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Disruption is the only norm in today’s consumer credit backdrop. The consumer credit market is flooded with a wide range of products. Each product is focused on the definite unfulfilled borrowing need. The countless consumer credit products reflect their desperation in the pursuit of these business goals. In many cases, the products are introduced to drive competition, thereby strengthening the market by attracting more financial institutions. Many banks endeavor to have robust competitive traction in offering value-added consumer credit products. That would help them to please customers, intensify market share, and grow earnings.
Consumer credit is a method of advancing that provides credit to a consumer for personal or household requirements. For example, consumers may need loans to buy household electronic products, automobiles, computers, mobile phones, furniture. The consumers may further need finance for medical expenses, educational spending, and many other requirements. Considering the pace at which consumer finance is growing, the demand for our short-term financial needs under no circumstances seems to end.
- Meaning of Consumer Credit
- Consumer credit for financial inclusion
- The Consumer Credit Sector
- Consumer lending market
- Sources of consumer credit and classification of consumer credits
- Demand and Supply analysis
- Lending Process
- Price sensitivity in consumer credit
- Interest rates
Meaning of Consumer Credit
Consumer credit, also referred to as consumer debt – the credit facility extended to individuals to buy goods or services. Though many sorts of loans are labeled as consumer credits, the term is used more specifically from the standpoint of unsecured lendings. However, it does not mean that the consumer credits are granted without collaterals. Many consumer credits are backed by collateral.
Consumer credits are granted by commercial banks, non-banking financial corporations, and retailers to allow consumers to buy goods and repay the amount later in different formats, for example, full payment dues within 21 days or EMI payment of dues, etc.
Consumer credit lets consumers get an advance to buy products and services. In a crisis, such as a car breakdown, health emergencies, etc., the consumer credits can be the lifesavers. Since credit cards are moderately safe to carry, America is progressively becoming a cashless society in which people habitually rely on credit for purchases. Some of the most common consumer credit products are listed below:
Loans to buy household items like furniture, electronics, and fixtures:
- Credit cards
- Housing loans
Consumer credit for financial inclusion
Financial inclusion is a major development goal for many countries across the world. They are striving hard to ensure that financial services are available to all the citizens of the country. Assuring access to high-quality financial services has always been a baffling task for financial institutions.
The financial inclusion story so far is led by commercial banks and NBFCs. The NBFCs have constantly been attempting to compete with banks for market share in financial services. This reflects in the Financial Stability report published in 2021. By extending loan facilities to the unbanked sector in the country, these entities are contributing immensely to financial inclusion. Credit facilities are essential in India as a large percentage of the population in the country are self-employed or run small business entities with limited capital resources.
The Indian financial market is mainly informal from a demand and supply standpoint. Notwithstanding gains in financial inclusion, the incorporation of the majority of people with the market is zero or far from acceptable. The advances to be made in this respect are enormous for both consumers as well as industries. It has been projected that if households move from non-institutional to institutional debt, they can move between 2.5 and 5.5 percentage points, correspondingly, up the wealth distribution ladder [RBI, 2017a]. It is in this setting that consumer credit becomes imperative. Maximum consumer loans are unsecured, deprived of any guarantee to the lending institution, and used typically to finance personal expenses on articles such as automobiles, consumer durables, etc.
The Consumer Credit Sector
Consumer credit mentions activities involved in granting credit to consumers to allow them to own goods for everyday use. In banks and financial institutions, consumer lending is part of retail credit or personal credit, a section that has been earning much adhesion in recent times. Although housing loans and vehicle loans form the major chunk of the personal/retail credit sector, other loan products such as credit cards, education loans, consumer durable loans, individual advances, etc., are also increasing remarkably. Faced with tough competition from non-banking finance companies, various scheduled banks are aggressively upholding this segment to earn their market share.
While there have been many fresh efforts towards financial inclusion by the Reserve Bank of India as well as the Government of India, there are still many encounters: it is in this context that NBFCs can play a vital part. This opens up an extraordinary opportunity for all players in the financial market, including consumer finance businesses.
While the market for consumer goods is continually growing and intensifying into previously unexploited segments of society, there are also a large number of people getting incorporated into the formal financial market. With the augmented use of know-how and digital interference, not only are new players inflowing the market, but existing players are also differentiating their products. This strengthens the competition as the same sector is being beleaguered by many troupes.
On the same note, it is very important to understand that not all categories of consumer finance are in the best interest of the ultimate consumers. Often in many parts of the world, financial institutions are lending money to consumers who have very poor credit ratings and lack the ability to repay financial obligations.
As with any category of financial arrangement, the consumer needs to recognize the precise nature of the guarantee that is made as part of any consumer finance strategy. By accepting the terms and conditions connected with any lending condition, the consumer is vowing that the capability to repay within terms is present and that the consumer has every purpose of obeying each component of the loan agreement. Ultimately, it is in the best interests of the individual consumer to seek out the most needed provisions for any type of consumer finance, taking care to evade any circumstances that will place an unwarranted amount of strain on the capital in the ownership of the customer.
Consumer lending market
The Indian lending market has grown considerably between the financial year 2017 to 2021, driven by microfinance and retail finance institutions. According to the survey results published by CRIF High Mark, an Indian credit bureau, the Indian lending market as of March 2021 is at Rs 156.9 lakh crore. The report mentions that over the last five years, segments like micro-lending, retail and commercial lending have grown by 91 %, 157 %, and 93 % correspondingly.
The changes in consumer lending patterns and super active digital financial intermediaries are set to be the game changers in financing lifestyle requirements of people not currently covered by the formal banking system. Buy-now-pay-later offers point-of-sale finance, letting credit cardholders convert purchases into zero interest EMIs and even direct borrower acquisitions by fintech players form a fascinating value chain for retail customers. This is a gigantic segment of borrowers underserved by traditional banks and non-banking financial companies. The ease in their lending process is a stimulating reform when compared to the elegant process espoused by banks. Person-to-person contact is bit by bit getting disregarded with their credentials speaking to lenders and partaking in the information of creditworthiness.
The fintech lenders are setting a new benchmark for services by disbursing loans in less than a day compared to weeks and months of practice of traditional commercial banks. The credit application process is made so simple and easy to complete, which is appreciated across the industry. They have reduced the unwanted steps, documents, and verifications that drastically cut down the loan processing time. However, they have developed an excessive dependency on credit rating agencies to understand their prospective clients and repayment capabilities. So far, so good, and that is working well with their business. They have constantly been working on a digital lending architecture that is getting built where a few clicks will make loans available.
Sources of consumer credit and classification of consumer credits
There are several sources to avail consumer credit. However, a few important sources have been briefly discussed below:
|Sources of consumer credit||Classification of loans||Lending approach|
|Commercial banks||Single payment loans||Screening prospective clients with strong credit history|
|EMI based loans||Obtain collaterals|
|Credit card loans||Concentrate on large loans like a vehicle, house construction etc.|
|Passbook loans||Prepare customized repayment plans|
|Mortgage based loans||Takes several days to process the loans|
|Consumer finance companies||EMI based||Many times loans granted without thoroughly screening the credit history|
|Mortgage based||Often unsecured loans|
|Rates are different based on the borrowers|
|Different repayment schedules|
|Maximum loans permissible by-laws|
|The process is much faster than commercial banks|
|NBFCs like Life insurance companies||Single vs monthly payment loans||Loans granted based on the value of policy held|
|No penalties on repayment|
|In case of default, the amount is deducted from the policy held|
|Credit Unions||Personal loans||Credit facilities extended only for the members|
|Monthly/Weekly EMIs||Predominantly unsecured loans|
|The committee involved in assessing the loan proposal and repayment capabilities of the borrower|
|Loans are granted from the savings of members|
|Lower interest rates|
|The size of loans will be smaller|
|Co-operative societies and diary associations are the best examples|
|Friends and family||Flexible repayment plans||Low or no interest often|
|Minimal collaterals taken|
|Personal relationships at stake in case of defaults|
Demand and Supply analysis
The increase in demand for consumer credit in India would be the result of four major factors:
A. Confidence in the economy is on the rise
B. Improved Credit score
C. Rising Employment levels
D. Rising consumption level
A. Confidence in the economy is on the rise
The Reserve Bank of India published the Consumer Confidence Survey report on Dec 08, 2021. The RBI has said that overall economic activity remains strong, with upbeat consumer and business confidence. A few critical statistics released from the Reserve Bank of India are shared below for better insights:
Perceptions and Expectations on the General Economic Situation
Perceptions and Expectations on the General Economic Situation
Perceptions and Expectations on Price Level
Perceptions and Expectations on Rate of Change in Price Level (Inflation)
Perceptions and Expectations on Income
Perceptions and Expectations on Spending
Perceptions and Expectations on Spending- Essential Items
Perceptions and Expectations on Spending- Non-Essential Items
B. Improved Credit score
Equifax, Experian, and TransUnion have introduced a new credit system in 2017 which helped many individuals to track and improve their credit scores. According to recent surveys, Indian consumers have been able to improve their credit scores. Many of those buyers who did not have the required credit score to access loans now are eligible due to higher FICO scores. This improvement, attached with the general upgrading of credit scores as insolvencies roll-off credit reports, will allow higher levels of consumer borrowing.
At the same time, many consumers who suffered through bankruptcies and delayed payments during the Covid 19 pandemic have also started recovering in terms of improving their cash flows. These consumers will soon have greater purchasing power through access to credit. Furthermore, credit score education events are showing effectiveness at getting consumers to change behaviours that undesirably influence their credit scores. These factors alone will fast-track growth for prime consumer finance entities in India
C. Rising Employment levels
According to the statistics released by the Ministry of Statistics and Programme Implementation (MOSPI), the Employment Rate in India increased to 43.10 % in the first quarter of 2021 from 42.40 % in the fourth quarter of 2020. The formation of added jobs pushed up India’s employment rate to 37.87% in September as compared to 37.15% in August 2021. The RBI has published a perceptions and expectations report to clarify this further.
Perceptions and Expectations on Employment
The players in the consumer credit industry must pull up their resources to serve more consumers who are expected to be added in the post covid situations.
As demand for consumer credit is expected to increase, providing an extremely well-organized means of gaining access to that credit is important. Market signals indicate that the rise in demand for consumer loans and credit cards has created an exceptional opportunity for online lenders and other fintech-powered loan service providers to meet the needs of this emerged market and that credit providers that influence fintech to ease the application and approval processes can effectively compete with traditional lenders who still use time-consuming, old-fashioned processes. The door is open and the time is right for innovative elucidations in the consumer lending space.
D. Rising consumption level
Conventionally the consumer loans were restricted only for emergencies and critical requirements. However, due to the changed lifestyle and ease of access to credit facilities consumers have started following the approach of consuming first pay next. Millennials evolving as credit aware and credit responsible. The new to Credit segment is getting ready credit. Most of these people are first either first time earners or anticipating loans for their higher education or to begin their career. Consumer finance companies are reluctant to lend money to these people since they do not have a track record of loans or credit history.
The lending process refers to the bank’s policies and guidelines implemented to make the lending process seamless, methodical and efficient. The lending process involves a series of tasks, subtasks that ultimately leads the application to an approval or rejection by the bank or financial institution. The lender hires skilled professionals to make the entire process of lending error-free thereby giving a seamless experience to the borrower.
Below is the common process for screening the loan application in consumer finance
Let’s have a look at each of these steps one by one:
1. Finding prospective loan customers
There are two ways in which the customer connects with the lender.
a. Individuals directly approaching a lender
b. Officials of lending institutions identify prospective clients and initiate the discussions
When there is a burning need, the prospective client personally either visits the lending institution or makes a call to the officials enquiring about a loan. On the other hand, bank loan division officials identify prospective clients and their exact financial needs and then connect with them for further discussions.
2. Application process
This is the second stage in the lending process. At this stage, the borrower fills out the necessary loan application forms, attaching the supportive documents as mentioned in the loan process of the bank. Traditionally the loan application process was predominantly paper-based where the applicants were required to personally fill each field of the form and sign in the appropriate places. However, thanks to technology. Many application procedures are now digitized. Now the lenders allow borrowers to fill the digital forms, attach proofs in the digital versions. Furthermore, digital signatures have been allowed to ease the life of borrowers in the loan application process. The digital methods of the loan application process have been saving a substantial amount of time, effort, and money for both lender and borrower.
Once the process of filling out forms and attestations are completed, the document will be moved to the credit division of the bank or financial institution. In the initial screening, the credit departments examine the completeness, validity, and accuracy of the loan application process and the attested documents. If the credit division officials are satisfied with the filled application forms, then they will initiate the further process and the process starts with 5C analysis.
3. 5C analysis
Once the application filling process is completed, the borrower will start screening each of the mentions in the application and ensure the material facts are not hidden in any of the mentions. 5C analysis is a popular framework used in gauging the creditworthiness of potential borrowers. The framework analyzes the five critical characteristics of borrowers and that gives confidence for a banker to proceed with the loan application in case the results of the analysis are favorable for the loan process. Technically this is an underwriting process in which the borrower will be screened under many critical considerations as shown in the 5C analysis diagram below:
Character refers to the borrower’s personal reputation in finance-related matters. For example, analyzing the educational background, employment history, personal behaviors, emotional status, and credibility speaks a lot about him/her.
Lenders many times confirm the repayment abilities of the borrower through the analysis of various factors like employment status, sources of income, family income, assets owned, and the debt obligations that are open in the name of the applicant. Investigating the payment history of current loans and expenses is an indicator of the borrower’s dependability to make loan payments.
Capital refers to the money a borrower owns at the time of borrowing money. It may include bank savings, investments, lending, and the assets he/she owns at the time of borrowing. Lenders use capital as an additional means to pay the debt obligation should income or revenue be broken up while the loan is still in repayment.
Private assets pledged by a borrower as security for a loan are known as collateral. Often business borrowers use equipment or accounts receivable to secure a loan, while individual debtors often pledge savings, a vehicle, or a house as collateral. Requests for a secured loan are looked upon more positively than those for an unsecured loan since the lender can gather the asset should the borrower stop making loan payments. Banks measure collateral quantitatively by its value and qualitatively by its apparent ease of selling out.
Conditions mention the terms of the loan itself, as well as any financial circumstances that might disturb the borrower. Business lenders review circumstances such as the strength or weakness of the overall economy and the tenacity of the loan. Financing for working capital, equipment, or expansion is a common motive listed on business loan applications. Though this criterion tends to put on more to corporate applicants, individual borrowers are also examined for their need for taking on the debt.
Each lender has its process for analyzing a borrower’s creditworthiness, but the use of the five Cs of credit analysis is common for both individual and business credit applications. The applicants who have high marks in each of these checklists are more suitable to receive bigger loans, a lower interest rate, and more promising repayment terms. The lender takes the support of credit rating agencies like CIBIL, Equifax, and Experian support in analyzing the above-mentioned parameters. The validity, authenticity, and trust of these credit rating agencies, credit scores, and their indications are outside the purview of this blog and hence not discussed in detail.
4. Credit Decision
Once the underwriting process is completed successfully, the application will be approved by the credit departments else the application will be rejected and notification will be sent to the applicant. If the loan application is still valuable for granting loans but missing some information, then it is up to the decisions of the credit department to move the application back to the borrower for further corrections and updates. The lender may also check the collaterals required in case of any issues in the creditworthiness of the borrower.
5. Quality control
The lenders do follow the process of quality control. In this process, the application will be moved for legal considerations since this is the last leg of the loan application process. Anything that goes wrong from this point would not be in control of the lender. Considering the criticality lenders initiate quality control verify the application form from the legal standpoint before funding. However, some lenders have a practice of screening applications from a legal standpoint at the very beginning of the screening process.
6. Loan sanction
Once the document is cleared by legal divisions, the application will be approved for a loan and the amounts will be credited to the borrower’s bank accounts as specified in the loan application process.
Price sensitivity in consumer credit
Price sensitivity refers to the degree to which the price of consumer credit products impacts consumer purchasing behaviors. The demand for a product is expected to change when there is a change in the cost of products. On the financial side, price sensitivity is usually measured using the price elasticity of demand, or the measure of the change in demand depending on its price change. The price sensitivity of a product diverges with the level of prominence consumers place on price comparative to other purchasing standards. Some individuals may value quality over price, making them less vulnerable to price sensitivity. For instance, customers looking for top-quality consumer credit products are characteristically less price-sensitive than bargain predators; so, they’re ready to pay more for a high-quality product.
On the other hand, individuals who are more sensitive to price may be willing to lose quality. These people will not spend more on something like lifestyle, a brand name, even when it has a higher quality over a common store brand product. These individuals show a willingness to borrow even when the interest rates are high or the terms of the loan are tougher. Price sensitivity also differs from person to person, or from one consumer to the next. Some people are able and ready to pay more for consumer credit products in terms of interest rates.
Pricing of consumer credit was long considered to be the direct mechanism. Though, the latest financial crisis has shown that mispricing and misallocating consumer credit can have severe costs for the global economy. For decades, risk-based pricing has been the state of the art in credit pricing. In the past few years, lenders have begun to adopt pricing optimization approaches that consider customer readiness to pay as well as risk in background prices for credit.
In the dynamic consumer credit industry, the out-fashioned credit lending standards have been faded away. For example, the borrowers with strong credit track records are in a position to dictate banks to offer credit facilities in the range that they feel appropriate for them.
There are two major categories of people we can witness in society.
- Those who require money(Borrows)
- Those who have excess money (Save/Invest)
These two categories of people are spread across different geographical locations. Banks and financial institutions bridge this gap and bring them together. For example, banks accept deposits from those who have excess money or money that they can save or invest. On the other side connect with those who require money and allocate funds for their requirement. In return, the bank collects interest. The below-mentioned diagram gives a clear idea of how basic banking works in real-time.
Well! How do banks determine these lending rates? Are these dates considered arbitrarily? Let’s have a look at that.
From the time when banks are bound by the Reserve Bank’s directive on interest rates on loans and advances, which are issued under Sections 21 and 35A of the Banking Regulation Act, 1949, banks are obligated to give effect to any revision of interest rates whether upwards or downwards, on all the advances. The base rates are always defined by the Reserve Bank of India.
Banks or financial institutions need not charge an identical rate of interest even under a consortium arrangement. Each member bank should charge a rate of interest on the portion of the credit limits extended by it to the borrower subject to its Benchmark Prime Lending Rate(BPLR)
Application of interest on monthly rests shall be restricted to all running accounts, e.g. Cash Credit, Overdraft, Export Packing Credit Accounts, etc. At the time of changing over to monthly rests, banks may obtain a consent letter or supplemental agreement from the borrowers for documentation.
Interest at monthly rests shall be applied in case of all new and existing term loans and other loans of the longer or fixed tenor. In the case of existing loans of longer or fixed tenor, banks shall move over to application of interest at monthly rests at the time of review of terms and conditions or renewal of such loan accounts or after obtaining consent from the borrower.
Zero per cent Interest Finance Schemes for Consumer Durables
Banks are suggested to stay away from offering low or zero percent interest rates on consumer durable advances to borrowers through adjustment of discount available from manufacturers or dealers of consumer goods, since such loan schemes lack transparency in operations and distort the pricing mechanism of loan products. These products do not also give a perfect picture to the customers regarding the applicable interest rates. Banks should also not promote such schemes by releasing advertisements in different newspapers and media indicating that they are promoting or financing consumers under such schemes. They should also refrain from linking their names in any form or manner with any incentive-based advertisement where clarity regarding interest rate is absent.
Excessive interest charged by banks
- Though interest rates have been liberalized, charging interest beyond a certain level is seen to be unethical and can neither be maintainable nor be compliant with normal banking practice. Boards of banks have, consequently, been advised to layout suitable internal principles and procedures so that unethical interest, including processing and other charges, are not levied by them on loans and advances. In laying down such principles and procedures in respect of small value loans, predominantly, personal loans and such other loans of similar nature, banks should take into account, inter-alia, and the following broad guidelines:
- A proper prior-approval procedure should be recommended for sanctioning such loans, which
- should take into account, among others, the cash flows of the potential borrower.
- Interest rates charged by banks, inter-alia, should include risk premium as considered sensible and defensible having regard to the internal rating of the borrower. Further, in considering the question of risk, the presence or absence of security and the value thereof should be taken into account.
- The total cost to the borrower, including interest and all other charges levied on a loan, should be admissible having regard to the total cost incurred by the bank in extending the loan, which is sought to be covered and the extent of return that could be sensibly expected from the transaction.
- An appropriate upper limit should be fixed on the interest, including processing and other charges that are levied on such loans, which should be appropriately publicized.
I hope you enjoyed reading the article and it is useful.
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