Fixed-Rate Component Break-Cost Methodology Policy¶
| Code | CRE-009 |
| Domain | Credit Risk |
| Owner | Chief Risk Officer |
| Status | Draft |
| Applicability | Platform |
| Jurisdiction | NZ + AU |
| Business domain | BD05 |
| Review date | 2027-05-08 |
Regulations: CCCFA 2003 · NCC Act 2009 (NCCP) · NZ Banking Code · ABA Banking Code¶
Purpose¶
Govern the methodology, documentation, and transparency of break-cost calculations for fixed-rate loan components. Ensures that the embedded interest-rate derivative nature of fixed-rate components is treated with the same rigour and transparency as a separately documented derivative, in response to conduct precedents (UK Tailored Business Loans, 2002–2012) and the requirements of the CCCFA and NCCP.
Scope¶
All fixed-rate components within the Flexible Loan Facility (PRD-024) and any other product that offers locked fixed-rate sub-facilities subject to a market-rate-dependent early termination cost. Does not apply to simple fixed-rate loans where the break cost is a minor administration charge; applies specifically where break cost is computed as a mark-to-market equivalent on the interest-rate differential.
Policy statements¶
The break-cost formula SHALL be the present value of (contracted_rate minus current_market_rate) multiplied by the outstanding principal over the remaining term, where current_market_rate is the mid-market swap rate for the residual tenor sourced from the live market rates feed at calculation time. The formula SHALL be documented, version-controlled, and approved by the CRO before the product is offered to customers.
The break-cost formula applied by the system SHALL produce results that are mathematically identical to any indicative quote or customer-facing calculator; no separate or simplified formula may be used for disclosed estimates.
On-demand indicative break-cost quotations SHALL be available to any authenticated customer with an active fixed-rate component at any time, without triggering any account action or commitment. The customer SHALL NOT be required to initiate a formal prepayment request to obtain an indicative figure.
A binding break-cost disclosure SHALL be delivered to the customer and acknowledged before any early termination, pre-maturity rollover, or restructure of a fixed-rate component is processed. No code path in any module may process a fixed-rate component change without a recorded acknowledgement ID from MOD-050. This requirement is additional to, not a substitute for, the general break-cost disclosure obligation under CON-005.
Every break-cost calculation — indicative and binding — SHALL be recorded as an immutable audit row including: the contracted rate, the current market rate and its source timestamp, the remaining principal, the remaining term, the discount rate applied, and the resulting break cost or benefit amount. This record SHALL be retained for 7 years.
The product documentation and customer-facing materials SHALL disclose in plain language that each fixed-rate component is economically equivalent to an interest rate swap from the customer's perspective, that the bank hedges this exposure, and that early termination of a fixed-rate component unwinds this hedge — resulting in a cost or benefit depending on the direction of rate movement since the component was established. A worked numerical example SHALL be included in the product information summary.
The break-cost methodology SHALL be reviewed by the CRO at least annually and whenever a material change occurs to the bank's hedging practice or to the benchmark rates used in the formula.
Where a fixed-rate component early termination results in a break benefit (positive mark-to-market for the customer), the bank SHALL pass this benefit to the customer in full. Retaining a break benefit in whole or in part is prohibited.
All break-cost disputes SHALL be handled through a dedicated complaint pathway. The bank SHALL provide the customer with a detailed calculation breakdown on request within 5 business days.
Rationale¶
Between 2002 and 2012, approximately 8,000 SME borrowers in the UK were sold multi-component fixed-rate loans (Tailored Business Loans) where the embedded swap cost was not adequately disclosed. When interest rates fell sharply after 2008, customers faced break costs they had not been told about. Class litigation followed affecting over 6,000 customers. The regulatory and legal fallout demonstrated that treating embedded derivatives as ordinary loan terms, without transparent disclosure of the derivative mechanics, creates material conduct risk. This policy requires the bank to disclose the embedded derivative nature explicitly, regardless of whether the relevant regulator formally classifies the instrument as a derivative product.
Satisfying modules¶
| Module | Name | Mode | Description |
|---|---|---|---|
| MOD-163 | Break-cost calculator | CALC |
Break cost is computed using the documented present-value formula against live market rates sourced from MOD-085; every calculation — indicative and binding — is immutably logged with contracted rate, current market rate, source timestamp, remaining principal, remaining term, and the resulting amount; the formula is version-controlled and produces identical results to any customer-facing quotation. |
| MOD-164 | Facility component self-service | LOG |
On-demand indicative break-cost quotes are accessible to any authenticated customer with an active facility at any time via the component detail screen, satisfying the on-demand quotation transparency requirement without requiring a formal change request. |
Part of Credit Risk · Governance overview
Compiled 2026-05-22 from source/entities/policies/CRE-009.yaml