BNM has finally came out with a comprehensive guide on how Islamic Banks in Malaysia can charge late payments on default accounts. This is certainly good news for the Banks, as for the longest time, Islamic Banks have been abused by delinquent customers due to the low penalties for late payments. Historically, BNM has only approved a 1.0% p.a. compensation charge on arrears with the intention to cover actual costs of managing the non-performing account.
Comparatively, non-Islamic Banks have been charging the loan interest rates + the penalty rate of 1.0% for delinquent accounts. If the interest rate for the loan is 4.40%, non-Islamic Bank will therefore charge 5.40% p.a. on the arrears. Until recently, non-Islamic Banks is also charging this based on a compounded basis.
While on the onset we see that the new guidelines will aim to address this imbalance, a close assessment of the guidelines will show the Banks that the imbalance is still not fully addressed. What it alleviates is only the point of removing the abuse by the customers. If a non-Islamic Bank can charge a penalty fee of 5.40% p.a. on the arrears, Islamic Banks can also do so (technically).
The guidelines goes to say that the Islamic Banks can also do so, with certain conditions. A summary as follows:
- Banks are allowed to charge Late Payment Charges (LPC) up to the Average Financing Rate (AFR) of a portfolio. For example, the portfolio of an Islamic Mortgage has an AFR of 6.0% p.a., the Banks can therefore charge an LPC of up to 6.0%. This calculation of 6.0% must be submitted to BNM on a yearly basis for their review and approval.
- The LPC itself is split into 2 components i.e. Compensation (Ta’widh) and Penalty (Gharamah). Banks are allowed to charged either LPC i.e. Ta’widh + Gharamah, or just Compensation i.e. (Ta’widh).
- If the Bank chose only to charge Ta’widh (which is business as usual for most Banks anyway), the maximum rate chargeable is up to 1.0% of the arrears amount (non-compounding). This 1.0% charge may be recorded in the Bank’s books as “Revenue” to off-set the actual expenses incurred in managing the delinquent account. This 1.0% charge must also be review, justified and approved by the Bank’s internal Sharia committee members on a yearly basis.
- If the Bank chose to charge the LPC i.e. both Ta’widh and Gharamah, there is a specific treatment required for Gharamah. While Ta’widh’s treatment remains the same as above, Gharamah can only be taken for the penalising the delinquent customer but without benefiting the Bank. This means the Gharamah portion must be flowed into payments to Charity and must not go into the revenue books of any kind. The Bank must not derive any benefits from Gharamah, directly or indirectly, and this Charity amount must be managed under the oversight of the Sharia committee.
- As mentioned, the maximum that can be charged under LPC is up to the AFR rate. If the AFR is 6.0%, this means the Bank can recognise up to 1.0% of Ta’widh as its revenue, while the remaining 5.0% is to be taken as amounts for charity account.
- There is also a change in the compensation for off-tenure accounts i.e. accounts already expired or matured. For such accounts, BNM allows the usage of the daily Islamic Interbank Money Market (IIMM) rate for the LPC calculation on the Balance Outstanding. In this case, the whole amount can be recognised as Bank’s revenue.
I try to best as possible summary the above in the following diagram:
While this is a good measure to allow the Banks to charge compensation accordingly to minimise risk of default, it does not provide a level playing field for Islamic Banks as the compensation for non-Islamic Banks can be fully recognised as “revenue”. Because of this, Islamic Banks are reluctant to make the changes to their systems, processes and documentation (which will incur development costs and valuable man-hours) to accomodate Gharamah where no revenue can be recognised. To spend money to develop a feature that gives back no returns to the shareholders would not make any economic sense. As such, the leniency afforded by the LPC Guidelines is just on paper.
Nonetheless, the intention of the guidelines is to deter and control delinquency. That may yet be motivation enough for some Banks to make this development.