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CONSUMER FINANCE/ CONSUMER CREDIT

A fund based financing service provided by banks and various Financial Institutions.

CONTENTS
Meaning & Concept Features of a Consumer Credit Transactions Mathematics of Consumer credit Legal Framework Consumer Credit Portfolio Management Credit Evaluation Credit Screening Method

REASONS FOR CHANGE IN IDEOLOGY OF CONSUMERS REGARDING CREDIT


Affordable Financing. Different Marketing Strategies being followed by banks. Increase in efficiency in Bank Services. Change in the Interest rates. Reduced EMIs (Equated Monthly Installments). Govt. provide Tax Incentives on Home Loans. Consumer new notion- Buy Today & Pay later. Increase in Disposable Income of Consumers.

This has give rise to credit financing.

MEANING & CONCEPT


It refers to raising of finance by individuals for meeting their personal expenditure or for the acquisition of durable consumer goods and for the purchase/creation of an asset. Here, an Individual pays a fraction of the purchase price in cash at the time of the delivery of an asset and pays the balance with interest over the pre-determined period of time. It is an asset-based financial service in India with the objective of providing finance on easy terms & at the door steps. This finance is extended for a period of 2-5 years.

FEATURES OF CONSUMER CREDIT


TRANSACTIONS

Number of Parties to the Transaction Structure of the Transaction Payment Repayment & Rate of Interest Security Product Range Borrower Profile & Eligibility Criteria

I-NUMBER OF PARTIES TO TRANSACTION

When two parties are involved in transaction, i.e. Borrower & dealer-cum-financier , such arrangement is bipartite arrangement.

When three parties are involved in transaction i.e. Borrower , Dealer/Seller & Financer (Bank/NBFC), such arrangement is tripartite arrangement. Here either dealer arranges credit from the financier or customer approaches himself to financier for finance.

II-STRUCTURE OF THE TRANSACTION


Consumer finance transactions may be structured in any of the following ways:Hire Purchase Installment system Overdraft/Demand Loans Credit Cards

HIRE PURCHASE
The Hire Purchase Act,1972 defines a hire purchase agreement as an agreement under which goods are let on hire & under which the hirer has an option to purchase them in accordance with the terms of the agreement & includes an agreement under which: Possession of goods is delivered by the owner thereof to a person on a condition that such person pays the agreed amount in periodic payments, and The property in the goods is to pass to such person on the payment of the last of such instalments, and Such person has a right to terminate the agreement at any time before the property so passes.
Section 3 of the Act provides that every hire purchase agreement must be in writing & signed by all the parties thereto.

ITS CHARACTERISTICS ARE AS FOLLOWS:

The payment is to be made by the hirer in instalments over a specified period of time. The possession of the goods is transferred to the buyer immediately. The property in the goods remains with the hiree till the last instalment is paid. The hiree can repossess the goods in case of any default. Each instalment is treated as hire charges till the last instalment is paid. The instalment includes interest & repayment of principal amount. Usually, the hiree charges interest on flat rate.

INSTALMENT SYSTEM
Under this system, the dealer of goods finances the asset & ownership and possession of an asset is transferred to the customer on the payment of first instalment. The balance amount is paid in no. of instalments. Their relation is of Debtor & creditor. It is of two types:

Conditional Sale :same as hire purchase Pledge or hypothecation:- Here, banks finance credit on the security of goods, jewellery, gilt securities pledged with the bank. When credit is returned, the hypothecation charge is vacated.

OVERDRAFT/DEMAND LOANS
Here an individual can overdraw their accounts upto the certain limits as laid down by the banks, commensurate with the value of security margins credit worthiness of the customer. Here interest is charged on the amount actually utilized by the individual. This overdraft facility is provided against the security of life insurance policies, FDs , G-securities such as NSCs , KVP/IVP, shares & debentures etc.

DEMAND LOANS

Loan Against Equitable Mortgage of Immovable Property Loans Against NSC/IVP/KVP Loans Against Life Insurance Policies Loans Against RBI Relief Bonds Loans Against Shares & Debentures.

CREDIT CARDS
It is embossed plastic card, issued to the customers serves as an evidence to merchants that the bank has granted a line of credit to the card holder. It involves three parties i.e. Card holder, Bank and merchant. Retail merchant agrees with the bank to accept the card for the payment of goods& services. Merchants deposits their sales slips with the bank and receive immediate credit to their account, less a small discount. Here the bank is financing the merchants account receivables & relieves them of the costs involved in operating a credit dept. Both private & public banks provide this facility.

III-PAYMENT:Down payment scheme:-20-25% of the value of the consumer durable. Deposit linked scheme:-15-25% of the amount financed. IV-REPAYMENT PERIOD & RATE OF INTEREST:The repayment schedule is drawn on the basis of monthly installments over a period of 12 months & 60 months. It is required to be made through post-dated cheques. The rate of interest is expressed as a flat rate but Citibank disclose effective rate of interest. V-SECURITY:The consumer credit is secured through a first charge on the asset concerned & the borrower is not allowed to sell/pledge the asset during credit period. VI-PRODUCT RANGE:Consumer Credit is available for a wide range of durables like TVs, PCs, washing machines, food processors cars. Now Credit is also available for construction/purchase/ renovation of house, education in India & abroad.

VII-BORROWER PROFILE & ELIGIBILITY CRITERIA


The types of the borrowers covered by the consumer finance schemes are individuals, partnership firms, private & public limited companies. Eligibility Criteria for Borrowers
TYPE OF BORRROWER CRITERIA

Individual

Minimum gross annual income of Rs.100000. At least 2 yrs of continuous employment . At least 5 yrs of service till retirement. At most 2 changes in service in last 5 yrs. Net take home salary is 3 times of EMI.

Partnership Firms and Companies

Must have been in existence for a minimum 4 yrs & making profits for at least last 2-3 yrs. Net profit+ Depreciation must be at least 3 times the annual installment. Must have a minimum net worth of Rs.2.5 lakhs.

MATHEMATICS OF CONSUMER CREDIT


In this , we determine (a) effective rate of interest (b) rebate in case of early repayment (c) effective rate of interest on completed transaction. Ques-EMI for a consumer loan of Rs.20000 under 3 repayment options are as follows:Repayment Period (in months)
12 24 36

EMI
1900 1070 799

Calculate the flat & effective rate of interest in each option? Solution:-

LEGAL FRAMEWORK
At present, there is no specific legal framework provided by any legislation to regulate consumer finance transactions in India. But, The Legislation seeks to (a) make the consumer more aware of the true interest rates implicit in the various lending schemes, & (b) to protect him against the unscrupulous once the agreement is made. The Act controls the way any business offers its customers credit agreements for purchasing goods. These provisions are as follows: A Business must obtain a credit license from the Officer of Fair Trading, after that he becomes a licensed credit broker. The Business decides to offer credit, it is obliged to inform the customer, all the details of the agreement. The business must ensure to display the interest rates to be charged on any potential agreement. The customer should be given the exact details of any purchase like cash purchase price, how the credit price works out, deposits, monthly costs, & what will be the cost of credit is. Based on the Consumer Protection Act,1974 of the UK, the Consumer Protection Act,1986 was introduced in India.

CONSUMER PROTECTION ACT,1986 In order to provide relief to the consumers , protect them from the exploitation & to save from the adulterated and sub-standard goods & services & to safe guard their interest, the Consumer Protection Bill, 1986 was introduced in the Lok Sabha on 5th December,1986. Its objectives are as follows:

This bill seeks to provide for better protection of the interest of the consumers, for the purpose, to make provision for the establishment of Consumer Councils & other authorities for the settlement of consumer disputes & for matters connected therewith. It seeks to promote & protect the rights of the consumers such as (a) Right to consumer education (b) right to seek redressal against the unfair trade practices (c) right to be assured that the consumer interests will receive due consideration in the appropriate forums. These objects are sought to be promoted & protected by the Consumer Protection Council to be established at the Central & State Levels. To provide speedy & simple redressal to consumer disputes, quasi-judicial machinery is set up at the District, State & Central level. These bodies will observe the principles of natural justice & provide relief, appropriate compensation to consumers.

CONSUMER CREDIT PORTFOLIO MANAGEMENT


Managing the consumer credit portfolio is difficult task rather than building a large portfolio. Because managing involves evaluating, monitoring & controlling a large no. of individual accounts. The Aspects to be considered in managing portfolios are as follows:-

CREDIT EVALUATION:The first thing is to define & articulate a clear cut procedure for evaluating customers. But there are no hard data available on the past payment record Or the financial position of the borrower to judge his willingness & the abilities to repay. In some countries credit reference bureaus do provide a large part of information for evaluating the credit applicant such as Record of bankruptcies & administration orders. In the Indian context, there is no credit bureau to aid the credit granting decision. For credit evaluation of an individual borrower, the finance Co. calls for a copy of the salary certificate & name , address of the employer.

For credit evaluation of business entities like sole partnerships , partnership firms, they call for the financial statements for the last 2 years duly certified by a C.A. and the address the bankers with whom the business entity has a credit facility.

PRE-SCREENING OF THE BORROWERS:Here a mechanical scoring system is used for preliminary evaluation of the credit applicants. An Individual borrower is required to fill the questionnaire then the most unfavorable response to each question will have risk index of 28 & favorable response will have risk index of 3 , then add-up the relevant probabilities of default in diff ques. And to compute the overall risk index of loan applicant. Then a finance company according to their own acceptable criteria (such as applicants with credit risk index of more than 10 will be rejected ), grant credit to the consumers.

BOOK-KEEPING AND COLLECTION Managing a consumer credit portfolio effectively requires :(A) A system of book keeping that is accurate (B) A collection program that is consistent & persistent. To enhance the effectiveness of the collection program , a credit manager has to follow the following guidelines:

A good collection practice is to ask for payment when the customer is most likely to pay. For Accounts which miss the first installment-the first paymentfailure, a personal call must be made immediately. The person following up an account should not threaten action unless his office intends to take that action if the account is not paid. Slow paying accounts with small balances do not justify legal action on economic grounds. In such cases, the collection can be achieved by getting the customer to sign a declaration to pay by say, weekly installment. Then only the last resort is recovering large accounts is legal action.