Concept paper on BLR replacement likely to be out this week

THE EDGE WEEKLY ISSUE#997

THE WEEK OF JANUARY 13 – JANUARY 19, 2014

By: ADELINE PAUL RAJ

Bank Negara Malaysia (BNM) is expected to issue a concept paper this month, possibly as early as this week, on a new reference rate framework for banks in the country to price their retail loans.

Currently, banks use the base lending rate (BLR) as the basis to price such loans, particularly mortgages.  BNM governor Tan Sri Zeti Akhtar Aziz, during a speech last month, said it no longer seemed relevant to use the BLR as a reference.

“The BLR has ……. Become less meaningful as a basis for pricing of loans, as the retail lending rates on new loans being offered by the industry are at a substantial discount to the BLR,” she said.

Hence, the central bank is proposing a more relevant reference rate framework in its upcoming concept paper, which banks a expected to examine and give their feedback on.  Implementation of the new framework will likely take place later this year, Zeti had said last month.

Bankers that The Edge spoke to, on condition of anonymity, agree that the BLR is no longer relevant as a reference rate.

“By definition, it’s a benchmark base rate.  This means that the bank’s lending rate to the customer should not be lower than the BLR.  But today – and it has been the trend for some 10 years now – the lending rate is minus-BLR.  The renders the BLR meaningless,” says one of them.

As it stands, all eight local banking groups, from the largest to the smallest, have a BLR of 6.6%.  Each bank makes known its lending rate by stating that it is BLR minus (a certain percentage)”.  For example, (Maybank)’s MaxiHome loan financing rate stands at BLR minus 2.2%, which means the actual lending rate to the customer is 4.4%.

The prevailing lending rate by banks today for home loans is between 4.2% to 5%, which is way below the BLR.  The rate for automotive loans is slightly higher, at between 5% and 6%, notes a banker.  But most automotive loans tend to be pegged to a fixed rate that banks set, rather than the floating rate.

“It also gets a bit confusing for the customer to know what the actual lending rate is when you use BLR as the reference.  It should just be stated outright,” notes another banker.

Banks set their respective BLR based on a formula that takes into consideration the overnight policy rate (OPR), their cost structure – which includes their cost of funds – and business strategies.  Banks have been allowed to announce their own BLR since April 2004.

However, banks have tended to have a similar BLR rate in order to stay competitive.

By right, the BLR should be different for each bank given that the costs they incur are different.  This again points to the irrelevance of the BLR.  The cost of funds for most banks is between 3% and 4%, says a banker.

Some of the foreign banks in Malaysia also have a BLR of 6.6% but most have set it lower.  The lowest at the moment is 6.25%.

What then will be the next best reference rate that the industry moves to?  “The new framework will be more related to the funding cost, especially the marginal funding cost, which is actually how banks are pricing their loans,” Zeti told reporters last month.

She said that the new reference rate would have to fulfil three roles: “First, it needs to allow banks to vary the floating costs.  Second, the reference rate need to also reflect changes in monetary policy.  And third, the reference rate should be a basis for the pricing of retail loans.”

Bankers speculate the new reference rate could be the KLIBOR (Kuala Lumpur Interbank Offered Rate), which would be more reflective of banks’ cost of funds.

KLIBOR is based on the interest rate at which banks offer to lend unsecured funds to each other in the interbank market.  It defines their cost of funds and also the interest rate for fixed deposits.

KLIBOR is determined by a daily poll carried out on behalf of the Finance Markets Association of Malaysia.

Using the KLIBOR as a basis could mean that banks would state their lending rate as “KLIBOR plus (a spread)”.

Will that mean more expensive loans to the consumer?  Bankers don’t think so.  “The absolute lending rate will likely work out to be the same as the BLR0minus rate,” opines one banker.

Banks in Singapore and Hong Kong, for example, adopt their version of the KLIBOR as the basis for setting their mortgage rates.  Singapore uses the SIBOR (Singapore Interbank Offered Rate), while Hong Kong uses the HIBOR (Hong Kong Interbank Offered Rate).

Just last month, (BNM) came out with a risk-informed pricing policy document, which calls for banks to price their loans more in line with the risks they take.  The document sets out some requirements for banks to comply with by March 17.  It states that the pricing of retail loans should be based on a risk-informed approach.

“(BNM)’s rhetoric in the document seems to suggest that it thinks banks are pricing household loans, especially mortgages, too low ….. in the sense that they are underpricing the risks they take.  They want to see more sensible pricing while letting the banks maintain ultimate discretion over pricing,” observes another banker.

This comes amid on-going moves by Malaysia to cool household debt, which some quarters view as being worryingly high.  Malaysia’s household debt stands at about 83% of (our GDP).                                                                       E