Debt recovery and the Bank of England base rate

Debt recovery and the Bank of England base rate

The Bank of England’s Monetary Policy Committee made headlines in the financial pages in June with the news that the decision to keep the historically low base rate of 0.25% – which has now been maintained since August 4th 2016 – was far from unanimous.

In fact, of the eight current serving members on the MPC, only five voted to maintain the current base rate, while three took the alternative view that it should be increased by 25 ‘basis points’ – equivalent to a quarter of a percentage point, which would take the base rate to 0.50%.

The base rate is officially set at a level designed to keep inflation as close as possible to a long-term target of 2.0%, while also helping to sustain positive economic growth and employment, and it is in this context – and not a direct consideration of, for example, interest on debts or on savings accounts – that the MPC makes its decisions.

However, the base rate is hugely important on both debt recovery and positive bank balances alike, as in a climate of a higher base rate, banks and other financial institutions tend to pay a higher rate of interest on savings, and also charge a higher rate on debts.

For business debt recovery, the base rate is also used to set the rate of statutory interest, typically at a rate of eight percentage points above the current base rate – therefore if the MPC voted for an increase, you would be entitled to charge 8.50% interest on overdue invoices, rather than the current 8.25%.

When does the base rate not apply?

It’s worth noting that the base rate – which is used to set the official rate of statutory interest – does not apply to all business debts, as it can be overruled by a mutually agreed alternative interest rate in your supply agreement or other contract of trade.

As such, if you have entered into a contract that specifies a rate of interest other than the official statutory rate, the MPC’s decisions should have little relevance to you on any overdue payments, as the contractual amount should apply instead.

However, it’s wise to keep an eye on the MPC’s decisions, as a higher statutory rate at the Bank of England might encourage you to write a higher rate into your own contracts, or even to refuse to set an alternative rate at all.

When will the base rate change?

Until recently, the MPC held a meeting every month, on the Thursday of the first full calendar week. However – perhaps because the current economic climate has prevailed for so long – the base rate has been set at 0.25% since August 4th 2016 and was at 0.50% before that since March 5th 2009.

After eight years of practically no change in the rate, the MPC have cut their monthly meetings down to eight per year, skipping the months of October, January, April and – crucially this time around – also not meeting in July.

This means their next scheduled meeting is now not until Thursday August 3rd 2017. It is also worth noting that this is the first Thursday in that month, but not the first full calendar week; under the old system, the meeting would typically have taken place the following week, on the 10th.

So we have no MPC meeting in July, which means no change to the base rate, and the meeting due to take place in August is a week earlier than would have been the case in previous years.

It’s also worth noting that there is a quarterly Inflation Report also due for publication on August 3rd. Historically, decisions to change the base rate have often coincided with the publication of the Inflation Report, which gives the Bank the clearest indication of influences on the rate of inflation, which is of course a key factor in deciding where to set the base rate.

What if the base rate changes in August?

If the base rate changes – and if it does, it is only likely to increase to 0.50% – then the statutory interest rate will rise accordingly to 8.50%.

Guidance on the government portal GOV.UK sets out how to apply this rate to commercial debt recovery, which we will outline in detail below.

If the rate changes, your debt recovery agent can help you to determine what rate applies to your outstanding invoices – and especially the finer details like how to calculate interest on debts that were already overdue when the base rate changed.

Generally speaking though, statutory interest is charged as a daily amount, based on the original invoice amount, the statutory rate over a full year, and the number of days by which the invoice is overdue.

Calculating statutory interest

To give more detail:

1. Take the original invoice amount.
2. Multiply by the statutory interest rate (currently 8.25% but likely to rise to 8.50% soon).
3. This gives you the amount of statutory interest payable for one full year overdue.
4. Divide by 365 to get a daily rate, and multiply by the number of days the invoice is overdue.

Again, if you are not confident on this, or if there are complications – such as a change in the base rate during the overdue period, or even a leap year with 366 instead of 365 days to calculate interest over – ask a reputable debt recovery agent to clear up any such issues.

If you decide to charge the statutory interest to the debtor, you should issue a new invoice showing the new amount owed, and again a debt recovery agent can help you to make sure this does not give the debtor any way to argue that the details or, crucially, the deadlines for payment have changed.

Will the base rate rise by more than 0.25%?

It’s unlikely that the base rate will go up by more than 0.25%, or 25 ‘basis points’, in the first month that the MPC votes for a change. It’s not even certain that a change will come in August, although the publication of the quarterly Inflation Report may help to influence the vote in that direction.

However, it is possible that currently unforeseen economic events could persuade the MPC to make a more radical move in the months ahead, and of course any decision made in August could be followed by another increase in September, November and/or December (with no MPC meeting planned for October under the new eight-times-yearly schedule).

The Bank of England website provides full details of the base rate going right back to October 1694, when it stood at 6.0%. The rate hit 10.0% several times over the centuries, but did not go above that benchmark until July 30th 1973, when it rose to 11.5%. It hit an all-time high of 17.0% on November 15th 1979, but the introduction of the MPC has seen a much more cautious approach to changing the rate in recent years.

Since 2006, the rate has never reached 6.0% – and has been at 1.5% or less since January 8th 2009. The current rate of 0.25% has stood since August 4th 2016, and is the lowest official Bank rate in history.

Is it worth chasing debts with low statutory interest rates?business debt

The short answer is yes. When you chase a debt in order to recover an overdue payment, your main aim is to get the amount you were originally owed – and in many cases any right to statutory interest works better as a bargaining chip to be waived than as an amount of money you actually expect to claim.

If you do try to force the debtor to pay the statutory interest to which you are entitled, remember that the rate you charge is not 0.25% (or 0.5% if the MPC put the base rate up to that level in August), but is eight percentage points higher than the base rate.

Compare 8.25% or 8.5% with the interest rates you are currently being paid on any savings you might have, and your overdue invoices are likely to suddenly appear as one of your healthiest investments.

Of course we are not suggesting that you would ever want to deliberately allow an invoice to go unpaid so that you can charge the interest on it later, but for those where payment is already overdue, the interest you can charge on top can be a healthy sum, even in this current climate of historically low base rates.

As always, your debt recovery agent can help you with any remaining queries, including how to calculate the amount of statutory interest owed to you on any overdue debts, and how to clear up any of the finer details mentioned throughout this article.

http://www.bankofengland.co.uk/publications/Pages/news/2016/070.aspx
https://www.gov.uk/late-commercial-payments-interest-debt-recovery/charging-interest-commercial-debt

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