Transparent Pricing Workshop

Implementing the New Rules for Truth in Lending

Time Session Speaker

830am Registration

900am Opening Activities

930am About Pricing Transparency

1015am Break

1030am BSP Circular 730 &Memorandum M-2011-040

1230pm Lunch

130pm Preparation and Action Steps

500pm Closing Activities

Prior to the session, you should have the following:

1. Laptop running on Windows OS with MS Excel

2. Data on sample loan product:– Interest rate;

– Finance charges,

– Term of the loan;

– Other conditions (forced savings amount, mandatory insurance); and,

– Frequency of collection.

3. Sample disclosure forms

• The following materials will be provided:1. Cartolina

2. Coloring pens or crayons

3. Paste

4. Pictures

5. Crayons

Objectives

1. Discuss and clarify what pricing transparency is all about.

2. Share insights and requirements for compliance to BSP Circular 730 and Memorandum M-2011-040.

3. 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?

PRICING TRANSPARENCY

How much is a kilo of banana?

How much is a car?

Model X Model Y Model Z

Color White only White, Black, Gold

White, Black, Gold

Wheels Standard mags Aluminum high performance mags

Aluminum high performance mags

Engine Diesel Gasoline Gasoline

Other features Manual Manual Automatic

Power windows Power windows and locks

Keyless entry

Note: Add motor insurance (P20,000), car registration (P50,000)

But if we rent a car, what is the price?

Softdrink P50.00

VAT (12%) 5.36

Vatable 44.64

Vat-exempt 0.00

Vat-zero-rated 0.00

TOTAL 50.00

How much is cash?

Since we do not make our own money, we are thus forced to ‘rent’ money...

What is the price for borrowing (renting) money?

Republic Act 3765

(Issued June 22, 1963)

Pricing Transparency

• What is it?– the price, terms, and conditions of financial

products are adequately and clearly disclosed to clients

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

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.

BSP CIRCULAR 730(Issued July 20, 2011)

Perspective

Understanding it from the point of

view of the customer

Understanding it from the point of

view of the customer

Quick Exercise

Loan Amount 120,000.0012 months term, 3% service charge

3.15%1.5%Nominal Effective

5%5%

3.50%3.50%

51.18% Annual EIR51.18% Annual EIR

25

Method of computing interest. Banks may only charge interest based on the outstanding balance of the loan at the beginning of an interest period.

BSP Circular No. 730Enhancing Loan Transaction Transparency

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• Service charges• Documentary Stamps• REM/CM fees• Appraiser’s fee• Notarial fees• CTC (cedula)?• Barangay clearance?• GRT?

Excluded• Savings collected• Insurance

• 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 120,000.00Contractual 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)

Sample Chart 1

Cases/Scenarios Annual EIR Monthly EIR

Fixed equal amortization ??

Fixed principal amortization ??

Fixed equal amortization with grace period

??

Case: Periodic interest payment, balloon payment at maturity

??

Fixed equal amortization with weekly installments quoted in monthly EIR

??

Use current bank product ??

Sample Chart 2: Monthly EIRCases/Scenarios Loan = P10,000

Weekly payment(6 months)Contractual rate = 1.5%

Loan = P10,000Weekly payment(3 months)Contractual rate = 1.5%

Fixed equal amortization

2.48% 3.48%

Fixed principal amortization

2.50% 3.49%

Fixed equal amortization with grace period

2.15% 2.69%

Case: Periodic interest payment, balloon payment at maturity

2.03% 2.67%

36

Information to be disclosed. The following are the minimum information to be disclosed:a)Total amount to be financedb)The finance charges (includes fees, interest, service charges, discounts and such other charges incident to the extension of credit)c)Net proceeds of the loan; and d)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

BSP Circular No. 730Enhancing Loan Transaction Transparency

• Exercise 3: Show and explain sample disclosure forms or disclosure statements.

• Instructions:1. Group into 3 or more groups.2. Choose a sample disclosure form for study.3. 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?

4. Present findings to the group.

Time: 15 minutes

PREPARATION & ACTION STEPS

Change Process Flow

• STEP 1: Product and Pricing Review1. Review products affected by Circular 730. That

is, review all loan products in particular those using flat rates.

2. Conduct scenario analysis for each product if these are calculated based on the following scenarios:

a) Use current terms and conditionsb) Use simple annual ratesc) Use EIR on an annual basisd) Use EIR quoted on a monthly basis

3. Compare these with the original flat rates.

• Exercise 4: Conduct scenario analysis with one sample bank product. (30 minutes) Scenario 1 Scenario 2 Scenario 3

Loan Amount

Contractual Interest Rate

No. of Installments

Installment Amount

Finance Charges

Annual EIR

Monthly EIR

Breakeven Point

Change Process Flow

• STEP 2: Test Market & Bank Impact 1. Considering market perception and

competition, choose which scenario is best acceptable for the bank.

2. Conduct sensitivity analysis by tweaking components of the finance charges or mandatory fees to reveal competitive prices.

3. Consider tiered pricing mechanisms for each market.

Competitor Survey

Lender Annual EIR Monthly EIR

Commercial Bank ??

Your Bank ??

Rural Bank ??

Finance Company ??

Microfinance NGO ??

Pawnshop ??

Informal Lender ??

Sample Survey ToolCOMPETITOR SURVEY

Date of Survey:  

Bank/Institution:            

           

Type of Loan Product:Name of Loan Product

Loan Amount, PhP Contractual Interest Rate1

Term of Loan (No. of Installments2)

Minimum Maximum Minimum Maximum

Salary loan            

Microenterprise loan            

Car/Auto/Motorcycle loan            

Multi-purpose loan            

Micro-agri loan            

Housing micro-finance loan            

Others (please specify):            

______________            

______________            

Finance charges:Name of Loan: Name of Loan:

Service charge    

Documentary stamps    

Insurance (MRI)    

Micro-insurance, if required    

Others (please specify):    

______________    

______________    

______________    

Name of Loan: Name of Loan:

Service charge    

Documentary stamps    

Insurance (MRI)    

Micro-insurance, if required    

Others (please specify):    

______________    

______________    

______________    

• Exercise 5: Conduct sensitivity analysis with sample loan product. (30 minutes)

Scenario 1 Scenario 2 Scenario 3

Loan Amount

Contractual Interest Rate

No. of Installments

Installment Amount

Finance Charges

Annual EIR

Monthly EIR

Sample Tiered Pricing

Loan Amount Effective Interest Rate per month

Terms

Less than P5,000 3% 3-6 months

P5,000 – P10,000 2.75% 3-6 months

P10,000 – P25,000 2.5% 3-9 months

P25,000 – P50,000 2.25% 3-9 months

P50,000 – P100,000 2.0% 6-12 months

Greater than P100,000 1.75% 6-12 months

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 1. Recommend the final prices for the loan

products to the Asset & Liability Committee or similar price-setting body within the bank.

2. Prepare the corresponding marketing & communication materials for distribution and to explain to staff and customers.

3. Modify IT/MIS system4. 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).

1. Divide into 3 or more groups.2. Each group will provide transition procedures

based on assigned topics (Marketing, Communications, IT).

3. Each group is given a maximum of 10 minutes to present their general procedure.

Action Planning

ACTION Step Activity Date Person in Charge

Resources

Change Process Flow

• STEP 4: Public Communications & Complaint Handling

“x307.4 Posters. Bank shall post in conspicuous places in their principal place of business and branches, the information as contained in the revised format of disclosure statement .... The posters shall include an explicit notification that the disclosure statement is a required attachment to the loan contract and the customer has a right to demand a copy of such disclosure.”

Change Process Flow

• STEP 4: Public Communications & Complaint Handling1. Put posters about the new pricing scheme

including:• Notification that the disclosure statement is a

required attachment to the loan contract, and;• The customer has a right to demand a copy of

such disclosure.

Change Process Flow

• STEP 4: Public Communications & Complaint Handling2. Prepare price comparisons between

competitors in case customers inquire and compare the bank with other lenders (banks, pawnshops, finance companies, NGOs).

3. Prepare script to be used by frontline staff for common complaints such as:

• Perceived high price, effect on existing loans,

Tips for Communicating

1. Develop key messages: “The new interest rates is about ...”

2. Write down key messages and assign branch point person.

3. Use posters as aid in explanation.4. Compare differences and similarities from

past and present loan proceeds.5. Be honest and professional in approach and

demeanor.6. Other tips?

• Exercise 7: Develop scripts for customer inquiries and complaints. Do a role play.

AND/OR

Develop a sample poster they can use to display in their bank branches.

(Total time: 30 minutes)

To Conclude

• Pricing transparency is only one among many challenges that a bank will face.

• To address the new rules on interest rate calculations, a multi-stakeholder approach must be utilized to address this bank-wide issue.

• Support across the organization is essential for proper execution.

• To differentiate oneself from one’s competitors, product modifications must be made.

• More importantly, preparation is key to adapting to these new rules.

• Be ready! Start early! Prepare now!