Loans

Loans are generally seen as something rather trivial, completely understandable and, above all, very simple financial transactions. In practice, however, serious questions of understanding often arise, which can lead to major problems due to a lack of detailed knowledge, whether at a technical and/or legal level.

Fundamentals

Technicals

This small mind map shows that a loan has many facets. Depending on the objective of the loan, numerous details should be taken into account for several reasons:

Technical questions

1. Interest rate reference, e.g. from the newspaper or unrecognized sources from Google, instead of a standard market source - LIBOR, EURIBOR etc.
2. Interest calculation, e.g. based on the currency and the term, the interest balance must be taken into account.
3. Basic calculations e.g. a loan that runs from 30.06.xx to 31.12.xx with an extension to 30.06.yy is calculated in Excel from 01.01.yy to 30.06.yy. One day is missing here - namely from 31.12.xx to 01.01.yy!

Legal matters

The following explanations refer as far as possible to trading rights of 1st world countries, e.g. Central Europe, North America. Depending on the country, however, there may be more or less extensive deviations.

The main features of a (money) loan are the lender's obligation to make a certain amount available to the borrower for a certain term by transferring ownership (obligation to deliver) and the borrower's obligation to subsequently repay the amount (obligation to reimburse). A not insignificant additional legal feature is the obligation of the lender to leave the capital value of the loan with the borrower during the term of the loan (so-called retention obligation).

However, the interest rate does not necessarily have to be defined for a loan, as surprising as this may sound at first. It is not a loan, but a separate benefit, namely the compensation for the lender for the use of the capital (= loan) during a certain period of time. In normal transactions, interest is only owed if it has been agreed. In principle. However, in most legal codes there is an additional clause which states that interest is owed in commercial transactions even without an agreement.

Interest also has an important legal characteristic: if there is no interest agreement, it could be assumed that the loan is not a loan in the traditional sense and therefore the repayment obligation does not apply! This has a particular impact on questions in especially tricky situations, e.g. bankruptcy of a group, where there are up- or cross-stream loans between different legal entities and, of course, in normal tax considerations. The subject of "hidden profit distribution" and thus "transfer pricing"!

Last but not least, it should be mentioned that in many countries there is no explicit obligation for a written loan agreement, e.g. in Switzerland Art. 11 para. 1 in conjunction with Art. 312 CO. Art. 312 OR. Even if this is the case in some commercial laws, it must be clearly pointed out at this point that the consequences of a lack of written form can lead to very serious problems for both the lender and the borrower!  

Legal issues

1. Liability issues - incorrectly issued or booked loans can become a serious problem!
2. Tax issues - transfer pricing: concerns internal loans; depending on the direction (see above), interest rates that are too low or too high can be regarded as a hidden profit distribution.
3. Documentation: was a written contract drawn up and properly updated?

Loan features in detail

Every loan based on basic commercial principles should take these points into account:

1. Lender
2. Borrower
3. Date of the agreement
4. Currency
5. Amount
6. Start and end date
7. Reference
8. Type of loan (internal or external)
9. Interest rate (Act/360, 30/360, Act/365, Act/Act)
10. Interest source (SARON, EURIBOR etc.)
11. Interest modality (p.a., s.a.)
12. Payment (fixed, monthly, semi-annual, etc.)
13. Fixed or floating interest
14. Account of the lender
15. Account of the borrower
16. Free text
17. Agreed interest dates
18. Authorized representatives of both parties, signature if applicable

Stumbling blocks in the interest calculation

Especially companies that do not have specialized financial software (such as our in-house development) and calculate interest in Excel, for example, sometimes make mistakes when calculating interest. Here are the most common problems:

Interest balance

Depending on the agreed currency and term, different interest calculation methods are used according to international standards.
Example: Fixed-term deposit, EUR for 1/2 year, 31.12.24 - 30.06.24 (2024 is a leap year)

Act/360
(1'000'000 x 1.0% x 182) / 360 x 100 = 5'055.56

30/360
(1,000,000 x 1.0% x 180) / 360 x 100 = 5,000.00

Act/365
(1,000,000 x 1.0% x 182) / 365 x 100 = 4,986.30

Act/Act
(1,000,000 x 1.0% x 182) / 366 x 100 = 4,972.68

In this example, the correct interest balance for a fixed-term deposit of EUR 1/2 year is Act/360. If other values are used, the result will be incorrect.

Period

It has often been observed in finance departments (especially in medium-sized companies) that the days are always calculated incorrectly.

Example: A new loan is to run from January 1, 2024 - March 31, 2024 and is then extended until June 30, 2024.
A) 01.01.24 - 31.03.24 and 01.04.24 - 30.06.24 = 90 days + 90 days = 180 days in Excel.
-> However, there are two errors here:

a) Interest run always begins on the date on which the money was available to the borrower for use. No amounts are credited on 01.01. of a year, at the earliest on 02.01.24 (CHF). Depending on the currency, also on 03.01.24 (EUR).

b) No interest was calculated between 31.03.24 and 01.04.24, one day of calculation is missing.

B) 02.01.24 - 31.03.24 and 31.03.24 - 30.06.16 = 90 days + 91 days = 181 days > Correct.

Interest rate fixing

The most frequently used interest rate sources are the official fixings of e.g. SARON or EURIBOR. Different interest rates are applied depending on the term of the interest leg. These interest rates, which cover the range up to 6 months for CHF and one year for EUR, are divided into different time intervals.

SARON (Swiss Average Rate Over Night):  Overnight, as well as 1, 3, 6 months compound rate. In addition, the Tomorrow Next (SARTN), 1 week (SAR1W), 2 weeks (SAR2W), 1 month (SAR1M) and also 3 months (SAR3M).  These are all closing rates in contrast to the SARON Compound Rates.

EURIBOR (Euro Interbank Offered Rate): 1 week and then 1, 3, 6 and 12 months.

When fixing, a distinction must be made between FIXING DATE and VALUE DATE. The fixing date is always 2 working days (of the currency, not the country) before the day on which the payment flow takes place. Example: 01.02.24 (Thursday) -> value date Monday, 05.02.24. This means that a loan term from 05.02.24 must already be fixed on 01.02.24. A loan that starts on 01.02.24 (payment date) must be fixed two days earlier on 30.01.24.