Banking in the new normal

ONE of the measures to provide some sort of relief for borrowers amid the onslaught of the Covid-19 pandemic has been the loan repayment moratorium given by the government to borrowers for a period of six months.

While there has been calls for an extension, the central bank has said that banks are not expected to extend the period but the banking sector will continue to offer targeted financial assistance in the form of restructuring and rescheduling to borrowers who continue to face repayment issues.

The announcement by the Prime Minister on Wednesday confirmed that some breathing space is now given to certain groups of borrowers, and a reduction in loan repayment amount in proportion to salary reduction for those who experienced pay cuts.

According to the Finance Minister and up to July 20, the value of the moratorium provided to consumers amounted to Rm38.3bil, while for businesses, the value stood at Rm20.7bil.

With Rm59bil in value for the moratorium already provided, it is estimated that by the end of September, that figure will increase to between Rm95bil and Rm100bil, as envisaged earlier by the government.

Obviously, these are huge amounts as the moratorium has provided a relief for borrowers from diligently paying their dues and not turn delinquent.

The impact on the banks too is significant as revealed by the Finance Minister earlier this week.

Having observed the peculiar nature of crisis after crisis, it is inevitable that every economic crisis, whether it originated from a housing bubble of the Global Financial Crisis or the Asian Financial Crisis from the attack on foreign exchange rates and due to the rapid flows of hot money, the banking sector is always vulnerable.

Banks being banks, they are exposed to the many facets of the economy and not just the housing market. It also lends to the economic sectors, consumption in the form of auto loans, hire purchases, leases and even credit cards. The new growth in lending is also towards personal loan financing.

Hence, an individual borrower can be having a mortgage, auto loan, credit card, a personal loan, an education loan, overdrafts, or even a margin financing loan.

However, what is peculiar is that all these loans carry different interest rates charged by the lender and it can vary from as little as 3% for a housing loan (assuming the rate is on a base rate (BR) of 1.75% +1.25%), to about 4% for share margin financing and to approximately 5% for personal loans.

The higher perceived riskier form of financing carries an even higher effective rate with auto financing at about 6% per annum for seven-year hire purchase loan, and as high as 15% per annum on credit cards.

For a company, the typical loans taken by them are either working capital loans, overdrafts, term loans, revolving credit facilities, property financing, commercial hire purchase, or even trade financing. The rates charged to corporates is typically tied towards the bank’s cost of funds (COF) or BR, which can range from as low as “COF +1%” to as high as “COF + 2.5%.”

Hence, the traditional method of finance and as we know it is based on the perceived risk of the underlying asset by the lender and hence a low rate of interest is charged for a low risk secured assets and higher rate is charge for high risk unsecured form of lending, which could typically be for personal loans and credit cards.

In addition, the traditional method of financing is also based on a standard form of repayment schedule, which could typically be on a monthly basis, or for companies, it could also be on a quarterly scheduled repayment basis.

Hence, when an economic turmoil strikes, whether it is an individual or a company, repayment of financial commitments become extremely challenging, especially if the individual borrower loses his source of income or in the case of a company, there is a disruption to its business.

In both cases, the borrowers are not entirely at fault. They are victims of an economic turmoil and due to no fault of theirs, they would likely default in their obligations to their respective lenders.

What follows is either in form of bankruptcies or in the case of a company, a winding-up order. It’s a lose-lose game for both the borrower and the lender when an economy takes a hit.

A borrower loses his prized asset and worst, he has also lost his source of income, while for the lender, the financial institution is now saddled with an asset they have no economic interest.

Inevitably, this leads to deterioration of asset quality or even non-performing loans and eventually, banks will sell the asset to the market at distressed valuation.

Hence, looking at the current situation as to how borrowing and lending is done and to protect the interest of both parties, we need to move away from the traditional way of finance.

We need to see the borrower as an individual or as corporation and not based on the purpose of the loan. For example, in an individual’s case, why should he be paying a range of different interest rates for different type of borrowings when that individual as a borrower has the same risk profile? Why should an individual pay a 3% interest rate for a housing loan but it doubles up to 6% for a personal loan and goes as high as 15% for credit cards? Why can’t individuals have a single rate of interest based on his credit score or risk profile?

In this way, the lenders will be guided in a structured manner as to how interest rates should be charge to an individual borrower rather than the purpose of the financing facility.

For companies, the similar rule should apply, ie a single rate of interest based on the company’s risk profile and not based on the purpose of the facility.

To have this in place, every borrower would need to have a credit score card and depending on the ratings from this assessment of risk, the borrower is subjected to a particular rate of interest.

In addition, we should also move away from the way how repayment is done by a borrower. During an economic turmoil, which could be as short as three months to as long as 18 months, instead of the scheduled monthly repayments, borrowers whom are affected, should only pay based on their ability to pay their monthly repayment.

If they are unable to make their required monthly repayment due to loss of job or income, the scheduled monthly repayments should be capitalised as additional borrowings. Should this occur, banks should be allowed to charge a higher rate as the risk profile of the borrower has increased.

However, if for example they are able to service their loans by paying only the interest amount, the lending facility provided is still deemed to be a performing loan and not a non-performing loan. (Note: This is now made as an option under the new flexibility repayment guidelines as announced on July 29)

Once the period of economic uncertainty has passed, and if the borrower is still not able to meet his/her obligations, an event of default can be said to have occurred.

In making the call whether an economic event has occurred, perhaps the central bank can provide the guide as to what constitutes an economic turmoil and the period when that economic uncertainty has passed. This is similar to the National Bureau of Economic Research which plays the role of determining the start and end of recession in the US.

For companies, the similar rule can be applied as companies too are vulnerable to not only an economic crisis but sometimes are also subjected to seasonality factors where the demand or supply of their goods or services varies from month to month or between quarter to quarter. Hence, if the company is not able to pay its monthly repayments, the lenders should not take action on the borrower but wait for the recovery that will translate into improved cashflow as well as repayment of the amounts due. In fact, during good times, a company can even make pre-payment to reduce their amounts outstanding with the lenders.

An event of default for a company should only occur if there are clear signs that the company is not going to be able to meet its obligations.

Many may think that is an absurd suggestion but look at this way, if you are an affected borrower due to an economic turmoil, wouldn’t you want some form of flexibility to meet your obligations?

Also, wouldn’t it be great to have a single rate of interest charge on your various financing needs instead of depending on the purpose of the facility that you are taking? At the same time, we also remove the potential occurrence of fire sale in the market as most of the time this will depress property market even more. Indeed, the economic crisis and pandemic as a result of Covid-19 requires new thinking and with the looming loan moratorium period coming to an end, perhaps this is the time for lenders to start thinking of banking in the new normal.

The views expressed here are the writer’s own.