18.4 Interest computation conventions

Interest math is precise. Ambiguity in conventions causes recurring borrower complaints and audit findings. This page sets the conventions the LMS executes — standard Indian practice.

Day-count convention

Standard

Actual / 365 — interest accrues based on actual calendar days, with 365 as the denominator (even in leap years).

daily_interest = principal_outstanding × annual_rate / 365

Alternative

• Actual / 360 — used by some legacy systems and certain banking products. Yields slightly higher effective interest. Not common for SME WC.
• Actual / actual — uses leap-year denominator (366 in leap years). Cleaner academically but rare in practice.

Recommendation

Use Actual / 365 consistently across all products. Disclose convention in KFS and loan agreement.

Compounding frequency

For most SME WC products:

• No compounding during the loan tenure for bullet products (interest accrues but isn’t capitalised until repayment).
• Monthly accrual for term loans — accrued interest is settled monthly via EMI; not compounded into principal.
• No compounding on penal charges (per RBI Aug 2023 circular).

Cash credit / overdraft variants

• Some legacy CC accounts compound monthly (interest added to outstanding at month-end).
• For NBFC revolving WC lines, simple interest on daily-rest balance is standard; no compounding.

Daily accrual mechanics

Every day at end-of-day batch:

For each loan:
    accrual_date = today
    outstanding_principal = current_outstanding (after any repayments today)
    days_in_year = 365
    daily_interest = (outstanding_principal × annual_rate) / days_in_year

    if loan_classification not in {NPA, SUB, DOUBTFUL, LOSS}:
        accrued_interest += daily_interest
        post event: accrual(amount=daily_interest, date=accrual_date)
    else:
        # NPA — interest accrual frozen
        pass

Worked example

Loan: ₹10 lakh outstanding, 19.5% annual rate, performing.

daily_interest = (1000000 × 0.195) / 365 = ₹534.25 per day

Accrual for 90 days = 90 × ₹534.25 = ₹48,082.19.

Calendar handling

Weekends and holidays

For accrual: weekends and holidays accrue interest normally. Interest doesn’t pause for Sundays.

For due dates: typically pushed to next working day if a due date falls on a Sunday or notified holiday.

• Working day definition: per board policy. Usually Mon–Sat for NBFCs (Saturday banking varies); excluding national / state holidays.
• NACH presentation: NPCI’s processing calendar applies; non-working-day dues presented on the next working day’s batch.

Month-end (EOM) handling

For monthly periodic accrual:

• Period end = calendar month end for accrual purposes.
• EOM differential for short / long months balances over the year.

Leap year

Actual / 365 ignores the extra day in leap years (Feb 29 still accrues but with 365 in denominator). The borrower pays 1/365 extra day of interest in leap years — typically considered a minor effect; disclosed.

Alternative Actual / Actual uses 366 in leap years; the borrower pays the same per-day; but the formula is messier. Most lenders accept the small leap-year asymmetry of Actual / 365.

Interest on overdue (penal charges separate)

Per the RBI Penal Charges in Loan Accounts circular (2.11.1):

• Interest on overdue principal continues to accrue at the contracted rate during the delay.
• Penal charges for the breach (delayed payment) are separate from interest and applied to a separate ledger (not capitalised into principal).
• No additional penal rate is added to interest itself.

Worked example (penal correct)

Loan: ₹50 lakh EMI of ₹2.45 lakh missed; borrower pays 10 days late.

Interest for 10 days delay:
  = (5000000 × 0.195 × 10) / 365
  = ₹2,671.23

Penal charge (per board policy: 2% of overdue EMI, min ₹500, max ₹5,000):
  = min(max(0.02 × 245000, 500), 5000)
  = ₹4,900

Total additional charges to borrower:
  Interest on overdue = ₹2,671.23 (continues at 19.5%; this is regular interest, not penal)
  Penal charge = ₹4,900 (separate ledger)
  Total = ₹7,571.23

The interest of ₹2,671.23 is regular interest on the period of delay — borrower had outstanding for those 10 days. The ₹4,900 is the penal charge for the breach. They are accounted separately.

EMI computation (term loan / amortising)

Standard EMI formula:

EMI = principal × (rate/12) × (1 + rate/12)^n / ((1 + rate/12)^n - 1)

where rate is annual rate as decimal, n is number of months.

Worked example

Loan: ₹10 lakh, 24 months, 21% annual.

monthly_rate = 0.21 / 12 = 0.0175
n = 24

EMI = 1000000 × 0.0175 × (1.0175)^24 / ((1.0175)^24 - 1)
    = 17500 × 1.5180 / 0.5180
    = ₹51,283 (approximately)

Each EMI breaks into interest + principal per amortisation schedule.

Interest-component per EMI

For month k (1-indexed):
    opening_balance = remaining_principal_at_start_of_month
    interest_k = opening_balance × monthly_rate
    principal_k = EMI - interest_k
    closing_balance = opening_balance - principal_k

Pre-EMI interest

For loans disbursed mid-month with EMI starting next month-end:

pre_emi_interest = principal × annual_rate × days_to_first_EMI / 365

Charged separately or added to first EMI per agreement.

Drawdown interest (for revolving lines)

For a revolving line with multiple draws:

• Each draw has its own tenure (e.g., 90-day draw on a 12-month line).
• Interest accrues from draw date to repayment date on that draw.
• Multiple concurrent draws each accrue separately.
• Line-level outstanding = sum of draws’ outstandings.

Worked example

WC line ₹40 lakh. Borrower draws:

• Draw 1: ₹15 lakh on 2026-04-01 for 90 days.
• Draw 2: ₹10 lakh on 2026-04-20 for 90 days.

Daily interest on 2026-04-25:

Draw 1: (1500000 × 0.21 / 365) = ₹862.97
Draw 2: (1000000 × 0.21 / 365) = ₹575.34
Total daily = ₹1,438.31

Each draw’s repayment schedule is independent. Daily accrual posts separately per draw or netted to line total (per ledger preference).

Prepayment / part-payment

When borrower prepays before tenure:

1. Current outstanding computed at the prepayment date (including accrued interest till date).
2. Repayment received.
3. Waterfall allocation per 18.8:
   • Penal charges (if any).
   • Late / bounce fees (if any).
   • Servicing / other fees (if any).
   • Interest accrued till date.
   • Principal (remaining).
4. Foreclosure charge (if applicable; not for floating-rate MSME term loans).
5. Remainder of principal reduced; tenure either shortened or EMI re-computed.

Worked example

Loan: ₹10 lakh outstanding (mid-tenure), 21%. Borrower prepays ₹4 lakh on 2026-04-15. Last EMI paid 2026-04-01.

Accrued interest from 2026-04-01 to 2026-04-15 (14 days):
  = (1000000 × 0.21 × 14) / 365 = ₹8,054.79

Borrower pays ₹4,00,000.
Allocation per waterfall (assuming no penal / fee):
  Interest: ₹8,054.79
  Principal: ₹4,00,000 - ₹8,054.79 = ₹3,91,945.21

New principal outstanding = ₹10,00,000 - ₹3,91,945.21 = ₹6,08,054.79

The next EMI is recomputed (either reduce EMI keeping tenure, or reduce tenure keeping EMI) per borrower’s selection / loan agreement.

Foreclosure

Full prepayment ending the loan.

Computation

foreclosure_outstanding = current_principal + accrued_interest_till_date + applicable_charges

Plus foreclosure charge only if:

• The loan product permits foreclosure charges per RBI rules.
• Per 2.11.1 Penal charges, foreclosure charges on floating-rate MSME term loans are banned.
• For fixed-rate or non-MSME, charges per disclosed policy.

Post-foreclosure

• Outstanding =0.
• Mandate cancelled.
• NOC issued.
• Bureau updated.

Restructuring effect on interest

When a loan is restructured:

• Old schedule and accrued interest are frozen at restructuring date.
• New schedule generated with new terms (extended tenure, possibly reduced rate, possibly moratorium).
• Accrued unpaid interest may be capitalised into principal (with explicit consent + IRACP downgrade), or kept separate per agreement.
• Provisioning stepped up per IRACP.

The decision to capitalise vs keep separate is a structuring choice; both are valid.

NPA — interest accrual freeze

When a loan turns NPA:

• Accrual freezes — no new daily interest posts for the NPA period.
• Accrued-but-uncollected interest from prior period is reversed from income recognition (under IRACP / IndAS rules).
• Any recovery is recognised on cash basis post-NPA.

Worked example

Loan: ₹20 lakh outstanding, 21%. Turns NPA on 2026-05-01.

Accrued interest from last EMI date to 2026-04-30 (say 25 days): ₹287,671
   → this remains as a receivable, but income recognition reverses if not recovered.

From 2026-05-01 onward: no new accrual posted to income.
   Outstanding interest "moratorium" — borrower still owes per agreement but
   lender does not recognise income.

If borrower pays ₹1 lakh on 2026-06-15:
   Cash basis: ₹1 lakh recovered.
   Apply per waterfall.
   Recognised as income.

When loan upgrades (full clearance), accrual resumes.

Statement representation

The borrower’s statement shows:

• Opening principal at start of period.
• Daily / monthly accrual (collapsed for borrower view).
• Repayments + allocations.
• Charges applied.
• Closing balance.

Multiple line items make the math transparent. Borrower can audit any single computation.

Tax (GST) on fees

• Interest is not GST-applicable (financial-service exemption).
• Fees (processing, servicing, foreclosure, late, bounce) are GST-applicable at 18%.
• Per intra-state: 9% CGST + 9% SGST. Per inter-state: 18% IGST.
• GST invoice generated per fee event.

What the LMS must execute

• Daily accrual at exact convention; tested against worked examples.
• EMI math reproducible.
• Allocation per waterfall consistent.
• NPA freeze automatic.
• Restructure handling per IRACP.
• GST computation per intra/inter-state.
• Audit trail of every computation.

Compliance touchpoints

• RBI Aug 2023 penal charges circular — separation enforced.
• RBI Nov 2021 IRACP clarification — upgrade only on full clearance; daily classification.
• RBI Foreclosure 2014 circular — floating-rate MSME foreclosure ban.
• GST law — invoice + filing.

Related

• 18.5 Schedule generation.
• 18.7 Charge ledger.
• 18.8 Waterfall math.
• 2.10 Asset classification.
• 2.11.1 Penal charges examples.