Consumer Loan

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Consumer loan

Consumer Credit came into existence when individuals who had the need for a product, but did not have ready cash to make the purchase resorted to borrowing in the market. As a result credit organisations sprang up to cater to the needs of these consumers wherein loans are granted to them after ascertaining their creditworthiness.

The typical form of a consumer credit transaction is one where the individual pays a part of the cash purchase price on taking delivery of the asset and agrees to pay the balance with interest over a specified period of time. In India, the practice of offering consumer credit has been in practice for a very long period of time but it remained fragmented and individualised until the late eighties.

Citibank is entitled to the credit for having educated the 300 million strong Indian middle class about the advantages of the ‘Buy Now; Pay Later’ culture, which went in for an aggressive marketing of consumer finance through a wide array of schemes – the Citi Mobile finance Scheme for financing purchase of new cars, the ‘Wheels’ Scheme for financing purchase of two wheelers and the ‘Easy Buys’ Scheme for financing purchase of consumer durables like VCRs, VCPs, TVs, refrigerators, washing machines and home appliances.

It was not long before the others in the banking sector followed suit, the State Bank of India, and a number of finance companies, which were on the lookout for concentric diversification opportunities jumped into the fray. The chief factors which motivated these financial organisations to enter the consumer credit industry were the growing strength of the upward-mobile Indian middle class, the rapid increase in the disposable income of this class and the boom in the consumer durables and automobile industries during the latter half of the eighties.

We shall now look at some of the salient aspects of consumer finance, the legislative framework governing these transactions in the developed countries, and the considerations in building a sound consumer credit portfolio.

Number of Parties to the Transaction

The transaction can be either a bipartite one involving the dealer-cum-financier and the borrower/customer or a tripartite one where the dealer and the financier are two distinct entities. The tripartite transaction can be of the sales-aid type where the dealer arranges for finance and does the necessary paper work on behalf of the borrower. Under such transactions, the credit granting decision lies with the dealer, of course subject to the eligibility criteria stipulated by the finance company. Such transactions are structured with recourse to the dealer. On the other hand, a tripartite transaction can be of the conventional type where the customer approaches the finance company to avail of the credit facility.

Structure of the Transaction

A consumer credit transaction can be structured in the form of hire purchase, conditional sale or credit sale transaction. A hire purchase is a contract of hire with the option to purchase. The customer, while having the option to purchase, need not necessarily do so and can terminate the agreement and return the goods at any given time subject to the terms and conditions of the agreement. In a conditional sale contract, the ownership is not transferred to the customer until the total purchase price (including the charge for credit) is paid and the customer cannot terminate the agreement before the purchase price is paid. In a credit sale contract the ownership is transferred to the buyer on payment of the first instalment and the customer cannot cancel the agreement before the total purchase price is paid. Most of the tripartite consumer finance transactions are of the hire purchase type.

Consumer Finance Schemes can be broadly classified under two categories

• Down Payment Schemes: The Down Payment varies between 20% and 25% of the value of the consumer durable.

• Deposit Linked Schemes: The security deposit under the Deposit Linked Scheme varies between 15-25 percent of the amount financed (which is equal to the investment outlay). The deposit is of a cumulative nature carrying interest at a prescribed rate (which at the time of writing cannot exceed 15% compounded monthly). Some finance companies also offer Zero Deposit Schemes under which the Equated Monthly Instalment (EMI) is higher than the EMI under the 15% and 25% deposit schemes.

Repayment Period and Rate of Interest

The repayment schedule is drawn on the basis of monthly instalments over a period varying between 12 months and 60 months. The borrower is permitted to choose the most convenient repayment period from the given range of options. While the rate of interest is calculated at a flat rate, some financial intermediaries like Citibank disclose the effective rate interest. In recent times many finance companies have dispensed with the practice of disclosing the rate of interest. Instead they disclose the equated monthly instalments associated with the different repayment periods and require the borrower to figure out the effective rate of interest himself.

The payments are made through post-dated cheques. In respect of institutional consumer credit schemes where the finance is routed through the organisation that employs the borrower, the organisation concerned is required to deduct the EMI at source and transfer the payments to the finance company. Most of the schemes provide for early repayment of the loan subject to certain conditions. They also provide for either a rebate for prompt payment (prompt payment bonus) or for a delayed payment penalty.

Security

The consumer credit is secured through a first charge on the asset concerned and the borrower is prohibited from selling or pledging or hypothecating the asset during the credit period.