by Arwin Rasyid
Unsecured Loans (often abbreviated as “KTA” in Indonesian) are one of the mainstay products of the banking industry. As personal loans, they are extended to micro businesses, formal and informal-sector workers and self-employed professionals. All sorts of people avail of such loans, ranging from teachers and public servants to street hawkers, food vendors and motorcycle taxi drivers.
According to banking-sector data, KTA lending currently accounts for some Rp 142 trillion of the Rp 1,000 trillion of outstanding loans in the SME sector, or a total of 14.2%. On average, the loans vary between Rp 10 million and Rp 15 million, but are sometimes as much as Rp 50 million. However, if we assume that the average KTA loan is Rp 15 million, this means that there are some 10 million KTA borrowers in Indonesia today.
KTA lending is a mainstay banking product that has proved very popular with the public, especially low-income people.
Given this, I will discuss the KTA business model in some detail in this article, both from the banking perspective and the perspective of borrowers given that problems related to KTA business model may have fallen under the radar amid the ongoing Covid-19 pandemic.
One of the characteristics of the KTA business is that borrowers are charged high interest rates. Some big banks (both foreign and domestic private) charge interest rates of a flat 1.6 – 1.9% per month. The setting of such high-interest rates is predicated on the “high risk, high yield” paradigm. For the banks, charging high KTA interest rates forms part of their credit-risk management policies, that is to say, this is one of the ways in which they maintain a low level of NPLs (non-performing loans) in the risky KTA business.
While this paradigm is acceptable, the problem is that the banks often fail to properly communicate the reality of high KTA interest rates to their customers. Indeed, the situation is often deliberately obfuscated so that KTA borrowers can end up being mislead, especially given that they are generally low-income people with low financial literacy levels.
When a bank provides a flat-rate KTA loan, the reality is that the interest rate may turn out to be much higher than anticipated by the customer. This is because KTA installments consist of 2 components: principal repayments and interest payments. At the outset, the interest payments are much higher than the promised flat rate. Indeed, an installment could be made up of as much as 75% interest and 25% principal repayment.
That is what happened to Mr. Tikno (not his real name) – my favorite fried-rice hawker. He is a KTA customer of a private bank whose story is instructive as to what is really happening on the ground amid the Covid-19 pandemic.
Initially, he applied for KTA and was offered a loan of Rp 17 million, repayable over 3 years (36 months) from November 2019 to October 2022. He was interested and agreed as he believed he would be able to pay a flat interest rate of 1.9% per month, meaning that he would have to pay interest of Rp 3,876,000 (or Rp 323,000 per month) over the course of 1 year.
However, based on the table given by the bank to Mr. Tikno, he actually has to pay interest of Rp 6,393,939 in the first 12 months, far above the flat interest he had imagined. That is what is known as the “effective interest.” In fact, the real interest rate on his loan in the first year amounts to 38%, or an average of 3.2% per month (not 1.9% as promised by the bank).
The Covid-19 pandemic has had devastating consequences for Mr. Tikno’s business. The partial lockdown introduced in Jakarta in March deprived him of his livelihood, as a result of which he has been late with his installments for March, April and May. Indeed, he had to pay his installments in April and May out of his savings. He has not paid yet June’s installment and the bank is now continually chasing him.
With his payment for March, it meant that he had paid a total of 7 months’ installments or almost Rp 6 million, accounting for 35% of the amount of the KTA loan.
The main problem Mr. Tikno faces now is that the loan agreement establishes a late-payment penalty of 6% of monthly installments, or IDR 250,000 (whichever is higher). As he has been late in making his payments on 4 occasions, the total penalties to date amount to Rp 1 million, which is added to the loan principal, meaning that this has increased from Rp 17 million to Rp 18 million. While Mr. Tikno has already paid 7 installments, the amount of the loan principal has not decreased but rather has increased, just because he has been late by 1 or 2 days in making his payments. How can this be?
The banks need to be sensitive in a crisis like this. Especially in the case of customers who are acting in good faith. The middle way is to ease the terms and conditions and to restructure the KTA. So, for example, if a customer is able to pay Rp 400,000 per month and the loan principal is only Rp 16 million, the bank should agree to provide a 6 to 9 months’ freeze on interest payments. This is only reasonable given that the bank has received Rp 6 million without any reduction in loan principal.
Another way might be for the bank to recalculate the KTA interest based on the bank’s cost of funds. If the cost of funds is, for example, 4% and operational costs 3%, then the total cost amounts to 7%. Thus, an interest rate of 14% would be pro-customer given the current crisis. Even if the bank reduces the effective interest in the first year from 38% to 14% for 6 to 9 months, it will still earn a 7% margin on the KTA, while at the same time the borrower’s business will be given room to breathe.
The above discussion highlights a number of important points that need to be considered by the banks:
First, greater transparency is needed in calculating KTA interest. The term “flat interest rate” is misleading as the interest payable by a customer in the first year is actually much higher than the flat rate would suggest. Thus, the banks need to provide more information to customers on the effective interest rate they will have to pay. The provision of incomplete and asymmetrical information is arguably in breach of Financial Services Authority (OJK) Regulation Number 1/POJK.07/2013 on the Protection of Consumers in the Financial Services Sector, in particular Article 4(1), which requires financial services providers to provide and/or convey information on products and/or services that is accurate, honest, clear, and not misleading,” and Article 7(1), which stipulates that financial services providers must employ “simple terms, phrases and/or sentences in the Indonesian language in every document so that they are easily understood by consumers …”
Second, the banks should be willing to recalculate the late-payment penalties they impose on KTA borrowers, who are generally micro-entrepreneurs and low-income individuals. By comparison, the late-payment penalties imposed on small, medium and large businesses generally only amount to 1-2% of monthly installments, while KTA penalties can reach up to 25%.
Third, the banks should eliminate the requirement that the first installment be deducted from the the KTA loan principal, which means that the loan amount received by the customer is not the same as amount that was agreed upon at the outset. This strategy, which is designed solely to increase the effective interest rate, means that if, for example, the agreed KTA loan amount is Rp 17 million, the amount transferred to the customer will only Rp 16 million as the first installment and various costs are deducted from the agreed loan amount.
Fourth, the banks should also remove the requirements to pay cancellation fees and fees for early repayment, which can be up to 8% of the outstanding loan balance, plus other costs. All this means that if a customer wishes to repay a KTA loan of Rp 17 million, with a 36-month tenor and monthly installments of Rp 800 thousand, and has already paid 7 months of installments, he or she will have to repay the Rp 17 million plus a cancellation fee of Rp 1.4 million, meaning that the total amount that will have to be paid is Rp 18.4 million, even though the KTA loan he received actually only amounted to Rp 16 million and he has already repaid IDR 6 million. This KTA business model serves as a strong disincentive to accelerated loan repayment. Why would a customer want to accelerate repayment if the total amount that must be paid actually increases? The impression one comes away with is that the banks are penalizing customers who wish to accelerate repayment, rather than supporting them in doing so, which would be the approach one would expect them to adopt given the ongoing crisis.
Amid current conditions, many KTA customers in the form of micro entrepreneurs whose businesses have run into trouble and individuals who have lost their jobs will be experiencing problems in meeting their program obligations under KTA loans. The banks need to relax the terms and conditions applied to such borrowers in line with OJK guidelines and regulations, and adopt other policy measures to support KTA borrowers who are experiencing liquidity difficulties.
It is time for the banks to review and reconsider their current KTA model so as to make it more sympathetic to their borrowers. This is the fervent hope of at least 10 million KTA customers, while many millions of other bank borrowers are waiting for similar breakthroughs in the case of other products, such as housing and apartment loans, auto loans, credit cards and so on.
The Covid-19 pandemic is the ideal time for banks to establish a “new normal” in the services they provide to both their loan and deposit customers. This new normal should be based on a sense of togetherness and concern for the businesses and financial circumstances of customers and the adoption of win-win solutions, irrespective of whether the economy is growing or facing a crisis.
*The writer, a former banker, is the founder and chairman of TEZ Capital Group