Flat Rate vs. Annual Interest Rate calculated daily

Flat Rate vs. Annual Interest Rate calculated daily

The Best Practice method of Late Payment Penalty calculation uses an Annual Interest Rate on the Actual Outstanding, calculated on a Daily Basis. This method is legally sound, used by all Financial Institutions as well as explicitly mandated by some State Governments in India such as Maharashtra.


Why is this recommended?
1. A Member, who has Rs.1000 outstanding for 1 day, pays higher penalty than someone who has Rs.10 outstanding for 1 day.
2. Similarly a Member having Rs.1000 outstanding for 20 days pays higher penalty than someone who has Rs. 1000 outstanding for 2 days.


However, Associations in Bangalore and other Southern states had to compromise with a Flat Rate Late payment Penalty due to the following reasons:
1. The penalty is calculated manually; hence using an Annual Interest Rate calculated on the Actual Outstanding on a Daily basis, is fraught with mistakes and Manual Effort. It is difficult for Associations with lean Office Staff to deploy the method confidently.
2. Since the process is manual, any impractical Penalty (e.g., Rs.25 per day, to someone who has Rs.5 outstanding for 90 days), is waived off using Manual Judgment, before the Penalty is manually posted against the particular member.


Why Flat Rate Penalty is a disaster when mirrored in an Automatic System:
1. In an Automated System, the Penalty will get automatically posted equally for a Member who ha Rs.8000 outstanding for 90 days, as well as a Member who have Rs.5/-. Outstanding for 90 days. The penalty amount will be same for both Members.
2. This will result in many disputes and reversals of Penalty, which will defeat the purpose of the Automated Penalty system. Members will stop taking the Penalty System seriously and Manual Effort will increase in waiving or reversing and giving explanations.


Recommendation:
1. In the interest of an effective Penalty System that requires no manual involvement, as well as to help Customers move to Best Practices, the Automated Penalty calculation system of ADDA supports only the Annual Interest Rate method.
2. Flat Rate penalty is suitable for Manual Penalty calculation only, which is judgment based and penalty can be waived off before posting. In case you wish to continue the Flat Rate only, then the decided penalty can be uploaded in an excel.

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