By R. Jayaratne
In anticipation of the forthcoming Sinhala and Tamil New Year, many commercial banks are offering tempting loan schemes to unsuspecting customers.
As an example, a bank is offering customers a preapproved loan of Rs. 1 million with a convenient monthly repayment plan based on a ‘loan on card’ program. Options for repayment are in 12 or six equal monthly instalments at a one-off processing fee of 8% or 5% respectively and valid only until 20 April.
The benefits are described as convenient cash bundled with instalments options, easy to apply, quick delivery, preferential rates and fixed equal monthly instalments.
The hidden negative feature is that the effective interest rate is not stated in the offer. The effective interest rate is defined as the interest rate on a loan restated as a rate with annual compound interest payable in arrears.
Take for example, a loan of Rs. 1 million payable in 12 equal monthly instalments of Rs. 84,000 at a nominal interest rate of 8%. The effective interest rate as calculated on the midpoint of outstanding balance would be approximately 14.8%. Assuming net of service charge, the actual cash received is 920,000 (net of first instalment) only, the effective rate of interest would be higher at 15.9%.
Upon checking with the bank, they confirmed by phone that the effective interest rate on the loan is between 13% and 15%. Hence, it is obvious that the bank’s stated ‘reduced one off fee’ is incorrect.
In addition, the banks’ promotion of the convenience of instalment payments by credit card is a mirage that puts customers at high risk in case of default. They become liable to a stiff penalty charge for late payment plus a high interest charge on defaulted payments.
Currently, the credit card maximum cap on interest rates stands at a high of 24% as authorised by the Central Bank. Although the high rate was imposed to discourage unproductive personal loans, it has not happened as banks do not explicitly state the real costs. The Government also charges stamp duty on credit card payments and it too adds a significant cost on card users.
The Central Bank instructs banks to publish the interest rates when promoting credit products in any media including the penal interest rate, the method of computation and changes in interest rates. Unfortunately, it does not happen due to its negative impact on marketing credit products.
As a result, ill-informed bank customers’ maybe duped into a serious financial crisis by the very bank that offers them financial support to enjoy the festive season.
In this regard, Sri Lankan chartered financial analysts who serve in banks are bound by the Code of Ethics and Standards of Professional Conduct of the Chartered Financial Analysts (CFA) Association, USA. The relevant sections are quoted below:
Duties to clients
A. Loyalty, Prudence, and Care. Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.
B. Fair Dealing: Members and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities. Misrepresentation: Members and Candidates must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities
In addition, the Central Bank Credit Card Operational Guidelines clearly states the following:
Section 2.2 Benefits, incentives, rewards or reduction of any charges/fees which are offered by the Card Issuers in any promotional campaign or any event with regard to Credit Card operations shall be clearly communicated to the Customers in legible writing (electronically or document form).
2.3. The terms and conditions relating to the Credit Card shall be clearly communicated to the Customers and the same shall be provided in writing in the preferred language of communication, on request. The terms and conditions shall be displayed in the Card Issuers’ websites.
2.6. Misleading and unethical information/advertisements shall not be conveyed/ published by Card Issuers.
Due to the rapidly rising convenience of credit card usage among the middle income population, the Central Bank must strictly enforce commercial banks to abide by codes of ethical conduct in order to protect unsuspecting credit card holders of over 1.3 million countrywide who are at the mercy of being exploited by unethical practices of most commercial banks.
It can be concluded that most commercial banks try to make quick profits by expanding their customer loan portfolios through enticement and covert marketing techniques which hide the true cost of capital which is unsustainable as most customers fall into financial traps due to unaffordable personal consumption. It would be in the mutual interest of banks and customers if banks made a proper assessment of potential customer credit needs, repayment capacity and savings potential. The absence of such evaluation has resulted in many customers being lured into un-affordable consumption which results in personal financial crisis.
From a macro perspective, Sri Lanka needs to set an economic growth trajectory by promoting local savings in order to bridge the savings investment gap. For this, commercial banks need to play their role in promoting personal savings rather over consumption. In the medium term, banks must promote value added new productive investments that generates economic growth.
Promoting local investments that produce value addition via sale of goods and services, especially with export earning potential will stabilise the external sector. Resultant growth and macro stability will eventually attract much needed Foreign Direct Investments, particularly, for the lucrative export sector.
This will, in turn, not only enhance the long term profitability and sustainability of commercial bank operations but also discourage current unsustainable and usurious practices by banks in exploiting personal banking customers with unaffordable credit products and thereby killing the proverbial goose that lays the golden eggs.