Mutual Fund Association of Pakistan (Mufap) has alleged that some banks are using a flawed formula for profit rate, which does not reflect the true picture of returns earned by the depositors. Mufap has recently launched a written complaint against banks to the State Bank of Pakistan (SBP), it was reliably learnt.
In the letter Mufap has drawn the attention of SBP toward the advertisements by some banks appearing recently in various newspapers and TV channels whereby they are advertising 17-18 percent pa profit rate on 10-year bank deposits.
According to Mufap banks'''' methodology for profit is absolutely flawed and does not reflect the true return earned by a deposit holder and "no authentic finance book subscribes to this methodology". The actual profit rate that the bank is paying, says Mufap, is not 18 percent per year but only 10.85 percent. "This amounts to misleading the deposit holders on the actual profit that they are earning," Mufap alleged.
"In most countries the regulator requires banks to disclose the effective rate of interest rather than the simple rate of interest. However this rule is not existing in Pakistan," Mufap complained.
Contrary to the practice in banks the Mutual Fund industry in Pakistan is required to seek approval from Mufap and Securities and Exchange Commission of Pakistan (SECP) for all advertisements before publishing, Mufap added.
Mufap pointed out there were no advertising standards for the banking industry by Pakistan Banks Association and even the regulator (SBP) was also not checking the advertisements for accuracy and disclosures. Mufap members claimed to have visited some branches of these banks and their branch managers mentioned that under this policy the deposit holder will get about Rs 280,000 after 10 years on a deposit of Rs 100,000, with no interim payments. The methodology used by these banks to calculate the annual return is as follows: (Investment value after 10-years - Initial Investment value) *(1/ No of Years.
INITIAL INVESTMENT VALUE:
-- (280,000-100,000) * (1/10) = 18 % p.a. 100,000
Mufap said that this methodology is absolutely flawed and does not reflect the true return earned by deposit holders. While, as per the actual Annual Percentage Yield (APY), if Rs 100,000 is invested for 10 years at 18 percent pa the amount that the depositor should get at maturity would be Rs 523,384 and not Rs 280,000.
Mufap said that the formula to calculate the Final value is as follows:
FINAL VALUE OF INVESTMENT = INITIAL INVESTMENT:
-- (1+ i) ^n, ("i" is the profit rate and "n" is no. of years)
-- Rs 100000* (1+.18) ^10 = Rs 523,384
As per this formula Mufap said that the actual profit rate that the bank is paying is not 18 percent p.a. but only 10.85 percent p.a. (100,000* (1+.1085) ^10= Rs 280,000).
Performance Presentation Standards, used globally, recommend the use of compounding methodology for presenting the return for periods greater than 12-months. GIPS (Global Investment Performance Standards) established by the CFA (Chartered Financial Analyst) Institute recommend practices in presentation and reporting of investment results.
GIPS recommends that annualised returns be calculated by taking nth root of chain linked return, where n is the number of years in period. Mufap said that for financial institutions in the United States the calculation of the Annualised Percentage Yield (APY) are regulated by the FDIC (Federal Deposit Insurance Corporation) Truth in Saving Act (TISA) of 1991.
Regulation No 6500 deals with Consumer Protection and Appendix A to Part 230 explain the APY calculation as follows, which is also consistent with Wikipedia calculations APY= 100 (1+Interest/Principal) ^ (365/days in term)-1 Mufap has said that section 230.8 of the part 230 of Truth in Saving Act (FRB Regulation DD) is related to advertising, which says that " if an advertisement states a rate of return, it shall state the rate as an "annual percentage yield" using that term.
The advertisement shall not state any other rate, except that the "interest rate," using that term, may be stated in conjunction with, but not more conspicuously than the annual percentage yield to which it relates."
Sources said that such types of advertisement is helping banks to capture the major share of deposits and after the advertisement depositors are preferring deposit in banks over the mutual fund industry, which is directly hurting them. As such Mufap has filed an official complaint with SBP to bind banks to present the real picture of interest rates.
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