How OPR hike will affect borrowers

PETALING JAYA: Bank Negara Malaysia (BNM) may have maintained the overnight policy rate (OPR) at 3% in the last Monetary Policy Committee (MPC) meeting on March 6, 2014 but a potential hike is estimated to happen late this year or early next year, which may translate to an increase in the pricing of loans for consumers.
Most analysts are expecting a high probability of a rate hike of 25 basis points (bps) in 2014, while less than a handful opined that it could go up to 50bps by the end of 2014. These views are flanked by a contrarian view that the OPR will not be increased at all and remain at 3% this year.
The OPR is an overnight interest rate set by BNM. It is the interest rate at which a bank lends to another bank.
The OPR, in turn, has an effect on employment, economic growth and inflation. It is an indicator of the health of a country's overall economy and banking system.
An analyst with a stock broking house told SunBiz that generally, if the OPR is increased, banks will pass on the cost in the form of a higher base lending rate (BLR) to consumers.
"In the past, banks have also passed on the basis points (increase) or in a similar quantum. If it's a hike of 25bps, banks will raise about 20bps to 30bps," said the analyst.
For example, if there is a 25bps increase in OPR, and assuming that banks follow suit and change their BLR by a similar quantum, consumers will see the BLR increase by 25bps (0.25%) from 6.6% to 6.85%. If there is a 50bps hike, one can generally expect that BLR will increase from 6.6% to 7.1%.
According to financial comparison portal iMoney.my, a mere 0.5% increase in BLR will result in a 14% increase in total interest paid over the loan tenure if one currently has a floating rate home loan. This is based on the example of a RM500,000 home loan of 30 years. (see table)
The BLR is at 6.6% currently but the prevailing interest rate charged by most banks is 4.2% to 4.9%. In view of this, BNM is proposing a new reference rate framework, which will be determined by the respective bank's funding costs that reflect its specific funding structure and strategy and the statutory reserve requirement.
Ultimately, consumers benefit from knowing the OPR, irrespective of whether they are a borrower or depositor. "If you're a borrower, when the interest rate goes up, you need to pay more in terms of installment. Alternatively, your term of loan (loan tenure) increases if you don't want to change your installment payment. But if you're a depositor, you will get better interest rates," said the analyst.
Another analyst told SunBiz the estimated 25bps hike is considered mild and will just be an upward normalisation.
"When there is a mild increase in OPR and if competition in the market is still intense, loans will still be priced below what it is supposed to be priced. It may not necessarily increase the (finance) cost although there'll be some temporary (adjustment)," said the analyst, adding that this depends on the market dynamics and competition in the market.
"If OPR is increased by 25bps due to stiff competition, banks may only be able to raise interest cost by 10bps, which is mild. You need to increase interest rates much more than 25bps to see an impact on banks. However, if you increase it too much, it's counter-productive because then the banks will see more non-performing loans (NPLs) and hence provisions will increase," he said.
The analyst said a hike in OPR will increase finance costs generally hence BNM needs to be mindful of not increasing interest rate too much due to the weak domestic consumption. If there is a sharp increase in OPR, growth will slow down more, causing NPL issues to creep up.
He said central banks increase interest rates to tackle inflation based on the scenario that growth is too strong and on fears that there could be asset imbalances in the system.
"When the interest rate is too low for too long, there's cheap cost of funding and people tend to over borrow or over-gear and there's a systemic slowdown and it puts the economy in a bad shape."
The last hike in the OPR was in May 2011, which saw an increase of 25bps to 3%, and remains unchanged until today. The next MPC meeting is on May 8, 2014.
"If the economy is relatively weak and there is an increase in interest rates, it will cause the economy to decline even more, and this was what happened to Japan."
He said one cannot compare Malaysia's OPR with other markets, because different markets have different stages of growth and different inflationary pressure, hence there is a need to look at it from a country's perspective.
"Neither is Malaysia's current OPR of 3% historically low nor historically high, and there could be some room for the interest rate to go up, possibly in the second half of the year or in the next six to nine months."