Transparent Pricing Workshop Implementing the New Rules for Truth in Lending
Prior to the session, you should have the following: • Laptop running on Windows OS with MS Excel • Data on sample loan product: • Interest rate; • Finance charges, • Term of the loan; • Other conditions (forced savings amount, mandatory insurance); and, • Frequency of collection. • Sample disclosure forms
The following materials will be provided: • Cartolina • Coloring pens or crayons • Paste • Pictures • Crayons
Objectives • Discuss and clarify what pricing transparency is all about. • Share insights and requirements for compliance to BSP Circular 730 and Memorandum M-2011-040. • Provide steps to transition loan products from flat rates to declining balance method.
Key Questions • What is pricing transparency? • What does the recent BSP Circular 730 & Memorandum M-2011-040 mean for rural banks? • How do we prepare for such regulations? • What are the action steps for banks?
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Since we do not make our own money, we are thus forced to ‘rent’ money... What is the price for borrowing (renting) money?
Pricing Transparency • What is it? • the price, terms, and conditions of financial products are adequately and clearly disclosed to clients
Transparent Pricing Disclosure of price terms and conditions of financial product to clients
Pricing Transparency • Why is it needed? • So clients can have accurate understanding of prices • To allow comparison of different products • Protect reputation of banks. If buyers get abused, banking becomes a tarnished industry. • Transparent pricing protects the poor and protects the rural banking industry (MF Transparency, 2011)
Benefits of Transparency • Funders and donors: • Know what their client MFIs charge their customers • Choose their partners accordingly • Regulators • Observe the prices prevailing in the market • Sharpen their ability to intervene specifically and refine policy Source: Laila Deles, MF Transparency, 2011.
Perspective Understanding it from the point of view of the customer
Quick Exercise Loan Amount 120,000.00 12 months term, 3% service charge 5% 1.5% 3.15% 3.50% Effective Nominal 51.18% Annual EIR
BSP Circular No. 730 Enhancing Loan Transaction Transparency Method of computing interest. Banks may only charge interest based on the outstanding balance of the loan at the beginning of an interest period.
Definition of Terms • Finance charge • includes interest, fees, service charges, discounts, and such others incident to the extension of credit. • Simple annual rate • uniform percentage representing the ratio of the finance charge and the amount to be financed, assuming that: • One-year term, • Lump sum payment upon maturity, and; • No upfront deduction of principal
What is included in the calculations? Included Excluded Savings collected Insurance • Service charges • Documentary Stamps • REM/CM fees • Appraiser’s fee • Notarial fees • CTC (cedula)? • Barangay clearance? • GRT?
Other conditions: • If assumptions are different, then the Effective Interest Rate (EIR) shall be calculated and disclosed as the relevant true cost to the borrower. • For contractual interest rate stated on a monthly basis EIR is stated on a monthly basis.
So what is EIR? • Effective Interest Rate • Rate that exactly discounts future cashflows through the life of a loan to the net amount of loan proceeds. • Uses IRR (Internal Rate of Return) method.
And IRR is? • Internal Rate of Return • Rate that makes the net present value of all cash flows from a particular loan equal to zero. • Also also known as the “Economic Rate of Return” • Extensively uses discounted rate of return of cashflows.
Exercise 1: Calculating annual and monthly EIR. For each scenario, assume: Loan Amount 120,000.00 Contractual Rate (Monthly) 1.50% Other Charges 3.00% No. of Monthly Installments 12 Exercise 2: Just like Exercise 1, do the same for your bank’s loan product. (Total Time: 30 minutes)
BSP Circular No. 730 Enhancing Loan Transaction Transparency Information to be disclosed. The following are the minimum information to be disclosed: Total amount to be financed The finance charges (includes fees, interest, service charges, discounts and such other charges incident to the extension of credit) Net proceeds of the loan; and The percentage the finance charge bears to the total amount to be financed expressed as simple annual rate or an effective annual interest rate (EIR). EIR may also be quoted as a monthly rate in parallel with the quoted contractual rate
Exercise 3: Show and explain sample disclosure forms or disclosure statements. • Instructions: • Group into 3 or more groups. • Choose a sample disclosure form for study. • Discuss the following questions: • What is the difference between your bank’s disclosure form and the new disclosure form? • What needs to be improved in the disclosure form in light of Circular 730? • How do we make the disclosure form understood by clients? • Present findings to the group. Time: 15 minutes
Change Process Flow • STEP 1: Product and Pricing Review • Review products affected by Circular 730. That is, review all loan products in particular those using flat rates. • Conduct scenario analysis for each product if these are calculated based on the following scenarios: • Use current terms and conditions • Use simple annual rates • Use EIR on an annual basis • Use EIR quoted on a monthly basis • Compare these with the original flat rates.
Exercise 4: Conduct scenario analysis with one sample bank product. (30 minutes)
Change Process Flow • STEP 2: Test Market & Bank Impact • Considering market perception and competition, choose which scenario is best acceptable for the bank. • Conduct sensitivity analysis by tweaking components of the finance charges or mandatory fees to reveal competitive prices. • Consider tiered pricing mechanisms for each market.
Exercise 5: Conduct sensitivity analysis with sample loan product. (30 minutes)
Strategies to Mitigate Impact • Drop or reduce some finance charges. What can be dropped or reduced? • Change collection practices to become optional. What are the collection terms that can be modified? Are you prepared to lower rates if loan payment is made at the branch? • Spread service charges throughout the term of the loan.
Strategies to Mitigate Impact • Educate borrowers on why EIR rules are in place and how this may not really affect the amount and quality of the loan. • Unbundle embedded products (insurance, savings, etc.) • Other strategies?
Change Process Flow • STEP 3: Approval and Internal Roll-out • Recommend the final prices for the loan products to the Asset & Liability Committee or similar price-setting body within the bank. • Prepare the corresponding marketing & communication materials for distribution and to explain to staff and customers. • Modify IT/MIS system • Conduct internal trainings about the new pricing schemes including how to handle customer reaction.
Exercise 6: Develop procedures or work plan for internal roll-out. (Total time including group presentations: 30 minutes). • Divide into 3 or more groups. • Each group will provide transition procedures based on assigned topics (Marketing, Communications, IT). • Each group is given a maximum of 10 minutes to present their general procedure.