Banks begin introducing floating interest rates

BoB announces its new rates, others to follow suit 

Interest: The much awaited revised lending rates of the financial institutions are finally being implemented with Bank of Bhutan Ltd (BoB) being the first bank to announce its new rates.

Others will follow suit after the boards of the respective banks and non-banking financial institutions give their green signals.

In doing so, for the first time in the country, the financial institutions are offering its clients an option to go for a “floating interest rate.”

A floating interest rate either moves up or down depending on the market forces. So it can vary over the duration of the debt obligation. For example, if someone takes out a fixed interest rate of 10 percent, he/she pays that rate until the maturity of the loan, and his/her payments are the same throughout the loan’s term. In contrast, if a borrower takes a floating rate, it may start with the same or even lower rate but then it either goes up or down, thus changing the monthly repayment amounts.

For instance, BoB has offered its clients a choice to opt for either floating or fixed rate for loan tenors with more than five years. However, for loans with a maturity of less than five years, customers have to go with the floating rate.

In case of BoB, the floating rate is applied on loan products like personal loans, loans against fixed assets, settlement loans and loans for trade and commerce where maturity is less than five years.

For housing, agriculture, manufacturing and education, among others, with maturity of more than five years extending till 20 years, clients have the choice to opt for either.

An official from BoB also said that the new rates would be applied to all new customers and even to existing customers currently repaying their loans, given that they fulfil certain criteria, one being their payment discipline.

The CEO for Druk PNB, Mukesh Dave, said the bank is yet to finalise its rate following its board’s approval on September 12.

The floating rate & reset

Banks usually offer lower floating rates than fixed rates because if a customer choses to opt for floating rate, he/she is exposed to risk. So, as an incentive of taking risks clients choosing floating rate are given lower lending rates in the initial period.

But even the fixed rate is not fixed throughout  because the Central Bank will revise the minimum lending rate every six months.

The minimum lending rate, set by the RMA is based on the average marginal cost of funds with all the banks, and is a uniform benchmark for lending that will be applicable to all the financial institutions. On top of the minimum rate, financial institutions will be allowed to charge additional rates such as tenor premium, credit risk premium and business strategy premium to arrive at the final rate.

This means that banks can choose to charge high rates in some areas and less in others, making some loan products expensive and others cheaper. This is expected to make interest rates cheaper in areas that boost economic growth and generate employment.

So the RMA will review the MLR every six months, meaning interest rates are bound to change twice a year based on the market forces.

However in case of the floating rate, interest rates are subject to change in credit risk premium and business strategy premium annually based on the bank’s audited accounts in addition to the change in MLR.

For loans with tenor of more than five years, the BoB has also offered its clients another option to go for floating rate with a five-year reset. This means that interest rates would be revised every six months to reflect the changes in MLR. However all the premiums would also be revised every five years based on the audited accounts of the bank.

This means that clients opting for floating rate with the five-year reset are exposed to less risk than those opting for the floating rate. Again the initial lending rate for the former is slightly higher than the latter.

A banker said that floating rates are highly uncertain. He said it is likely that with the new system being implemented, the profitability of the banks may fall. Should the profitability fall, the marginal cost of fund would increase and so would the MLR and other cuts banks can charge.

BoB, for instance reduced its interest rates by 2.75 percent on an average. The impact of the reduction will translate into loss of income from interest by Nu 250 million.

The banker said it is more likely that an interest rate with floating rate may increase from the initial 10 percent to more than 11 percent in the next two years. But as prescribed in the RMA circular, banks have to make an effort to lower interest rates on lending towards productive sectors.

BoB has reduced its rates from 11.75 percent to 8.49 percent (floating) and 11 percent (fixed) for lending towards the agriculture sector. For crops with a gestation of more than five years, the bank has introduced the floating rate with five-year reset loan at 10.18 percent.

The RMA circular instructed the banks to implement the the MLR policy effective from August 1. Sources however said that it took time to finalise the rates owing to the technicalities involved in determining the final lending rate.

Tshering Dorji

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