For months there has been talk, especially from the government of a major policy to basically reduce loan interest rates.
That policy billed as a ‘National Policy’ by the Royal Monetary Authority was the ‘Minimum Lending Rate’ 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.
However, things may not be as simple as the Financial Institutions Association of Bhutan (FIAB) head and Bhutan National Bank MD Kipchu Tshering said it will depend on demand and supply or market forces.
Explaining the market forces the MD 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.
This is combined with an increasing interest from banks who have money to loan money to several domestic hydro projects coming up across the country.
“Once you increase rates bringing them down is a very difficult situation,” said the FIAB head.
In plain speak while Financial Institutions do acknowledge that the 2012 Base rate system forced them to charge higher interest rates they now see no real point in reducing their profits by reducing rates since there are takers for these high interest loans.
The RMA Governor Dasho Penjore said that the base rate system was brought in 2012 to bring about transparency in pricing loans and also control credit growth that had reached 33 percent. Base rate is the minimum rates below which banks cannot lend.
The goal of credit control ultimately lead to very high base rates with the lowest being 10.35 percent.
While this and a combination of other measures cooled credit growth to the current 15 percent the base rate year of 2012 subsequently saw a dramatic rise in bank interest rates in all sectors. Just in the housing loans available at around a minimum of 10 percent in 2012 went up to a maximum of 15 percent in 2015.
Even when various restrictions got lifted banks realized that they could still charge much higher rates than even the base rates and still there would be demand for credit.
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.
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.
The RMA has come to a MLR of 7.25 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 7.25 percent is considered to be the lowest rate below which it is not possible for banks to lend, however, now on top of this 7.25 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.
The RMA Governor 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.
He said that the 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 Governor was that banks should work harder and compete under the new policy to also attract savings deposits. He 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. The Governor pointed out that fiscal measures like taxation measures from the government among others would also help encourage a savings culture.
Despite some early skepticism, the RMA Governor said that the RMA would give banks a few months time to fully understand and adopt the MLR system and then the RMA would review the policy on a six monthly basis on what to do next.
Currently both the RMA and the government are expecting the Financial Institutions to play ball on both the issue of a more competitive loan interest rates especially for productive sectors and also in terms of encouraging a savings culture.
The Finance Minister Lyonpo Namgay Dorji said, “They will definitely reduce interest rates as there is now a single uniform MLR rate when earlier the base rate system imposed much higher minimum lending rates.”
The Minister said since there are both state and private banks they do not want to tell the banks what to do but they expect healthy competition among the banks.
However, both the RMA and the government have various options at its disposal if banks do not compete and are not transparent.
The RMA Governor said that the RMA has an array of micro and macro prudential guidelines and other monetary tools at its disposal.
In an interview in the last issue a senior Finance Ministry official on the condition of anonymity talked about using state control in state owned banks to bring down interest rates if banks do not cooperate.
The FIAB head himself acknowledged that if RMA want banks to focus on more productive sectors the RMA has a lot of weapons at hand to do so through various monetary policy measures.