The RMA Guidelines on Base Rate System

Transcription

1 The RMA Guidelines on Base Rate System In exercise of the powers conferred by Section 203 (e) and Section 210 of the Financial Services Act of Bhutan 2011, the Royal Monetary Authority of Bhutan (RMA) hereby issues this guideline to the credit lending institutions 1 and shall come into force from July 01, While this guideline provides a broad framework for determination of base rate of the credit lending institutions, the institutions will have to determine their own base rate which shall be reviewed by their respective Board or the Asset Liability Management Committee (ALCOs) and approved by the RMA. Such methodology, as considered appropriate, ought to be consistent and made available to the RMA for review and inspection, as and when required. However, in order to give some flexibility with the base rate system, the credit lending institutions will be provided with an adjustment period of 3 (three) months (until September 01, 2012) after the introduction of the system. During this period, credit lending institutions shall seek any approval from the RMA routed through the Financial Regulation and Supervision Department. 1) Rationale Until 1999, interest rate in Bhutan was administered by the RMA. The RMA deregulated the interest rates with effect from April 1999 on the condition that any revision in the interest rates shall be approved by the respective Board of the credit lending institutions and subsequently by the RMA. The approved rates and any revisions, thereof, need to be publicly announced. It is also mandated that the credit lending institutions shall follow the simple daily product method while computing their interest rates. Although the interest rates were deregulated more than a decade ago, both deposit and lending rates remained sticky. Such stickiness is impervious to growth and inflation cycles. A large difference between lending and deposits rates are mirrored in the high interest spread of about 5.7 percent which is substantially higher than that of many similar economies of the world. High spread reflects either low deposits rates or high lending rates or a combination of both. Low deposit rates encourage saving in unproductive physical assets or other speculative activities, away from financial assets, and reduce overall domestic savings. On the other hand, high domestic lending rates encourage more risky investment projects or encourage foreign currency borrowing. On overall, high spreads shall lead to lower savings and investment rates and hence lower growth rates. Given the stickiness compounded by the lack of transparency in the 1 Includes the commercial banks and non-bank financial institutions Page 1

2 methodology of pricing of lending products in the financial sector, it became necessary for the RMA to introduce the base rate system. 2) Base rate system and its benefits The base rate is the minimum rate below which it is not viable for the credit lending institutions to lend in the domestic market. The base rate also serves as the reference benchmark rate for floating rate loan products, apart from other external market-based benchmark rates. The base rate captures all those elements of the lending rates that are common across all categories of borrowers. However, the actual lending rates charged to the borrowers would be the base rate plus borrower-specific charges, which will include product-specific operating costs, credit risk premium and tenor premium. The introduction of base rate has several benefits in the financial sector. The base rate system promotes transparency in product pricing and encourages healthy competition in the economy. The base rate system will prevent undercutting in interest rates due to competition, increase the credit flow to small borrowers at a reasonable rate of interest and also prevent the credit lending institutions from overcharging any customers at the cost of another, safeguarding the interest of low income people. Besides meeting the primary objective of bringing about required transparency in the pricing of the lending products, the base rate shall also facilitate the transmission of monetary policy that translates through the policy rate and other policy instruments. Thus, in order to make the lending rate more responsive to the RMA s policy rate, the credit lending institutions are required to periodically review and announce their base rates to the public. Similarly, other advantages of the base rate are as underlined as follows: 1. Offer interest rate differential treatment for different borrowers for the same products 2. Provide better rates for good borrowers on the same product 3. Enable floating interest rates 4. Promote domestic savings 3) Methodology and computation of base rate Each credit lending institutions shall fix their own base rate which would be the minimum lending rate and shall include all those elements of the lending rates that are common across all categories of borrowers. The credit lending institutions shall fix their base rate based on the following variables: Page 2

3 Cost of deposits shall be determined using one-year deposit rate of individual (excludes corporate deposit rates) as the benchmark 2. Negative carry on the CRR and the SLR 3 Unallocated overhead which includes aggregate employee compensation relating to administrative functions in corporate office, directors and auditors fees, legal and premises expenses, depreciation, cost of printing and stationery, expenses incurred on communication and advertising, spending on information and technology, operating expenses, etc. Average return on net worth (for all banks) shall be used to arrive at the actual base rate calculation for the individual credit lending institutions. The actual lending rates charged to borrowers shall be the base rate plus the credit risk premium (based on the report prepared by the Credit Information Bureau) and the tenor premium. Determination of base rate Base rate = Cost of deposits (one-year term deposit rate of individuals) Negative carry on CRR and SLR Unallocatable overhead cost Average return on net worth 2 To ensure uniformity in the deposit rate across all lending institutions, the individual s one-year deposit rate shall be used while computing the base rate. 3 Return on SLR balances is considered to a minimal return of 1% for all lending institutions. Page 3

4 Actual lending rate charged by Banks to the borrowers = Base rate Credit risk premium (based on CIB report) Tenor premium 4) General provisions The credit lending institutions shall exhibit the information on their base rate at all branches and also on their websites. Any change in the base rate should be conveyed to the general public time to time through appropriate channels of media. The base rate system would be applicable for all new loans and existing loans which comes for renewal, restructuring, enhancement and rescheduling. Existing loans based on the contracted interest rate system shall be permitted until their maturity. In case existing borrowers want to switch to the new system, before the expiry of the existing contracts, an option may be given to them, on mutually agreed terms. The credit lending institutions, however, should not charge any fee for such switch-over. In light of unconventional lending practices and RMA s future plan to restrain such lending, the RMA advise all the non-bank financial institutions to adhere to the average base rate of the banks as their base rate for their lending purposes. For base rate computation for the current year, the lending institutions shall adhere to the previous year s annual audited balance sheet. Page 4

5 5) Exceptions The base rate system, however, will not be applicable to the following type of loans until further notice from the RMA. Loans for agriculture sector Loans for small businesses and artisan schemes EDP loans Staff Incentive loans Loans against fixed deposit ************** Page 5

6 Understanding Important Terminology 1. CASA Adjustment The one year deposit rate is adjusted for the positive carry on account of Current and Savings Account (CASA) deposits. The CASA adjustment is based on (i) the difference between the 1-year deposit interest rate of individuals and the savings bank deposit rate, multiplied by the share of savings bank deposits; and (ii) the share of current accounts multiplied by the 1-year deposit interest rate, expressed as a percentage. 2. Negative Carry on CRR and SLR Negative carry on CRR and SLR balances arises because the return on CRR balances is nil, while the return on SLR balances (proxied using the 90-day Treasury bill rate to be at 1%) is lower than the one year deposit rate. Negative carry on CRR and SLR is arrived at in three steps. In the first step, return on SLR investment was calculated using 90-day Treasury bills. In the second step, effective cost was calculated by taking the ratio (expressed as a percentage) of one year deposit rate (adjusted for return on SLR investment) and deployable deposits (total deposits less the deposits locked as CRR and SLR balances). In the third step, negative carry cost on SLR and CRR was arrived at by taking the difference between the effective cost and the 1-year retail deposit interest rate. 3. Unallocatable Overhead Cost Unallocatable overhead cost is calculated by taking the ratio (expressed as a percentage) of unallocated overhead cost and deployable deposit. 4. Average Return on Net Worth Average return on net worth is computed as the product of net profit to net worth ratio and net worth to deployable ratio expressed as a percentage. Page 6