IT must be mentioned that the Philippine Development Plan (PDP) 2023-2028 aims to promote an inclusive, innovative, and healthy financial sector. So, the following outcomes will be pursued by the government: 1) financial inclusion broadened and deepened; 2) financial innovation strengthened and accelerated; and 3) financial sector health ensured. In fact, just last Monday, November 20, 2023, Congressional Research Fellows from the Ateneo de Manila University, namely Dr. Alvin P. Ang, Dr. Luis F. Dumlao, Mr. Genesis Kelly S. Lontoc, and Dr. Ser Percival K. Peña-Reyes, went to the House of Representatives to present their paper on strategies to achieve such desired triple outcomes in line with the PDP.
Today’s column specifically focuses on a strategy to achieve the third outcome (financial sector health ensured) as it relates to consumer protection. The paper presenter, Dr. Luis F. Dumlao, highlighted the need to disclose annual percentage rates or, ideally, effective annual interest rates, so that consumers have a standard basis for comparing interest rates. As it is right now, when finance companies speak to consumers about loans, they often do so in terms of monthly interest rates. Sometimes, interest rates are not even mentioned in advertisements.
Real-life examples abound. One example goes thus: “Avail of emergency funds in a flash! Get a loan amount of up to P125,000 fast and hassle-free. Pay as low as P4,972 for 36 months with this exclusive personal loan offer. No documents required.”
With the help of Microsoft Excel, one can compute for the internal rate of return (IRR) of cash flows. One can type “Month” in cell A1 and then “Cash Flow” in cell B1. Cells A2 to A38 should contain the month numbers (0 to 36). Cell B2 should contain the total loan amount, which is 125,000 (for month 0). Cells B3 to B38 should each contain -4,972, which is the monthly installment payment for 36 months (for months 1 to 36). In some other cell—say, D1—one can type this formula: =IRR(B2:B38).
It turns out that the IRR, or the effective monthly interest rate, is 2.0859 percent. It gets more interesting when one tries to compute for the effective annual interest rate. On a scientific calculator, one can type ((1+0.020859)^12)−1 and get 0.281115. In other words, the effective annual interest rate is 28.1115 percent. The accompanying table presents the amortization schedule.
Another example goes thus: “Convert your credit limit to cash and pay in fixed monthly installments. Get as low as 0.99 percent monthly add-on rate for 36 months. Have your application processed in as fast as five banking days. Avail up to 100 percent of your credit limit.”
If the principal is still P125,000, then dividing it by 36 months yields P3,472.22 per month. The “low” monthly add-on interest rate of 0.99 percent should be multiplied to the principal to get P1,237.50. So, every month for 36 months, one should be paying P3,472.22 + P1,237.50 = P4,709.72. Following the same procedure in Microsoft Excel, one should get an effective annual interest rate of 23.1503 percent.
So, the policy recommendations regarding this matter are straightforward. Government regulators are not advised to define and ban usury. Rather, there ought to be greater transparency, such that even if one enters into a subjectively defined usurious agreement, at least he or she has already been made aware of what he or she is really entering. Also, having a standard basis for comparing interest rates should promote healthy competition in the industry.
Indeed, it is time to get real on rates!
Dr. Ser Percival K. Peña-Reyes is the Director of the Ateneo Center for Economic Research and Development.