Bank Interest calculation

rb10

YorkshireBoy wrote: »

Section 8 seems to give them the option of using either 365 or 366 days in a leap year...not always 366 as your quote (which I can't seem to find an exact match for?) seems to state.

They do go on to say "if making an adjustment for AER purposes the divisor should be 365 in all cases".

Oops - you are correct. Not sure how I missed that last night. The full quote is:

interest is calculated by taking the balance multiplied by the annual interest rate divided by 100, multiplied by the number of calendar days that the balance is held, divided by 365 in a normal year or by 365 or 366 days in a leap year

The bank does not have to use 366 days, but have the option to go either way during leap years, at their own discretion.

antrobus

rb10 wrote: »

..."interest is calculated by taking the balance multiplied by the annual interest rate divided by 100, multiplied by the number of calendar days that the balance is held, divided by 365 in a normal year or 366 in a leap year".

That is the Day Count Convention that normally applies for GBP - actual/actual. Other conventions are available; Americans often use 30/360.

See: http://www.deltaquants.com/day-count-conventions.html

Mirno

Not wanting to get into the day count basis, I just wanted to correct the maths of annual interest / days it is in fact:
1 + (interest% / 100) <to the power> (days / 365)

i.e.
1.02 ^ (214 / 365)

It's the reverse compounding of interest - and will explain a small difference compared to the simple interest calculation.

Note that if using windows calculator - it needs to be in scientific mode and that "Y" is the power button (despite ^ being the symbol used on screen).

Mirno

rb10

Mirno wrote: »

Not wanting to get into the day count basis, I just wanted to correct the maths of annual interest / days it is in fact:
1 + (interest% / 100) <to the power> (days / 365)

i.e.
1.02 ^ (214 / 365)

It's the reverse compounding of interest - and will explain a small difference compared to the simple interest calculation.

Note that if using windows calculator - it needs to be in scientific mode and that "Y" is the power button (despite ^ being the symbol used on screen).

Mirno

That calculation assumes that interest is compounded daily - which is incorrect.

The correct calculation - as stated in the BBA link from my earlier post - is

Interest rate / 100 * days / 365 (or 366)

redbuzzard

The bank quotes annual interest, not a daily rate. Ergo, the same number of days could yield different amounts of interest dependent on how many days there are in the relevant year.

I'm surprised they do it that way though. I would have predicted that the way banks calculate interest (at least officially) goes back to the practicalities of pre-computer days. In my youth, just pre-computerising of Nat West's deposit accounts, I used to compute and add interest in a ledger, literally writing in the amounts. Counting the number of days that each balance applied, then looking up the days at the relevant rate in a book of tables. Lord knows how many days/year they assumed for the tables, but it would in effect have given a daily rate of simple interest so more in a leap year than a non-leap one.

It's a "first world problem" though.

[Deleted User]

YorkshireBoy wrote: »

Section 8 seems to give them the option of using either 365 or 366 days in a leap year...not always 366 as your quote (which I can't seem to find an exact match for?) seems to state.

They do go on to say "if making an adjustment for AER purposes the divisor should be 365 in all cases".

Thank you all for taking an interest in my thread. This BBA code of conduct is very interesting, but as usual with these documents, somewhat ambiguous. Should I take this to mean that if an account is showing a rate of interest expressed in AER then the bank must use 365 as a basis for the divisor and not 366.

The way I see it, is that had my account been opened prior to Feb 29, the number of days that the account would have been opened, would be increased by 1 day. ie divisor and dividend ( if my maths terminology is correct) are in par. But, in my case, the account was opened after this date, but the extra day is still added to the divisor thereby giving me a reduction in interest. I can't believe that this is an accceptable practice.

innovate

How many potential pence are we talking about?

ViolaLass

[quote=[Deleted User];61844439]OK Thank you Innovate and Opinions4u for your replies. It sounds that my thinking is not correct, as I'm sure you guys know more than I do on this subject. But the method of interest calculation that the bank uses during a leap year is misleading. To me, annual interest calculation should be calculated over a rolling 365 days. Isn't that what is meant by an AER, otherwise the AER would vary depending on whther the year in question is a leap year or not.[/QUOTE]

The whole point is that the AER does NOT vary. If it is a leap year, the daily amount changes, not the yearly.

SnowMan

ViolaLass wrote: »

The whole point is that the AER does NOT vary. If it is a leap year, the daily amount changes, not the yearly.

You overlook that the leap year is purely an astronomical correction - and irrelevant for accounting purposes :beer:

Sensory

[quote=[Deleted User];61862137]The way I see it, is that had my account been opened prior to Feb 29, the number of days that the account would have been opened, would be increased by 1 day. ie divisor and dividend ( if my maths terminology is correct) are in par. But, in my case, the account was opened after this date, but the extra day is still added to the divisor thereby giving me a reduction in interest.[/QUOTE]

Perhaps try interpreting the scenario from a different perspective: there were 366 days in 2012, and you opened your account on day 153, giving you 214 days of interest; had there only been 365 days in 2012, you would have only received 213 days of interest.

214/366 is greater than 213/365.

[quote=[Deleted User];61862137]I can't believe that this is an accceptable practice.[/QUOTE]

I can think of far worse banking practices than a perceived interest reduction of less than 0.28% of the expected interest, effectively reducing 3% AER to 2.9918%.

I do fully understand your line of thinking though. If your period of 1 year, e.g. 1st June 2012 to 1st June 2013, is not 366 days, then the interest calculations should not divide by 366. Even so, it would average out after a period of four consecutive years regardless.