Meanwhile RMA is looking at tinkering with base rates and creating a Money Market for more funding options
Many, from the ordinary person on the street to the government now feel that Bhutan’s banks pay low rates on deposits and charge too much with much higher loan interest rates. This size of the problem can be seen when the loan interest rates of Bhutan are compared with regional countries and even countries across the world.
A record high margin
If one compared the Net Interest Margin (NIM) or difference of one year’s deposit interest rates with one year’s loan product interest rates then Bhutan’s NIM is the highest in the South Asia region at 8 percent which is ahead of Maldives which is second at around 7 percent.
NIM rate is the difference between the interest generated by banks on loans and the amount of interest paid out to depositors, relative to the amount of their interest-earning assets. In short it is the difference between the interest you get on your deposit and the interest earned by the bank from its loans.
A Royal Monetary Authority (RMA) official on the condition of anonymity said, “Given the still very nascent financial sector there is every little competition and so the general margin between the deposit and lending rate all across is very high.”
The Bhutan National Bank Managing Director who is also the head of the Financial Institutions Association of Bhutan (FIAB) Kipchu Tshering said Bhutan’s overall NIM, if one takes into account deposits and loans beyond one year is close to six percent.
The Druk-PNB Bank CEO Mukesh Dave said Bhutan’s NIM rate is well above five percent when a healthy international rate is around 2.5 percent.
Decrease in deposit rates and increase in loan rates
If this was not enough the 2014-2015 annual report of the Royal Monetary Authority found that from June 2014 to June 2015 the average deposit rates of Bhutan’s banks decreased from 7.47 percent to 7.28 percent.
In contrast for the same period the average overall lending rate increased from 13.7 percent to 14 percent.
A regional comparison of loan rates
Even if a regional comparison of Housing loans is done Indian banks charge much lower for housing loans.
In Bhutan banks charge between 13 to 15.25 percent for housing loans while major Indian banks like State Bank of India, HDFC and ICICI charge between 9.40 to 9.70 percent interest rate.
On deposit rates given the huge size of the Indian market there are those that offer both lower and higher deposit rates compared to Bhutanese banks.
If a comparison was done for car loans Indian banks offers them at around 10 to 12 percent while it is up to 16 percent for Bhutanese banks. In fact Bhutanese banks have hiked car loan interest rates by almost two percent between 2014 and 2015.
Lack of Competition
Kipchu Tshering said that bank loan interest rates are high due to high demand of loans from the banks.
He also said that there seemed to be a lack of competition between the Financial Institutions to bring down interest rates as it would affect the NIM rate.
In the past the National Pension and Provident Fund (NPPF) brought down housing loans to around 10 percent forcing banks to follow suit and even then they still made profits.
Currently, though differing slightly, all the banks have similar loan interest rates leading to spectacularly high annual profits. This has lead to some industrialists suggesting informal collusion among Financial Institutions to stop a major drop in interest rates affecting each other’s profits.
Speaking as head of FIAB Kipchu Tshering dismissed such claims and he said that banks don’t talk to each other on such issues.
Mukesh Dave said that in the current regulatory environment the banks are not allowed to differentiate the risk between different clients and then accordingly set different interest rates. So a client with a better credit worthiness would get a lower interest rate.
He said that as a result banks include a high proportion of their costs in this risk taking element of loans further pushing up interest rates.
Dave said that the current system of higher interest rates is not healthy for the economy as it is like taking from the pockets of businesses and business houses. He said that banks should act as a catalyst for the economy and should not affect businesses and their profitability. He said there is need for systemic financial changes.
A Base rate problem
While most financial institutions and common sense shows a high overall NIM of around six percent the RMA’s official NIM for December 2015 is calculated at 3.03 percent.
An RMA official on the condition of anonymity said that the RMA’s lower NIM rate calculation in essence shows the nature of the problem as the RMA calculation is based on the base rate set by it in 2012.
Base rate is a formula introduced by RMA in 2012 which calculates the minimum interest rate below which banks cannot lend.
So the RMA’s NIM calculation varies from what bankers are saying as a lot of the actual NIM is already included in the base rate.
It is for this reason that a major part of the RMA’s interest rate reforms will look at correcting the base rate which even many bankers call rigid and blame as one of the main reasons for a higher rate of interest.
Though not officially acknowledged base rate is seen by many as one of the measures by RMA in 2012 to curb excessive lending by banks in the face of the rupee and credit crisis.
Kipchu said that he had always felt that the current base rate system is not required and should be done away with.
The RMA interest rate reforms will look at making the base rate more flexible to allow a platform for banks to lower their interest rates and compete for both deposits and loans.
A long term Money Markey solution
However, if one looks at the bank loan interest rates for the period prior to 2012 then there still seems to be no big difference as even the loans back then had high interest rates. The problem therefore appears to be deeper than just base rates as it shows an excessive reliance on banks for loans and money, in turn allowing them to dictate rates in an uncompetitive environment.
Another RMA official said that prior to 1997 the RMA regulated interest rates but after that it was decided to be left to the market forces with the idea of promoting both savings and investment.
Prior to 1997 Banks offered good deposit rates between 8 to 9 percent and even the loan rates were reasonable between 10 to 13 percent.
The RMA official said that from 1997 onwards it has not been going very well with lower deposit rates compared to the higher loan interest rates.
He said this is primarily due to too much dependence and reliance on banks which in turn is caused by the lack of development of a money market that can provide alternatives.
The official said that the long term solution would be to help develop a ‘Money Market’ in Bhutan which would provide a less costly way of raising money from borrowers to meet short run liquidity needs.
Money market would have financial instruments like using Certificates of Deposit, Treasury Bills, Interbank loans, etc.
RMA working on reforms
Meanwhile, RMA Governor Dasho Penjore said that the RMA is seriously working on the interest reforms issue considering the interest of borrowers, depositors, and financial institutions. He said that the RMA has thoroughly reviewed the interest spread (NIM) that is existing and how it made good interest income for financial institutions while at the same time, being mindful about the real interest rate the depositors are experiencing.
“So drawing from the lessons from the past and looking at a balanced approached, we are preparing a draft reform report, which will be formally discussed, first at the Board, then in a consultation with Financial Institutions,” he said.
“Following which, we will also consult the government stakeholders like Ministry of Economic Affairs and Ministry of Finance. We have asked for an expert from RBI to look at our proposal from a professional relevance perspective. It would be a thorough job,” the Governor added.
While the monetary policy is entirely the RMA’s responsibility as an independent agency the government is also concerned with the high loan interest rates which it feels is curbing investment and job creation in the economy apart from the interest burden on ordinary people.
This is in contrast with the record breaking profits of banks every year even while other sectors of the Bhutanese economy are not doing as well or are even suffering in some cases.