Compound Interest on Loans Is Still Contentious

EghtesadOnline: New rules governing bank loans passed by the Majlis this week, legally ban lenders from charging compound interest and is designed to help boost the business environment, lawmakers say.

News ID: ۷۸۷۱۸۴

20 October 2021

In line with a broader legislation package, known as “Facilitating Business Permit Issuance Bill”, MPs ratified regulations that oblige banks and credit institutions to “electronically register the lending agreements”.

The order obliges lenders to develop electronic platforms to ease borrowers’ access to data about the provisions of the loan agreement with the bank and changes thereto.

The loan agreement must also be easily accessible to the guarantors and mortgagors, and include all the data about repayment guarantees, evaluation of the mortgage, granted deferrals and the likes.

Lawmakers say the new rules will improve much-needed transparency in loan processing and benefit borrowers.

Mohammad Hossain Hossainzadeh, a member of the Parliament Economic Commission said the rules in effect prohibit banks from demanding compound interest on loans, which is not allowed based on Sharia law.

“This will be mandatory on banks and end compound lending rates,” he was quoted as saying by the parliamentary news website ICANA.

Compound interest (or compounding interest) is interest calculated on the principal amount, which also includes all the accumulated interest of previous periods of a deposit or loan.

While the Money and Credit Council earlier prohibited compound interest on loans, it was never put into effect becsue of the opposition of banks the MP said.

Due to the bulk of bank arrears, many manufacturers over the years were neither able to repay their debts nor could apply for new loans.

Head of the key commission, Mohammad-Reza Pour-Ebrahimi, concurred that the rules will put an end to the controversial policy of compound interest.

He said scrapping compound interest will benefit banks as they would be able to recover a portion of their mounting non-performing loans.

Many debtors to banks are unable to repay because their arrears have snowballed due to compound interest. “This will enable banks to recover their debts,” he was quoted as saying by Securities and Exchange Organization.

High NPL ratios have hurt the balance sheets of banks and forced them to suspend lending, despite the chronic need of businesses to borrow to survive, in particular in the covid era that has battered companies of various sizes and forced many to down shutters and file for bankruptcy.

In the same vein, Mehdi Toghiani, another member of the Majlos commission, said the rules will protect the rights of borrowers.

Earlier he had said borrowers had no access to their loan contracts that often remained incomplete to be later filled in by banks depending on their whims and wishes. In other words, provisions of the deals are rather tentative and open to change(s) by the lender.

“If contracts are registered electronically changes can be monitored,” he said.