Despite the BSD circular No 9 of 12 November 2003, issued by State Bank of Pakistan, the banking industry remains flummoxed over:
1. Lawful accounting of mark-up on various credit facilities to customers, and
2. On the methodology of accrual where compounding occurs bi-annually, quarterly, or monthly.
Against the backdrop of a large body of extant judicial pronouncements on the subject, I suggest that the SBP issue an appropriate circular clarifying the following two issues:
A. ACCRUAL ACCOUNTING FOR VARIOUS FACILITIES:
Term Loan: (Demand Finance)...mark-up must be accrued in compliance with related term loan agreement and taken to the Bank's P&L as and when received from the customer. Accrual to cease upon maturity of term loan. Unless it is for the sole purpose of giving borrower extended time for repayment of principal, rollover of any unpaid term loan (and unpaid accrued mark-up thereon) may not be packaged into a fresh term loan for continuation of mark-up accrual, as already expounded in several superior court judgements.
Overdraft: (Running Finance): Mark-up to be accrued and collected quarterly in line with sale-purchase agreement between customer and bank. No mark-up charges, or other levies to be debited to the RF account as it causes compounding of mark-up on mark-up, which has been castigated by superior court judgements. And, if sale-purchase agreement is not renewed, disbursed principal obligation of a customer should be frozen as an NPL claim. More importantly, no mark-up accrual (even in a bank's memo or suspense account) is lawful thereafter. These issues are not very clearly addressed in the language of BSD circulars to date, including circular No 9 of 12 November, 2003.
Trade Finance: This includes import financing (PADs, TRs, and FIMs), discounting of inland bills (IBPs), export credit (including SBP refinance), and any other facilitation of trade, commerce, and manufacturing with predetermined maturity under 360 days tenor. Banks usually treat these obligations as perpetual loans and keep accruing and charging mark-up on them long after the maturity of respective trade tenors. Courts have ruled such accounting as unlawful because it is not sanctioned by terms of associated sale-purchase agreements. Furthermore, when faced with default on such trade transactions, instead of transferring related obligations to their NPL portfolios (and reversing uncollected accrued mark-up, while suspending further accruals), banks often debit these obligations to the customers' overdraft (RF) facilities. This is manifestly unlawful.
B. ARITHMETIC OF ACCRUAL ACCOUNTING:
With the recent explosion in consumer credit, consequences of the banking industry's current methodology of mark-up calculation are an accident waiting to happen. What do I mean?
Without exception, all banks in the country equate monthly, quarterly, and half-yearly mark-up with annualised mark-up rates by dividing contractual annual rates (percent per annum) by 12,4,and 2 respectively. Where mark-up is collected on such frequencies, it results in annualised mark-up rates, significantly higher than contractual annual rates. For instance:
-- 12% p.a. is not the same as 1% per month. Collecting 1% every month is actually the equivalent of 12.7% p.a. [because ((1.01) 12 -1) x 100 = 12.6825];
-- 12% p.a. is not the same as 3% per quarter.
Collecting 3% quarterly means 12.6% p.a. [because ((1.03) 4 -1) x 100 = 12.5509]; and so on.
In the foreseeable future, whenever a customer goes to court to challenge the mark-up accrued claimed by his bank, he will be able to show that he has been overcharged. Following that, all banks may have to reverse large amounts of excessive accrued mark-ups that they have taken to their P&Ls. As you are aware, in developed countries, "Truth in Lending" laws forbid this practice.
The aforementioned issues are at the heart of complaints from borrowers who have been historically charged excessive and unlawful mark-ups - quite a big dollop which has long since been capitalised into "undisbursed" new term loans. The SBP still appears reluctant to enforce large-scale reversals by the banks under its supervision, (BSD circular No 9 of 12 November envisages no retrospective application) even though, whenever asked to pronounce on its legality, courts have disallowed such accounting. Perhaps, in enforcing lawful accounting practices, the Central Bank is afraid of consequences to the entire banking industry's capital base.
It may not be out of place to add here that the banking industry's confusion on accrual accounting finds echoes within the SBP itself. For instance, Mr Murtaza Naqvi of SBP believes that if, under threat of section 15 of the Banking Ordinance 2001 (a one-sided and defective law the vires of which have been already challenged in a suit filed in PHC - Noor Match Factory Vs. Bank of Khyber), a customer is forced to acknowledge a liability far in excess of what is actually owed, then complaining to the SBP is a futile exercise even though detailed analyses of account histories prove that the bank has been guilty of unlawful accounting. I take this opportunity to encourage the SBP to make this a test case, and in doing so, to send the right message to the banks under their supervision.
Comments
Comments are closed.