Regulated interest rates

Regulated interest rates – IFRS 9 recognises that in some jurisdictions, the government or a regulatory authority sets interest rates – e.g. as part of a broad macro-economic policy, or to encourage entities to invest in a particular sector of the economy. In some of these cases, the objective of the time value of money element is not to provide consideration for only the passage of time. [IFRS 9 B4.1.9E]

  • In spite of the general requirements for the modified time value of money, a regulated interest rate is considered to be a proxy for the time value of money if it:
  • provides consideration that is broadly consistent with the passage of time; and Regulated interest rates
  • does not introduce exposure to risks or volatility in cash flows that are inconsistent with a basic lending arrangement. Regulated interest rates

The Board decided to include the specific guidance on regulated interest rates in the standard, as these regulated rates are set for public policy reasons and are therefore not subject to structuring in order to achieve a particular accounting result. Regulated interest rates

The Board gave an example of French retail banks collecting deposits on special ‘Livret A’ savings accounts. The interest rate is determined by the central bank and the government according to a formula that reflects protection against inflation and remuneration that incentivises entities to use these accounts.

This is because legislation requires some of the amounts collected to be lent to a governmental agency, which uses the proceeds for social programs. The Board noted that the time value element of interest on these accounts may not provide consideration only for the passage of time; however the Board believes that the amortised cost measurement category would provide relevant and useful information, as long as the contractual cash flows do not introduce risks or volatility that are inconsistent with a basic lending arrangement. [IFRS 9 BC4 175, IFRS 9 BC4 179–180] Regulated interest rates

Determining SPPI for loans in highly regulated countries

Certain loans in highly regulated countries are regulated by the government, and they are reset according to the original maturity of the loan rather than according to the remaining maturity or the period until the next reset date (for example, where the interest rate is reset to a three-year rate because the instrument has an original maturity of three years).

Do such loans meet the SPPI criterion?

Under the exception, this type of feature would not cause the instrument to fail the SPPI criterion, provided that the regulated interest rate provides consideration that is broadly consistent with the passage of time and does not provide exposure to risks or volatility in the contractual cash flows that are inconsistent with a basic lending arrangement.

Government regulation

In some jurisdictions, the government or a regulator sets out or restricts the terms and conditions allowed in loans, particularly loans to retail customers. Examples include loans in:

  • China, where interest rates set by the government might include a modified time value of money (see also ‘Tenor mismatch’ below); Regulated interest rates
  • Poland, where some loans contain a leveraged interest rate cap set at a multiple (such as 2x or 4x) of a specified floating interest rate; and
  • the USA, where the terms of bank-issued student loans eligible for certain government compensation (for example, if a student becomes a public employee and their loan is waived) are predefined in legislation that specifies an interest rate with a tenor mismatch (see also ‘Tenor mismatch’ below).

These types of loan require careful analysis. An interest rate or clause that is set by the government or a regulator might not necessarily fail SPPI, even if it would in other circumstances. This is because paragraph B4.1.9E of IFRS 9 has specific guidance for such arrangements that allows some additional flexibility. Regulated interest rates

However, it is important to be clear which of the features of the loan arise from the regulation and which do not. If a feature does not arise from the regulation, paragraph B4.1.9E of IFRS 9 will not apply.

Tenor mismatch

Some instruments have a so-called ‘tenor mismatch’, where the time period or ‘tenor’ in the variable interest rate paid (for example, 3 months in the case of 3-month Libor) does not match the frequency at which the variable interest rate is reset on the instrument (for example, monthly in the case where the rate resets each month). This is an example of what IFRS 9 calls a ‘modified time value of money’. Such features have been seen in parts of the Eurozone and elsewhere.

One reason for this type of feature is that longer-term interest rates are generally more stable, and so they can protect retail customers from the volatility that a shorter-term interest rate might create.

If the time value of money element is modified, the bank will need to compare the contractual cash flows of the instrument to the cash flows of a ‘perfect’ (‘benchmark’) instrument that does not have the tenor mismatch. If the cash flows could be significantly different, the contractual cash flows of the instrument are not considered to be SPPI. In some circumstances, the bank might be able to make this determination by performing a qualitative assessment; in other cases, a quantitative assessment is needed.

Leveraged interest rates

The variable interest rate charged on a loan can be ‘leveraged’ (that is, more than 1x the floating reference rate, such as 120% of the reference rate). If the interest rate is ‘leveraged’, this is very likely to result in the loan failing SPPI. The reason is that if, for example, 100% of LIBOR appropriately compensates the holder for time value of money, a rate of 120% of LIBOR would over-compensate, which suggests that the extra 20% is for something other than the time value of money and so breaches SPPI.

Leveraged interest rates have been identified in some Chinese and Polish loans (the guidance on government-regulated rates is also relevant here – see ‘Government regulation’ above) and some Brazilian loans, where the interest rate is not required by regulation or law but reflects how the market operates.

Although loans with leveraged interest rates will generally fail SPPI, there might be rare instances where this is not the case. In particular, if it can be determined that the leverage (that is, the ‘extra’ 20% in the example above) does not result in cash flows that do not have the economic characteristics of interest, the SPPI criterion might still be met.

Regulated interest rates

Regulated interest rates

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