### Pemulih loan moratorium - is there really no interest on interest?

Case Notes 11. This article looks at the interest element in the loan moratorium under the Pemulih plans. It disputes the message that there is no interest on interest

Under the Pemulih scheme, banks will waive the compounded interest and penalty charges incurred during the 6 months loan moratorium period.

According to Investopedia

"...compounding is the process whereby interest is credited to an existing principal amount as well as to interest already paid. Compounding can thus be construed as interest on interest."

What exactly is interest on interest?  My layman's understanding seemed to be different from the examples provided by the banks.

To illustrate what I meant I simulated the repayment based on the examples provided by 2 banks.
• One bank extended the loan tenure with the loan moratorium scheme.
• The other bank did not extend the loan tenure with the loan moratorium. Instead, it increased the final month's payment amount.

Chart 1 illustrates the difference in the simulated payment scheme for one of the banks.
• The box on the left shows the schedule based on the current loan term.
• The box on the right shows the schedule assuming the 6-months loan moratorium. You can see that there is no payment for the first 6 months.

For each box, the chart shows the amount due at the start of the month (Opening Bal). This is equal to the amount at the end of the previous month (Closing Bal) plus the interest charged for the month. For details refer to the Methodology section. Chart 1: Comparative payment schedule

What does the chart illustrate?  If you look at the Closing Bal for the case with 6 months moratorium you will find the following:
• At the start of month 1, the borrower owned the bank RM 137,871. This was because there was one month interest of RM 372 based on the starting loan balance of RM 137,499.
• Then at the start of month 2, the monthly interest was computed to be RM 373 based on the month 1 Closing balance of RM 137,871.
• At the start of month 3, the monthly interest was computed to be RM 374 based on the month 2 Closing balance of RM 138,245.

As you can see, for the subsequent months the monthly interest was computed based on the previous month's Closing balance.

But the previous month's Closing balance included the accumulated interest.

This meant that the current month's interest is based not only on the outstanding balance at the start of the moratorium. It also included the accumulated interest.

If this is not interest on interest, I am not sure what is interest on interest.

My layman's understanding was that if there was no interest on interest, the bank would have used the same interest for month 1 for the 6 for the loan moratorium period.

The simulated result for the other bank showed the same interest computation.

Doesn’t this show that the banks are charging interest on interest?

I am of course not disputing the banks' right to compute the interest as they see fit.

But I would like to think that the description should suit the layman's understanding.  As it is there is interest on interest in a disguised form.

## Banks’ examples

In my analyses, I looked at the financing schemes by two banks - Maybank and CIMB.

Maybank had the following loan profile.

The bank illustrated the differences between the existing repayment schedule and one with a 6 months moratorium as follows. This assumed that there is no change to the interest rate during the loan tenure.

As you can see there is about RM 6,004 additional interest under the moratorium. This is equal to an additional RM 1,000 per month interest during the 6-months period.

Shouldn’t the interest be RM 137,499 X 3.5 % X ½ year = RM 2,406 for the 6 months period if there was no interest on interest?  This would be equal to just an additional RM 401 per month.

CIMB had the following loan profile.

The bank illustrated the differences between the current and moratorium schemes as shown below. Note that in this case, the loan tenure remained the same. The difference was in the amount payable in the final month.  The example assumed that the interest rate during the loan tenure remained the same.

In this case, there was an additional RM 8,993 interest payable under the loan moratorium plan. This is equal to RM 1,499 per month.

I would argue that if there was no interest on interest, the interest would be RM 300,000 X 3.5 % X 1/2 year = RM 5,250. This is equal to RM 875 per month.

## Methodology

To ensure that I understood the bank computation, I created an Excel spreadsheet model as shown in Chart 2. This is a simple payment model with the following formulae.
• Opening Bal for month = Closing Bal of previous month plus monthly interest.
• Closing Bal for month = Opening Bal - Payment.
• The monthly interest is based on the Closing Bal of the previous month.  The monthly interest = 3.25 % divided by 12

To get exactly the figures as those for the Maybank example for the current payment schedule, the actual monthly repayment sum had to be RM 598.405.  The results are close enough to validate the model. Chart 2: Extract of financial model based on the current payment plan

I next used the same model to compute the case where there is 6 months moratorium on the loan as illustrated in Chart 3.

Basically, I just assumed that there was no repayment for 6 months. The rest of the formulae remained the same.

Not surprisingly, if the monthly repayment was RM 598.461, I could match the bank Total payment of RM 241,431, Total Interest of RM 83,931, and the extended tenure of 31.3 months.

I would conclude that the model explained how the computation for the loan moratorium was done. Chart 3: Extract of financial model based on the 6-months moratorium

## Conclusion

I carried out the simulation for both banks. Even though they have different payment schemes for the loan moratorium, the way the interest was computed for each month was the same.

How was the monthly interest for the moratorium period computed?

If you look at the Closing Bal in Chart 3 you will find the following:
• At the start of month 1, the borrower owned the bank RM 137,871. This was because there was one month interest of RM 372 based on the starting loan balance of RM 137,499.
• Then at the start of month 2, the monthly interest was computed to be RM 373 based on the month 1 Closing balance of RM 137,871.
• At the start of month 3, the monthly interest was computed to be RM 374 based on the month 2 Closing balance of RM 138,245.

As you can see, for the subsequent months the monthly interest was computed based on the previous month's Closing balance.

You should not be surprised by this as I did not change the interest formula when I moved from Chart 2 repayment scenario to Chart 3 repayment scenario. I merely deleted the payments for the first 6 months.

This meant that the interest formula for the loan moratorium case was based on the same formula without the loan moratorium. In other words, it was based on compounded interest.

If this is not interest on interest, I am not sure what is interest on interest.

My layman's understanding was that if there was no interest on interest, the bank would have used the same interest for month 1 for the 6 months period.

So are the banks charging interest on interest?

I am of course not disputing the banks' right to compute the interest as they see fit. Nor am I suggesting that this is the actual formulae used by the banks to work out the payment plan.

But I think the analysis shows that there is some debate on what is actually meant when the government said that there no compounding of interest.

As I said, this is my layman's understanding of compounding of interest. If you have other views, please feel free to email me at i4value@gmail.com.

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