery Practices

Recovery of dues from borrowers is the responsibility of the ‘collection department’. However, when a borrower does not clear all his dues, the case is transferred to the loan recovery department. Legally, under Section 15 (sub-section 2) of the Financial Institutions (Recovery of Finances) Ordinance, 2001, the banks are required to send three legal notices to the borrowers for payment of dues within the specified time periods. If the borrower fails to pay the dues even after third legal notice, only then the bank has the authority (under sub-section 4 of section 15) to sell the property of the mortgagor, without the intervention of any court, which was kept on mortgage as a security for the bank.

Keeping aside the law, the banks have constituted recovery teams comprising thugs who use strong-arm tactics to harass the borrower and make threatening calls. Despite the fact that bank’s recovery teams have no legal authority to visit the borrower’s residence; sometimes, recovery teams reach the borrower’s house to intimidate and pressurize them for payment of dues. In some instances, they illegally coerce and misbehave the borrowers, and, in desire of earning more commission, cross the limits by abusing, brutally beating, showing guns, locking in the house and threatening to dreadful consequences.

Man commits suicide due to harassment by loan recovery team

Due to the alleged immense pressure and threats from the loan recovery staff of a bank, a man committed suicide inside his house within the jurisdiction of the New Karachi police station. Mohammed Tufail, 27, according to his father, Mohammed Munchi, was residing at R-93, Block-11L, New Karachi, which is where he committed suicide. He added that his son, Tufail, got married a few years back and had one son. Due to some differences with Tufail, his wife had left him and gone to her parents’ house. A few months back, he had also gone through another setback, suffering a big financial loss in his LPG business.

Later, he applied for a loan from the Muslim Commercial Bank (MCB). Due to a delay in the payment of an instalment, the recovery staff of the MCB started visiting his house and threatening him with dire consequences. On Sunday, when Tufail was present at his house, the recovery personnel once again came calling and began to continuously pressurise his son. After a heated argument, the MCB recovery staff left. Later, ostensibly due to the constant harassment of the recovery staff, Tufail locked himself inside his room and hanged himself from a ceiling fan. Station House Officer, New Karachi, Pervez Gujjar, said that they were waiting for the statement of the family and, as soon as they approached the police for the registration of an FIR against the recovery staff of the MCB, they would oblige.

Courtesy: The News, Karachi (Monday, April 28, 2008)

Despite the fact

that bank’s

recovery teams

have no legal

authority to visit

the borrower’s

residence;

sometimes,

recovery teams

reach the

borrower’s house

to intimidate and

pressurize them

for payment of

dues.



Second annual report (2006) of the Banking Ombudsman stated a rise in the unrestrained action by the debt collectors; cases have also come to light where innocent people have been accost and maltreated as well as cases where borrowers with up-to-date payment record have been needlessly harassed. The report mentioned that in most countries, debt collection is regulated by the law. In the US, to prohibit certain methods of debt collection and treat borrowers fairly, the “Fair Debt Collection Practices Act” was incorporated in the “Consumer Credit Protection Act” in 1977. According to Banking Ombudsman Report (2006), some banks in Pakistan have developed guidelines applicable to debt collection but these are not strictly followed by external recovery agencies engaged for the purpose. To protect consumers from abuse by debt collectors, it was recommended that Pakistan Banks Association be asked by SBP to draft suitable set of instruction for compliance by external debt collection agencies.

3.2.10 Weaknesses in Regulatory Framework

The frequent violation of financial rights of the consumers is attributed, mainly, to weaknesses in the regulatory framework governing the banking sector, and low level of consumer education about the relevant policies and rules. The existing regulations do not capture the full range of problems being faced by the users of consumer financing services. For example, the regulations do not restrict the banks to levy unjustified service charges such as high fee on depositing cash in one’s own account. Another case in point is the Credit Worthiness Reports maintained by the Credit Information Bureau (CIB). According to the rules, these reports are confidential documents for the borrowers, and amount to denial of the right to one’s own personal information.

On the top of it, whatever regulations exist, they are yet to be fully implemented. As a matter of fact, the banks enjoy a great degree of freedom for formulating their own policies and procedures regarding credit cards, automated services, loans, interest rates, etc., which suit their interests best. These missing links, if not abridged adequately, would continue to harm the interest of the consumers on one hand, and affect the potential of banks to serve as a strong base of economy in the longer term, on the other hand.

As a matter of

fact, the banks

enjoy a great

degree of

freedom for

formulating their

own policies and

procedures

regarding credit

cards,

automated

services, loans,

interest rates,

etc., which suit

their interests

best.


Chapter 4

ATM and Credit Cards



ATM and Credit Cards Credit cards include any card that a customer can use to make payments on credit, whereas ATM cards are debit or cash cards used for transactions on bank account using cash machines. The use of ATM and credit cards has increased manifold in Pakistan. Estimates suggest that about 2 million credit cards are currently on issue compared with around 500,000 during 2002. According to the official estimates, the number of ATM and credit card users is increasing in excess of 50% every year.1 The SBP has notified separate guidelines for ATM, whereas credit cards have been covered in Prudential Regulations for Consumer Financing.

Keeping in view the increase in users of ATM and credit cards, CRCP conducted a survey of card users in Rawalpindi, Islamabad and Karachi. In total, 124 interviews were conducted. Only those customers were interviewed who were currently using or had previously used at least one of the ATM or credit card. Findings of the survey are presented below.

4.1 ATM and Credit Card Consumption Patterns

According to the survey, most the respondents were using both ATM as well as credit cards. The percentage of ATM users (87.4 %) is higher than that of credit card users (74.3%). About 14.8% respondents said that they used a credit card previously, whereas 10.9% were those whose applications for credit card were rejected by their bank on count of failure to meet minimum salary requirement or bad credit worthiness. On the average, the data reflects that the propensity of using ATM cards is greater than credit cards. The proportion of the respondents whose applications were rejected and those who were previously using the cards are similar.

Chart 1: Users of ATM and Credit Cards (percentage)

0

10

20

30

40

50

60

70

80

90

Pe

rce

nta

ge

ATM Card Credit Card

Using Currently Used Previously Never Used

Application Rejected Don’t remember

1 Government of Pakistan, Economic Survey of Pakistan 2006-07. p.97.

According to

the official

estimates, the

number of ATM

and credit card

users is

increasing in

excess of 50%

every year.



4.2 Reasons for Choice of Bank for Credit Card

The respondents who were currently using credit card were asked why they chose the credit card of their current bank, and not any other bank. Most of the users chose their current bank due to multiple reasons. A majority (65.5%) said that they had been approached by the bank to use the card. In contrast, a far less percentage was using the credit cards of the bank due to low or no annual fee or larger network of the banks. As many as 58.6% of the respondents was using credit card primarily due to easy instalments for their credit repayments. Suitability of terms and conditions was the third largest reason for choosing a particular bank for credit card. This indicates that majority of the banks are involved in aggressive marketing of credit cards.

Chart 2: Reasons for Choice of Bank for Credit Card

65.5

50

58.6

0

10

20

30

40

50

60

70

Pe

rce

nta

ge

The bank approached

me to use this card

Suitable terms and

conditions

Easy installments

% Credit Card Users

4.3 Credit Card Charges & Terms and Conditions

Prior to signing an application form for a credit card, prospective clients have the right to be provided with relevant information such as terms and conditions, schedule of charges, and brochures either in English or Urdu, or both. However, consumers complain that they do not receive enough information to make an informed choice. According to the survey, a very low percentage of current credit card users received the document in both languages and a negligible proportion received it in Urdu. About 8o% applicants are not provided Schedule of Charges, which indicates the high tendency in banks to hide information.

All banks levy a variety of charges (annual fee, processing fee, collection charges, late payment charges, over limit fee, transaction charges, credit shield, etc) on credit card users. Generally, the bank officers inform the applicant about major charges such as processing fee, mark up and annual fee.

About 8o%

applicants are

not provided

Schedule of

Charges, which

indicates the

high tendency in

banks to hide

information.



Table 1: Current Credit Card Users who Received Documents before

Signing the Application Form (Percentage)

No

Document

Received Not

Received English

Only

Urdu

Only Both

1 Terms and Conditions 83.0 0 15.1 2.1

2 Schedule of Charges 17.0 0 3.8 79.2

3 Information Brochure(s) 84.0 10.0 0 6.0

According to the survey, 75% of the respondents who are currently using credit card were provided information about processing fee while 64% were informed about late payment charges, as far as provision of written information about these charges is concerned. A relatively low percentage of respondents were also informed about collection and service charges, which stand at 60% and 54% respectively.

Table 2: Current Credit Card Users informed about Charges before

Signing the Application Form (Percentage)

No. Charges Informed

Verbally Written

1 Annual Fee 51.8 41.1

2 Credit Shield 20.0 45.5

3 Counter Charges 14.0 36.8

4 Cash Advance Fee 25.4 30.5

5 Federal Excise Duty 18.2 1.8

6 Finance Charges 14.0 15.8

7 Service Charges/Fee 10.9 54.5

8 Processing Fee 10.7 75.0

9 Collection Charges 27.3 60.0

10 Late Payment Charges 25.4 64.4

11 Credit Protection Charges 17.9 1.8

12 Over Limit Fee 21.4 8.9

13 Transaction Charges 10.9 1.8

According to the survey, 51.8% of the respondents were informed about the annual fee; this percentage is slightly more than that of respondents who were provided with written information. Overall, 54.5% of the respondents using credit card were informed about applicable charges. Of these, 33.8% were provided with written information and 20.7% were verbally informed. On the average, percentage of the respondents received information about annual fee, processing fee, collection charges

Overall, 54.5%

of the

respondents

using credit card

were informed

about applicable

charges. Of

these, 33.8%

were provided

with written

information and

20.7% were

verbally

informed



and late payment charges where more respondents were provided with written information about applicable charges and a comparatively less percentage was informed verbally. However, a very low proportion of respondents was informed about finance charges, federal excise duty, over limit fee, and credit protection and transaction charges.

Credit Card Charges

In addition to the survey based on exist interviews, CRCP collected information from banks through physical visits. Based on the analysis of data provided in brochures and Schedule of Charges, charges levied by selected banks are as follows:

Majority of the banks charge an annual fee on credit cards. Askari Bank charges Rs.2000, Rs.4000, and Rs.5000 per annum on its Classic, Gold and Platinum Cards, respectively. Soneri Bank charges Rs.150 for Classic Card and Rs.500 per Gold Card. ABN Amro charges Rs.2000, Rs.4000 and Rs.15000 on Standard, Gold and Platinum cards, respectively. Citibank levies annual charges on Ultima Card up to Rs.100,000, Platinum Card Rs.10,000, Gold Card Rs.4,000, and Silver and Clear Card Rs.2,000. HSBC also provides credit card facility to its customers charging annual fee of Rs.3000 at Platinum, Rs.2000 at Gold, and Rs.1000 at Classic Card.

Banks also charge Cash Advance Fee ranging from Rs. 500-800 or 3-4% of cash advance amount, whichever is higher. Alfalah Bank, Askari Bank and MCB are charging Rs.500 or 3% of the cash advance amount, whichever is higher. Whereas ABN Amro and Citibank charge 3% and 4% of cash advance amount, respectively or Rs.600, whichever is higher. HSBC charges Rs.800 or 3% of cash advance amount, whichever is higher, including all charges passed on by the acquiring bank.

ABN Amro charges up to 3.25% on outstanding amount per month translated into APR of 39% per annum. HSBC charge 3.25% per month as finance and service Charges. Alfalah, Askari, and MCB levy service charges at the rate of 3%, 3.5%, 2.83% per month, respectively.

4.4 Time Taken for Processing of Applications for ATM

and Credit Cards

Processing delay is a major consumer concern, as banks fail to process the application within stipulated time. Questions were asked from users of ATM and credit cards about application processing time. The survey showed that 71.9% users got their applications processed within the stipulated time, whereas 28.1% respondents suffered delays in the process.

As far as the duration of application process is concerned, maximum percentage of the respondents got their applications processed in less than one to three months time, whereas 11.9% respondents suffered delay as their applications were processed in more than three and less than six months.

The survey

showed that

71.9% users got

their

applications

processed within

the stipulated

time, whereas

28.1%

respondents

suffered delays

in the process.



Chart 3: Timely Processing of ATM and Credit Card Applications

72%

28%

Processed within stipulated timeframe

Not processed within stipulated timeframe

There are several reasons for delays in processing. Over 66.7% respondents using ATM cards provided incomplete application forms, as a result of which their applications could not be timely processed. On the other hand, 16.7% respondents suffered delay in the process of their applications owing to the lethargic attitude of bank officials.

Chart 4: Time Spent on Processing of ATM and Credit Card Applications

88.1

11.9

0 00

10

20

30

40

50

60

70

80

90

Pe

rce

nta

ge

% of Respondents

Less than 1 moth – 3 months More than 3 and less than 6 months

More than 6 and less than 12 months 12 months or more

Same reason applied to 64% respondents’ applications regarding credit cards while 58.8% respondents were provided incomplete application forms. On the average, incomplete application forms is the main reason for delay in the stipulated application processing time. The trend of delay in application processing is faced more by credit card users than the ATM users.

On the average,

incomplete

application

forms is the

main reason for

delay in the

stipulated

application

processing time.

The trend of

delay in

application

processing is

faced more by

credit card users

than the ATM

users.



Table 3: Reasons for Delay in Processing of Applications

No Reasons % of Users

ATM Credit Card

1 Incomplete application form 66.7 58.8

2 Lethargic attitude of the bank officials 16.7 64.7

3 Other reasons 33.3 47.1

4.5 Common Problems faced by ATM Users

The ratio of complaints regarding ATM is increasing day by day. According to the survey, more than 60% users face inconvenience because the ATM machine shows error, and they have to move to other ATM machine. An increasing percentage of respondents faced problems with reference to the use of ATM whereas 63.9% faced problems regarding information available on ATM screens as it was in English only. Long queues at ATM are faced very often by about half of the ATM users. Moreover, 33.3% respondents’ cards were held by the ATM very often. 56% respondents said that ATM failed to generate a receipt.

Table 4: Common Problems faced by ATM Users (Percentage)

No. Problem

ATM Users who faced problems

Always Very

Often Rarely Never

1 ATM machine did not process request due to error

9.7 60.5 29.7 0

2 ATM machine was out of money 0 44.9 55.1 0

3 Long queues at ATM 36.1 50.0 11.1 2.8

4 The cash limit was set below Rs.10, 000 by the bank

4.3 3.7 28.6 50.0

5 Information on ATM screen was only in English

63.9 27.0 5.6 2.8

6 Another bank of ATM network accepted cards of its own customers but not mine

54.1 35.1 8.1 2.7

7 ATM not able to give receipts 56.0 38.0 6.0 0

8 Unclear information provided on ATM screen

55.6 41.7 2.8 0

9 Card captured by ATM machine 0 33.3 5.6 61.1

10 Slow processing by the machine 55.6 35.0 9.4 0

According to the

survey, more

than 60% users

face

inconvenience

because the

ATM machine

shows error, and

they have to

move to other

ATM machine.



An equally comparable 55.6% of the respondents found that information provided on the ATM was unclear and its processing very slow. 44.9% respondents very often found the ATMs out of cash when they wanted to use it.

4.6 Common Problems faced by Credit Card Users

With reference to problems faced by credit card users, 47% respondents complained that they are not informed about any change in schedule of charges. 9.4% respondents are frequently faced by the problem of unauthorized withdrawals followed by 11.3% respondents who suffer due to hidden charges. According to the responses of credit card users, 22.6% were charged with late fee despite timely payment. Less than 9% respondents think that the process of credit payment is complex.

Chart 5: Problems most frequently faced by Credit Card Users

9.4

47

22.6

11.38.8

0

5

10

15

20

25

30

35

40

45

50

Pe

rce

nta

ge

Problems Faced by the Respondents

Unauthorized withdrawals No information on change in charges

Charging late fees despite timely payment Hidden charges

Complex payment process

4.7 Regular Statements and Updates

As far as the monthly statements of credit cards and written notification about changes in terms and conditions and schedule of charges are concerned, 18.9% respondents were never informed or updated by the banks. Majority of the respondents however are regularly provided the statement of credit card/bill at monthly intervals and are regularly notified in writing about changes in terms and conditions of the cards.

This ratio stands at 64.1% regarding written notification about changes terms and conditions and 56.6% for schedule of charges. Comparatively less percentage of the respondents is sometimes provided statement of credit bill and notified about changes in terms and conditions, and schedule of charges. 28.2% of the respondents sometimes receive written notification about changes in terms and condition of credit cards.

With reference

to problems

faced by credit

card users, 47%

respondents

complained that

they are not

informed about

any change in

schedule of

charges.



Table 5. Credit Card Users who are kept Informed by their Bank

(Percentage)

No. Statement

Users who are kept informed by

the Bank

Always/

Regularly Sometimes Never

1 My Bank provides the statement of credit card/bill at monthly intervals

64.1 25.6 10.3

2 I am notified in writing about changes in terms and conditions of credit cards

64.1 28.2 7.7

3 I am notified in writing about any changes in schedule of charges for credit cards

56.6 24.5 18.9

Only 24.5% respondents are sometimes notified about changes in the schedule of charges. On the other hand, a far less percentage of the respondents (7.7%) is never notified in writing about changes in terms and conditions of credit cards, whereas 10.3% are never provided statement of credit card bill at monthly intervals.

Late Payment Fee before Activation of Credit Card

Mr. Mohsin Babbar, a resident of G-6/4, Islamabad, applied for a credit card at the Aabpara branch of Muslim Commercial Bank, of which he is an accountholder also. On April 30, 2007, a credit card bearing No. 478972000041 was issued to him. Even though the card was not activated, he received a bill on June 18, 2007, meaning thereby that the bank had charged Mohsin with late payment, for the month of May even before he activated the card. According to the contractual obligation, the bank cannot levy charges unless the card is activated. Complaints made by Mr. Mohsin to the bank, as well as to the Manager Service Quality Department, Credit Card Division, MCB, Karachi, merited no redress.

Eventually, Mohsin lodged a complaint with the Consumer Complaint Cell of TheNetwork for Consumer Protection on June 20, 2007. Upon registration of the complaint, letters were sent to Manager, Service Quality Department, Credit Card Division, MCB, Karachi, and copies of the same were sent to Governor State Bank and President MCB Head Office, Karachi. After a few days (on July 11, 2007), the Consumer Complaint Cell received a letter from Assistant Director, State Bank of Pakistan, Banking Policy & Regulation Department, Karachi, that on their persuasion, MCB has reversed the charges levied on the complainant’s credit card.

This is a common practice among banks. The customers who are not aware of the rules generally do not file a complaint allowing the banks to cash the ignorance.

Courtesy: TheNetwork for Consumer Protection

Concerning written notification about changes in schedule of charges, 18.9% are never informed. On the average, 61.6%, of the respondents are always kept informed and updated by the banks, whereas 26% respondents claimed that sometimes they are kept updated and provided

Concerning

written

notification

about changes in

schedule of

charges, 18.9%

are never

informed.



information by the bank. As statistics indicate, 12.3% respondents are never informed and or updated by the bank.

4.8 Registration of Complaints

Pertaining to filing of complaints, a fair percentage of respondents using credit cards filed complaints when a grievance occurred. Its ratio stands at 33.6%, whereas percentage of respondents who filed complaints regarding ATM is 6.3. All of the respondents filed complaints to their concerned banks where 53.3% respondents filed complaints 12 to 18 months back, 26.7% lodged complaints 6 to 12 months back, 13.3% filed complaints 18 to 24 months back whereas 6.7% respondents filed complaints less than 6 months ago. On the average, a majority of respondents filed complaints 12 to 24 months back.

Table 6. Users who Registered Complaints (percentage)

No. Product % of Users

1 ATM 6.3

2 Credit Card 33.3

Majority of the respondents, including 34.8% ATM users and 29.2% credit card users did not have any grievance against the bank therefore they did not file any complaint.

Table 7. Reasons for Not Filing Complaints

No. Reasons

% of users who never filed a

complaint

ATM Credit Card

1 No grievance against the bank 34.8 29.2

2 Lack of information about complaint forums and procedures

26.1 15.3

3 I thought my complaint would not be resolved

8.7 22.2

4 Lengthy procedure of complaint submission 28.3 26.4

5 Other reasons 2.2 29.2

Owing to lengthy procedure of complaint submission, 28.3% respondents using ATM card and 26.4% using credit cards did not file any complaint. 26.1% respondents using ATM and 15.3% respondents using credit cards did not have information about complaint forums and procedures, whereas 22.2% respondents using credit card and 8.7% respondents using ATM did not file complaints as they perceived their complaints would not be resolved.

Owing to

lengthy

procedure of

complaint

submission,

28.3%

respondents

using ATM card

and 26.4% using

credit cards did

not file any

complaint.



4.9 Nature of Complaints

Increasing percentage, 31.6% of respondents, lodged complaints about staff attitude, whereas 26.3% respondents filed complaints with reference to hidden charges. Owing to processing delay 21.1% respondents filed complaints followed by equally comparable proportion of respondents who lodged complaints about imposition of hidden charges and misleading information - its percentage stands at 10.5%. Overall, staff attitude and high mark-up rates are some of the major problems faced by credit card and ATM card users.

Table 8. Nature of Complaints

No. Nature of Complaints % of users

1. Processing Delay 21.1

2. High Mark-up 26.3

3. Staff Attitude 31.6

4. Hidden Charges 10.5

5. Misleading Information 10.5

4.10 Response Time

All complaints were responded by the respective banks, however, applications of 10.5% respondents were rejected in less than 1 to 3 months and 5.3% respondents have their complaints pending since less than 1 to 3 months.

Table 9: Response Time for Complaints

No. Complaints resolved in % of card users

1. Less than 1 – 3 months 52.6

2. More than 3 and less than 6 months 10.5

3. More than 6 and less than 12 months 21.1

4. 12 months or more 0

Regarding resolution of complaints, 84.2% of the respondents got their complaints resolved whereas increasing proportion of respondents (52.6%) got their complaints resolved in time, i.e. in less than 1 to 3 months. Moreover, 21.1% respondents’ applications were resolved in more than 6 and less than 12 months duration, while 10.5% respondents whose applications were resolved in more than 3 and less than 6 months.

Overall, staff

attitude and high

mark-up rates

are some of the

major problems

faced by credit

card and ATM

card users.



4.11 Overall Satisfaction with ATM and Credit Cards

As many as 79.4% respondents using the ATM cards are dissatisfied. As for the respondents using ATM card, 11.8% are undecided in their opinion, whereas a nominal percentage of the respondents is satisfied and not a single respondent is highly satisfied. Comparatively, most of the credit card users are undecided in their opinion with a percentage of 51.9%. Only 19.2% respondents are highly satisfied while 15.4% are satisfied. However, level of dissatisfaction is low. So, on the average, there is a high level of dissatisfaction.

Table 10: Overall Satisfaction with ATM and Credit Cards

No. Card Highly

Satisfied Satisfied Undecided Dissatisfied

Highly

Dissatisfied

1 ATM 0 2.9 11.8 79.4 5.9

2 Credit Card 19.2 15.4 51.9 13.5 0

The collected data reflects that a large percentage of the customers is approached by the banks to avail the credit cards of the bank. This approach indicates that banks motivate the people to buy their card even if he does not need it. Access to information at the sign up stage is also crucial. Majority of the customers are provided information brochures, terms and conditions, schedule of charges and application form in English. However, customers are neither given enough time to read nor are they briefed at length about the terms and conditions and applicable charges. Consequently, difficult terms make no sense to them. Majority of the respondents is provided written information about applicable charges, whereas most of the customers are not provided information about over limit fee, credit protection charges, transaction charges and federal excise duty. As far as complaints are concerned, majority of the aggrieved customers do not register complaints. Such problems need to be addressed on priority basis to improve efficiency in the banking sector, and service the customer in line with the value of his money.

As many as

79.4%

respondents

using the ATM

cards are

dissatisfied.

Comparatively,

most of the

credit card users

are undecided in

their opinion

with a

percentage of

51.9%.


Chapter 5

Auto Loans

Auto Loans


Auto Loans Auto financing has the second largest share in total consumer financing portfolio in Pakistan. According to the data compiled by Baking Surveillance Department of SBP, 30.36% of consumer financing comprised of auto financing and leasing products by mid 2007. At the same time, the total number of auto loan borrowers has exceeded 0.26 million. From a macroeconomic standpoint, the growth in auto loans has put great pressure on the economy by increasing the demand for extension of road networks as well as fuel imports. In fiscal year 2008, the annual growth of auto loans has decreased to 6.6% from 8.0% in 2007 during the months of July to January. The deceleration is attributed to increase in prices of locally manufactured cars. Increasing ratio of auto loan default is also a critical factor in moving the banks to adopt a cautious approach.

CRCP conducted a survey of bank customers who are currently using at least one auto loan or had availed an auto loan in the past. The customers whose applications for auto loan were rejected were also included in the survey. In total, 99 customers were interviewed. Out of a sample of 30 branches of 15 banks, 22 branches were providing auto loans. The survey covered only these selected bank branches at Rawalpindi, Islamabad, and Karachi. Findings of the survey are presented in the following sections.

5.1 Patterns of Access to Auto Loans

There are two types of auto loans being offered by the banks: car leasing and car financing. Car financing is a type of loan in which car is registered under the name of borrower and is mortgaged to the bank as long as the consumer pays off the amount borrowed from the bank. In case of car lease, the car is registered in the name of the Bank and the original papers are also in the name of the bank. Most of the banks offer car financing instead of leasing. As compared to individual loans, a higher interest rate is charged on consumer financing.

With reference to different types of auto loan, CRCP survey revealed that the percentage of respondents whose applications for new car financing were rejected is higher (24%) than the borrowers who are currently availing car finance facility (14%). Similarly, the respondents whose applications for new car leasing were rejected is also quite high (12%), but it is lower than current users of car leasing. In comparison, the number of respondents who avail used car financing is very low. More respondents are using brand new car leasing than brand new car financing.

The tenure of auto loans varies from one to five years. Some banks have fixed a minimum tenure of auto loans. A telephonic survey conducted by CRCP revealed that Askari, HMP, Soneri and ABN Amro have fixed the

Most of the

banks offer car

financing

instead of

leasing. As

compared to

individual loans,

a higher interest

rate is charged

on consumer

financing.

Auto Loans


minimum tenure at one year, whereas Dawood Islamic Bank and KASB have the minimum tenure as high as 3 years.

Chart 1. Patterns of Auto Financing and Leasing

0

5

10

15

20

25

Pe

rce

nt

Brand New Car

Financing

Used Car Financing Brand New Car

Leasing

Used Car Leasing

Using Currently Used Previously Application Rejected Never Used Don’t remember

As Chart 1 shows that a high percentage of respondents were those whose applications for auto financing or leasing were rejected. The ratio of rejected applications is higher for car financing, as compared to car leasing. Out of the total respondents whose applications for auto loan were rejected, 51.0% and 44.7% applications were rejected due to bad credit worthiness and income below the bank’s desired limit, respectively. In some cases, the bank did not give any reason for rejection of application. This percentage stands at 34.8% whereas 27.7% respondents were unable to provide the required documents.

Chart 2: Minimum Tenure of Auto Loans

0

0.5

1

1.5

2

2.5

3

Ye

ars

Askari Dawood HMP KASB Soneri ABN

Amro

Banks

Minimum Tenure (Years)

51.0% and

44.7%

applications

were rejected

due to bad credit

worthiness and

income below

the bank’s

desired limit,

respectively.

Auto Loans


Table 1. Reasons for Rejection of Application

No. Reasons % of

Applicants

1 I could not provide all required documents 27.7

2 My income was below the bank’s desired limit 44.7

3 Bank gave no reason for rejection of application 34.8

4 My credit worthiness was bad 51.0

5.2 Factors Affecting the Choice of Bank for Auto

Loans

The factors that influence the decision of borrowers to choose a particular bank for availing auto loan are legion. Suitability of terms and conditions is cited by nearly 59% respondents as the single largest reason for selection of bank from which they have borrowed the auto loan. A considerable proportion comprising 35% respondents chose the bank because they were approached by the bank officer to avail the auto loan. Mark up rate and quality of bank services stand out to be the third and fourth main reasons for selection of bank for auto loan.

Chart 3. Factors Affecting the Choice of Bank for Auto Loans

65.4

4237.3

30

0

10

20

30

40

50

60

70

Pe

rce

nta

ge

T e rms a n d c o n d itio n s o f th is b a n k a re su ita b le fo r me . T h e b a n k a p p ro a c h e d me to a v a il th is lo a n . T h e ma rk -u p o r in te re st ra te o n th is lo a n is lo w e r th a n o th e r b a n k s S e rv ic e s a n d in c e n tiv e s o f th is b a n k a re b e tte r th a n o th e r b a n k s

Terms and conditions of this bank are suitable for me.

The bank approached me to avail this loan.

The mark-up or interest rate on this loan is lower than other banks

Services and incentives of this bank are better than other banks

5.3 Information about Terms and Conditions &

Charges

Before signing the contract, almost all the respondents received the terms and conditions, and draft contract in English, whereas a nominal percentage received these documents in both languages (English and Urdu). Besides, quarter of the respondents received the information brochures in both languages and the remaining 69% received the document in English.

Suitability of

terms and

conditions is

cited by nearly

59%

respondents as

the single

largest reason

for selection of

bank from which

they have

borrowed the

auto loan

Auto Loans


Table 2: Borrowers who Received Documents before Signing the

Contract (Percentage)

No. Documents

Received Not

Received In

English

In

Urdu Both

1 Terms and Conditions 98.3 0 1.7 0

2 Draft Contract 96.6 0 1.7 1.7

3 Information Brochure(s)

69.0 0 25.9 5.1

However, some of the respondents commented that they faced difficulty in comprehending the terms and conditions for two main reasons – use of difficult terminologies/words that made no sense or insufficient provision of time for reading/comprehension of the terms and conditions.

As for written information, the percentage of respondents who received information verbal information about mark-up rate is very high (80.4%), as compared to other charges. Information about most of the charges was provided in written form such as brochures, leaflets, etc. This indicates that bank officers explain only major charges such as processing fee, late payment charges, and mark up, etc.

Table 3. Borrowers who were informed about Charges before Signing

the Contract (percentage)

No. Type of Charge

% of Borrowers Informed

Verbally Written

1 Processing and documentation fee 19.6 80.4

2 Late payment charges 23.2 62.5

3 Mark-up rate 80.4 8.9

4 Registration fee 16.1 33.9

5 Insurance premium 19.6 48.2

6 Transportation charges 21.4 12.5

7 Equity 20.0 18.2

8 Pre-payment penalty 51.9 3.7

9 Other charges 32.1 1.9

Concerning verbal information about the applicable charges, high percentage of the respondents was informed about the prepayment penalty and other charges, whereas the ratio of respondents for these charges is nominal with regard to written information.

As for written

information, the

percentage of

respondents who

received verbal

information

about mark-up

rate is very high

(80.4%), as

compared to

other charges.

Auto Loans


The overall ratio of written information stands at 36.6%, whereas less percentage of the respondents was verbally informed. On the average, 59% of the respondents were informed about applicable charges by the bank officer.

Mark up on auto loan is a critical decision factor for borrowers. CRCP conducted a telephonic survey of banks about mark up rate on auto loans and found that it ranges between 14% and 16% for many banks. The rate varies according to the tenure and type of the loan.

Chart 4: Monthly Mark-up Rate on Auto Loans (percentage)

15.5 15.5

14.46 14.5 14.5

15

16

13.5

14

14.5

15

15.5

16

Pe

rce

nta

ge

Alfalah

Bank

Askari Dawood HMP KASB Soneri ABN

Amro

Banks

Mark-up (%)

The most common problems faced by auto loan borrowers include levy of late fee payment despite timely payment and imposition of pre-payment penalty. About 29% respondents were of the view that their bank most often levied late payment fee even when they had paid the instalment in time. A few respondents commented that when they asked the bank to reverse the charges, the bank officer promised that the charges would be reversed but it never happened.

5.4 Delays in Application Processing

With regard to the time taken in the process of application, 60% of the respondents’ applications were not processed within the stipulated time, while the applications of the rest of the respondents were processed within the stipulated time. Cumulative percentage of the respondents was of the opinion that incomplete application form was the major reason for delay in the process of application, whereas 41.9% provided other reasons. The ratio for lethargic attitude of the bank officials stands at 29.2%.

With regard to

the time taken in

the process of

application,

60% of the

respondents’

applications

were not

processed within

the stipulated

time.

Auto Loans


Auto Loan Charges

In addition to the survey based on exist interviews, CRCP collected information from banks through physical visits. Based on the analysis of data provided in brochures and Schedule of Charges, charges levied by selected banks are as follows:

Processing and Documentation Charges: Processing and documentation charges of Alfalah Bank vary for locally assembled and branded vehicles. As regards locally assembled vehicles, Rs.4200 and Rs.5200 are charged on new and used cars, respectively. EGIB charges Rs.4000 and Rs.5000 for new and used vehicles, respectively. Askari levies Rs.5000 as processing fee and documentation charges are as per actual. HMB, MCB, ABN Amro and Citibank charge Rs.3000, Rs.4000, Rs.4000, and up to Rs.5000 as processing and documentation fee, respectively.

Down Payment: Most of the banks providing auto loans levy 10-20% of the ex-factory price as down payment. For instance, MCB and FWBL charge 10%, whereas Soneri bank charges minimum 15% of car price on finance up to Rs.1.0 million and minimum 20% of car price on finance exceeding Rs.1.0 million but not more than Rs.2.0 million.

Late Payment Charges: FWBL has flexible repayment options. Among other banks, HMB and ABN Amro charges Rs.200, whereas Bank Alfalah charges Rs.100 per day as late payment fee. Askari and Citibank charge Rs.550, and up to Rs.700, respectively. MCB charges 10% of instalment or Rs.1000, whichever is higher, as late payment fee.

Prepayment Penalty: FWBL applies no charges as prepayment penalty. On the other hand, full prepayment fee by MCB is 7%, 5% and 3% for the first, second and third year, respectively. Likewise, Soneri bank charges 2% on outstanding principal amount of finance being prepaid, and Citibank levies up to 10% of the loan outstanding. While, rates of ABN Amro vary depending on duration of full prepayment of cars with registration and partial prepayment.

Cheque Return Charges: HMB charges Rs.100 as the cheque return fee, whereas EGIB charges as high as Rs.2500. MCB and Alfalah charge Rs.500, while Askari charges Rs.550. Citibank levies up to Rs.800, ABN Amro Rs.200 per instrument drawn on the bank, and Rs.400 per instrument drawn on other banks.

Auto Loans


Chart 5. Processing of Loan Applications within the Bank’s Stipulated

Time

40%

60%



As far as the duration for the process of application is concerned, 53.7% respondents’ applications were processed in the duration of more than 3 and less than 6 months. Moreover, 40.7% respondents got their applications processed in less than 1 to 3 months duration.

Chart 6. Time taken in Processing of Auto Loan Applications

40.7

53.7

5.6

00

10

20

30

40

50

60

Pe

rce

nta

ge

% of Users

Less than 1 moth – 3

months

More than 3 and less than

6 months

More than 6 and less than

12 months

12 months or more

5.5 Duration for Car Delivery after Approval of Loan

Application

The collected data showed that 61.4% respondents were delivered car between one to three months after approval of loan application. A significantly high percentage of respondents’ car delivery was processed within the timeframe of less than 1 to 3 months, whereas, 35.8% of the respondents got the car in more than 3 and less than 6 months. Comparatively, a small percentage of respondents suffered delay and

The collected

data showed that

61.4%

respondents

were delivered

car between one

to three months

after approval of

loan application.

Auto Loans


their car delivery was processed in more than 6 and less than 12 months. However, all respondents received the cars in less than one year period.

Table 4: Duration of Car Delivery after Approval of Loan Application

No. Duration of processing % of Borrowers

1 Less than 1 moth – 3 months 60.4

2 More than 3 and less than 6 months 35.8


4 12 months or more 0

5.6 Regular Updates

The survey data show that banks do not provide regular updates to the auto loan borrowers. The percentage of respondents who regularly received information about changes in terms and conditions, and schedule of charges is very low. The ratio of the respondents who are always informed about changes in schedule of charges is 20%, whereas 14.5% are not informed about the changes. This ratio stands at 12.7% and 21.8% for information about change in terms and conditions. The data indicates that occasional updates are provided to the loan borrowers.

Table 5. Borrowers who are kept informed by the Bank

No. Statement

% of Borrowers

Always/


1 I am notified in writing about changes in terms and conditions

12.7 65.5 21.8

2 I am notified in writing about any changes in schedule of charges

20.0 65.5 14.5

5.7 Premature Full Payment

The survey showed that some respondents preferred to make premature full payment due to various reasons such as poor services of the bank, high mark-up, hidden charges, etc. As per gathered information, majority made premature full payments owing to hidden charges applied by banks. This ratio stands at 57.1%. Likewise, high mark-up rate is another reason where ratio of the respondents stands at 46.4%, followed by 42.9% of respondents who managed to get money for full payment. A very low percentage of respondents made full payment for the reason of poor services of the bank or non-resolution of complaints by the bank.

Majority made

premature full

payments owing

to hidden

charges applied

by banks. This

ratio stands at

57.1%. Likewise,

high mark-up

rate is another

reason for 46.4

respondents.

Auto Loans


Table 6: Reasons for Making Premature Full Payment

No. Reasons % of

Respondents

1 Poor services of the bank 27.6

2 High mark-up 46.4

3 Hidden charges 57.1

4 I managed to get money for full payment 42.9

5 Unprofessional and unethical attitude of the bank staff 28.6

6 The bank did not resolve my complaint 21.4

5.8 Registration of Complaints against Banks

As far as filing of complaints is concerned, only 12.5% respondents filed complaints where all the respondents lodged the complaints with the State Bank of Pakistan. As per figures, there is equally comparable percentage of respondents who filed complaints less than 6 months ago, 6 to 12 months back and 18 to 24 months back. This ratio stands at 28.6%. However, only 14.3% of respondents filed the complaint 12 to 18 months back.

Table 7: Borrowers who Filed Complaints against Banks

No. Duration % of Respondents

1 Less than 6 months ago 28.6

2 6 to 12 months back 28.6



5 More than 24 months back 0

6 Don’t remember 0

For a variety of reasons, 87.5% respondents did not lodge the complaint despite that they had a grievance. Owing to lengthy procedure of complaint submission, 51% respondents did not file a complaint followed by 44.7% who did not have any information about complaint forums and procedure. 34.4% respondents did not file complaints as they thought that they would not be resolved. However, 27.7% respondents had no grievances against the banks.

For a variety of

reasons, 87.5%

respondents did

not lodge the

complaint

despite that they

had a grievance.

Auto Loans


Table 8: Reasons for not Filing Complaint

No. Reasons % of users

1 No grievance against the bank 27.7

2 Lack of information about complaint forums and procedures 44.7

3 I thought my complaint would not be resolved 34.8

4 Lengthy procedure of complaint submission 51.0

5 Other reasons 4.5


A high percentage of the respondents, 85.7% submitted complaints regarding hidden charges imposed by the bank. However, 71.4% respondents lodged complaints about staff attitude, followed by 57.1% respondents who filed complaints complaining about high mark-up rates. Whereas, equal proportion of the respondents filed complaints about processing delays and delay or fraud in relation to the payment or collection of cheques.

Table 9. Nature of Complaints related to Auto Loans

No. Nature of Complaints % of

Complaints

1 Processing Delay 28.6

2 High Mark-up 57.1

3 Staff Attitude 71.4

4 Hidden Charges 85.7

5 Misleading Information 0

6 Delays or fraud in relation to the payment or collection of cheques

28.6

5.10 Time Consumed in Resolution of Complaints

The survey reveals that not a single complaint was resolved in less than 3 months, which indicates that the process for complaint resolution is lengthy. 42.9% complaints got resolved in more than 3 and less than 6 months, whereas 14.3% complaints got resolved in more than 6 and less than 12 months. Of the remaining 42.9% complaints, 28.6% respondents

The survey

reveals that not

a single

complaint was

resolved in less

than 3 months,

which indicates

that the process

for complaint

resolution is

lengthy.

Auto Loans


have their complaints pending for more than 3 and less than 6 months, while complaints of 14.3% respondents are not responded by the bank.

Table 10: Time Taken in Resolution of Complaints

No. Duration % of Complaints

1 Less than 1 moth – 3 months 0




5.11 Satisfaction with Redress of Complaints

As per statistics, all of the respondents are dissatisfied with the grievance redress procedure of the banks. In terms of bank-wise users, none of the banks have the respondents satisfied with the grievance redress procedure of the bank. Owing to delays in complaint processing, 75% respondents are dissatisfied with the grievance redress procedure of the banks, followed by 66.7% respondents complaining of biased judgments. 53.6% respondents are dissatisfied on account of insufficient or no compensation at all. As a result of complexity of the procedures, only 22.2% respondents are dissatisfied.

Table 11: Reasons for Dissatisfaction

No. Reasons for dissatisfaction % of Complainants

1 Biased judgment 66.7

2 Delay in complaint processing 75

3 Complexity of procedure 22.2

4 Insufficient or no compensation at all 53.6

5.12 Problems related to Auto Insurance

Increasing percentage of respondents faced problems with reference to insurance of their cars leased or financed by the bank, as 75% respondents were not given any option to choose the insurance company of their own choice. Moreover, the insurance premium was high according to 71% respondents, followed by 50% respondents who, in case of accident/disaster, suffered delay in disbursement of their insurance. About one fourth of the respondents were of the opinion that the insurance company selected by the bank was not trustworthy.

Owing to delays

in complaint

processing, 75%

respondents are

dissatisfied with

the grievance

redress

procedure of the

banks, followed

by 66.7%

respondents

complaining of

biased

judgments.

Auto Loans


Table 12: Problems in Auto Insurance

No. Problems % of

Borrowers

1 The bank did not give me any option to choose the insurance company of my choice

75.0

2 The insurance premium is higher than other companies 71.4

3 The company selected by bank is not reputable 25.0

4 In case of accident/disaster, the company took long time to disburse my insurance

50.0

5.13 Overall Satisfaction with Auto Loan Services

As far as the overall satisfaction level of respondents is concerned, highest number of respondents remained undecided in their opinion over the level of satisfaction.

Table 13: Satisfaction Level of Respondents

Satisfaction Level % of Borrowers

Highly Satisfied 1.75

Satisfied 10.53

Undecided 63.16

Dissatisfied 22.81

Highly Dissatisfied 1.75

This ratio stands at 63.16%. Only 10.53% respondents are satisfied in comparison to 22.81% respondents who are dissatisfied. However, there is an equal proportion (1.75%) of highly satisfied and highly dissatisfied respondents.

Increasing

percentage of

respondents

faced problems

with reference to

insurance of

their cars leased

or financed by

the bank, as

75%

respondents

were not given

any option to

choose the

insurance

company of their

own choice.


Chapter 6

Personal Loans

Personal Loans


Personal Loans Personal loans include the loans provided to individuals for the payment of goods, services and expenses as well as running finance or revolving credit to individuals. In Pakistan, such loans have constituted the largest pie in total financial outlay of consumer financing with more than 40% share, whereas the number of borrowers has exceeded 1.4 million in June 2007. The growth rate of personal loans has, however, slowed down to 6.6% in July-January of fiscal year 2008 from 7.9% in the corresponding period of 2007. The deceleration is attributed to deteriorating loan service capacities o f borrowers due to high interest rates and rising inflation.

CRCP conducted a survey of bank customers who are currently using at least one personal loan or had availed a personal loan in the past. The customers whose applications for personal loans were rejected were also included. In total, 90 customers were interviewed. Out of a sample of 30 branches of 15 selected banks, 18 branches were providing personal loan services. The survey covered only these selected branches at Rawalpindi, Islamabad, and Karachi. Findings of the survey are presented in the following sections.

6.1 Patterns of Access to Personal Loans

According to the CRCP survey, 55.1% respondents are currently using a personal loan whereas 15.7% had used a personal loan previously. Among the respondents, 29.2% were those whose applications were rejected. Out of the current users, 16.9% respondents had their loan approved less than 1 to 3 months ago. Almost equally comparable proportion of the respondents had their loan approved more than 3 and less than 6 months ago. A majority of about 65% borrowers were those who had their personal loan approved more than 6 months ago.

Chart 1: Patterns of Access to Personal Loans

55.1%

15.7%

29.2%

Current borrowers

Previous borrowers

Borrowers whose applications were rejected

The growth rate

of personal

loans has,

however, slowed

down to 6.6% in

July-January of

fiscal year 2008

from 7.9% in the

corresponding

period of 2007.

Personal Loans


Out of 29.2% respondents whose applications were rejected, 45.8% applications were rejected because the income of the applicant was below the bank’s desired limit. This shows that a considerable number of applicants apply for loan without ascertaining the salary requirements of banks in advance. A fair 39.1% percentage of respondents complained that they were not informed of the reason for rejection of their applications. In some cases, respondents could not provide all the requisite documents. This ratio stands at 30.8%. On account of bad credit worthiness, 21.7% respondents got their applications rejected.

Table 1: Reasons for Rejection of Personal Loan Applications

No. Reasons % of

respondents

1 I could not give all required documents 30.8

2 My income was below the bank’s desired limit 45.8


4 My credit worthiness was bad 21.7

6.2 Factors Affecting the Choice of Bank for Personal

Loan

A question was asked from the respondents what factors affected their choice of bank for availing personal loan. A majority of the respondents (69.4%) who were currently using the loan said that they chose the bank because its terms and conditions were suitable. This reason counts as the most effective factor for choosing a particular bank for personal loan. Slightly less than half of the current borrowers (49.2%) informed that they had chosen the bank because the bank had approached them to take the loan. A reasonable percentage of current borrowers counted more than one reasons for choice of the bank. Low mark-up or interest rate was the main reason for 47.5% respondents.

Chart 2. Factors influencing the Selection of Bank for Personal Loan

49.2

69.4

47.5 46.7

29.3

16.3

0

10

20

30

40

50

60

70

Pe

rce

nta

ge

The bank

approached

Suitable

terms and

conditions

Low mark-up

or interest

rate

Lack of

information

Low

Processing

charges

Other

reasons

A majority of

the respondents

(69.4%) who

were currently

using the loan

said that they

chose the bank

because its

terms and

conditions were

suitable.

Personal Loans


Access to information is also a vital factor. As many as 46.7% current borrowers selected the bank just because they did not have much information about the personal loans of other banks. A low percentage, 29.3%, used the loan because processing charges of the bank were low.

6.3 Information about Charges & Terms and Conditions Access to comparative information about bank charges, and terms and conditions at the initial stage is a critical factor for understanding future financial liabilities. Generally, banks have the tendency to hide important information that can otherwise help the potential borrowers to make informed choices. Borrowers often complain that bank officers do not fully explain the terms and conditions, and all charges applicable on loan. Those charges about which a potential borrower is not explained at the sign-up stage or subsequently are perceived as “hidden charges”.

CRCP survey asked a number of questions about issues in access to information documents before signing the contract. Out of 55.1% current borrowers, 85.2% received terms and conditions in English. Only a negligible percentage of 1.6% current borrowers received them in Urdu and an equal percentage received in both languages. Similarly, 86.7% borrowers received application form and draft contract in English before signing the contract, whereas the ratio for those who received information brochures stands at 70.5%. These statistics indicate that, while a majority of loan applicants get documents before signing the agreement, but they are predominantly in English language.

Table 2: Personal Loan Applicants who Received Documents before

Signing the Contract (Percentage)

No. Documents Received Not

Received English Urdu Both

1 Terms and Conditions 85.2 1.6 1.6 11.6

2 Draft Contract 86.7 0 0 13.3

3 Information Brochures 70.5 1.6 11.5 16.6

As regards information about applicable charges, mark-up stands out to be the most important type of charge about which 96% applicants receive verbal information before signing the contract, whereas 62.3% received written information. It indicates that some applicants receive information both verbally as well as written, i.e. in form of brochures. A far less percentage of applicants receive verbal information about processing fee, late payment charges, collection charges, and cheque return charges. On the average, over 57.7% respondents were informed about applicable charges before signing the agreement whereas 32.9% respondents were provided written information while 24.8% were informed verbally.

As regards

information

about applicable

charges, mark-

up stands out to

be the most

important type

of charge about

which 96%

applicants

receive verbal

information

before signing

the contract.

Personal Loans


Table 3. Personal Loan Applicants who were informed about Charges

before Signing the Contract (Percentage)

No. Charges % of Applicants

Verbal Written

1 Processing fee 44.4 54.0

2 Late payment charges 36.1 44.3

3 Mark-up or interest 96.0 62.3

4 Collection charges 22.6 22.6

5 Cheque returned charges 19.7 21.3

6 Pre-payment penalty 22.6 14.5

Mark-up rate on personal loan stands out to be the most important factor, as it is vital determinant of borrowers’ repayment capacity. Banks offer personal loans on the basis of fixed as well as variable mark up. According to 2006 Annual Report of the Banking Ombudsman, most of the consumer loans are on the basis of variable interest rate. A telephonic survey of mark up rates conducted by CRCP found that mark up on personal loans varies significantly across different banks

Chart 3: Variation in Mark up on Personal Loans (%)

15

19

11.5 12

15

23

12

0

5

10

15

20

25

Pe

rce

nta

ge

NBP HMP KASB MCB Soneri ABN

Amro

HSBC

Banks

Mark-up Rate (%)

Source: CRCP telephonic survey of banks, April 3, 2008

As for problems faced by borrowers of personal loans, 39.7% respondents were not provided information about changes in applicable charges, whereas 29.3% respondents did not receive information whenever a change in schedule of charges was made. Similarly, a majority of borrowers complain that banks levy late payment despite timely payment of instalment. 30.5% borrowers said they were rarely charged late fee while 27.1% never faced the problem.

As for problems

faced by

borrowers of

personal loans,

39.7%

respondents

were not

provided

information

about changes in

applicable

charges.

Personal Loans


6.4 Time Taken for Processing of Loan Application The banks try process the loan application swiftly with least documentation. This practice has increased the ratio of non-performing loans because the banks pay least attention to loan service capacities of the borrowers. This trend, however, is changing now, as banks have been directed by the SBP to consult credit worthiness report of the borrower. CRCP survey revealed that 54% applications for personal loan were processed within the time stipulated by the bank, whereas 46% applications took longer time.

Chart 4: Processing of Personal Loan Applications

54%

46%

Processed within stipulated timeframe Not processed within stipulated timeframe

According to the survey, 68.3% loan applications were processed in less than 1 to 3 months followed by 23.8% applications, which took more than 3 and less than 6 months. Comparatively low ratio of applications is delayed. 6.3% applications were processed in more than 6 and less than 12 months, whereas 1.6% applications took 12 months. Thus, an overwhelming majority of the respondents got their applications processed within the time stipulated by the bank.

Chart 5: Time Taken in Processing of Loan Application

68.3

23.8

6.31.6

0

10

20

30

40

50

60

70

Pe

rce

nta

ge

Less than 1 moth

– 3 months

More than 3 and

less than 6

months

More than 6 and

less than 12

months

12 months or

more

CRCP survey

revealed that

54%

applications for

personal loan

were processed

within the time

stipulated by the

bank, whereas

46%

applications

took longer time.

Personal Loans


The main reasons for delay in processing of application are incomplete documentation and lethargic attitude of bank officials. Out of total respondents whose applications could not be processed within the time stipulated by the bank, 64.5% said their application forms were incomplete and therefore took longer. Lethargic attitude of the bank officials was stated a reason of delay by 46.2% respondents. Inability of applicants to provide necessary documents in time is another major reason for delays.

Table 4. Reasons for Delay in Processing of Loan Applications


1 Incomplete application form 64.5

2 Lethargic attitude of the bank officials 46.2

3 Other reasons 27.6

6.5 Regular Updates

Concerning written notification about terms and conditions, an overwhelming majority of 60.3% respondents were sometimes notified and 30.2% respondents were never informed, whereas 9.5% respondents were always informed about the changes in terms and conditions. Comparatively less percentage of the respondents is provided written information about schedule of charges. This ratio stands at 53.2%, followed by 27.4% respondents who were never informed about the change in charges.

Table 5: Borrowers kept informed by the Bank

No. Statement

% of Borrowers



9.5 60.3 30.2


19.4 53.2 27.4

On the whole, the number of respondents who are notified sometimes in writing about changes in terms and conditions and schedule of charges is very high, whereas a very low ratio of respondents is always/regularly informed.

Concerning

written

notification

about terms and

conditions, an

overwhelming

majority of

60.3%

respondents

were sometimes

notified.

Personal Loans


\Personal Loan Charges

Banks levy different types of charges on personal loans in addition to mark up on the principal or outstanding amount. Loan processing fee, late payment fee, cheque return fee, pre-payment penalty are a few examples. A comparison of some types of charges is provided below for selected banks.

Processing Fee Bank Alfalah charges Rs.1000 as loan processing fee. ACB charges different loan processing fees for civilians and Armed Forces personnel. For civilians, it charges 1.10% of the loan amount or minimum of Rs.2500 (including legal and documentation charges) for clean loans, and 1.10% of the loan amount or maximum up to Rs.5500 (legal & documentation charges at actual) for secured loans. Armed forces personnel are charged 1.10% of loan amount or minimum Rs.1600 (including legal & documentation charges) for clean loans, and 1.10% of loan amount or maximum up to Rs.5500 (legal & documentation chares at actual) for secured loans. HMB charges minimum Rs.1500 or up to 1% of loan amount, whichever is higher, inclusive of stamp duty, while ABN Amro charges up to Rs.2000 or 1% of the loan amount whichever is higher. Citibank levies up to Rs.5000 or 3% of the loan amount, whichever is higher, for non-end use, and up to Rs.2000, subject to approval of the loan, is charged for end use. HSBC charges Rs.3000 or 3% of the disbursed amount, whichever is higher, subject to approval of the loan.

Late Payment Charges All banks apply late payment charges ranging from Rs.200 to 700. Bank Alfalah and HMB charge Rs.200 per day whereas Soneri Bank charges Rs.200 per month per instalment. ACB charges Rs.550 per instalment and ABN Amro Rs.500 or 10% of the amount, whichever is higher. MCB charges 10% of instalment or Rs.1000, whichever is higher. Both Citibank and HSBC charge Rs.700 as late payment fee.

Prepayment Penalty

Bank Alfalah charges 5% on the outstanding principal as prepayment penalty. MCB charges 10% on 12 months maturity, 5% within 12 to 36 months, and 4% after 36 months. Soneri Bank accepts prepayments without any penalty. ABN Amro charges up to 10% of the remaining principal amount within a year of outstanding loan and up to 6% of remaining principal amount within second and third years of outstanding loan, up to 4% of the remaining principal amount during fourth and fifth years of outstanding loan. Citibank and HSBC charge Rs.5000 or 10% of outstanding, whichever is higher.

6.6 Registration of Complaints

As far as filing of complaints is concerned, majority of the respondents who had a grievance lodged complaints in their concerned banks. The ratio of respondents filing complaints 18 to 24 months back is more than respondents who filed complaints 12 to 18 months back, whereas 40% respondents do not remember at what time they filed the complaint. All complaints were responded to by the banks. While 80% complaints have been resolved, 20% are pending for the last 12 months or more. With reference to resolution of complaints, 40% complaints were resolved in

As per statistics,

50%

respondents

complained of

hidden charges

levied by the

bank.

Personal Loans


less than 1 or up to 3 months’ duration and an equal proportion of complaints were resolved within more than 3 and less than 6 months.

Table 6: Reasons for not Filing Complaint

No. Reasons % of

Borrowers


2 Lack of information about complaint redress forums and procedures

52.9



As high as 52.9% of the respondents did not file any complaint because they lacked information about complaint forums and procedures; 49% did not do so owing to lengthy procedure of complaint submission; 44% did not have any grievance against the bank while 44% did not file a complaint, anticipating that it would not be resolved.


The submitted complaints were about processing delay, staff attitude, high mark-up rate, hidden chares and misleading information by the bank. Not a single respondent complained about charges without prior notice, delay or fraud in relation to payment of collection of cheque and failure to act in accordance with banking regulation or guidelines related to card. As per statistics, 50% respondents complained of hidden charges levied by the bank; 20% against staff attitude; and an equally comparable ratio lodged complaints about processing delay, high mark-up and misleading information.

Table 7. Nature of Complaints

No. Nature of Complaint % of Complaints

1 Processing Delays 10

2 High Mark-up 10

3 Staff Attitude 20

4 Hidden Charges 50

5 Misleading Information 10

An overwhelming majority i.e., 80%, of the respondents were dissatisfied over the amount of time and cost consumed during redress of a grievance. 40% respondents expressed dissatisfaction owing to biased judgment and a quarter of the respondents complained of complex procedures. On account of insufficient or no compensation at all, 20%

An

overwhelming

majority i.e.,

80%, of the

respondents

were dissatisfied

over the amount

of time and cost

consumed

during redress

of a grievance.

Personal Loans


respondents were dissatisfied. Time loss and cost are the main reasons for dissatisfaction with procedures pertaining to redress of grievances,

The above analysis indicates that most of the respondents choose a bank for personal loan due to suitable terms and conditions of the bank. Terms and conditions, information brochures and application forms are generally provided in English and less information is provided about cheque return charges, pre-payment penalty and mark-up or interest rate. Most of the borrowers are not regularly informed about any change in term and condition and schedule of charges. Lacking information about complaint forums and procedures and owing to lengthy procedure of complaint submission, users do not file complaints. However, maximum complaints filed are about hidden charges imposed by the banks. Overall, majority of the personal loan users are dissatisfied with the personal loan services of the banks.


Chapter 7

House Financing

Conclusions and Recommendations


House Financing House financing includes loans for construction, purchase, renovation, purchase of house or apartment, purchase of land, house expansion, and purchase of land plus construction. In total consumer financing outlay in 2007, house financing carries 16.39% share. The total number of borrowers of house loans exceeded 24,000 in June 2007. The SBP data suggest that housing loans increased by 17.6% during first seven months of the fiscal year 2008, as compared to 15.5% during the same period in 2007.

CRCP conducted a survey of bank customers who are currently using at least one housing loan or had availed a housing loan in the past. The customers whose applications for housing loan were rejected were also included in the survey. In total, 95 customers were interviewed. Out of a sample of 30 branches of 15 banks, 22 branches of 11 banks provided housing loans. The survey covered only these selected bank branches at Rawalpindi, Islamabad, and Karachi. Findings of the survey are presented in the following sections.

7.1 Patterns of Access to House Financing

CRCP survey shows that there is high incidence of house financing applications that are rejected by the banks due to various reasons. This ratio stands at 24% for applications for house construction, 11.5% for house purchase, and about 7% for purchase of land. The highest number of house loans is for construction of house. The survey shows that 20.4% respondents were using the loan for house construction followed by 7.5% using the loan for house renovation.

Chart 1: Patterns of Access to House Financing

0

5

10

15

20

25

Pe

rce

nta

ge

Using Currently Used Previously Application Rejected

House Construction House Purchase

House Renovation Purchase of Land

Purchase of Land and Construction House Expansion

The SBP data

suggest that

housing loans

increased by

17.6% during

first seven

months of the

fiscal year 2008,

as compared to

15.5% during

the same period

in 2007.



As the statistics suggest that the ratio of rejected applications is highest in house financing, as compared to credit cards, auto loans or personal loans. The majority of applicants (48.6%) could not get loan, as they were able to provide all the required documents. This indicates that house financing requires more documentation than other types of loans. A considerable proportion of respondents (39.5%) could not get loan because their income was below the bank’s mandatory limit. Other respondents (38.9%) were not given any reasons, while 35.3% respondents did not possess favourable credit worthiness. Thus, use of credit worthiness reports maintained by Credit Information Bureau (CIB) constitutes as one of the major reasons for decline of house financing applications.

Table 1: Reasons for Rejection of House Financing Applications

No. Reasons % of Borrowers

1 I could not give all required documents 48.6

2 My income was below the bank’s mandatory limit 39.5


4 My credit worthiness was not favourable 35.3

5 Other reasons 26.5

7.2 Factors Affecting the Choice of Bank

Several factors affect the decision of the applicants to choose a specific bank for availing house financing loan. Survey data reveals that a high proportion of respondents (74.5%) who availed the loan chose the bank because of suitable terms and conditions. Other respondents (63.3%) decided to obtain the loan because they had already an account with the same bank. Lower mark-up or interest rate was another factor that prompted 47.9% of the respondents to avail the loan. Lacking information about house loans offered by other banks, 34.7% respondents preferred availing the loan, whereas 33.3% of the respondents were those approached by the bank itself. Over all, a majority of the respondents either found the terms and conditions suitable, or had their account with the same bank.

Survey data

reveals that a

high proportion

of respondents

(74.5%) who

availed the loan

chose the bank

because of

suitable terms

and conditions.



Chart 2: Factors Affecting the Choice of Bank for Housing Finance

74.5

47.9

63.3

0

10

20

30

40

50

60

70

80

Pe

rce

nta

ge

Suitable Terms and

Conditions

Low Mark-up or

Interest Rates

Account in the same

bank

% of Respondents

7.3 Information about Terms and Conditions & Charges

The potential borrowers of house financing loans have the right to access terms and conditions, draft contract and schedule of charges before signing the agreement. Data findings reveal that an overwhelming majority of respondents received these documents in English only, whereas a very nominal ratio received the documents in Urdu or both languages. Incidence of respondents receiving terms and conditions and draft contract in English is equally comparable. This ratio stands at 92.7%. While only 7.3% respondents received terms and condition and information brochures in Urdu, 54.5% respondents received information brochures in English. Other respondents (38.2%) received the information brochures in Urdu.

Table 2: Applicants who Received Documents before Signing the

Contract

No. Documents

% of applicants

In English In Urdu Both

1 Terms and Conditions 92.7 7.3 0

2 Draft Contract 92.7 1.8 0

3 Information Brochure 54.5 7.3 38.2

Banks provide both verbal and written information to their prospective clients about applicable charges. Data shows that more clients are provided written information as compared to verbal information about applicable charges. Concerning written information, an overwhelming majority is informed about processing and documentation fee, late payment charges, and property insurance premium. However, most of the respondents are informed about counter cash payment charges property evaluation/appraisal charges, legal chares and life insurance charges.

Incidence of

respondents

receiving terms

and conditions

and draft

contract in

English is

equally

comparable.

This ratio stands

at 92.7%..



Table 3: Applicants informed about Charges before Signing the

Contract

No. Charges

% of applicant informed by the bank

officer

Verbal Written

1 Processing Fee 74.5 20.0

2 Late Payment Charges 21.8 67.3

3 Property Insurance Premium 10.9 60.0

4 Income Estimation Charges 23.6 18.2

5 Property Evaluation 36.4 27.3

6 Legal Charges 36.4 14.5

7 Life Insurance Charges 30.9 20.0

8 Partial Payoff 9.1 7.3

9 Equity 12.7 7.3

10 Counter Cash Payment Charges 40.0 16.4

11 Prepayment Penalty 52.7 21.8

Mark-up rate on housing financing is a vital factor in determining the loan service capacity of borrowers. A telephonic survey of mark up rates conducted by CRCP found that mark up on loans varies significantly across different banks. The survey of seven banks showed that it ranged between 11% and 15%.

Chart 3: Variation in Mark up on House Financing Loans

12.511.5

1514 14

15

11

0

2

4

6

8

10

12

14

16

Pe

rce

nta

ge

NBP Alfalah ACB KASB MCB Soneri Citibank

Banks

Mark-up Rate (%)

Data shows that

more clients are

provided written

information as

compared to

verbal

information

about applicable

charges.



Bank Charges on Housing Loans

Different types of charges are levied by banks on loans borrowed by individuals for housing purposes. Processing fee, late payment fee, cheque return fee, pre-payment penalty are a few examples. A comparison of some types of charges is provided below for selected banks.

Processing and Documentation Fee: NBP charges Rs.500 for government employees for loan less than 1 million, Rs.1000 for loan worth 1 million, Rs.3000 for loan worth 4 million, and Rs.6000 for other than government employees. ACB charges Rs.5500 (flat), while EGIB charges Rs.6000. MCB levies 4% for the first year, 3% for the second year and 2% for the third and for the subsequent years of financing for full prepayment. Soneri Bank charges 0.50% of the financed amount or Rs.2500 whichever is higher, and is recoverable up-front, which is refundable in case of non-approval of finance. ABN Amro charges Rs.4000 for loan amount up to Rs.3 million and Rs.6000 for loan amount more than Rs.3 million with actual documentation charges. Citibank charges Rs.6000 from resident Pakistanis and Rs.15,000 for non-resident Pakistanis.

Late Payment Charges: Soneri Bank, Bank Alfalah and ACB levy Rs.200, Rs.500, and Rs.550 respectively, per month/instalment whereas ABN Amro charges Rs.1000 or 10% of instalment, whichever is higher, as late payment charges, depending on product and segment. Up to 20% of monthly instalment overdue is charged by Citibank.

Prepayment Penalty: NBP has complete as well as partial prepayment options while Soneri Bank accepts prepayment without any penalty. Citibank charges up to 8% of the repayment amount. Bank Alfalah charges up to 5% of the outstanding amount in case of BTF (i.e. the facility is transferred to another lender and sale of plot without completing the construction), and levy no charges if the facility is repaid through own sources.

7.4 Delays in Processing of Application

Delay in processing of loan application is a major consumer concern. The data collected through the survey reflects that a high percentage of respondents reported timely processing of their applicants. This ratio stands at 60%. A considerable proportion of applications (40%) are not processed within the time stipulation by the bank.

Applications of majority of the respondents were processed in the duration of less than 1 month to 3 months followed by 25.5% respondents whose applications were processed in more than 3 and less than 6 months. A very low percentage i.e. 1.8% of the respondents had to suffer delay in the process of application – for duration of 12 months or more.

A considerable

proportion of

applications

(40%) are not

processed within

the time

stipulation by

the bank.



Chart 4: Processing of Loan Applications within Stipulated Timeframe

60%

40%



Chart 5: Time Taken for Loan Application Process

69.1

25.5

3.6 1.8

0

10

20

30

40

50

60

70

Pe

rce

nta

ge

% of Respondents

Less than 1 moth – 3 months More than 3 and less than 6 months

More than 6 and less than 12 months 12 months or more

As far as reasons for delay in application processing are concerned, applications of 40% of the respondents were not processed within the stipulated time due to a variety of reasons.

Table 4: Reason for Delays in Processing of Loan Applications


1 Incomplete application form 63.6

2 Lethargic attitude of the bank officials 28.6

3 Other reasons 9.5

Survey data reflects that 63.3% respondents provided incomplete application forms causing delay in the process of application within the

Survey data

reflects that

63.3%

respondents

provided

incomplete

application

forms. Owing to

lethargic

attitude of the

bank officials,

28.6%

respondents had

to suffer delay.



fixed duration. Owing to lethargic attitude of the bank officials, 28.6% respondents had to suffer delay.

7.5 Duration of Loan Disbursement after Approval of

Application

In most of the cases, loan is disbursed in less than 1 month and maximum 3 months duration. This ratio stands at 69.1%. Loan of 25.5% respondents was disbursed in more than 3 and less than 6 months. Comparatively, a very low percentage of the respondents’ amount was disbursed in more than 6 and less than 12 months duration.

Table 5: Duration of Loan Disbursement

No. Duration % of borrowers

1 Less than 1 moth – 3 months 69.1




In addition to delays in processing and loan disbursement, 76.2% respondents reported that their bank charges late fee despite timely payments. Likewise, 68.3% respondents were very often not informed about change in applicable charges followed by 77.4% respondents who very often found that the procedure of early redemption is lengthy and difficult. A very low percentage of the respondents rarely or never faced such problems.

7.6 Provision of Updated Information

Banks also notify in writing about any change in terms and conditions and schedule of charges. Survey findings display that an overwhelming majority of the respondents is sometimes notified in writing about any change in terms and conditions and schedule of charges, whereas a very low ratio is always or regularly informed.

With reference to any change in the terms and conditions, only 15.5% respondents are always notified and majority 82.1% is sometimes notified in writing. Pertaining to schedule of charges, 79.8% respondents are sometimes notified in comparison with 9.5% respondents who are always or regularly informed.

In addition to

delays in

processing and

loan

disbursement,

76.2%

respondents

reported that

their bank

charges late fee

despite timely

payments.



Table 6: Percentage of Respondents Kept Informed by the Bank

No. Statement

% of users who are kept informed

by the bank

Always/



15.5 82.1 2.4


9.5 79.8 10.7

7.7 Registration of Complaints against Banks

Users facing problems with reference to loan, lodge complaints with their concerned bank. Survey reveals that all of the respondents who filed complaints, lodged their complaints with their concerned banks.

Table 7: Respondents Who Filed Complaints (Percentage)

No. Duration % of users

1 Less than 6 months ago 25

2 6 to 12 months back 50



5 More than 24 months back 0

6 Don’t remember 0

Majority, 50%, of the respondents lodged complaints 6 to 12 months back, whereas there is an equally comparable percentage of the respondents filing complaints less than 6 months ago and 12 to 18 months back.


As for the nature of complaints registered, 44.4% respondents filed complaints on account of high mark-up rate imposed by the bank, whereas 33.3% respondents complained about staff attitude. However, equivalent ratio of the respondents lodged complaint owing to processing delays and hidden charges imposed by the bank. This ratio stands at 11.1%.

As for the nature

of complaints

registered,

44.4%

respondents filed

complaints on

account of high

mark-up rate

imposed by the

bank.



Chart 6: Nature of Complaints

11.1

44.4

33.3

11.1

0

5

10

15

20

25

30

35

40

45

Pe

rce

nta

ge

Processing Delay High Mark-up Staff Attitude Hidden Charges

Nature of Complaints

% of Respondents

7.9 Time Consumed in Resolution of Complaints

In the application processing phase, complaints of all the respondents were resolved within the duration of less than 1 to 3 months. Complaint applications of not even a single user is neither rejected by the bank nor is pending for any duration.

Table 8: Percentage of users who did not file complaint for given

reason”

No. Reasons %


2 Lack of information about complaint forums and procedures 51.1



All of the respondents facing problems with reference to loan do not file complaints in owing to a variety reasons. Maximum percentage of respondents positively responded for lacking information about complaint forums and procedures where the ratio stands at 51.1%. There is an equal percentage of the respondents for having no grievance against the bank and anticipating that their complaints would not be resolved. This ratio stands at 45.5%. Owing to lengthy procedures for complaint submission, over 44.4% respondents did not file the complaint.

7.10 Problems Related to Housing Insurance

Banks, extending housing mortgage, also provide housing insurance facility to their clients. As per data collected, all of the respondents of NBP, Alfalah and NIB got their property insured by the bank followed by 75% respondents of FWBL and Citi Bank. Likewise, 66.7%

76.9%

respondents

were not given

any option to

choose the

insurance

company of their

choice.



respondents of Askari and EGIB, and 50% respondents of MCB, Soneri and ABN Amro got their property insured by the banks.

Table 9: Respondents who Faced Insurance-related Problems

No Problems %

1 The bank did not provide any option to choose the insurance company of my choice

76.9

2 The insurance premium is higher than other companies 40.0

3 The company selected by bank is not reputable 25.6

4 In case of accident/disaster, the company took long time to disburse my insurance

56.8

5 Other 2.6

Generally users face problems with reference to insurance of their house. Survey data reflects that 76.9% respondents were not given any option to choose the insurance company of their choice, whereas in case of accident or disaster, 56.8% respondents suffered delay in disbursement of insurance. 40% respondents found that insurance premium was higher than other banks, while 25.6% respondents complained that selected insurance company was not reputable.

7.11 Satisfaction with Redress of Complaints

Among the respondents who filed complaints, no one is satisfied with the grievance redress procedure of the bank.

Table 10: Reasons for Dissatisfaction

No. Reasons for dissatisfaction % of users

1 Biased judgment 75.0

2 Delay in complaint processing 75.0

3 Complexity of procedure 75.0

4 Insufficient or no compensation at all 50.0

5 Other -

As for reasons regarding dissatisfaction are concerned, owing to biased judgment, delay in complaint processing and complexity of procedure, an equally comparable percentage of the respondents is dissatisfied. This ratio stands at 75%. However, 50% respondents were dissatisfied due to insufficient or no compensation at all.

Owing to biased

judgment, delay

in complaint

processing and

complexity of

procedure, an

equally

comparable

percentage of

the respondents

is dissatisfied.

This ratio stands

at 75%.



7.12 Overall Satisfaction with House Financing

With regard to the satisfaction level of the respondents, an overwhelming majority of the respondents is undecided in their opinion over the satisfaction level. A very low ratio of the respondents is satisfied or dissatisfied, showing greater tendency towards dissatisfaction, whereas not even a single respondent is highly satisfied or highly dissatisfied. In terms of bank-wise respondents, all of the respondents of EGIB, MCB and Citi Bank are undecided in their opinion over the satisfaction level followed by 90% respondents of Askari and 87% respondents of ABN. Placing the bank at the top, 30% respondents of NBP are dissatisfied.



Chapter 8




Conclusions and Recommendations 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.

At the macroeconomic level, consumer financing has significantly contributed to economic turnaround 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 jeopardized the competitiveness in economy. A cartel-like pattern appears to have emerged in the banks, given that interest rate spread is among the highest in the world. Moreover, consumer financing has significant impact on inflation, which is rising sharply. In face of the economic challenges facing Pakistan, the SBP can no longer afford to overlook the state of poor competition in the financial sector.

From a consumer perspective, consumer financing has been helpful in improving the quality of life of the people who have the capacity of servicing the loans. However, there is mounting evidence that this capacity is deteriorating due to high spread and variable interest rates on loans. Depositors are not getting due returns due to high difference between lending and deposit interest rates. Further, the volume of consumer complaints is rising day by day due to processing delays, service inefficiencies, hidden charges, and poor disclosure practices. Lack of consumer education on banking terms and conditions, policies, rules, and regulations is also a critical factor in securing financial rights.

Based on the analysis, the study makes the following recommendations:

8.1 Interest Rates and Competition in Banking Sector

8.1.1 High interest rate spread is damaging the competitiveness in economy in general, and in the financial sector in particular. Further, huge profit margins of banks at the cost of depositors’ savings cannot be justified on any ground whatsoever. The SBP 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. The average spread in India, Sri Lanka and Bangladesh is less than 6%.



8.1.2 Presently, almost all consumer loans are on the basis of variable mark up. It should be mandatory for all banks to offer both fixed as well as variable mark up on consumer loans. If a borrower chooses fixed mark up, it should not exceed the market rate current at the time of the signing of agreement.

8.1.3 The banks should introduce discounted variable rates for fixed periods. The small borrowers should be provided opportunities to pay interest on loan at a lower level than the standard variable rate.

8.2 Compliance with SBP Regulations

8.2.1 The rising volume of public complaints indicates that banks are not fully complying with existing SBP regulations. The mechanism for enforcement of regulations needs to be strengthened. The compliance assessments conducted by SBP should be publicized, and a ranking of banks according to the degree of compliance be publicized through print and electronic media to deter the banks from non-compliance. Also, the banks should be penalized for non-compliance with mandatory requirements.

8.2.2 The SBP should develop and enforce minimum customer service standards modelled on the Citizen’s Charter to be observed by every bank. Some illustrative examples of the standards are: maximum waiting time for customers, minimum information to be proactively disclosed by the banks, minimum instructions to be displayed inside ATM cabins, reduction in time for resolution of 80% registered complaints, etc. This initiative should be undertaken in collaboration with consumer protection groups and other civil society organizations.

8.2.3 Aggressive marketing and unsolicited financing is promoting unnecessary private consumptions at the cost of consumer savings. The SBP regulations should discourage this approach. The unsolicited financing through personal loans, auto loans, credit cards, etc. should be forbidden. Nevertheless, the banks should have the right to offer products through transparent advertising.

8.3 Transparency and Access to Information related to

Consumer Financing Products and Services

8.3.1 The available data about consumer financing is collected and analyzed mainly from the viewpoint of monetary policy and macroeconomic indicators. The issues, which affect the borrowers at individual level, are not fully captured in research. Standalone stories appear in the media, which are not sufficient to articulate the real issues in a broader context. Therefore, the SBP should conduct national Survey of Consumer Financing (SCF) at least every two years. The findings of this survey



should be used to adjust and modify the regulations, and introduce reforms in the banking sector to address the grievances of consumers.

8.3.2 Presently, individual borrowers do not have the right to access their own Credit Worthiness Report (CWR) maintained by Credit Information Bureau (CIB). The SBP should amend the rules to allow the borrowers to access their CWR.

8.3.3 Although Prudential Regulations for Consumer Financing prescribe disclosure requirements for the banks, the data indicate that the present disclosure practices are not adequate from the perspective of consumer and researchers. Therefore, the need of the hour is to enact legislation for transparency in lending for protection of consumer rights. Lesson should be learnt from the USA’s Truth in Lending Act that protects consumers in credit transactions by requiring the banks to make adequate disclosures. As an additional step, the SBP should direct every bank to formulate and implement Freedom of Information (FOI) Policy. The policies should provide for overall presumption in favour of disclosure while allowing for adequate protection of personal information.

8.3.4 It should be mandatory for all banks to make available Consumer Credit Policy and updated Schedule of Charges on the website. Copies of the Policy and Schedule should be made available to any citizen on demand.

8.3.5 The existing FOI laws do not extend to the private sector. No person can access information from a private bank under any law, except as provided in the SBP regulations or bank’s own terms and conditions. The SBP regulations do not entitle a citizen to access information from a bank as a legal right other than personal information (although restrictions apply even on personal data). The Government of Pakistan should amend the FOI laws and extend them to the private sector including the private banks.

8.4 Consumer Education

8.4.1 Comparative information is not available to the consumers to make informed choices. If a consumer is interested to find out the bank with lowest mark up on the personal loan for instance, consolidated bank-wise data is not available in Pakistan. As a result, the consumer has to rely on misleading advertisements and false promises of banks. The SBP should prepare and advertise bank-wise consolidated data in form of charts and tables for the public in Urdu and local languages so that they are able to choose a bank on the basis of reliable information. This practice would help promote competition among the banks, and create an incentive for improving efficiency and the quality of services.



8.4.2 All banks should be directed to provide latest copy of Terms of Conditions and Schedule of Charges to all applicants for consumer loans and credit cards well before signing the application form. The applicants should be encouraged to read and understand these documents before they enter into the agreement.

8.4.3 There is a need to establish independent consumer credit counselling centres such as those established in the USA. These centres should develop and implement programs for consumer education on one hand, and provide advice to the consumers to choose the right kind of products.

8.5 Complaint Redress Mechanism

8.5.1 The complaint procedure is lengthy. The normal time allowed to banks, the Banking Ombudsman and in case of appeal, to the SBP for redress of a consumer complaint aggregates to about 4 months. If a consumer has to go the judicial process against the SBP’s decision, then it might take even longer. The number of days for redress of complaints should be reduced.

8.5.2 Generally, bank officials are reluctant to provide Complaint Form to the aggrieved customer. The banks should be required to place the Complaint Forms at a prominent place within the bank’s premises.

8.5.3 The procedure of complaint registration with Banking Ombudsman is cumbersome and tends to discourage the customers to lodge a complaint. The Ombudsman should have the powers to accept application on plain paper without the requirement of attestation by Oath Commissioner.

8.5.4 The powers of Banking Ombudsman are restricted in scope. The Ombudsman should have the authority to take cognizance of maladministration and violation of SBP rules based on information collected from any source. The responsibilities of entertaining the complaints pertaining to corruption, negligence of duties by bank officers in dealing with customer and excessive delay in taking decisions can be exercised only in respect of public sector banks.

8.6 Bank Charges

8.6.1 The SBP regulations should bind the banks to explain ALL applicable charges on consumer loans before signing the contract.

8.6.2 Banks fix different types of charges on credit cards and loans as a percentage as well as a minimum amount, and charge to the customer whichever is higher. For instance, some banks charge Rs.500 or 3% of cash advance amount on credit cards, whichever is higher. If the cash advance amount to be paid by the customer at the rate of 3% is less, then the bank would charge Rs.500, instead of 3%. This practice is unfair and should be abolished



immediately. The bank should either charge fee or only percentage.

8.7 ATM

8.7.1 ATM users face a lot of inconvenience due to out-of-order or out-of-cash ATM machines because there is nothing compelling the banks to keep their machines in good order. If ATM machine returns the card due to any technical error or unavailability of cash, it amounts to bank default from a consumer perspective. It is just like a customer who visits a bank to debit certain amount from his account, but the cashier says the bank has run out of money. If the ATM machines fail to service the customer, the respective bank must be penalized and the customer be compensated. If the banks have the right to charge handsome fee to credit borrowers if the cheque is dishonoured, should not the customers have the right to be compensated when the ATM machine does not work. The consumer must be compensated for this inconvenience.

8.7.2 Some banks de-link their ATM machines from 1Link at their discretion. This practice not only causes inconvenience to the ATM users of other banks, but also amounts to cheating the customer. When the ATM machine is de-linked, it accepts ATM cards of that bank only, which owns the machine. Whereas, customers with ATM cards of other banks are shown some technical error on the screen. The SBP should take notice of this practice, and centralize the linking of ATM machines so that no bank could de-link from the network to cause inconvenience.

8.8 Sustainability of Consumer Financing Sector

8.8.1 The problems in interest rate spread and service delivery notwithstanding, consumers have benefited a lot from the consumer financing sector. A large number of people have been able to meet their real needs by accessing credit from the banks. Therefore, steps need to be taken for sustainability of this sector. This requires the banks to develop data-based lending strategies to manage the risks associated with this sector.

8.8.2 The protection of this sector, however, should be based on a cautious approach. Pakistan needs to learn from the South East Asian financial crisis, which jolted the leading economies in the region as a result of high private sector borrowing. Banks that are aggressively involved in consumer lending need to learn lessons from the crisis that forced Thailand to fix a universal cap of 18% as being chargeable on credit cards, besides raising the minimum monthly income criterion for issuance of cards.


Bibliography

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Review, 2006, State Bank of Pakistan.

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Obstacles to Financial Literacy.

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Laws, Regulations and Guidelines

The Competition Ordinance, 2007

Prudential Regulations for Consumer Financing

Guidelines in Dealing with Customer Complaints

Guidelines for Standardization of ATM Operations

The Financial Institutions (Recovery of Finances) Ordinance, 2001

The Payment Systems and Electronic Fund Transfers Act, 2007


Annex I

List of Selected Banks

1 ABN Amro Bank

2 Bank Alfalah Ltd.

3 Allied Bank Ltd.

4 Askari Commercial Bank Ltd.

5 Citibank

6 Dawood Islamic Bank Ltd.

7 Emirates Global Islamic Bank Ltd.

8 First Women Bank of Pakistan Ltd.

9 Habib Metropolitan Bank Ltd.

10 Hong Kong & Shanghai Banking Corporation Ltd.

11 KASB Bank Ltd.

12 Muslim Commercial Bank Ltd.

13 National Bank of Pakistan

14 NIB Bank Ltd. (PICIC merged)

15 Soneri Bank Ltd.


Annex II

List of Interviews

1. Dr. Pervaiz Tahir, Mahboob-ul-Haq Professor of Economics,

Government College University, Lahore

2. Dr. Aliya H. Khan, Chairperson, Department of Economics,

Quaid-e-Azam University, Islamabad

3. Mr. Azhar Hameed, Banking Ombudsman, Karachi

4. Mr. Masood Yasin, Manager, National Bank of Pakistan,

Islamabad

5. Ms. Amber Rathor, Manager, Allied Bank Ltd., Islamabad

6. Malik Noor Khan, Manager, Askari Commercial Bank Ltd.,

Islamabad

7. Mr. Gul Muhammad Khan, Manager, Muslim Commercial

Bank Ltd., Islamabad

8. Mr. Ehtesham, Senior Reporter, Daily Dawn, Islamabad

9. Mr. Asif Ali, Joint Director, State Bank of Pakistan,

Islamabad


Annex III

List of Banking Courts

No. Name of Court Name of The Judge

1 Banking Court-I, Peshawar Mr. Ataullah Khan

2 Banking Court-II, Peshawar Mr. Jehangir Khan

3 Banking Court, Abbottabad Mr. Syed Rafique Hussain Shah

4 Banking Court, Rawalpindi Mr. Abdul Qadir Shad

5 Banking Court-I, Gujranwala Mr. Muhammad Sarfraz Khan

6 Banking Court-II, Gujranwala Mr. Pervez Ali Chawala

7 Banking Court-I, Lahore Mr. Justice (R) Ghulam Sarwar Sheikh

8 Banking Court-II, Lahore Mr. Justice (R) Raja M.Sabir

9 Banking Court-III, Lahore Mr. Justice (R) Pervaiz Ahmad

10 Banking Court-IV, Lahore Mr. Manzoor Hussain Malik

11 Banking Court, Sargodha Mr. Safdar Hussain Malik

12 Banking Court-I, Faisalabad Mr. Abdul Shakoor Chaudhry

13 Banking Court-II, Faisalabad Mr. Talib Hussain Baluch

14 Banking Court-I, Multan Mr. A.D.Khalid

15 Banking Court-II, Multan Mr. Muhammad Aslam

16 Banking Court-III, Multan Mr. Muhammad Aslam Khan

17 Banking Court-I, Bahawalpur Mr. Aziz-ur-Rehman

18 Banking Court-I, Sukkur Mr. Khair Muhammad Talpur

19 Banking Court-II, Sukkur Mr. Sikandar Ali Bhutto

20 Banking Court-I, Larkana Mr. Muneer Ahmed Khawaja

21 Banking Court-II, Larkana Syed Zakir Hussain

22 Banking Court-I, Hyderabad Mr. Ali Nawaz Peerzada

23 Banking Court-II, Hyderabad Mrs. Farzana Anwer Shah

24 Banking Court-I, Karachi Mr. Yamin Yousaf

25 Banking Court-II, Karachi Mr. Farooq Ali Channa

26 Banking Court-III, Karachi Mr. Hassan Feroze

27 Banking Court-IV, Karachi Vacant

28 Banking Court-V, Karachi Mr. Riaz Ahmed Phulpoto

29 Banking Court, Quetta Mr. Rozi Khan Barrach


Annex IV

List of Tables

Key Issues in Consumer Financing : An Overview

Table 1 Consumer Financing Portfolio of Banks (December 2006 and June 2007)

Table 2 Growth in Consumer Financing (July-January 2007 and 2008)

Table 3 Interest Rate Behaviour in Pakistan

Table 4 Average Interest Rate Spread in South Asia (2003-05)

Table 5 Consumer Complaints against Banks in 2006


Table 1 Current Credit Card Users who Received Documents before Signing the Application Form (Percentage)

Table 2 Current Credit Card Users informed about Charges before Signing the Application Form (Percentage)

Table 3 Reasons for Delay in Processing of Applications

Table 4 Common Problems faced by ATM Users (Percentage)

Table 5 Credit Card Users who are kept Informed by their Bank (Percentage)

Table 6 Users who Registered Complaints (percentage)

Table 7 Reasons for Not Filing Complaints

Table 8 Nature of Complaints

Table 9 Response Time for Complaints

Table 10 Overall Satisfaction with ATM and Credit Cards

Auto Loans

Table 1 Reasons for Rejection of Application

Table 2 Borrowers who Received Documents before Signing the Contract (Percentage)

Table 3 Borrowers who were informed about Charges before Signing the Contract (percentage)

Table 4 Duration of Car Delivery after Approval of Loan Application

Table 5 Borrowers who are kept informed by the Bank

Table 6 Reasons for Making Premature Full Payment

Table 7 Borrowers who Filed Complaints against Banks

Table 8 Reasons for not Filing Complaint

Table 9 Nature of Complaints related to Auto Loans

Table 10 Time Taken in Resolution of Complaints

Table 11 Reasons for Dissatisfaction

Table 12 Problems in Auto Insurance

Table 13 Satisfaction Level of Respondents


Personal Loans

Table 1 Reasons for Rejection of Personal Loan Applications

Table 2 Personal Loan Applicants who Received Documents before Signing the Contract (Percentage)

Table 3 Personal Loan Applicants who were informed about Charges before Signing the Contract (Percentage)

Table 4 Reasons for Delay in Processing of Loan Applications

Table 5 Borrowers kept informed by the Bank

Table 6 Reasons for not Filing Complaint

Table 7 Nature of Complaints

House Financing

Table 1 Reasons for Rejection of House Financing Applications

Table 2 Applicants who Received Documents before Signing the Contract

Table 3 Applicants informed about Charges before Signing the Contract

Table 4 Reason for Delays in Processing of Loan Applications

Table 5 Duration of Loan Disbursement

Table 6 Percentage of Respondents Kept Informed by the Bank

Table 7 Respondents Who Filed Complaints (Percentage)

Table 8 Percentage of users who did not file complaint for given reason

Table 9 Respondents who Faced Insurance-related Problems

Table 10 Reasons for Dissatisfaction


Annex V

List of Charts


Chart 1 Share of Products in Total Consumer Financing Portfolio

Chart 2 Rise in Pre-Tax Annual Profits of Banks in Pakistan

Chart 3 Weighted Average Lending and Deposit Rates in February 2008

Chart 4 Nine Year Average Interest Rate Spread of 14 Countries

Chart 5 Types of Consumer Complaints in 2006


Chart 1 Users of ATM and Credit Cards (percentage)

Chart 2 Reasons for Choice of Bank for Credit Card

Chart 3 Timely Processing of ATM and Credit Card Applications

Chart 4 Time Spent on Processing of ATM and Credit Card Applications

Chart 5 Problems most frequently faced by Credit Card Users

Auto Loans

Chart 1 Patterns of Auto Financing and Leasing

Chart 2 Minimum Tenure of Auto Loans

Chart 3 Factors Affecting the Choice of Bank for Auto Loans

Chart 4 Monthly Mark-up Rate on Auto Loans (percentage)

Chart 5 Processing of Loan Applications within the Bank’s Stipulated Time

Chart 6 Time taken in Processing of Auto Loan Applications

Personal Loans

Chart 1 Patterns of Access to Personal Loans

Chart 2 Factors influencing the Selection of Bank for Personal Loan

Chart 3 Variation in Mark up on Personal Loans (%)

Chart 4 Processing of Personal Loan Applications

Chart 5 Time Taken in Processing of Loan Application

House Financing

Chart 1 Patterns of Access to House Financing

Chart 2 Factors Affecting the Choice of Bank for Housing Finance

Chart 3 Variation in Mark up on House Financing Loans

Chart 4 Processing of Loan Applications within Stipulated Timeframe

Chart 5 Time Taken for Loan Application Process

Chart 6 Nature of Complaints


Annex VI

List of Boxes

Regulatory Framework for Consumer Financing

What is a Grievance?

Confidential Credit Worthiness Reports


Information Disclosure Practices of Banks

Banking Cartel and Competition

Man commits suicide due to harassment by loan recovery team


Credit Card Charges

Late Payment Fee before Activation of Credit Card

Auto Loan

Auto Loan Charges

Personal Loan

Personal Loans

Personal Loan Charges

House Financing

Bank Charges on Housing Loans


Glossary

Auto loan Includes any loans used to purchase a vehicle for personal or commercial use

Car financing A type of loan in which the car is registered

under the name of borrower and is mortgaged to the bank as long as the consumer pays off the amount borrowed from the bank

Car leasing A type of loan in which the car is registered in

the name of the bank and the original papers are also in the name of the bank

Consumer financing Any kind of lending to consumers by the

banking sector and financial institutions Credit cards Include any card, which a customer can use to

borrow credit from the bank Debit card A card that resembles a credit card but which

debits a transaction account (checking account) with the transfers occurring contemporaneously with the customers purchases

Discount rate Interest rate at which an eligible depository

institution may borrow funds, typically for a short period, directly from the central bank

Fiscal policy The federal government’s decisions about the

amount of money it spends and collects in taxes to achieve a full employment and non-inflationary economy

Floating exchange rate The flexible exchange rate system in which

the exchange rate is determined by the market forces of supply and demand without intervention

Housing finance Includes the loan, which is provided to

individuals for the purpose of purchasing or improving a residential house, or apartment, or land

Interest rate The rate charged for the use of borrowed

money. The interest rate is expressed as a percentage of the amount borrowed


Liquidity risk Risk that a depository institution will not have sufficient cash or liquid assets to meet the claims of depositors and other creditors

Nominal interest rate The interest rate that does not factor in the

effects of inflation Non-performing loan A loan that is in default or close to being in

default Personal loan Include the loans provided to individuals for

the payment of goods, services and expenses Real interest rate Nominal interest rate minus inflation rate Revolving credit A line of credit where the customer pays a

commitment fee and is then allowed to use the funds when they are needed

Running finance A credit facility established for a specific time

limit at variable interest rates Spread The difference between lending rate and

deposit rate Variable interest rate Variable-rate agreement, as distinguished from

a fixed rate agreement, calls for an interest rate that may fluctuate over the life of the loan. The rate is often tied to an index that reflects changes in market rates of interest.