AMMAN, 29 December 2003 — The consumer market has emerged as the sector of choice for many Arab banks. Most if not all of them are now aggressively promoting retail lending which includes consumer, housing and personal loans, and their balance sheets are being re-ordered in the process. Lending to consumers is deemed to be less risky because it relies on direct salary deductions as a collateral for the loan. It is allowing banks in the region to diversify their revenue sources away from their traditional core business of corporate lending and trade finance and has been lately a major contributor to the profitability of Arab banks.
The rising demand for consumer loans is being fueled by a young and growing population eager to improve its living standards and a general decline in borrowing cost. Total credit facilities extended to the retail consumer market rose by around 47 percent in the past five years in Jordan and now accounts for 25 percent of total credit facilities. During 2000 and 2002, consumer lending surged by 28 percent in Kuwait, 25 percent in Saudi Arabia and 20 percent in the UAE.
While the demographic characteristics of the region (50 percent of the population below 20 years of age) have supported the growth of consumer lending, rapid developments in the information technology field have made it possible for banks to better serve and interact with their customers and made transactions at the retail level cheaper and easier. The lack of momentum in the corporate sector and the rising risk of non-performing loans also encouraged banks to seek more profitable and less risky opportunities elsewhere. Most, if not all, retail borrowers tend to be employed when requesting a personal loan, putting them in a relatively low risk category. Moreover, consumer credits are usually collateralized by the financed asset itself and repayments are made through directly transferring a certain percentage of the borrower’s monthly wage into bank accounts to service the personal loan. Heavy social pressure not to default on a consumer loan is also a factor which helps to minimize the incidence of non-performing loans.
The consumer market offers banks the attraction of wide spreads in comparison with the low margins available in the more competitive corporate credit market. It is no surprise that Arab banks today are competing aggressively to offer consumer loans in their respective markets. The drop in domestic interest rates in line with the decline in dollar rates have reduced the cost of borrowing and boosted the demand for consumer loans. Increasingly more consumers have been borrowing to refinance existing mortgages at lower rates and to take personal loans to buy furniture, cars, pay for tuition expenses and finance a new house or property. The growth in consumer borrowing is reflecting positively on the housing, real estate and consumer durable sectors, and because the cash borrowed is mainly spent in the domestic economy, this is contributing as well to the growth of the region’s private sector GDP.
Most Arab banks do not yet have the sophisticated credit control mechanisms available to lenders in Europe and the US. As a result they have a far more cautious approach to the extension of consumer credit. No bank will give personal loans without having salary assignment or access to collateral. Insufficient credit information about clients, as well as, underdeveloped capital markets are the major constraints to the growth of consumer lending in the region. The introduction of credit bureaus in the respective Arab countries to compile active credit data base would certainly assist local banks in extending loans based on credit worthiness and would limit many of the obstacles facing the expansion of consumer lending. When such bureaus currently under consideration in several Arab countries become fully functional, they could trigger a new wave of consumer loans not based on salary related lending.
Developing the region’s capital market would also ensure more efficient intermediation of local capital and would create a secondary market for the trading of collaterized debt instruments. The mismatching of banks’ assets and liabilities remains a major hindrance to the growth of mortgage and consumer lending. The sources of funds for most Arab banks are mainly short-term deposits while consumer loans are by nature long term. A more developed corporate bond market would allow banks to secure long term funding, by issuing five-to-ten-year bonds in the domestic market and extend consumer loans of similar maturities. Local banks could also face stiff competition from larger global and regional financial institutions which have so far been less interested in retail lending activities due to high costs associated with setting up a branch network in the domestic market. Nevertheless, with electronic banking gaining more acceptability, this will become less of a constraints and more competition in consumer lending should be expected.
Governments in the developed markets of Europe and the US are trying to establish a ceiling for consumer indebtedness, especially that non-mortgage borrowing has risen above $6,100 per capita in the US and $4,100 in the UK. Levels of consumer indebtedness in the region are way below that. In Jordan for example, per capita lending to consumers, including mortgage borrowing, estimated at $334 is a small fraction of the levels reached in the developed markets. The corresponding levels in the other markets of the region is also low at around $1,300 in the UAE, $650 in Saudi Arabia and $930 in Kuwait.
However, given the recent rate of expansion of personal indebtedness, Arab commercial banks and the region’s central banks are now assessing sustainable level of consumer indebtedness, especially if the low interest rate environment is to be reversed. To date, even as personal loans are rapidly increasing in size, there have been no signs of asset deterioration. In fact, banks in the region are becoming more familiar with consumer lending and are learning to provide a better service. Interest rates on consumer loans are now fixed for a longer period of time, reaching in some cases three years and several complementary services are being offered to borrowers in an attempt to attract more of them and encourage others to refinance existing loans.
Consumer lending in the region will continue to grow at rates exceeding the growth rate of total credit extended by the banking sector. However, competition between the banks will lead to further reduction in spreads and could as well lower the fees on products and services offered as a package with the consumer loans. Heightened competition may lead to the segmentation of the market, with those consumers who are perceived to be less risky commanding lower interest rates and better services. Most Arab banks will continue to be able to make money in consumer lending but they have to spend more on advertising and on providing a wide range of complementary products. Those who are able to fix the rates on consumer lending for a longer period of time than what is currently available in the market place and aggressively promote their services will be able to stay ahead of competition.
(Henry T. Azzam is chief executive officer at Jordinvest.)