Saturday, April 14, 2007

How can such Banks afford to give 20%pa on Deposits?

The simple answer to "how Banks can afford to pay out 20%pa on Deposits", is "they do so, by charging high Interest Rates for 'Loans' (typically up to 36%pa)".

Now you may be thinking that 36%pa is very high Loan Rate?

Well that is 3% per month, and typical of what a Credit Card company might be charging.

In much of the Philippines, the only way villagers can borrow money is from loan sharks. They collect from their debtors every day. The most efficient private entities who are engaged in micro-lending are the "Bombays". Although they operate illegally as usurers, they have actually mastered the technique of marketing and collecting, so much so that they have flourished and grew and their simple "5-6" operation have been passed through generations.

They're known as five-sixers because they take six pesos back for every five they lend. That works out to an annual interest rate of over 1,000 percent.

Indebtedness to informal loan sharks is a huge problem in the Philippines.

Many of the Philippines poorest, who live on the edge of subsistence without a single peso's margin, have no option but to go to the local money lender for loans to buy stock for their small businesses, or to tide them over when emergencies come up.

These guys charge anywhere from 5 to 20% interest per month ( that's 60 - 240% per year! ) and can use brutal tactics on anyone who don't pay.

In the "one-day-loan" system they might charge 100% per day!

At these kind of rates, debts quickly skyrocket, and many find themselves in a swift, downward spiral, with more and more of their money going just to pay the interest, losing all hope of getting out of debt.

It seems crazy to pay this kind of interest, but to those with no other credit options, the money lender means survival, and so people keep going back.

This is why the poor stay poor.

I think this explains why many in the Philippines, are willing to borrow money from a Bank that charges as much as 36%pa, for such a loan.

How can these Banks be sure they will collect the loan repayments?

Generally such Banks typically offer such loans, only to those with proven means to repay. This might be various types of loans like micro-finance loans for entrepreneurs. Salary loans for government teachers for example, with automatic salary deduction schemes guaranteeing a 100% collection. These, among others, ensure the Banks of receiving between 24% to 36% interest income per year. OFWs, soldiers, and SMEs, are other typical borrowers of money from these Banks.

Why such a difference between these 'Rural Banks', and the 'Commercial Banks'?

As an example, I heard that BPI Family Bank have a rule of thumb for its bank: add 7% to the cost of money and you have the general cost of capital.

A 'Commercial' Bank's long-term lending rate might typically be 11% now. Deduct 7% and you have just 4%. The bank can offer its clients is 2% for saving deposits, with just 2% profit for the bank. Commercial Banks don't make their big money from savings/loans - rather from Credit Cards and the like.

A 'Rural' bank's lending rate averages 36% for short-term loans. Deduct the 7% and a Rural Bank has 29%, leaving 9% profit ,after offering clients 20%pa on Deposits.

Other banks may set aside a big percentage as provision to write-off bad loans, while a Rural Bank that has a low ratio of bad loans, would need only a smaller percentage as provision.

Of course, other factors like stakeholder expectations on ROI, and actual operating expenses all come into play. Generally you find most Rural Banks have lower overheads - smaller, less prestigious offices, a lot less 'managers', means lower salaries also.

Rural Banks have to stay 'competitive', to attract 'cash' Deposits.

Rural banks lose P500m accounts
By Eileen A. Mencias

The Rural Bankers Association of the Philippines has asked the Bangko Sentral ng Pilipinas to stop the migration of deposits from rural banks to big commercial banks.

Pablo Ronquillo, a consultant of the Rural Banks Association of the Philippines and a former central bank lawyer, said deposits in the rural banking industry were being siphoned off by the big universal and commercial banks through their high yielding unit investment trust funds.”

"The good prices on the bonds and equities resulted in an improvement in the value of most trust funds, with some even reporting a net return of as much as 24 percent.

“The UITF offers as much as 24 percent net interest on deposits which is too attractive and tempting for the enterprising depositors to transfer their accounts not only from rural banks but also from other thrift and commercial banks,” Ronquillo said.

Tetangco, however, told reporters that the central bank had seen an increase in deposits in the system. He said higher deposits were also noted in thrift and rural banks".

So Rural Banks need to offer products such as 5 Year Term Deposits with 20%pa Interest Rates (with interest credited monthly), to remain attractive to Depositors, who might otherwise consider UITF's paying 24%?

Personally, I will stick to these Rural Bank Time Deposits, for the following reasons:-

  1. Less Risky - Deposit insured by PDIC
  2. Guaranteed Return - CTD states Interest Rate of 20%pa, paid monthly for full term
  3. Tax Free - Interest payment gross of 20% Withholding Tax (as exempt)
  4. Ability to Cancel, quick payout and with known costs - High net balance.
    If needing urgent cash for some emergency, it is possible to cancel the Time Deposit.
    This can be done quickly (1-2 days), and the penalties are fixed and known for doing so.
    In most cases you will still be better off financially, for having placed than the Time Deposit, then terminated, over any other form of savings investment over the same period.

So far, I have not come across any, overriding reasons, why one should NOT consider such Deposits?


boostah said...

Great information thanks so much for writing this article, 20% sounds effing awesome.

Anonymous said...

Hi there Brit in Cebu,

Your blogs are really interesting. I know of these accounts as I have a few myself in a certain bank. I am thinking of investing more but do you know which other banks are currently offering them? And do you advise to invest in such banks taking into consideration of the current economic situation.

David Whittall said...

I know of 14 x Rural Banks offereing at least 18%pa on a 5 Year Peso Time Deposit.

1 x Rural Bank is offering 33.33%pa, on a 3 Year Peso Time Deposit, Monthly out. Minimum Deposit Php1M.

With falling FOREX RATES meaning you get less Peso for your GBP, EUR, USD or whatever, and Oil Prices increasing Cost of Living, you have to earn more, just to stay EVEN, so why not get the highest Interests Rates avilable?

Complete and Submit the Form to get sent an 'Invite' to Join my 'Private' Wiki, that is replacing the Yahoo Group, that got hacked.

Satin said...

Well written article.