For months the government and the Royal Monetary Authority (RMA) has been promising a more fair and realistic loan interest rate. The RMA worked on a Minimum Lending Rate policy (MLR) which was a much more scientific and flexible improvement over the rigid and exaggerated old base rate system below which banks could not lend.
The RMA’s MLR policy saw its first and biggest success with the Bank of Bhutan (BoB) sharply cutting interest rates in several of its loan products ranging from housing to agriculture.
In the fixed interest loan section which is for loans above five years loans the interest rate for non-commercial housing that applies to home ownership has dropped from 13 percent to 11 percent. Student loans have fallen from 12.33 percent to 9.86 percent (see page five BoB graph). There has also been marginal decrease in mining, service, public, transport and agricultural loans.
In the fixed rate loan the Credit Risk Premium, Tenor premium and Business Strategy Premium which all go into deciding loan rates will remain fixed for the entire tenor of the loan and only the MLR portion of the pricing will be revised every six months as advised by RMA.
However, the real major change by the BoB has been the introduction of ‘Floating Rate’ loans and ‘Floating Five Years Reset’ loans which offer much lower interest rates then fixed loans but also carry some market risk for the consumer.
The risk is that the loan interest rate will not remain largely fixed like the fixed rate loan but will move up and down based on the prevailing rates. This would mean different levels of interest payment on a monthly basis.
The ‘Floating Rate’ will see the interest rate move up or down or “float “ to reflect changes in the MLR as advised by the RMA every six months and the change in Credit Risk Premium and Business Strategy Premium annually based on the bank’s audited accounts. The Floating Rate does not incorporate the tenor risk premium since it is an annual rate.
All customers taking a loan of less than five years have to take the Floating rate loan but for those customers whose loans are above five years can chose either the fixed or a floating rate.
Since the customers are taking a certain level of risk with the interest rate and in the process eliminating the bank’s risk, they will get much lower interest rates. However, the rates will not be fixed and can move up or down based on the financial market’s condition.
For instance the new Fixed rate loan for commercial housing which is the big buildings you see around town had not changed from the old rate of 13.25 percent but its floating rate is much lower at 10.31 percent and a slightly higher ‘Floating Five Years Reset’ rate of 11 percent.
A personal consumer loan based on salary was 12.75 percent earlier under the fixed loan rate but now under the floating rate it starts at a much lower 9.64 percent.
The Floating with the five year Reset interest rate will be revised every 6 months to reflect the changes in MLR but the credit risk premium, tenor risk premium and business strategy will be reviewed and revised every 5 years based on the audited accounts of the bank and the interest rates accordingly will be “Reset”.
Another major reform is that the bank will give interest rate discounts for customers who have good credit worthiness. The Bank has developed a Credit Scoring Model which would allow the Bank to evaluate the borrower and provide discount on the Credit Risk Premium on a product to an individual borrower so that he or she is compensated on their good credit worthiness.
The BoB’s moves have seen a reduction of interest rates from a maximum of 4.5 percent to a minimum of 0.28 percent. On average, interest rates were reduced by 2.76 percent which would mean that Nu 250 million would be lost annually in interest income. The projected reduction in profit after tax for 2016 for the Bank would be approximately Nu 58 million.
In the agriculture sector, the interest rate has been reduced from 11.75% (Fixed) to 8.49% (Floating). This was done in order to benefit the sector where the crop cycle is one year. For crops with a gestation period of up to 5 years, the Bank has introduced the Floating with Five Year Reset loan product at 10.18% interest rate. This, the Bank hopes, will encourage growth in the agriculture sector.
The BoB CEO Pema N. Nadik said that the above moves clearly indicates the bank’s commitment to contribute in the development of the economy and stimulate private sector growth at the cost of reduced interest income for the Bank. “Hopefully, we will be able to recover this through increased demand for loans in the long run,” he added.
With BoB, the biggest bank, leading the way what the other banks will now do is also being keenly awaited.