BSP, banks tepid on capping credit card interest charges

The Bangko Sentral ng Pilipinas (BSP) is tepid on proposals to impose any cap on credit card interest rate charges, worried that this would only create distortions in the credit market. In a position paper submitted to the House of Representatives committee on banks and financial intermediaries, the BSP maintained that the principle of market-determined pricing is the best way to serve the interest of the public and the most effective way of allocating credit. “This market-oriented interest rate policy allows market forces to determine the interest rates that apply to loans and other financial transactions," the BSP said. The BSP clarified that the Monetary Board only sets the interest rates for the central bank’s overnight facilities for borrowing and lending in order to influence the cost and availability of money and credit. There are seven bills pending in Congress seeking to set ceilings on interest rate and other charges on credit card transactions to help cardholders who are experiencing financial difficulties. These are House Bills 1561, 1900, 1919, 2195, 3015, 3410, and 3824. Market-oriented vs administratively fixed interest rates The BSP warned that capping interest rates would “invariably fuel the moral hazard and adverse selection problem that underpin a credit rationing framework." Moral hazard is the economic principle that individuals would alter their behavior if they knew they were insured against some outcomes. Adverse selection is when a certain group of people who offer the worst return for the company select a product or service, thereby inflating prices but reducing demand from other would-be customers. Past experience with interest rate-setting led to the shift from administratively fixed interest rates to a market-oriented interest rate policy through Central Bank Circular 905 which prompted the Supreme Court in 1984 to rule as “legally inexistent" Republic Act 2655 or the Usury Law. The BSP explained that it could not impose a statutory ceiling on interest rates as this would undermine the ability of financial institutions to price their credit exposures based on the underlying risk profiles on their client resulting to more stringent requirements leading to reduced credit availability. “The re-imposition of interest rate ceilings would only introduce distortions in the credit market," the BSP stated in the 14-page position paper. The BSP warned there would also be costs associated with enforcing interest rate ceiling through increased burden on banking supervision and policy consistency in regulating fees and surcharges. The adoption of a market-based interest rate policy, the BSP reiterated, is intended to ensure adjustment of interest rates in line with changes in market conditions and to facility transfer of policy signals to all sectors of the economy. The BSP added that it is also intended to promote efficient and effective financial intermediation of funds between savers and borrowers. The BSP said the Monetary Board “may eliminate, exempt from, or suspend the effectivity of, interest rate ceilings on certain types of loans or renewals thereof for forbearances of money, goods, or credit whatever warranted by prevailing economic and social conditions" under Circular 905. Credit cards vs ‘five-six’ For its part, the Bankers’ Association of the Philippines (BAP) said the imposition of a cap on interest rate would result in lower credit extension. “Given the proposed cap on interest rates, credit card businesses may be compelled to close its operations," BAP president Aurelio Montinola III said in a position paper. Montinola said the closure of credit card companies would force borrowers to turn to the informal sectors such as loan-sharks locally known as “five-six" who charge interest ranging from 20 percent to 240 percent per annum resulting to lower tax collections. Data from the BSP show that at present there are 19 credit card issuers, including 15 universal and commercial banks as well as their subsidiaries, and four thrift banks. About 6.7 million credit cards are in force while credit card receivables stood at P111.88 billion as of end September 2010. About 13.2 percent of the total receivables are non-performing. – MRT, GMA News