Floor and Cap Reference Rates
Overview
With the Summer'22 release, the system allows you to define a Floor Reference Rate and a Cap Reference Rate for both the loan product as well as the loan contract so that the system can automatically apply these rates on the loan if the floating index rates fall below or go above the threshold as agreed with the borrower.
Thus,
| If... | Final Index Rate considered by the system | Final Interest Rate |
|---|---|---|
| Floating Index Rate < Floor Reference Rate | Floor Reference Rate | Floor Reference Rate + Margin Rate |
Floating Index Rate > Floor Reference Rate and Floating Index Rate < Cap Reference Rate | Floating Index Rate | Floating Index Rate + Margin Rate |
| Floating Index Rate > Cap Reference Rate | Cap Reference Rate | Cap Reference Rate + Margin Rate |
If the Minimum Interest Rate and Maximum Interest Rate are defined in the lending product, then:
| If... | Interest Rate considered by the system |
|---|---|
| Final Interest Rate < Minimum Interest Rate | Minimum Interest Rate |
| Final Interest Rate > Maximum Interest Rate | Maximum Interest Rate |
Final Interest Rate > Minimum Interest Rate and Final Interest Rate < Maximum Interest Rate | Final Interest Rate |
The following example explains how the final interest rate is derived for the defined Floating Index Rate, Floor Reference Rate, Cap Reference Rate, Margin Rate, Minimum Interest Rate, and Maximum Interest Rate:
| Floating Index Rate | Floor Reference Rate | Cap Reference Rate | Final Index Rate considered | Margin Rate defined | Final Interest Rate = Final Index Rate considered + Margin Rate | Minimum Interest Rate | Maximum Interest Rate | The Interest Rate considered |
|---|---|---|---|---|---|---|---|---|
| 2% | 5% | 10% | 5% | 1% | 6% | 8% | 10% | 8% |
| 15% | 5% | 10% | 10% | 1% | 11% | 8% | 10% | 10% |
| 6% | 5% | 10% | 6% | 1% | 7% | 8% | 10% | 8% |
| 8% | null | null | 8% | 1% | 9% | 8% | 10% | 9% |
Thus,
- Floor Reference RateThis field is used to define the agreed lower limit of the reference rate, on which the floating index interest can be accrued on a loan. This is the minimum rate that will be applied if the floating index rate falls below the Floor Reference Rate. It is a financing mechanism to ensure the lender is able to assess interest regardless of how external variable interest rates are performing. It is a fixed interest rate that is triggered should interest rates drop below the floor. Even if prevalent market rates drop to 0%, you will still be subject to a rate equal to at least the floor.
- Cap Reference RateThis field is used to define the agreed upper limit of the reference rate, on which the floating index interest can be accrued on a loan. This is the maximum rate that will be applied if the floating index rate falls above the Cap Reference Rate. It is the maximum interest rate that a lender can charge a borrower when negotiating a loan.
UI Enhancement
This section lists the enhancements made in the UI release-wise.
Summer'22 Release
The following two new fields are added to the lending product as well as the loan contract page in the Summer'22 release:
- Cap Reference Rate
- Floor Reference Rate
On contract page
The new fields, Cap Reference Rate and Floor Reference Rate, added to the contract page, are highlighted in the following image:
On the lending product page
The new fields, Cap Reference Rate and Floor Reference Rate, added to the lending product page, are highlighted in the following image:
Additional Information
The fields, Floor Reference Rate and Cap Reference Rate, are valid only if the Interest type = Floating. The fields hold no significance when the Interest Type = Fixed.
These fields are automatically inherited at the contract level and are set with the values defined at the product level. You can override these values at the contract level.
These fields can be defined with values up to 5 decimal places.
These fields can be defined with negative values, however, the final Interest Rate cannot be negative.
These fields can have a null value.
If there is a Floor Reference Rate defined on a contract and on a particular date, if the floating rate goes below the floor rate, the system automatically applies that rate on the contract for interest calculation.
If there is a Cap Reference Rate defined on a contract and on a particular date, if the floating rate goes above the cap rate, the system automatically applies that rate on the contract for interest calculation. This holds true both while creating a product or a loan contract.
As explained earlier, if there is a Minimum Interest Rate, Maximum Interest Rate, Floor Reference Rate, and Cap Reference Rate defined, then:
The Floor Reference Rate + Margin Rate can be equal to or more than the Minimum Interest Rate, but cannot be less than that.
The Floor Reference Rate + Margin Rate can be equal to or less than the Maximum Interest Rate, but cannot be more than that.
The Cap Reference Rate + Margin Rate can be equal to or more than the Minimum Interest Rate, but cannot be less than that.
The Cap Reference Rate + Margin Rate can be equal to or less than the Maximum Interest Rate, but cannot be more than that.
If the user changes the Floor Reference Rate or the Cap Reference Rate or both the rates on the product, these new rates will be applicable to only the new contracts drawn on that product, and the existing contracts will be unaffected by this change.
The Floor Reference Rate and the Cap Reference Rate once defined on a loan contract can be changed only via the Rate Change action after disbursement. However, the user can change these rates directly on the contract when the contract is in the Partial Application state.
With the Summer'22 release, all the interest rate-related fields are now grouped in a section called the Interest, both on the product details as well as the contract details page. You can refer to this image.
The system compares the Floor Reference Rate each time the index rate is updated as per the Rate Revision Frequency so that the index rate on the deal does not fall below the defined Floor Reference Rate.
The system applies the Floor Reference Rate on the deal if the index rate is below the Floor Reference Rate during the booking process.
The system applies the Floor Reference Rate on the deal if the index rate is below the Floor Reference Rate during the rate revision process.
The system applies the Floor Reference Rate on the deal if the index rate is below the Floor Reference Rate during the index change process.
All interest calculations will be as per the Floor Reference Rate if the index rate is below the Floor Reference Rate.
You can amend the Floor Reference Rate defined for a given product so that you can adjust the Floor Reference Rate as per market conditions.
The Floor Reference Rate defined for a product will be the same across all index rates.
The Floor Reference Rate once defined at the contract level will never change through the life of the deal.
Rescheduling to change the Cap and Floor Reference Rates is not supported for the Summer’22 release. When a loan is rescheduled to change the Cap Reference Rate or the Floor Reference Rate to a new value, the system will not change the Cap Reference Rate to the new value. For the Summer’22 release, the modification of Cap and Floor Reference Rates is not supported. However, these can be modified at the contract level when the contract is in the Partial Application status.
Scenarios
The following table depicts various scenarios for the final rates applicable on the loan contract: