HOW BANKS OVERCHARGE BORROWERS

For being one of the organizers of the Light a Fire Movement, an underground group set up against the Marcos dictatorship, Eduardo B. Olaguer languished for six years in the Bicutan detention compound and the Muntinlupa penitentiary. Saved from the firing squad by the intercession of Cardinal Sin, Ed was released shortly before the February 1986 People Power Revolution.

Having faced death many times during his incarceration, nothing has fazed Ed since then. He now has a nice home in upscale Alta Vista, Quezon City. With some friends, he built on Aurora Boulevard the 18-story Aurora Milestone Building which he runs. Ed has paid his dues, lived a full life, and should just lie back and enjoy and do charity work.

Instead, Ed has taken up arms against the four banks he does business with. He has also brought his complaint to the attention of Bangko Sentral and the Senate and House committees on banks. I suggest the Bankers Association should start circling the wagons. Ed is on the warpath and everyone who has ever taken out a bank loan should rally to his side.

Ed complains that the interest the banks had actually charged his company was over and above the rate agreed upon and specified in the promissory notes. My guess is that this practice of overcharging borrowers is done in all banks and, for that matter, also by finance companies.

Let us go to the basics. Interest is what you pay for using the bank’s money. But when is the interest due and payable? Since ancient Rome, and even earlier to ancient Phoenicia, the basic concept is that the interest is due and payable at the end of the period over which you borrow the money; in other words, after you have used the money. Also, rates are always expressed in percent, or each hundred, and reckoned on a yearly basis; hence, the Latin or Roman term per annum, or each year.

When a Roman merchant borrowed the equivalent of P100 at 6 percent interest per annum to finance a business trip, he forked over to the lender, at the end of one year, P106. If the lender relends the entire P106 for another year at the same 6 percent per annum, then the merchant paid, at the end of the second year, P100 x 1.06 x 1.06, or a total of P112.36. Notice that the P6 interest earned at the end of the first year also earned interest, of thirty-six centavos, at the end of the second year. The interest is said to have been compounded, or as bankers quaintly put it, rolled over.

These basic concepts on compound interest have come down to us through the centuries. Today, these are drilled in every high school and college all over the world. But, it seems, the banking world is different.

Now, Ed’s complaint. Let us say the interest rate specified on a promissory note is 18 percent per annum. The bank makes you feel it is doing you a favor by allowing you to pay interest on easy monthly installments at the rate of one-twelfth of 18 percent, or 1.5 percent, at the end of one month. This means that the monthly 1.5 percent interest is compounded twelve times over the next twelve months. At the end of the twelve-month period, you will have paid, not 18 percent as written on the note, but 19.56 percent or an excess of 1.56 percent. If any banker is interested, I will show him the mathematical proof over a cup of coffee at his expense.

In other words, because of the factor of time, 1.5 percent paid at the end of each month for twelve straight months is not the same as 18 percent paid in lump sum at the end of twelve months. It is higher. In effect, the bank, instead of giving you a discount, actually penalizes you for paying interest in advance.

But Ed’s revolutionary fervor has cooled down. He does not go far enough. The bank raises the rate even higher. For example, on a P1,000 loan, the bank computes the interest for, say January, based on a 360-day year, thus: P1,000 x 0.18 x (31 / 360) = P15.50. At the end of twelve months, you will have paid P1,000 x 0.18 x (365 / 360) = P182.50 in interest, not P1.000 x 0.18 = P180. Your interest rate rises by an additional 1.39 percent per annum.

By the way, if you place P1,000 in the bank to earn 18 percent interest per annum, the interest the bank gives you for January is computed, based this time on a 365-day year, thus: P1,000 x 0.18 x (31 / 365) = P15.29. Notice the difference? The bank gets you coming and going.

What all this boils down to is that the interest rate you actually pay (the bankers call this the effective rate; it should be called the defective rate) on your promissory note is 18 percent plus 1.56 plus 1.39 for a total of 20.95 percent, an excess of 2.95 over the agreed and documented 18 percent. For every P1,000,000 you borrow, the bank overcharges you P29,500 in interest every year. Hey, that excess is nothing to sneeze at.

Ed says, and I agree with him, that with this overcharge, the bank violates the terms of the promissory note and the Truth in Lending Act.

Not content with overcharging borrowers, the banks still have a few tricks up their collective sleeves. If you are really unlucky in choosing the bank to borrow money from, you can get clobbered with any number of the following:  application fee, reservation fee, inspection fee, appraisal fee, notarial fee, legal fee that raises the cost of your loan.

Then, there is the pretermination fee. This fee is a throwback to the good old days when you could take out a long term loan at a preferential rate. The longer the term, the lower the interest rate. Conversely, the shorter the term, the higher the rate. When I borrowed money to build my house fifty years ago, I took out a 20-year at a fixed preferential rate of six percent per annum. If I cancelled the loan anytime within those 20 years and for whatever reason, I would have been charged a pretermination fee. The is to penalize you for being such an ungrateful ass.

The pretermination fee is similar to the so-called short rate penalty that an insurance company charges you for cancelling a fixed-rate fire policy before the annual expiry date.

Today, the banks have turned the world upside down. The longer the term (if you can get it) the higher the rate; the shorter the term the lower the rate. It is really a ploy to nail you down to prevailing market rates. For example, on a yearly renewable note payable on regular monthly installments, the bank charges you what the market rate is on the morning a payment is due. If you cancel the note, you get clobbered with a pretermination fee. This is not right, since you are not getting any preferential treatment anyway on your note. Nowadays, the pretermination fee is really to discourage you from jumping to another bank. In other words, the pretermination fee is a tool for restricting competition.

But the deepest cut a bank inflicts on a borrower is the so-called discounted loan. The full annual interest is discounted, meaning deducted, from the initial disbursement of your loan. For example, if you borrow P100,000 at 18 percent per annum, the bank deducts a full year’s interest of P18,000 and you are handed P82,000. In other words, you paid 18 percent interest of the full P100,000 but you get to use only P82,000. Another way to look at this is that the interest is collected, not at the end of twelve months, but at the beginning. The immediate effect is to raise your interest rate to (P18,000 / P82,000) x 100 percent = 21.95 percent.

Then, when you consider the opportunity loss on the P18,000, the cost to you of your loan rises some more. Assuming you make a modest 20 percent profit on your working capital, the opportunity loss is P18,000 x 0.20 = P3,600. This translates into an additional rate of (P3,600 / P82,000) x 100 percent = 4.39 percent. The whopping cost of the loan is now 21.95 plus 4.39 = 26.24 percent. This is 8.24 percent over and above the agreed 18 percent.

Finally, considering that these loans are backed up by collateral, usually urban real estate appraised by the bank at a minimum of around one and a half times the loan, under a written agreement that binds the borrower in a tight steel grip, the cost of borrowed money becomes truly staggering.

Ed Olaguer raises the issue to the macro level, the big picture. He estimates that the total loans outstanding from commercial banks is P2 trillion. In which case, the total overcharge that banks illegally gouge the borrowing public is between P50 to P156 billion a year. This is added to the selling prices of all goods and services. No wonder consumers are groaning under steep prices. No wonder the Philippines cannot compete globally.

What should be done? I am not about to suggest that the banks return all the money that he have illegally gouged from the public. That would trigger the collapse of the banking system. And nobody, not even the victimized borrowers, wants that. But the banks had better start cleaning their act. There are a number of Opus Dei stalwarts in the banking system. Perhaps, they can spearhead the clean-up.

But, take heart, fellow suffering borrowers. Ed Olaguer sued the banks some years back. He won in the lower Court. He won on appeal.  The case is now in the Supreme Court.  Ed is supremely confident that he has a winning case. When, not if but when, the Supreme Court rules in Ed’s favor, I suggest he should the canonized as the patron saint of bank borrowers.

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WHY BANKS ARE AGAINST THE VALUE ADDED TAX

The continuing media war being waged by the banking industry against the imposition of the value added tax (VAT) is getting to be a bit too irritating to ignore.

The banks were exempted from the tax when President Aquino introduced it in 1987.  They were again exempted when, in 1992, President Ramos expanded the scope of the tax. But, time has finally run out. The exemption has been finally cut and the banks’ income is not subject to VAT just like everybody else, notably the non-life insurance industry.

The banks complain to high heavens. First, they say that the tax is too complex to implement without putting up expensive office systems. If the banks are scared of the intricate procedures involved in the value added tax system, it is because they have been exempted from the tax since 1987. They worked hard to get the exemption, and now, sixteen years later, they want to use their ignorance that stemmed from that exemption to justify the continuation of the exemption. They want their cake and eat it too.

When insurance came under the VAT system in 1992, the companies shifted gears from the old premium tax (similar to the banks’ gross receipts tax) without too much strain. Insurance brokers like me quickly adjusted to the new tax.

Second, the banks claim that VAT will violate the sanctity of long term contracts now in force. My son Louie has a loan with a fixed term of ten years. But the interest rate is not fixed. It fluctuates with market conditions. VAT applies to whatever is the current interest on the loan. Do you see a violation of the sanctity of the contract?

Third, the banks say that VAT should not apply to them because there is no value added to their services. The interest rate, the various fees (notarial, commitment, inspection, appraisal, transfer, whatever) are the values added.

Fourth, the banks say that the VAT will hit the poorest of their borrowers since they cannot pass on the tax to anybody else. The rural banks are pushing this line. They are correct that, if the borrower is an individual, the VAT on the interest is an additional cost of his loan. And he cannot pass this on to anybody. But if this is a valid reason for exempting bank transactions, then the VAT should be scrapped altogether whenever an individual buys anything subject to the tax. He should not pay the tax when he buys fire insurance on his house, checks in at a hotel, eats in a restaurant, buys clothes, and sees a movie. The fact is the hapless individual payer, the low man on the totem pole, always ends up  paying the tax, whatever name it may be called.

The banks – organized here as a cartel – shed crocodile tears over the poor borrowers. When did the cartelized banks ever worry over their poor borrowers’ welfare? Haven’t they been soaking their poor borrowers with high interest rates all these years? I haven’t forgotten that, not too long ago, interest rates were as high as 24 percent, pretty close to usurious.

The banks say nothing about the benefits they will enjoy. From their VAT collections from clients, the banks can now deduct the VAT they paid on all the taxable purchases, such as stationery, office machines, computers — and executive lunches.

The tax does raise the cost of borrowings. As a result, there will be fewer borrowings, and more defaults. Under these conditions, the banking cartel may not survive, as there will be more competition among banks. Interest rates and fees will go down, thereby cutting the banks’ huge profits. This is what really worries the banks.

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