Introduction to Interest and Charges

Traditionally, interest and charges are the main sources of income and expense for a retail bank. Interest includes the cost of borrowing funds and the income that accrues to those who deposit funds in a savings account. Interest is calculated as a percentage of the loan or deposit balance, which is paid to the lender by the borrower in the case of a loan and from the financial institution to the depositor in the case of a savings account.

Charge levied is another source of income. A charge is a fee charged for a service provided. For example, arrangement fee for arranging a loan.

Temenos Transact Transact enables locally developed charges and commission to be set-up. It is a collection of a host of individual facilities that a user can use to collect various types of charges.

• It allows different capitalisation frequency to be configured. Frequency for each charge can be set to monthly, quarterly, half yearly or yearly.
• Taxes can be applied on these charges.
• Charges created through generic charge functionality can be set at a group and currency level, or at an account level.
• Interim capitalisation can also be specified for these charges.

Interest and charges are accrued or amortised and capitalised at regular intervals and charged to the bank’s customer account in case of income and paid to bank’s customer account in case of expense.

Accrual – Accrual is the amount of interest earned on a lending, but not yet received. This is also known as interest receivable. Conversely, for deposits, it is an amount of interest that needs to be paid but not yet paid. Also known as interest payable.

Amortisation – Interest can be collected up-front (for example, on a discounted debt instrument where the amount given to customer is less than the face value of the instrument, the difference between accrual and amortization is, with amortisation, interest income is collected upfront) and recognised to P&L over the life of the debt instrument. Charges can be accrued or amortised.

Capitalisation – Capitalisation is when the receivable interest/charge is actually received and the payable interest/charge is actually paid.

The Account module is controlled by high-level grouping conditions. These grouping conditions are used for calculating Interest and Charges.

The system has the flexibility to allow users to apply interest and charges at group level using the grouping conditions or apply interest and charges rules at individual account level.

Components Used in the Calculation of Interest

This section describes the types of calculations and components used in the calculation of interest.

Calculation Type – There are two basic kinds of interest calculation:

• Simple Interest (or flat-rate interest) is calculated as a percentage of a deposit or loan’s principal balance. Interest will be calculated on the original amount, irrespective of how long a depositor keeps money in the bank or a borrower does not repay a debt.
• Compound interest is calculated when interest is added to the principal, thus increasing the principal balance on which interest rate applied. Consider compounding as interest on interest.

Day Basis – Interest is calculated on a day-count convention. The day count convention determines how interest accrues over time. It is often due and payable at shorter intervals, usually a number of months (the interest period). The day count (or 'daycount') convention regulates how the parties calculate the amount of interest payable at the end of each interest or other specific period.

It is commonly expressed as a fraction, for example, 30/365. The numerator will be the convention for the number of days in the period - usually actual or a notional 30. The denominator is the convention for the number of days in the reference period, often annual expressed as 360 or 365 days.

Conventions vary depending on the market type, location and the currency in question. For example, euro-denominated bonds are usually calculated on an actual/actual basis, while fixed rate non-euro denominated bonds are often calculated on a 30/360 basis. The London interbank market, on the other hand, operates on the basis of actual/360, except where the currency is sterling, for which the London interbank convention is actual/365 fixed.

Interest Rate – The interest rate is the rate a bank or other lender charges to borrow its money, or the rate a bank pays its savers for keeping money in an account. The interest rate is typically noted on an annual basis known as the annual percentage rate (APR).

Interest can be fixed or variable and may depend upon a base rate on which an interest spread is added.

Types of Interest Rates – Interest rates can be fixed or variable. Variable is also called floating and is based on a base rate of the jurisdiction the bank is based in. Base rates are normally set by the central bank of each country.

Additionally, a periodic interest rate can be charged on a loan or investment over a specific period of time. Lenders typically quote interest rates on an annual basis but the interest compounds more frequently than annually in most cases. The periodic interest rate is the annual interest rate divided by the number of compounding periods.

Product Configuration

This section covers the product configuration of Interest and Charges.

Illustrating Model Parameters

The high-level configurations available in the Model Bank are given below:

Illustrating Model Products

Model Products are not applicable for this module.