• BNM proposed amendments to abolish using Rule of 78 in personal financing under the Hire Purchase Act 1967, scheduled for tabling in Parliament in 1H25

• We believe the reduced front-loaded interest income and higher reinvestment risk from early repayments could be managed by raising effective interest rates

• Reiterate OVERWEIGHT on the banking sector. Sector top picks: liquid large-cap with strong ASEAN footprint (CIMB, TP: RM9.30;), defensive banks with strong asset quality (PBB, TP: RM5.10; HLB, TP: RM24.30), high dividend yielder (RHB, TP: RM7.50; Maybank, TP: RM11.40), and a small-cap exposure (AMMB, TP: RM6.30)

New requirements proposed for Personal Financing

Bank Negara Malaysia (BNM) has introduced a new exposure draft that proposes the abolition of the Rule of 78 method for calculating interest charges on personal financing (PF) products. This change will be implemented through amendments to the Hire Purchase Act 1967, with plans to table the legislation in Parliament in 1H25. BNM is also considering reducing the maximum tenure for PF products from 10 years to 7 years, subject to public feedback.

What is Rule of 78, and what are the implications for the banking sector?

The Rule of 78 is a method commonly used by banks to front-load interest charges payments, where borrowers pay a higher proportion of interest earlier in the loan tenure (refer to Table 2). These structures benefit banks in the short term as they receive more interest upfront but discourage borrowers from making early repayments due to minimal interest savings. Most PF products are structured this way (refer to Table 3). If banks can no longer benefit from front-loaded interest income and early loan repayments become frequent, this would increase reinvestment risk for banks, as they may face higher portfolio turnover and be forced to redeploy funds in potentially lower-yielding assets. However, this may be manageable if banks could raise their effective interest rates to compensate for the reduced interest, hence we think the net effect on interest income could be positive. In addition to that, shifting to a variable-rate PF loan (similar to RHB) would allow the bank to benefit from a rising interest rate environment. Banks with the largest exposure to PF is Alliance (11%), followed by Affin (6%), CIMB (6%) and RHB (6%). Globally, the Rule of 78 has faced criticism for being unfair to borrowers, and its removal is seen as a step forward in consumer protection. This change could also pave the way for similar reforms in other consumer financing products, such as hire purchase loans, which could have a larger impact on the banking sector.

Stay OVERWEIGHT, Pecking order BUYs: CIMB > AMMB > HLB > PBB > RHB > Maybank

We maintain our OVERWEIGHT call on the Malaysian banking sector, with the sector trading at 1.15x, in line with a 10-year average multiple of 1.14x. We like CIMB (BUY; TP: RM9.30) as a liquid large-cap pick with strong ASEAN footprint, PBB (BUY; TP: RM5.10) and HLB (BUY; TP: RM24.30) backed by its defensive nature with strong asset quality, RHB (BUY; TP: RM7.50) and Maybank (BUY; RM11.40) for attractive dividend yield, and AMMB (BUY; TP: RM6.00) as a preferred small-cap bank pick. Key risks to our Overweight stance include contagion risk from geopolitical issues, extended NIM compression, asset quality deterioration, higher inflationary pressures from upcoming removal of subsidies affecting repayment ability, and weak economic growth.

Source: Philip Capital Research - 18 Dec 2024