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“The world is the limit as far as consumer financing is concerned”

Published in Jul-Aug 2005

Interview with Dr Ishrat Husain, Governor, State Bank of Pakistan.

Dr Ishrat Husain speaks about the benefits of consumer finance as an agent for social change in Pakistan.

AURORA: How important a role has consumer financing played in Pakistan’s economic turnaround?
Dr ISHRAT HUSAIN: In any country, banks are one of the major influences in nurturing the middle classes. They do it by providing financing to enable people to buy their own house, car, consumer electronics or meet other expenditures. The logic is extremely simple. Nobody at a young age (except those who have rich fathers or fathers-in-law, or who are corrupt) ever has the entire sum of money necessary to purchase a house or a car. Yet, the young have an income stream coming their way every month. So, instead of spending 40% of their income on rent, they use that money to buy a house and pay back in instalments, knowing that the value of their house or apartment will rise every year, so that their equity rises and the loan declines. In this way, wealth is generated among the middle classes, who use this equity to borrow for a car or other goods; living standards improve and these purchases help the economy. The construction industry has 38 industries dependent on it and if it takes off, demand for steel, wood, bricks, plumbing services etc. increases and people working in these sectors also see their incomes rise, and in turn, they employ more people, and when more people join the labour force, income levels start rising in the economy. But we are at a very early stage, because four years ago the State Bank had rules that did not allow mortgage financing, which was totally absurd.

A: How far have we come?
IH: From a zero share in consumer financing, today we have reached 20% of the loans going to consumer financing. Almost two and a half million new borrowers have taken advantage of this. There are 21 million households in Pakistan and we are concentrating on the middle-class, the lower middle-class and the upper middle-class, which comprise 13 million households. If out of these, two and a half million households have access to bank credit, this will keep the economy in expansion. In Malaysia, for example, 50% of the portfolio of the banks is mortgage finance and we haven’t even touched the five percent mark. The world is the limit as far as consumer financing is concerned, and the way banks are positioning themselves, the future for consumer financing is very, very bright.

A: So far consumer financing has been an urban phenomenon, will banks be as successful in the villages?
IH: Fifty billion rupees of additional income was generated last year in the rural areas simply because cotton production went up from 10 to 15 million bales; wheat production went from 19 to 22 million tonnes and the price of wheat went from 350 to 400 rupees. These are the incomes that are being generated. When you have additional income, your creditworthiness improves, which is why people are going in for these kinds of loans.

A: But wasn’t last year an exception due to exceptionally good weather conditions?
IH: Instead of a four percent growth, we have seven and a half percent growth. But a four percent growth in agriculture is very, very impressive. Even when we had very poor GDP growth in the 1990s, agriculture was growing by four percent and that is why we don’t have food shortages in this country; why we are exporting rice and why we are the fifth largest producer of cotton in the world. Of course, there are year to year variations, depending on weather conditions, but if you take a 10 year average, even in the 1990s, agriculture in Pakistan has performed well. The other good thing is, like every other country in the world, as productivity increases more and more people move away from agriculture and into other sectors of the economy; therefore a much smaller proportion of people are able to produce enough food for the county and for export. That is how progress takes place. In the US, three percent of the population produces enough to feed 250 million people plus the rest of the world. This is the transformation in Pakistan, from almost 80% of the population in the 1950s, we are down to 46% directly employed in agriculture. The contribution of agriculture, which used to be 50%, is down to 23%; productivity is improving.

A: How do you respond to concerns that consumer financing is encouraging people to live beyond their means and that one day the system will crash?
IH: It is a very flawed concept in Pakistan, to think that consumer financing is something bad. Consumer financing forces you to save money from your income, which you use to build assets and that is how wealth is generated and the middle-class expands. If you don’t have a middle class, your country will never be able to go anywhere in the world, and consumer financing is one of the pillars for nurturing the middle-class.

A: Is default likely to become a problem?
IH: The default ratio is very low. Auto financing has been going on for five to six years and the recovery rate is about 97%. Of course, some people will not be able to pay up, but with this system, you have a tangible asset behind it. With a mortgage, if you are unable to pay back your loan, the bank will foreclose your property and sell it to somebody else. However, the thing to keep in mind is that in our society there is a social stigma; if the bank repossesses my flat, I will cut a very sorry figure in front of my family, friends and relatives. So I will beg, borrow and steal to ensure the payment is made. In Asian counties, the default rate on mortgages and autos is very low because there is a social compulsion for people to pay back. Why do you think young, foreign educated Pakistanis want to remain abroad? Because as soon as they find a job, they know they can buy an apartment or a car, which they will repay every month from their income. Today, if you look at the banking or the telecom sector, you will see that a lot of people are coming back, because now they can buy a flat or a car here on instalment, just like they did when they were abroad. This is a powerful inducement to stop the brain drain and bring back our educated skilled manpower. No country can progress unless you invest and retain your skilled manpower, because everything is based on knowledge and skill.

A: When will the Credit Bureau be established in Pakistan and how will it change the current credit scenario?
IH: The Credit Bureau will become operational from September 1st this year. With the Credit Bureau, your credit history, good or bad, will be available with every single bank. If the bank is dealing with a good customer, and the market rate averages, say, five percent, to retain him, the bank may offer him four percent as an inducement and the customer will extend his borrowing with that bank.

A: Banks are now raising the lending rate. How will this affect consumer financing?
IH: When you have low interest rates, people don’t save because their rate of return is low. When the interest rates go up, the deposit rates go up. Banks get their money from the depositors and give it to the borrowers. When you have high deposit rates lending rates have to be curtailed, because if you have higher lending rates you won’t have many borrowers. That’s the principle of economics. So what do you do? You try to become more efficient and reduce your administrative costs. So if you were getting deposits at an average of let’s say six percent and you are giving loans at 11%, your administrative cost is five percent. But a lot of people will not borrow at 11%. So the bank has two choices. Either reduce the administrative costs, or go those households that have never done any bank borrowing and through marketing, acquire new customers willing to borrow at that rate. Let me give you a very important example. In microfinance, where there is no collateral and loans are given to landless and poor women in rural areas and katchi abadis, the interest rate was 22%, and these are poor borrowers. Yet, they were not only borrowing, they were repaying, because this was the first time in their life that they had any money coming in. So they borrowed at 22%, bought some goats, sheep, a sewing machine, made money and then a profit and they returned the money with 22% interest. Access to credit is so limited that a lot of families in Pakistan who want to set up a business cannot do so. Banks should reach out and market to them. Private sector banks like any business are fighting for market share and the competition is healthy for customers because it will bring prices down.

A: What is the likelihood of further increases in the interest rate?
IH: If inflation keeps rising, interest rates will go up, if inflation stabilises, interest rates will stabilise and if inflation goes down, interest rates will go down. For four years, the rate of inflation was between three to four percent, but there was no economic activity. The choices are very simple. Would you like to have a low inflation, low income growth scenario, whereby a lot of households do not have a single earning member in the family? Or, do you want a situation where there is a high growth and employment, so that at least one member of your family is earning, but you pay higher prices in the form of inflation? When the economy was stagnant, and per capita incomes were declining, we had to jump start the economy to ensure more people became employed, took money home and put food on the table, and, of course, this generated inflation. We are trying to control inflation through various means and we hope we will be successful. International oil prices haven’t helped by going up from 25 to 55 dollars. We have absorbed a lot of that through the budget, but if we absorb it all, the fiscal deficit will be very high and inflation even higher. In economics you have winners and losers at any particular time, but these are not permanent winners or permanent losers. During the last three years, depositors were the losers and borrowers the winners. Next year, depositors are going to be the winners because rates are going to up and borrowers are going to be the losers because they have to pay a higher price. That is what economics is about. You have to keep the objective in view. If you become populist because there is a hue and cry that interest rates should not go up, you will lose sight of the objective and botch up the strategy. You will please some people and some people will get hurt. This is not politics, where you want to please everyone. In economics, you have to make some hard choices.

A: What measures is the State Bank taking to encourage e-banking?
IH: Four years ago, there were hardly any ATMs or online banking services available. Today there are more than 850 ATMs all over the country. Out of 7,000 branches, almost 50% have online banking services and by the end of 2006, we expect every branch in Pakistan to provide online services. Customers will no longer have to go to their branch to transfer money or pay their utility bills; they can do it sitting at home. The cost of doing business through a brick and mortar branch is much higher than through ATMs or e-banking. The customer gets convenience and the banks don’t have to employ so many tellers, so their costs go down, which is passed on to the customers in terms of lower charges. It’s a win-win situation for everyone.

A: Howe successful is Islamic banking proving to be?
IH: Extremely successful and the reason is very simple. There are a lot of Pakistanis, particularly in NWFP and Baluchistan and even some in Punjab and Sindh, who, because of their faith and beliefs, do not want to have anything to do with non-Islamic banking. They keep all their money in cash at home or at the shop. This does not help them expand their business either as nobody is going to give them a loan because if you don’t have a deposit, you don’t get a loan. Today, all these people are depositing their money with branches that offer Islamic banking facilities, and against these deposits, they are borrowing to expand their business. We are drawing into the banking net a large number of people who in the 57 years of Pakistan’s history never did any banking of any sort. In this way, we are also helping small and medium enterprises to expand and this is a very positive feature for Pakistan’s banking history. The State Bank is proceeding very slowly because we don’t want to have a situation where there is no capacity among the banks to carry out Islamic banking; human resources being the constraining factor.

A: What role does the State Bank play in documenting the economy?
IH: We encourage people to make transactions by cheque, and in this budget we have imposed a tax, whereby if you withdraw an amount exceeding 35,000 rupees, you have to pay .01% per transaction, so people will be careful not to enter into transactions in cash. The tax authorities also expect people to make payments above 50,000 rupees by cheque. But our society has a tendency of not doing things the right way; real estate transactions are a good example.

A: Can banks sustain themselves in terms of human resources?
IH: We are investing in human resources at entry level. For example, at United Bank, 12,000 candidates applied. 7,000 qualified in the written examinations of which 400 to 500 were interviewed and from these, 80 applicants were selected. They will now go through a training programme and after one year, they will become officers. This process is going on in every bank and it has done wonders for younger people. Earlier, they used to question the point of working so hard to achieve first position, when the job goes to people who have influence or sifarish. Now the paradigm has shifted. People from the tribal areas, from poor families and no connections are selected by banks, and when they go back to their village, their relatives and friends see that without sifarish they have a job worth 25,000 rupees. The whole paradigm in banking is based on attracting young people because the old generation was trained in the bureaucratic way and not as professionals. Today, we are producing professionals who can deal with the challenges of the 21st century and I am very proud that our human resources are second to none. It is a question of identifying and training them the right way. Technology, human skills and systems, these are the three ingredients of a successful banking system. Without them the banking sector, will not prosper.

Mariam Ali Baig was in conversation with Dr Ishrat Husain. For feedback: