Bank Negara Malaysia’s (BNM) proposed abolition of the Rule of 78 could lead to broader reforms in other financing products, such as hire purchase loans, potentially bringing significant changes to the banking sector, according to Phillip Capital.

The Rule of 78, a widely used method for calculating loan repayments, front-loads interest charges on personal financing products, requiring borrowers to pay a higher proportion of the interest early in the loan tenure. While this approach benefits banks by ensuring they collect more interest upfront, it discourages early loan repayments, as borrowers save little on interest when settling loans ahead of schedule.

However, the removal of this rule could introduce challenges for banks. Without front-loaded interest income, there may be an increase in early loan repayments, resulting in higher portfolio turnover. This, in turn, could compel banks to reinvest funds into lower-yielding assets, thereby heightening reinvestment risk, Phillip Capital noted in a report. 

To offset these potential challenges, banks may consider raising their effective interest rates, which could help mitigate the impact of lost interest income. Phillip Capital also observed that despite these adjustments, the net effect on interest income might still be positive.

The report further suggested that a shift towards variable-rate personal financing loans could provide banks with an opportunity to benefit from a rising interest rate environment. Such a transition would allow banks to maintain profitability by aligning loan structures with market dynamics.

As part of its broader efforts to promote fairer lending practices, BNM is now seeking feedback on proposed requirements to prohibit personal financing products where interest or profit charges are calculated using the flat rate method under the Rule of 78.

(Source: The Edge)

• TAGS:
• Bank Negara Malaysia
• BNM
• Phillip Capital
• Rule of 78