Activity

Consumer Lending
1. Definition:
Consumer lending refers to making a wide range of loans to individuals for consumable items
like car, house, furniture etc. It is deferent then the loans awarded to business which are
generally referred to as commercial lending.
Consumer lending provides financing for personal, family, or household purposes. The loans can
come from a variety of places, including financial institutions or lending platforms. Many
consumer-loan products are not secured by property or assets.
Consumer loans include:
 Home loans
 Auto loans
 Personal loans
 Credit Cards
 Other niche consumer-targeted loan products
2. Types of loans:
There are 2 basic types of loans:
i. Term Loans: A loan which is repaid through regular periodic payments (monthly,
quarterly, semi annually or annually), over a period of one to 30 years.
ii. Revolving Loans: Arrangement which allows for the loan amount to be withdrawn,
repaid, and redrawn again in any manner and any number of times, until the arrangement
expires. Credit card loans and overdrafts are revolving loans.
3. Goal of consumer lending for the bank:

The bank’s consumer loan application process has four primary objectives:
i. Generate a flow of consumer applications to meet the bank’s consumer loan objectives.
ii. Obtain enough information to make the best possible loan decision.
iii. Ensure compliance with regulations.
iv. Ensure a timely response to the consumer’s request.

4. Credit Investigation:
Credit investigation is the loan process which is base on 5 steps:
 Receive application and review it for information
 Check the bank’s credit files to determine and review account history
 Obtain a report from a credit-reporting agency like blacklist, central report etc
 Contact employers and other creditors for references directly
 Verify collateral value of the item to securing the loan
5. Credit Scoring:
 Lenders use credit scores to evaluate the potential risk posed by lending money to
consumers and to mitigate losses due to bad debt.
 Lenders (Banks) use credit scores to determine
Who qualifies for a loan
At what interest rate
What credit limits.
 Lenders also use credit scores to determine which customers are likely to bring in the
most revenue.
6. Credit Cards:
 A credit card is a small plastic card issued to users as a system of payment.
 It allows its holder to buy goods and services based on the holder’s promise to
pay for these goods and services.
 A credit card allows the consumers a continuing balance of debt, subject to
interest being charged.
 Most credit cards are issued by banks.
 How credit card’s work:
 A cardholder selects his goods and presents his card for payment.
 The merchant submits the purchase details to its financial institution for approval.
 The merchant’s financial institution sends the purchase details to the cardholder’s
financial institution.
 The merchant receives a payment and the cardholder receives the goods.
 The cardholder’s financial institution remits to the merchant’s financial institution the
retail price less the interchange rate.
 The merchant’s financial institution remits to the merchant the retail price less the
Merchant Discount or Merchant Service fee, which may include interchange the cost
of transaction processing, terminal rental and customer service, and the merchant
financial institution’s or processor’s margin, among other costs.
 This charge is negotiated directly between the merchant’s financial institution and the
merchant.
 Electronic verification systems:

 It allow merchants to verify in a few seconds at the time of purchase that the card
is valid and the credit card customer has sufficient credit to cover the purchase.
 The verification is performed using a point of sale (POS) system with a
communications link to the merchant's acquiring bank.
 Data from the card is obtained from a magnetic stripe or chip on the card.
 Payment:
 A credit card statement is sent monthly indicating the purchases made on the card,
any outstanding fees and the total amount owed.
 The cardholder must pay a defined minimum proportion of the bill by a due date or
a higher amount up to the entire amount owed.
 The bank charges interest on the amount owed if the balance is not paid in full.
 If the card holder fails to make at least the minimum payment by the due date, the
bank may impose a “late fee” or other penalties.
 Some banks arrange for automatic payments to be deducted from the user's bank
account to avoid such penalties.
 Benefits of credit card to Customers:

 The main benefit is convenience as it eliminates the need to carry any cash for most
purposes.
 It is also considered a quick loan that can be financed for a short term.
 Many credit cards offer rewards and benefits packages to enhanced product
warranties at no cost, free loss/damage coverage on new purchases and points which
may be redeemed for cash, products, or airline tickets.
 Benefits of credit card to Merchant:

 For merchants a credit card transaction is often more secure than other forms of
payment such as checks because the issuing bank commits to pay the merchant the
moment the transaction is authorized regardless of whether the consumer defaults on
the credit card payment.
 In most cases cards are even more secure than cash because they discourage theft by
the merchant's employees and reduce the amount of cash on the premises.
 Cost to merchants:
 Merchants are charged several fees for the privilege of accepting credit cards.
 The merchant is usually charged a commission of around 1 to 3 per-cent of the value
of each transaction paid for by credit card.
 The merchant may also pay a variable charge, called an interchange rate, for each
transaction.
 Merchants with very low average transaction prices or very high average transaction
prices are more averse to accepting credit cards.
 Revenue to bank:
The major income generators are:
 Interchange Fee (fees are typically from 1 to 6% of each sale)
 Interest on outstanding balance
 Other fees charged to the customer:
 Late payments or overdue payments
 Exceeding the credit limit on the card called over-limit fees
 Cash advances (often 3% of the amount)
 Transactions in a foreign currency (as much as 3% of the amount).
 Membership fees (annual or monthly)
 Exchange rate loading fees (sometimes these might not be reported on the
customer's statement, even when applied).
 Interest Rate:
 Interest rate for credit cards is usually the highest compared to other consumer
lending products. It ranges from 1.75% to 2.5% monthly.
 Many issuers have moved to variable-rate pricing that ties movements in their interest
rates to a specified index such as the prime rate. Interest rate can also change
depending on credit risk, consumer usage patterns and behavior.
7. Salary Transfer:
 The process of transferring an employee’s monthly salary to a certain party usually the
bank. This is done with a commitment letter from the employer to the bank.
 The commitment does not constitute a guarantee of the loan by the employer.
8. Guarantor:
 A guarantee in finance is a promise by one party (the guarantor) to assume responsibility
for the debt obligation of a borrower if that borrower defaults.
 The person or company that provides this promise is also known as a surety or
guarantor.
9. Loan Agreement:
 A contract is a legally enforceable agreement between two or more parties with
mutual obligations
 A loan agreement is a contract entered into between which regulates the terms of
a loan.
 Contents of a Loan Agreement:

 a professionally drafted loan agreement will incorporate the following terms:
 Parties to contracts with their addresses
 Definitions or interpretation provisions
 Type of loan and purpose
 Payment provisions
 Repayment term provisions
 Prepayment and cancellation provisions
 Interest and interest periods
 Events of late payment, default and their remedies
 Provisions for fees of the lenders
 Amendments and waivers provisions
10. Contribution Consumer Banking in Economic Development:

 In Pakistan consumer finance despite rapid growth during initial period of 2-3 years
has started declining.
 During past few years the domestic consumer finance emerged as one of the key
factors to boost economic growth.
 Regional and global markets and economic players have become highly competitive
and banking sector is more concerned to safeguard its capital and enrich itself with
higher returns on loans than government‘s concern about boosting economic growth
11. Consumer Financing and Economic Growth:
 Lending through credit cards, personal loans, auto loans, loans for durables and housing
finance emerged main streams of consumer finance.
 Consumer finance has also brought social change through higher circular of money and
relaxation of income constraints for borrowing particularly among those middle class
segments that were eager to become part of growing economy and keen to benefit from
economic growth.
 Without consumer finance being in the driving seat of the banking sector a large number
of people would not have benefited.

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Consumer Lending

Consumer loans include:

 Other niche consumer-targeted loan products

3. Goal of consumer lending for the bank:

iii. Ensure compliance with regulations.

iv. Ensure a timely response to the consumer’s request.

 Receive application and review it for information

 Contact employers and other creditors for references directly

 Verify collateral value of the item to securing the loan

 How credit card’s work:

 Electronic verification systems:

 Benefits of credit card to Customers:

 Benefits of credit card to Merchant:

The major income generators are:

 Interchange Fee (fees are typically from 1 to 6% of each sale)

 Interest on outstanding balance

 Other fees charged to the customer:

 Late payments or overdue payments

 Exceeding the credit limit on the card called over-limit fees

 Cash advances (often 3% of the amount)

 Transactions in a foreign currency (as much as 3% of the amount).

 Membership fees (annual or monthly)

 Contents of a Loan Agreement:

10. Contribution Consumer Banking in Economic Development:

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