Ending Flat-rate Loan Calculations Can Curb Household Debt, Bankruptcy Risks -- Economists

By Karina Imran

KUALA LUMPUR, Dec 24 (Bernama) -- Bank Negara Malaysia’s (BNM) proposal to abolish the flat-rate method for calculating personal financing is seen as a significant step towards improving the financial health of households, said an economist.

In the Exposure Draft on Personal Financing released on Dec 13, 2024, BNM sought public input on new requirements to abolish the offering of personal financing where interest/profit charges are computed using a flat rate with the Rule of 78 method.

The central bank noted that the move is consistent with joint efforts by the central bank, the Consumer Credit Oversight Board (CCOB) Task Force, and the Ministry of Domestic Trade and Cost of Living through amendments to the Hire Purchase Act 1967, which is scheduled for tabling in Parliament in the first half of 2025.

According to the exposure draft, the Rule of 78 is a widely used method for calculating loan repayments that front-load interest charges on personal financing products, requiring borrowers to pay a higher proportion of the interest early in the loan tenure.

AmBank Group chief economist Firdaos Rosli explained that the flat rate interest, combined with the Rule of 78, often results in borrowers paying higher interest upfront, disproportionately impacting those who repay early.

“The Rule of 78 front-loads interest payments, meaning borrowers pay a larger portion of the total interest in the early stages of the loan.

“This disproportionately affects those with long-tenure loans, as early repayments do not result in significant savings, making personal financing more expensive for borrowers who may want to settle loans early,” he told Bernama.

Banks and consumers can adjust to the new environment

Bank Muamalat Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid emphasised that abolishing the Rule of 78 could encourage borrowers to settle their loans earlier by reducing the financial burden of interest payments.

“The financing principal amount is paid off in a greater share relative to the share of profit (interest),” he told Bernama, suggesting that this could be an incentive for early loan settlement, ultimately benefiting borrowers’ long-term financial health.

He added that the banks are very nimble as they always have their asset and liability committee to decide on liquidity and demand for financing.

“The banks will adapt to the new environment,” he explained.

Meanwhile, Firdaos suggested that the transition should not be overly challenging as most financial institutions already recognise interest using effective interest rates (EIR).

“For ‘Buy Now, Pay Later’ (BNPL) providers, while the changes may introduce additional compliance requirements, they are unlikely to discourage these providers from serving a broad consumer base.

“The shift could even enhance consumer trust in such products by promoting fairer practices,” he said.

Impact on bankruptcy rates

BNM’s Exposure Draft on Personal Financing reveals that as at end-2023, aggregate household debt stood at RM1.53 trillion, with 12.6 per cent attributed to personal financing.

Personal financing has also been identified as one of the top contributors to bankruptcy, accounting for 46.26 per cent of total bankruptcy cases in 2023.

As at end-April 2024, 32.8 per cent of the loan facilities enrolled in Agensi Kaunseling and Pengurusan Kredit’s (AKPK) Debt Management Programme comprised personal financing.

Firdaos opined that while the new policy may help, it will not be the panacea to bankruptcy.

“In any case, BNM’s measures are a step in the right direction to address structural issues in personal financing. While they could help reduce bankruptcy rates, complementary interventions are necessary, including those from the fiscal perspective,” he said.

Meanwhile, Association of Banks in Malaysia (ABM) executive director Amina Kayani agreed that the abolishment of the Rule of 78 might help alleviate some financial burdens for borrowers, but addressing bankruptcy requires a holistic approach.

“This includes promoting financial literacy, encouraging responsible borrowing, and supporting accessible debt management solutions,” she said.

Amina added that the BNM’s proposal on the abolishment of the Rule of 78 aligned with ABM’s commitment to supporting fairness and transparency in the financial sector, as well as the well-being of the consumers.

“ABM and our member banks will work closely with BNM to effectively implement any changes based on the final policy document on personal financing to be issued in the future while addressing any operational details along the way,” she said.

Challenges of higher repayments

Under the general requirements for personal financing products, the tenure shall not exceed 10 years.

Hence, BNM is also seeking public feedback on reducing the maximum tenure for personal financing products to seven years, as seen in other jurisdictions such as Australia and Singapore.

Mohd Afzanizam welcomed the proposed changes, particularly the potential for healthier household finances.

“It is a positive move as the main intention is to promote a healthy financial condition for the borrowers. Reducing the tenure to seven years would mean households’ indebtedness is limited to seven years instead of 10 years maximum tenure.

“So in terms of monthly repayments, it is going to be slightly higher, and therefore, the borrowers would really need to compute its affordability whenever they want to apply for personal financing,” he said.

Meanwhile, Amina said Malaysia’s 10-year tenure provides flexibility for borrowers, particularly in managing affordable monthly repayments.

“Reducing the tenure to align with other countries, such as Australia and Singapore, would require careful evaluation to ensure accessibility is not compromised for lower-income segments,” she said.

-- BERNAMA