Rule of 78 removal might prompt banks to raise rates

The change could also pave the way for similar reforms in other consumer financing products, such as hire purchase loans, which could have a larger impact on the banking sector, Phillip Capital Research noted.

PETALING JAYA: Bank Negara’s proposed amendments to abolish using Rule of 78 in personal financing under the Hire Purchase Act 1967, which will reduce front-loaded interest income and potentially pose higher reinvestment risk for banks from early repayments, could be managed by raising effective interest rates, Phillip Capital Research says.

“If banks can no longer benefit from front-loaded interest income and early loan repayments become frequent, this would increase reinvestment risk for banks, as they may face higher portfolio turnover and be forced to redeploy funds in potentially lower-yielding assets.

“However, this may be manageable if banks could raise their effective interest rates to compensate for the reduced interest, hence we think the net effect on interest income could be positive,” it said.

Banks with the largest exposure to personal financing are Alliance Bank Malaysia Bhd (11%), Affin Bank Bhd (6%), CIMB Group Holdings Bhd (6%) and RHB Bank Bhd (6%).

Globally, it said Rule of 78 has faced criticism for being unfair to borrowers, and its removal is seen as a step forward in consumer protection.

This change could also pave the way for similar reforms in other consumer financing products, such as hire purchase loans, which could have a larger impact on the banking sector, the research house noted.

Bank Negara has introduced a new exposure draft that proposes the abolition of the Rule of 78 method for calculating interest charges on personal financing products.

It plans to table the legislation in Parliament in the first half of 2025.

The central bank is also considering reducing the maximum tenure for personal financing products from 10 years to seven years, subject to public feedback.

Phillip Capital maintained its “overweight” call on the banking sector and said key risks included contagion risk from geopolitical issues, extended net interest margin compression, asset quality deterioration, higher inflationary pressures from upcoming removal of subsidies affecting repayment ability, and weak economic growth.