Borrowers who like to make early repayments on their loans (prepayments) will soon be literally laughing all the way to the bank. This is thanks to the newly passed Financial Service Consumer Protection law which prohibits banks from charging penalties on prepayments. The law championed by the National Bank of Rwanda (BNR) is mainly aimed at protecting clients of financial services providers. These clients include depositors and borrowers of banks, insurance policyholders, and other clients of entities regulated by BNR. This is the first time that a comprehensive financial service consumer protection law has been enacted in Rwanda. Previously, financial services consumer protection provisions were set out in several different laws. The new law seeks to create a more level playing field between financial service providers and their clients. Retail customers have less information about their financial transactions than do the financial institutions providing the services, which can result in hidden charges, excessively high-interest rates, clients making wrong financial decisions and insufficient avenues for redress. The new law intends to address these issues by requiring financial service providers to be more transparent and fair in their dealings with clients. It is a timely and welcome development as Rwanda positions itself to become a financial hub. Perhaps one of the biggest changes in the new law that will affect lenders and borrowers is the ban on prepayment penalties on loans. The ban is the first of its kind in the region. Kenya is the only other East African country with a ban on prepayment penalties, however, its ban does not apply to prepayments on mortgage loans. What is a prepayment? A prepayment means the settlement of a loan by a borrower in advance of its official due date. Prepayments mostly apply to loans that are repaid with regularly scheduled monthly payments. Each monthly payment on such a loan includes repayment of a portion of the amount borrowed (principal) and also the payment of interest on the debt. Most personal loans, vehicle loans, mortgage loans and commercial loans require monthly repayments. For instance, you may take a personal loan of Rwf 15 million payable in 4 years which requires you to pay Rwf 500,000 each month for 48 months. Each payment of Rwf 500,000 includes repayment of part of the principal and payment of interest on the debt. Any payment that is made outside of this scheduled monthly repayment of Rwf 500,000 is considered a prepayment. A prepayment might be made for the entire balance of the Rwf 15 million loan or it could be for a smaller portion of say Rwf 2 million. Prepayments enable borrowers to reduce the interest payments they will have to make on the principal borrowed. A typical 10 or 20 year mortgage loan from a commercial bank in Rwanda will have an interest of between 15- 18 per cent per year which will result in the borrower paying roughly 2 or 3 times the borrowed amount by the end of the 10 or 20 years respectively. The amount is high because of the interest payments made on the principal. Interest rates are high partly due the fact that most commercial banks borrow money from depositors and other lenders at high interest rates and can only be able to pay back this money and make a profit by charging the banks’ borrowers higher interest rates than the bank paid to its depositors and lenders. The interest charged by commercial banks also factors the risk they are taking by lending to borrowers who might default and result in the bank making a loss. One of the ways in which the borrower can drastically reduce these interest payments on loans is by making prepayments. A borrower could rely or savings or other sources of income to make these prepayments. Any prepayment made will reduce the principal and this will consequently reduce the interest payments. What is a prepayment penalty? A prepayment penalty is a penalty charged by a bank on any prepayments made by the borrower. In Rwanda most commercial banks charge between 5-8 per cent as a penalty on any prepayment made (though this penalty rate can be negotiated down by borrowers). An illustration of how the penalty is applied is: if a borrower makes a prepayment of 5 million and is charged an 8 per cent prepayment penalty, this would result in the borrower paying Rwf 400,000 as a penalty. Banks deploy their capital by lending and they expect a return for the risk they have taken. The penalty allows a bank to earn some fees to slightly offset the cost of having to redeploy capital allocated towards a loan that has now been repaid. A prepayment penalty also enables the bank to make some of the money they would earn in interest charges if the borrower had not made any prepayments. What does the new law say about prepayments? Article 25 of the new law states in part: “…A financial service consumer who pays off early a credit he or she has borrowed from a financial service provider without transferring it to another financial service provider, is not liable to sanction of early repayment…” The above provision prohibits any penalties on prepayments as long as the borrower does not transfer the loan to another financial institution. If a borrower is offered lower interest rates by another bank and chooses to transfer the loan to that other bank, the borrower will still have to pay the prepayment penalty to the borrower’s current bank. The above ban on prepayment penalties is great news for borrowers. Borrowers will be incentivized to make prepayments as this will save them a lot of money—money they normally would spend on interest payments. However, before making prepayments borrowers may wish to consider whether after making them, they will have enough surplus funds left for their other cash flow needs and emergencies. Banks on the other hand will lose some of the income they used to make from prepayment penalties and will need to find other innovative ways to make income. The new law states that financial service providers have 18 months within which to comply with its provisions. However, BNR should provide clearer guidance on how soon the ban on prepayment penalties will take effect and how it will affect pre-existing loans and new loans. The new law on Finance Services Consumer Protection is a welcome development that will further boost Rwanda’s quest to become a financial hub. It will also have borrowers literally laughing all the way to the bank. The views expressed in this article are of the author and do not constitute legal advice. Please seek professional advice in relation to any particular matter you may have. The writer is a Partner at Trust Law Chambers where he heads the Banking and Finance and Capital Markets practice.
