Proof of Lazy Banking and Cartel if banks do not play ball with MLR

rmaThe Royal Monetary Authority (RMA) recently announced the ‘Minimum Lending Rate’ (MLR) policy effective from 1st August 2016 which replaces the earlier 2012 Base Rate system of the RMA which was blamed for the higher interest rates since its introduction. Base rate is the minimum rates below which banks cannot lend.

The main aim of the lowered rate under the MLR policy is to encourage banks to compete with each other for loan interest rates especially in productive sectors and also in deposit rates.

Though the RMA has explicitly said that the MLR is not aimed at lowering loan interest rates but only encouraging genuine competition among banks, the impact of such competition is expected to lower loan interest rates and lead to more competitive deposit rates.

All of this happened after Bhutan’s financial market was heading into a regressive direction offering the highest loan rates in the region and one of the highest in the world contrasted by lower deposit rates.

However, even after the MLR policy there remain concerns that the Financial Institutions will either not take it seriously or see no incentive to compete given their already high profit margins.

In a candid interview given to the paper a few months ago the Financial Institutions Association of Bhutan (FIAB) head and MD of Bhutan National Bank said there is a lack of competition. He, however, also denied any allegations of the banks being a cartel and keeping interest rates high.

The FIAB head in a recent interview to the paper said that not much is possible due to low liquidity in the market and also reluctance by banks to drastically reduce interest rates.

He said it will depend on demand and supply or market forces. Explaining the market forces the FIAB head said that currently there is low liquidity or money available to loan out in the Bhutanese financial market along with a high demand for credit.

Now a senior RMA official on the condition of anonymity but clearly serious said that so far the signs have been encouraging as banks have agreed to cooperate in implementing the MLR Policy.

He said that time would be given until September 2016 and even beyond as banks fully comprehend and implement the MLR system.

However, he said that if banks do not take MLR seriously and do not compete and instead continue as before then the RMA would be drawn to take two conclusions.

One is that the banks and their managers are conducting ‘Lazy Banking’ and not willing to work hard and compete.

He said the MLR is a test of the bank managers leadership as to if the heads have full knowledge of the mechanism, if he or she understands the risks, model and costs and can still remain competitive.

The other more serious issue would be that the banks by refusing to compete would indicate the existence of a cartel not only to the RMA but also the media, public, government and the nation at large.

The RMA official said that should such an eventuality arise then appropriate action would be taken.

The latest development is that the new MLR is 6.75 percent and not 7.25 percent. This is because the earlier 7.25 percent was based on the May end figures whereas the 6.75 percent is based on the actual June figures worked out together with the banks.



The RMA’s new MLR policy is basically a single and much lower base rate that is both flexible and calculated on a more scientific basis. Base rate is the minimum rates below which banks cannot lend.

The RMA has come to a MLR of 6.75 percent by taking the average of all the five banks.

The MLR is composed of three key elements. The first is the marginal cost of funds or deposit interest rates multiplied into what percentage that type of deposit is of the total deposit. The second is the negative carry charges which is the 10 percent of the total deposits that must compulsorily be kept with the RMA multiplied into the marginal cost of funds. The third is the operating costs calculated by finding what percentage it is of the total deposits.

The 6.75 percent is considered to be the lowest rate below which it is not possible for banks to lend, however, now on top of this 6.75 percent each bank will add its three types of costs. The first is the credit risk premium calculated by looking at the credit worthiness of the borrower. The second is the tenor risk premium calculated according to the maturity of each loan and finally business strategy based on the expected profit from the business.

So the final lending rate of the banks based on the minimum MLR will be higher and different for each bank.

RMA made it clear that it is not the aim of the RMA to reduce interest rates but the focus is on providing the guidelines and then leaving it up to the market to compete and decide. The Governor hinted that if the banks competed with the new MLR policy system then there should be competition in rates.

RMA would like to discourage loans in non productive sectors like consumption loans that would hurt the current account deficit and instead encourage loans in productive sectors that can generate exports, cut imports and generate jobs.

Another important point made by the RMA was that banks should work harder and compete under the new policy to also attract savings deposits. The RMA said that it is not necessary to raise loan interest rates in order to give attractive deposit rates. In this line the RMA showed that it was much cheaper for banks to attract individual fixed deposits then the more expensive corporate deposits where they had to pay higher rates.

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