The Barbados National Bank continues to distinguish itself as the leading financial institution in Barbados. The company’s Managing Director Robert Lehunte, is reporting a profit of 25.4 million dollars over the first half of its financial year. The bank’s retail sector led the way with 21.4 million dollars in profits, the Barbados Mortgage Finance Company Limited 2.3 million and BNB Finance and Trust 1.7 million. Mr. LeHunte says shareholders will continue to benefit handsomely from the company’s gains. Mr. Lehunte has described the next year as one for consolidation in which the bank will focus on implementing a new computer system, and on upgrading its branches.

Source: CBC

BU recently received a note from a poster who wanted us to investigate why Barbados National Bank calculates interest on loans using a method called “add-on”. We must confess that it sounded like Greek to us and it explains why the note has been slipping down the list in the BU “inbox” for a few weeks. The piece BU did on the non-performing BNB Mutual Funds back on May 07, 2007 prompted the writer to email us.

First of all let us thank the writer for having the confidence in us to write on what is a quasi-technical matter. With topics such as this one, we have to make several inquiries, so we ask that BU readers to be patient with us given this constraint.

BU wish to congratulate BNB on the achievement of reaching #1 status in Barbados which is due it seems to their Trinidadian aggressive way of doing business in Barbados.

A Google of “add-on” interest calculation tossed-out several definitions, the one we like:

Add-on Method

In this type of calculation, the interest costs are calculated by adding the total interest payable over the life of the loan to the original loan principal, which is the amount you wish to borrow. Therefore, your effective principal includes the interest rate due (hence ‘add-on’). Here’s a simple formula to calculate interest using this method:
Add-On Interest = Principal x Interest Rate x Number of Months in the loan / 12

The principal repayment due is computed by dividing the original principal into a number of months for payback according to the terms of the loan. The total fixed repayment is made up of the interest charges plus the principal repayment.

Here’s a simple example: You borrow $200,000 at 11 percent add-on interest for 2 years. Monthly payments are to be made. Total add-on interest = $200,000 x 11% x 24 / 12 = $44,000. This figure is added to the principal amount of $200,000 to get $244,000.

Your monthly repayments would be $244,000 / 24 = $10,166.67

Wow! That explanation was simple enough to understand.

The next step in our investigation was to determine what made the “add-on” method of calculating interest by BNB so offensive that it would upset our BU poster. Calls were made to the other banks to inquire how interest was calculated on loans. The outcome of the 20 minute exercise showed that BNB is the ONLY bank in Barbados which uses the “add-on” method of calculating interest.

A Google of the “reducing balance” interest methof of calculation tossed-out this definition:

Reducing Balance Method

In this repayment method, interest is calculated for each period by multiplying the agreed interest rate by the principal that’s remaining to be paid at that time. The difference between reducing balance and add-on is that interest is not charged on the principal that has already been repaid.

There are two ways of repaying your reducing balance loan: fixed principal payments and fixed total payments. In the first, the original principal is divided into equal monthly payment amounts according to the term of the loan. The initial interest amount is charged on the original principal and subsequent interest charges are computed on the balance of principal owing.

The total repayment reduces over the life of the loan. If you borrowed $200,000 at 21.5 percent per annum over 24 months, your total repayment amounts would vary from $11,867.58 per month to $8,480.59 by the end of the loan.

In the fixed total payment option, a calculation is used to determine how much the total repayment would be, given the interest rate and the term of the loan. The amount that is paid towards the principal would be computed by subtracting the interest amount due each month from the fixed repayment figure. Given the above example, you would pay about $10,300 every month to pay off the loan.

So far so good!

The two methods using the two examples appear to be easy enough to understand. The question which we had to answer next is why would the other banks in Barbados with the exception of the Barbados National Bank have switched from “add-on” to the “reducing balance” method.

In the USA it is mandatory that all loans advertised must show the Annual Percentage Return-commonly referred to as APR. This ensures that customers can compare the cost of a loan from different lending institutions using a standard approach. A more formal definition of APR:

The annual rate that is charged for borrowing, expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction.

BU was able to determine that there is no law in Barbados which forces a bank to offer one of the interest calculating method above the other. It seems from our investigation that it comes down to business ethics. In the two examples used, in example one if BNB were to advertise a loan at 11% (add-on) instead of 21% (reducing). To unsuspecting Barbadian borrower might view the BNB loan advertised at 11% as being cheaper. It is the method which the marketing people would prefer because most Barbadians do not take the time to calculate what is the “effective interest rate” on the loan or to read the special condition notice which maybe stated. In this example the add-on rate of 11% in comparable terms calculates to an effective rate of approximately 21%.

In the USA it is mandatory that lending agencies quote the “effective rate” when advertising add-on loans. In Barbados it is our understanding that the Fair Trading Commission require lending institutions to do the same but it is not police with any rigour and it is usually listed under the notice “special conditions apply”.

BU wishes to advise our concerned person that as an outcome to our investigation, which was a learning experience, they should calculate what the effective interest rate on the loan from BNB is and compare to what it would cost using the ‘reducing balance” if it was taken from another bank.

At the BU if we had to make the choice we would prefer a loan using the “reducing balance” simply because the customer has control of how much interest is finally paid. If we wanted to pay more than the minimum monthly payment or to repay the loan early to save interest, having an “add-on” loan would not be advantageous.

Related Story:

Barbados National Bank~Tell Us About Your Non-performing Mutual Funds

Website Used To Research Topic:

Jamaican Observer