Interest Calculation Methods in Deposit Accounts
• 15 May 2023
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# Interest Calculation Methods in Deposit Accounts

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Article Summary

In this article we discuss how we calculate the deposit interest, overdraft interest, and how we manage days in a year.

## Deposit interest calculation

In deposit products, interest is accrued daily on the account and applied at a later time. Both the balance used for accruing the interest and the date to apply it are defined by the settings explained in this article.

### What account balance is used for calculations?

• Average Daily Balance: Mambu will calculate the average balance that the client had in their account during the day, and base the interest calculation on that amount.
• Minimum Daily Balance: Mambu will base the interest calculation on the minimum balance the client had in their account during the day.
• End of Day Balance: Mambu will base the interest calculation on the balance the client had in their account at the end of the day. For this method, you can also choose a Maximum Balance to be used for interest calculation and if the end of day balance is greater than the maximum balance, then Mambu will base the interest calculation on the maximum balance value instead and will only use the end of day balance when it falls below the maximum balance.

The first transaction dictates the account's opening balance.

### Example

Day 1

• No transactions. The account is not activated yet.
• The average daily balance for interest calculation is 0.
• The minimum daily balance for interest calculation is 0.
• The end of day balance for interest calculation is 0.

Day 2 (starting account balance = 40)

• A deposit of 40 is made, the account is activated and the balance is 40.
• A withdrawal of 5 is made, the balance is 35.
• A deposit of 25 is made, the balance is 60.
• The average daily balance for interest calculation (40+35+60)/3 = 45
• The minimum daily balance for interest calculation is 35.
• The end of day balance for interest calculation is 60.

Day 3 (starting account balance = 60)

• No transactions.
• The average daily balance for interest calculation is 60.
• The minimum daily balance for interest calculation is 60.
• The end of day balance for interest calculation is 60. ### When is the interest paid into the account?

For more information about all the available options for when interest can be paid into the account, see Setting up new deposit products.

## Overdraft interest calculation

In deposit products with overdraft, interest is also accrued daily on the account and applied at a later time. Both the balance used for accruing the interest and the date to apply it are defined by the settings explained in this article.

### What account balance is used for calculations?

When using the Minimum daily balance option, Mambu will calculate interest based on the maximum amount the client has overdrawn for a given day. This means that if an account was overdrawn by 100 EUR in the morning and the account holder makes a payment of 50 EUR in the afternoon, interest will still be charged on a value of 100 EUR.

### When is the interest paid into the account?

Interest will be accrued daily when an account has gone overdraft and will be paid into the account at the same frequency as any interest from positive balance would be. This is configurable in the product settings in the Interest rate section. For more information on how to configure this option, see Overdraft products .

Just like for positive balance interest, interest accrued from overdrafts can also be applied manually. From the account detail page for an account with Overdraft Accrued Interest greater than 0, select More > Apply Accrued Interest. Both manually and automatically applied interest transactions can be adjusted by following the steps in Interest application.

### Interest rate terms

Two interest rate terms are available for Overdraft interest: Fixed & Tiered per Balance.

### Tiered interest rate terms

When selecting a Tiered interest rate, you can select a starting and ending balance for each tier and an associated interest rate. When interest is accrued on the account, Mambu determines the Overdraft interest rate from the tier corresponding to the account's Minimum Balance at accrual moment (mathematical minimum; which, if the balance is negative, is the equivalent of the maximum overdrawn amount).

The Overdraft interest rate displayed on the account is updated based on the current account balance and is changed every time the account balance matches another tier.

When selecting the Current Interest Tier in the Account Details tab, a dialog is displayed showing all the tiers that are available for that account. When changing the positive interest rate tiers on the product, you can choose to update existing accounts with the current changes performed on the tiers.

The tiers can be printed in contracts and any other product documents using available placeholders. These placeholders can be indexed with the tier number, so all the tiers defined in the product can be printed in the document. For example:
• Tier 1 Interest Rate: {INTEREST_TIER_RATE:1,numericPattern=#,###.##}
• Tier 2 Interest Rate: {INTEREST_TIER_RATE:2,numericPattern=#,###.##}

### Fixed interest rate terms

When selecting Fixed Interest terms for a deposit product, it implies a set overdraft interest rate that is constant. At product level, you can set the minimum and maximum constraints for interest rates available for accounts under that product. These overdraft interest rate constraints can be changed in retrospect and applied to either all existing and new accounts or only new accounts.

At account level, any overdraft interest rate rounded to two decimal places can be set within the product constraints. Deposit accounts under the same product can have different overdraft interest rates, as long as they remain within the set contstraints.

## Interest rate source

Two sources of interest rates are supported for overdraft interest: fixed and indexed interest. This section is not available if there isn't any index rate defined in the Administration module. For more information, see Customizing Index Interest Rates and Tax Rates.

Interest source can be defined at the moment only for the overdraft interest.

### Fixed Interest Rate

A fixed interest rate is agreed upon at account opening and remains fixed until renegotiated.

#### Example

Let's assume an Overdraft account with a 10% overdraft interest rate and interest calcuated based on the Minimum daily balance.

Day 1:

• Starting account balance: USD0
• At 10:00:00 a withdrawal of USD100 is made, account balance is -USD100
• At 20:00:00 a second withdrawal of USD200 was made, account balance is -USD300
• End of day balance: -USD300 = Minimum daily balance
• Overdraft interest for Day 1: -USD300 (Minimum balance from Day 1) * 10% (Overdraft daily interest rate) = -USD30
• Total accrued interest on account: -USD30

Day 2

• Starting account balance: -USD300
• No transactions are posted that day
• End of day balance -USD300 = Minimum daily balance
• End of day accrued interest on account: -USD30 (from Day 1)
• Overdraft interest for Day 2: - 300 (Minimum balance from Day 2) * 10% (Overdraft Interest rate) = -USD30
• Total accrued interest on account: -USD60

### Index Interest Rate

A floating interest rate is also known as a variable or adjustable rate. It is calculated as the sum of a reference (benchmark) index interest rate and a specified spread (margin). As a result, index interest rates will change as the reference (benchmark) index interest rate changes.

By selecting the Index Interest Rate option, you can define:

• Interest Spread constraints: The constraints of spread that will be added to the reference index rate.
• Interest Rate Review Frequency: How often the overdraft interest rate should be updated or reviewed.

Index Rates are managed under Administration > Financial Setup > Rates, where you can create and manage index rate sources as well as update the rates.

Additionally, the frequency for which the interest is reviewed is determined when creating a product.
If there is a new index rate at the end of the indicated frequency period, the index interest rate will be updated and Mambu will log an overdraft interest rate changed transaction on the account to mark that the rate was changed at that time.

Mambu does not support negative interest rate from overdrafts. If index interest rate source has a negative sign, please make sure that:
Index rate + Interest spread > 0

#### Example

One of the most common reference rates to use as the basis for applying floating interest rates is the London Inter-bank Offered Rate (LIBOR) - the rates at which large banks lend to each other.

We have based our example on the LIBOR index (reference) rate, reviewed daily and spread of 1% and interest calculated based on the Minumum daily balance.

Day 1

• LIBOR Overnight on Day 1 = 0.2%
• Overdraft daily Interest rate = 0.2% LIBOR Overnight on Day1 + 1% Spread = 1.2%
• Starting account balance: \$0
• At 10:00:00 a withdrawal of USD100 is made, account balance is -USD100
• At 20:00:00 a second withdrawal of USD200 was made, account balance is -USD300
• End of day balance -USD300 = Minimum daily balance.
• Overdraft interest for Day 1: -USD300 (Minimum balance from Day 1) * 1.2% (Overdraft daily Interest rate) = -USD3.6
• Total accrued interest on account: -USD3.6

Day 2

• LIBOR Overnight on Day 1 = 0.5%
• Overdraft daily Interest rate = 0.5% LIBOR Overnight on Day 2 + 1% Spread = 1.5%
• Starting account balance: -USD300
• Accrued interest on account: -USD3.6
• No transactions are posted that day
• End of day balance -USD300 = Minimum daily balance
• Overdraft interest for Day 2: -USD300 (Minimum balance from Day 2) * 1.5% (Overdraft daily Interest rate) = -USD4.5 (Day 2 interest accrued)
• Total accrued interest on account: -USD8.1 (the sum of accrued interest on Day 1 and Day 2)

## Days in Year

The day count convention, also referred to as day count fraction or day count, determines how interest accrues over time.

Because months and years have different numbers of days, calculating interest for different periods can be complicated and susceptible to error. To address this, day count conventions were developed to standardise this methodology, to avoid disputes and provide uniformity and transparency.

Based on the market and financial product, you can choose from the following day count conventions that Mambu has to offer.

### Actual/365 Fixed (365 Days)

The Actual/365 Fixed is a day count convention that counts the actual number of days in each month, but deems each year to be 365 days. It applies in leap years as well as in normal years.

#### Example

Let’s consider a loan with the following terms.
Loan amount : USD 1000
Interest rate: 10% per year
Number of installments: 5

Formula:

Interest expected for one month with 30 days: 10%* 1000/365 * 30 = USD 8.22
Interest expected for one month with 31 days: 10%* 1000/365 * 31 = USD 8.49

### Actual/360 (360 Days)

Actual/360 is a day count convention that counts the actual number of days in each month, but deems each year to be 360 days.

#### Example

For the same loan terms as in the example above, the interest expected is calculated as follows.

Formula:

Interest expected for one month with 28 days: 10%* 1000/360 * 28 = USD 7.78
Interest expected for one month with 31 days: 10%* 1000/360 * 31 = USD 8.61

### 30E/360 ISDA (30/360 German)

The 30E/360 ISDA day count convention deems all months to be 30 days in length and each year to be 360 days. With this method, the interest accrues at a daily interest rate equal to 1/360th of the interest rate, but for each full month is deemed to accrue for 30 days, regardless whether the month has 28, 29, 30, or 31 days. Therefore, for a month with 31 days, the number of accrued interest days will be the same on the 31st of that month as on the 30th while the last day of February is considered to be the 30th day of the month. In all cases, with this day count convention, the total number of days in a year will always be 360.

#### Example

For the same loan terms as in the examples above, the interest expected is calculated as follows:

Formula:

Interest expected for one month with 28 days: 10%* 1000/360 * 30 = USD 8.33
Interest expected for one month with 31 days: 10%* 1000/360 * 30 = USD 8.33

### Actual/Actual ISDA

Calculates the interest daily by counting the number of days in the calendar and also considers leap years.