A recent conversation with a compliance officer took me back to the earliest days of my career. The bank is in the middle of a conversion to a new core accounting system. One of the company reps suggested the bank adopt the 365/360 method of accruing interest. Apparently management was excited about the increased yields on the loan portfolio and wanted to move immediately on the suggestion. The compliance officer wanted to know if there was anything wrong with the practice.
When I started banking as an examiner in the mid-1970s many states had very restrictive usury limits. Using the 365/360 method slightly increased the yield on the loan. For a $1,000 loan at 6% the daily interest factor using a 365 day calendar is $.16438. The daily interest factor for the same loan using the 360 day calendar is $.16666. Switching the accrual method increases the yield by approximately 1.4%. That is not much on a $1,000 loan, but on a $100 million dollar portfolio earnings are increased by over a $1million. If the state usury ceiling was 6% there was no other way to increase the yield. Today most states have very liberal usury laws; so if the creditor needs a higher yield, they charge a higher rate.
That raises the question, why would anyone want to use the actual/360 method if they simply need to raise the rate to increase the yield? In many cases the answer is “We can tell the customer the rate is 6.00% but our actual yield is higher.” In other words, we want to deceive our customer. While we have not seen regulators cite this as an Unfair, Deceptive or Abusive Act or Practice, it appears to have the makings of a fine UDAAP violation.
