According to banking sector data, KTA lending currently accounts for some Rp 142 trillion (US$9.8 billion) of the Rp 1 quadrillion of outstanding loans in the SME sector, or a total of 14.2 percent. On average, the loans vary between Rp 10 million and Rp 15 million. However, if we assume that the average KTA loan is Rp 15 million, there are some 10 million KTA borrowers in Indonesia today.

KTA lending is a mainstay banking product that is very popular among lower-income people.

One of the characteristics of the KTA business is that borrowers are charged high interest rates. Some big banks (both foreign and domestic private) charge interest rates of a flat 1.6-1.9 percent per month. The setting of such high interest rates is predicated on the "high risk, high yield" paradigm. For the banks, charging high KTA interest rates forms part of their credit risk management policies.

The problem is that the banks often fail to properly communicate the reality of high KTA interest rates to their customers. Indeed, the situation is often deliberately obfuscated so that KTA borrowers can end up being misled.

When a bank provides a flat-rate KTA loan, the reality is that the interest rate may turn out to be much higher than anticipated by the customer. This is because KTA installments consist of two components: principal repayments and interest payments. Indeed, an installment could be made up of as much as 75 percent interest and 25 percent principal repayment.

That is what happened to Tikno (not his real name), my favorite fried-rice hawker. He is a KTA customer of a private bank whose story is instructive as to what is really happening on the ground amid the C0VID-19 pandemic.

Initially, he applied for KTA and was offered a loan of Rp 17 million, repayable over 3 years (36 months) from November 2019 to October 2022. He was interested and agreed as he believed he would be able to pay a flat interest rate of 1.9 percent per month, meaning that he would have to pay interest of Rp 3,876,000 (or Rp 323,000 per month) over the course of 1 year.

However, based on the table given by the bank to Tikno, he actually has to pay interest of Rp 6,393,939 in the first 12 months, far above the flat interest he had imagined. That is what is known as the “effective interest". In fact, the real interest rate on his loan in the first year amounts to 38 percent, or an average of 3.2 percent per month (not 1.9 percent as promised by the bank).

The COVID-19 pandemic has had devastating consequences for Tikno's business. The partial lockdown introduced in Jakarta in March deprived him of his livelihood, causing him to be late with his installments for March, April and May. He has not yet paid June’s installment and the bank is now continually chasing him.

The main problem Tikno faces now is that the loan agreement establishes a late payment penalty of 6 percent of monthly installments, or Rp 250,000 (whichever is higher). As he has been late in making his payments on four occasions, the total penalties to date amount to Rp 1 million, which is added to the loan principal, meaning that this has increased from Rp 17 million to Rp 18 million.

The banks need to be sensitive in a crisis like this. Especially in the case of customers who are acting in good faith. The middle way is to ease the terms and conditions and to restructure the KTA. So, for example, if a customer is able to pay Rp 400,000 per month and the loan principal is only Rp 16 million, the bank should agree to provide a six to nine months’ freeze on interest payments.

Another way might be for the bank to recalculate the KTA interest based on the bank’s cost of funds. If the cost of funds is, for example, 4 percent and operational costs 3 percent, then the total cost amounts to 7 percent. Thus, an interest rate of 14 percent would be pro-customer given the current crisis.

The above discussion highlights a number of important points that need to be considered by the banks.

First, greater transparency is needed in calculating KTA interest. The term "flat interest rate" is misleading as the interest payable by a customer in the first year is actually much higher than the flat rate would suggest. Thus, the banks need to provide more information to customers on the effective interest rate they will have to pay. The provision of incomplete and asymmetrical information is arguably in breach of Financial Services Authority (OJK) Regulation No. 1/POJK.07/2013 on the protection of consumers in the financial services sector, in particular Article 4(1), which requires financial services providers to provide and/or convey information on products and/or services that is accurate, honest, clear and not misleading.

Second, the banks should be willing to recalculate the late payment penalties they impose on KTA borrowers. By comparison, the late payment penalties imposed on small, medium and large businesses generally only amount to 1-2 percent of monthly installments, while KTA penalties can reach up to 25 percent.

Third, the banks should eliminate the requirement that the first installment be deducted from the KTA loan principal, which means that the loan amount received by the customer is not the same as the amount that was agreed upon at the outset.

Fourth, the banks should also remove the requirements to pay cancellation fees and fees for early repayment, which can be up to 8 percent of the outstanding loan balance, plus other costs.

This KTA business model serves as a strong disincentive to accelerated loan repayment. Why would a customer want to accelerate repayment if the total amount that must be paid actually increases?

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The writer is founder and chairman of TEZ Capital Group and a former banker.