The proposed change in interest calculation for hire purchase to reducing balance from Rule 78 will not likely be a significant event, said RHB Research in the recent Malaysia Sector News Flash Report. The reducing balance method results in declining charges with each period.
More is charged at the beginning of an asset’s lifetime, becoming less towards the end. RHB added that banks have sufficient levers in place to support earnings, and dividend growth to help tide investors through this volatile period.
Other proposed changes mentioned include the acceptance of digital and electronic signatures for hire purchase agreement processes. Under Rule 78, interest is computed upfront based on the total principal, and does not take into account the reduction in principal outstanding after each repayment the borrower makes.
Hence, borrowers pay a greater portion of interest in the earlier period of the loan tenure and those that opt for early settlement will be faced with a higher principal amount outstanding, compared to other methods of calculating interest payments.
As such, this method is expected to be replaced with the more conventional reducing balance method. According to the article, Rule 78 has been prohibited in Australia, New Zealand, the UK and some states in the US.
The proposed change will only apply to new hire purchase contracts signed after the relevant changes are made to the Hire Purchase Act. Existing borrowers will continue to be bound by their existing hire purchase contracts.
RHB understands that banks are already recognising interest income from hire purchase using the effective interest rate method. With the effective interest rate method, the interest increases or decreases as according to the value of the hire purchase.
Hence, assuming the effective rate remains the same after changes to the Hire Purchase Act, the impact should be neutral. Banks currently also maintain the repayment schedule based on Rule 78.
For early settlement cases, an adjustment will need to be made for the differences in balances between the Rule 78 and effective interest rate calculation.
Overall, RHB does not expect the impact from the switch to be substantial given that the change does not apply retrospectively, and RHB expects banks to keep the effective interest rate unchanged.
Assuming banks move to a floating rate method for hire purchase after the change, this raises the rate leverage for banks and mitigates potential modification losses should banks have to go through a similar loan moratorium programme as back in 2020.
At this juncture, it is still early days and the banks RHB spoke to were unable to provide more colour on this.
