By San Thein
Significant developments in the banking sector
Momentous transformation has been taking place in the Myanmar Banking Sector with series of significant reforms. The latest ones are five directives, issued in March 2019, covering eligibility, responsibilities and accountability of board of directorsand external auditors, fit and proper criteria for bank directors and top management, and restrictions on acquisition of substantial interest and related party transactions. In July 2017 also, the monetary authority issued four prudential regulations covering capital adequacy requirements, management of problem assets and maintenance of adequate provisions and reserves, concentration of risks and large exposure limits, and appropriate liquidity requirements in banks.
These regulations and directives are not invented locally but adapted from the Basel standardssetby the Basel Committee on Bank Supervision (BCBS) to suit the needs and requirements of local banks.BCBS is an international body of central bankers and supervisors formed to strengthen the regulation, supervision and practices of banks worldwide with the purpose of financial stability.
The other essential directives issued for the smooth transformation are Directive No.7/2017, 1/2019 and 2/2019.Issuing these directives, the monetary authority has allowed local banks (a) to make medium-term loans of up to three years based on the business cycle and cash flow patterns,(b) to extend loans without collateral at a maximum lending rate of 16 per cent, and (c) to make long term housing loans of up to 5 per cent of total loan portfolio.
The above regulations and directives can be viewed as significant restructuring measures towards modernization of banking sectorto be able to effectively promote optimum allocation of financial resources for a long-term economic development. Local banks are trying to comply with these regulations and directivesin the face of large outstanding amount of overdraft loans with potential loan defaults and lack of proper risk management, largely associated with the collateral-based lending system that prevailed in the banking sector for a long time.
Collateral-based vs. risk-based lending
Under the collateral-based lending system, banks usually accept land and landed property as collateral. After assessing the market value of the collateral, the bank estimates the forced-sale value of the collateral. To keep themselves on the safe side, banks usually grant credit of up to 50 per cent of the forced-sale value of the collateral without making any comprehensive appraisals on the loan proposals. Under the system, banks are risk-averse and credit risk assessment does not play an essential role there. Routine rolling over of loans mostly in the forms of overdrafthad becomea normal banking practice for a long time leaving the legacy issue of large volume of outstanding overdraft loanswith potential loan defaults in banks.
Directive 7/2017 dated 24 November 2017 is a significant departure from the old and outdated banking practice of collateral-based to cashflow-based system of lending. Issuing the directive, the monetary authority allows local banks to make three-year term loans based on the cashflow pattern of the borrower. It is a risk-based lending. It promotesrisk-appetite in banks. In promoting the culture of risk-appetite, liberalization of product innovation and price setting is crucial. It is encouraging to learn that in the DirectiveNo. 7/2017, the Central Bank of Myanmar encourages local banks to develop new lending products with repayment terms that consider the business cycle and cash flow pattern of the borrower.
Pricing of products
Pricing is still mandated in the banking sector.Based on the central bank rate of 10 per cent, the monetary authority sets a nominal interest rate of 8 per cent on deposit and 13 per cent on commercial loansleaving a profit margin of 5 per cent for the lender.However, the current situation does not allow banks to enjoy a full net interest margin of 5 per cent. Low net interest margin (NIM), resulting from the low loan to deposit ratios together with insufficient non-interest income and low actually received interest payments mainly due to the large amount of overdraft loans, is putting pressure on bank profitability.
In fact,Myanmar is among a few countries in the world left with regulated interest rates. The mandatory interest rates usually do not reflect the actual market condition and tend to create distortions in investment. The fixed interest rate environment does not allow banks to price their risks and hence reduces their ability to choose viable businesses for effective financing. Offering the same price to every customer would weaken the bank’s quality of risk assessment and henceheighten the risk ofdefault on loans.
Interest rate liberalization for risk-based pricing
In contrast, under the risk-based or cash-flow based system of lending, banks can take a more holistic approach when judging the weaknesses, strengths, viability, credit amount and particularly the repayment capacity of each business. Under the risk-based system of lending, banks have a systematic approach to risk assessment to determine an acceptable level of risk. They are well prepared to accept the level of risk in pursuit of their objectives.
At the same time,market-based pricing would allow the customers to select the bank they trust.Reliability, well established reputation and good performanceevidenced by their degree of transparency, accountability and efficiency are the three main determining factors for customers to select the bank they trust.
Risk-based pricing together with cash flow-based lending would enhance the lenders’ ability for selecting viable businesses for effective financing and hence promote the optimum allocation of financial resourcesfor economic development.
Liberalization of interest rates based on borrower risk profiles, one of the action plans under the Strategy 2.2: ‘Reduceinflation and maintain monetary stability’ of the Myanmar Sustainable Development Plan, is an essentialprerequisite for risk-based pricing. It would give banks more room for maneuvering to make necessary adjustments while implementing the reform measures adopted by the monetary authority. While waiting for the local banks to be mature enough to practice the healthy competition among themselves, gradual liberalization of interest rates would be desirable to helpstrengthen the bank restructuring process.
(San Thein is a former central banker and is currently a senior adviser for the German development agency, GIZ.)
