AER: Annual Equivalent Rate

Research into AER regulation, calculation, and rounding for UK savings products, based on the UK Finance / BSA "Annual Equivalent Rate (AER) Practice Note" (January 2025) and the underlying regulatory framework.

1. Regulatory Framework — Detailed

There is no single UK statute that defines AER or mandates its formula. AER disclosure sits on a layered framework of legislation, FCA rules, advertising codes, and industry guidance. Understanding which layer does what is essential.

Layer 1: Primary legislation

Payment Services Regulations 2017 (PSR 2017) (SI 2017/752) — transposes PSD2 into UK law. Covers payment services (current accounts, payment instruments). Schedule 4 requires pre-contractual disclosure of "details of the interest and exchange rates to be applied" for framework contracts (Reg 48, Sch 4 para 3(b)). However, the PSR 2017 does not define AER, does not prescribe any specific rate format, and does not specifically cover savings-only deposit accounts. Its relevance to AER is indirect: the FCA's mandate to monitor compliance with PSR 2017 extends to its oversight of BCOBS.

Consumer Credit Act 1974 (CCA) — applies to lending, not to savings/deposit accounts. The CCA defines APR (Annual Percentage Rate) for credit, not AER for savings. The CCA and the Consumer Credit (Total Charge for Credit) Regulations 2010 are not applicable to savings interest rate disclosure. There is no interaction between CCA and AER requirements.

Payment Accounts Regulations 2015 (SI 2015/2038) — transposes the Payment Accounts Directive (2014/92/EU). Requires providers of payment accounts to supply a Fee Information Document and annual Statement of Fees. Schedule 2 para 3(1)(f)-(g) requires disclosure of "the credit interest rate or rates applied to the payment account during the relevant period" and "the total amount of interest earned during the relevant period". Does not mention AER specifically, and applies to payment accounts (current accounts), not savings-only products.

Key finding: No UK primary legislation defines AER or prescribes how it must be calculated. There is no statutory formula.

Layer 2: FCA Handbook — BCOBS

Banking Conduct of Business Sourcebook (BCOBS) applies to firms accepting deposits from banking customers. Key provisions:

BCOBS 2.2 — "The fair, clear and not misleading rule". All communications and financial promotions must be fair, clear, and not misleading. This is a binding FCA Rule (R), not guidance.

BCOBS 2.2A — Summary box for savings accounts. Introduced by PS15/27 (Cash savings remedies), effective 1 December 2016. Requires a standardised summary box in direct offer financial promotions for savings accounts. The summary box must include the rate or rates of interest (BCOBS 2.2A.1R). The form is set out in BCOBS 2 Annex 1R, with guidance on interest rate presentation in BCOBS 2 Annex 2G.

BCOBS 2.3 — Other general requirements for communications and financial promotions. Contains guidance (G) that "when designing a financial promotion, a firm may find it helpful to take account of" the industry Code of Conduct (now Practice Note). This is a cross-reference to industry guidance, not an incorporation of it into the rules. The Code/Practice Note "is cross referred to in the BCOBS and supplements it" but "there will be no change in the status of this Code of Conduct" (FSA, 2009 BCOBS introduction).

BCOBS 4.1 — Enabling banking customers to make informed decisions. Contains rules and guidance about interest rate disclosure in ongoing communications:

  • Rate of interest must be "prominently shown" alongside or in close proximity to account balance information (including in online banking — one click away).
  • Where multiple rates apply, the lowest rate must not be given less prominence.
  • "Prominently" means the attention of the average banking customer would be drawn to it. A link to a separate page is not sufficient.

Critical point: BCOBS requires interest rates to be displayed clearly and prominently, and the summary box must include rates. But BCOBS itself does not define AER, does not contain the AER formula, and does not mandate how AER must be calculated. It relies on the industry Practice Note for the definition and methodology.

The FCA acknowledged this gap during the 2015 Cash Savings Market Study (CP15/24). A consumer group noted that "the AER is only industry guidance and providers are free to follow a different standard, which could undermine the purpose of a single comparable interest rate measure." A trade association felt it was "anomalous the AER Code remains outside the scope of FCA rules." Despite these representations, the FCA chose not to incorporate AER into its rules but continued to rely on industry self-regulation.

Layer 3: Advertising Standards — ASA/CAP and BCAP Codes

The CAP Code (non-broadcast) and BCAP Code (broadcast) are enforced by the Advertising Standards Authority (ASA).

BCAP Code Rule 14.7 (broadcast advertising — TV, radio):

  • 14.7.2: Advertisements quoting a rate must employ "the Annual Equivalent Rate (AER) and the contractual rate as set out in the British Bankers' Association and Building Societies Association Code of Conduct for the Advertising of Interest Bearing Accounts" (now the UK Finance/BSA Practice Note).
  • 14.7.4: Rates must make clear whether gross, net of tax, or tax-free.
  • 14.7.5: Variable rates must be stated as such.

CAP Code Rule 14.3 (non-broadcast advertising): "The basis used to calculate any rate of interest, forecast or projection must be apparent immediately." The CAP Code similarly cross-references the BBA/BSA Code for savings rate advertising.

These codes give the industry Practice Note quasi-regulatory force through the back door: the ASA enforces compliance with the CAP/BCAP Codes, which require adherence to the Practice Note's methodology.

Layer 4: Industry guidance — the AER Practice Note

UK Finance / BSA "Annual Equivalent Rate (AER) Practice Note" (January 2025)

This is the document that actually defines AER, prescribes the formula, sets rounding rules, and provides worked examples. It replaced the "Code of Conduct for the Advertising of Interest Bearing Accounts" (the Code) and the "Calculation of the Annual Equivalent Rate (AER) appendix to the Code", which were in place between 1985 and 2024.

Published jointly by UK Finance and the Building Societies Association (BSA).

Legal status: "This Practice Note is for guidance only. Banks and building societies are free to reach their own conclusions on interpretation." However, "a copy of this Practice Note has been sent to the Financial Conduct Authority, which is responsible for monitoring compliance with the Payment Services Regulations 2017 (PSR) and its Handbook, in particular the Banking Conduct of Business Sourcebook (BCOBS)."

In practice, deviation from the Practice Note would likely trigger FCA scrutiny under BCOBS 2.2 (fair, clear and not misleading rule) and ASA enforcement under the CAP/BCAP Codes.

Summary: Who requires what

Requirement Source Binding?
Interest rates must be fair, clear, not misleading BCOBS 2.2 (R) Yes — FCA Rule
Summary box must include rate(s) of interest BCOBS 2.2A.1R Yes — FCA Rule
Rates must be prominently shown alongside balance BCOBS 4.1 (R/G) Yes (R) / No (G)
AER must be quoted using the Practice Note method BCAP 14.7.2 / CAP 14.3 Yes — ASA enforced
AER formula and calculation methodology Practice Note No — guidance only
Rounding to 2dp Practice Note A5 No — guidance only
Gross rate definition Practice Note s.2 No — guidance only
AER = 365-day basis always Practice Note s.3 No — guidance only

History of the AER Code

  • 1985: The "Code of Conduct for the Advertising of Interest Bearing Accounts" introduced by the British Bankers' Association (BBA) and Building Societies Association (BSA). Principal objective: ensure common terminology for interest rates across institutions.
  • 1985-2009: The Code operated as pure self-regulation alongside the Banking Code (voluntary code for retail banking).
  • 2009: The FSA introduced BCOBS (effective November 2009), replacing the voluntary Banking Code with binding FCA rules. The FSA explicitly stated "there will be no change in the status of this Code of Conduct" — it remained industry guidance, cross-referenced from BCOBS 2.3.
  • 2015: FCA Cash Savings Market Study (CP15/24, PS15/27) considered whether to incorporate AER into FCA rules. Decided against it; instead introduced BCOBS summary box requirements (effective December 2016).
  • 2017: BBA merged into UK Finance. The Code continued under UK Finance/BSA stewardship.
  • January 2025: The Code and its AER appendix replaced by the consolidated "Annual Equivalent Rate (AER) Practice Note", published jointly by UK Finance and BSA.

What must be advertised

When an interest rate is quoted, advertisements must state (Practice Note s.2):

  • X% gross — the Gross Interest Rate payable before deduction of income tax at the rate specified by law. An explanatory phrase must be used.
  • Y% tax free — the rate where interest is exempt from income tax. An explanatory phrase must be used.
  • Z% Annual Equivalent Rate ("AER") — a notional rate illustrating the Gross Interest Rate (excluding conditional bonuses) as if paid and compounded annually. An explanatory phrase must be used. Any assumptions in the calculation must be stated (e.g. if interest not paid into account, AER will not be achieved).

AER must be quoted "in respect of the Gross Interest Rate only" (s.2).

No rate or return shall be given greater prominence than the AER (s.3). If AER equals the gross rate (annual compounding), "5% gross/AER" suffices.

The explanation of AER, "gross", or "tax free" need not be included in TV, radio, telephone, SMS, mobile app, social media, paid search or banner ads.

Ads not quoting a specific rate (e.g. "x% below base rate") need not quote AER.

Additional disclosure requirements

Advertisements quoting a rate must also state (Practice Note s.4):

  • Frequency of interest payment
  • Whether the rate is fixed or variable (and the term if fixed)
  • Minimum deposit / maximum withdrawals to achieve the rate

Gross rate rules

The Practice Note defines "gross" as the rate before income tax deduction at the rate specified by law. There is no separate statutory definition of "gross rate" for savings accounts. The definition comes entirely from the Practice Note (and its predecessor Code).

Where Gross Interest Rates are quoted on a basis other than a 12-month period, this must be clearly stated (s.3).

Where interest is calculated on a basis other than actual/365, the basis should be stated and the AER should nonetheless be calculated on an actual/365 basis (s.3).

2. What AER Means

AER is a notional rate. It illustrates the Gross Interest Rate (excluding conditional bonuses) as if interest were paid and compounded once a year.

The purpose is comparability: two products with different compounding frequencies can be compared on a like-for-like basis using AER.

Key properties:

  • If interest is paid annually, AER = gross rate.
  • If interest is paid more frequently than annually, AER > gross rate (compounding benefit).
  • If interest is paid less frequently than annually, AER represents the equivalent annual rate that would give the same result if compounded yearly.

3. AER Formulae

The Practice Note defines four formulae for different product structures.

(a) General formula

For a product with m years, deposits Dₙ at the start of year n, and interest rates iⱼ (%) payable at the end of year j:

Σ Dₙ (1 + α/100)^(1+m-n) = Σ Dₙ ∏(1 + iⱼ/100)  (= T)

where α is the AER and T is the total amount received at the end of year m. In the general case, α must be found by iterative computation (trial and error).

(b) Single deposit, varying annual rates

If only one deposit is made at the start:

α = ( (∏ (1 + iₙ/100))^(1/m) - 1 ) × 100

(c) Total interest quoted over the period

If the rate r% is the total payable over m years on the initial deposit:

α = ( (1 + r/100)^(1/m) - 1 ) × 100

(d) Sub-annual compounding

Where interest is paid n times per year at annual rate i%:

α = ( (1 + i/(n × 100))^n - 1 ) × 100

This is the most common case for UK savings products. For monthly compounding (n=12) at 5.8% annual:

α = (1 + 5.8/1200)^12 - 1 = 5.96%

4. AER Calculation Guidelines (A1-A7)

The Practice Note sets out seven guidelines to ensure consistency.

A1: Only contractual deposits

Only deposits required by the product terms are included. For a standard savings account: one initial deposit, no subsequent movements. For a monthly saver: each monthly deposit is included.

A2: Only stated rates at the outset

No allowance for future rate changes. If a product has a 6-month bonus at 5.5% then reverts to 5%, the AER uses both rates as stated. No prediction of base rate movements.

A3: Fixed or minimum term

If the product has a fixed term, calculate AER for that period. If indefinite, calculate to the first interest payment or one year, whichever is later.

A4: Interest reinvested at the same rate

All interest paid is treated as if reinvested and earning at the same rate as the deposit. For a 6-month bond at 6% gross:

AER = ((1 + 6/(2×100))^2 - 1) × 100 = 6.09%

Not 6.00% — the assumption is that the 6-month proceeds are reinvested at 6% for the remaining 6 months. Providers should not underquote by assuming a lower reinvestment rate.

A5: Rounding

AERs are to be rounded and displayed up to two decimal places.

This is the only rounding rule stated. The Practice Note does not specify the rounding method (half-up, half-even/banker's). In practice, the worked examples are consistent with standard half-up rounding (round 0.005 up to 0.01).

The note on the quarterly interest example (s. "Explanation of the AER") shows intermediate calculations carried to more decimal places, with rounding applied only at the final AER display step.

A6: Date-dependent AER

Where AER varies by deposit date (e.g. bonus until a fixed calendar date, or different gross rate for application-pending funds):

  • Advertising must state the date assumed for the AER calculation
  • The date must be within 1 month of publication
  • AER must be recalculated monthly if it would be lower than advertised

A7: Monthly savings with annual interest

For regular monthly savings with a limited life (e.g. 1 year) where interest is credited once annually, the AER is deemed equal to the nominal rate. The calculation should not account for interest earned after maturity.

5. Rounding: Regulation vs Practice

What the law/regulation says about rounding

There is no rounding requirement in UK statute or FCA rules. No provision of the PSR 2017, BCOBS, Payment Accounts Regulations 2015, or any other legislation specifies how AER should be rounded.

What the Practice Note says (industry guidance)

A5: "AERs are to be rounded and displayed up to two decimal places."

This is the sole rounding rule. It comes from industry guidance, not law.

The Practice Note does not specify:

  • The rounding method (half-up, half-even/banker's, truncation)
  • Whether gross rates have any rounding requirement
  • How intermediate calculations should handle precision

What the worked examples imply

The Practice Note's worked examples are consistent with:

  • Full precision in intermediate calculations
  • Standard mathematical rounding (half-up) at the final display step
  • Example: 6.771...% becomes 6.77%; 5.956...% becomes 5.96%

The quarterly interest example note states: "In practice, the calculation is worked to more decimal places to avoid rounding errors."

Daily interest rounding (separate issue)

The Practice Note is about advertising AER, not about how banks calculate daily interest internally. The daily rounding question (2dp vs 4dp accumulator) is an operational choice, not an AER regulation issue.

However, the choice of internal rounding method affects whether the customer actually achieves the advertised AER. If daily rounding systematically loses fractions, the effective return will be slightly below the advertised AER.

Worked examples from the Practice Note

Example 1: Annual interest, 10% gross

  • AER = 10.00% (annual compounding = gross rate)

Example 2: Simple interest over 2 years, 7% p.a. (= 14% total)

  • T = £100 × 1.14 = £114
  • AER = (√(114/100) - 1) × 100 = 6.77%
  • Lower than 7% because interest is deferred (not compounded)

Example 3: Two deposits, escalating rates

  • £100 at start, £50 added at year 2 (contractual), 10% year 1, 11% year 2
  • T = £100 × 1.10 × 1.11 + £50 × 1.11 = £177.60
  • AER found iteratively: 10.59%

Example 4: Same without the additional deposit

  • AER = (√(1.10 × 1.11) - 1) × 100 = 10.50%

Example 5: Monthly compounding, 5.8% annual

  • AER = (1 + 5.8/1200)^12 - 1 = 5.96%
  • Compare: 6% paid annually → AER = 6.00%. Monthly at 5.8% is worth less.

Example 6: 8-month bond, 5.5% annual

  • Monthly AER: (⁸√(1 + 5.5×8/1200) - 1) × 100 = 5.413...% per month
  • Annualised: (1 + 5.413/1200)^12 - 1 = 5.55%
  • Higher than 5.5% because interest is received after 8 months, not 12

Example 7: Unconditional bonus with step-down

  • 5.5% for 8 months, then 5% for 4 months (bonus expires)
  • Half-yearly AER = 5.333...%
  • Annualised AER = 5.40%
  • Must state "AER calculated assuming investment on [date]"

Example 8: Irregular cash flows over 5 years

  • £3,000 + £1,800×3 + £600 deposits at various dates, 7% annual, 2% bonus
  • Quarterly compounding, T = £11,785.78
  • AER including conditional bonuses = 7.45%
  • Solved iteratively; full table of 20 quarterly periods provided

Edge cases for implementers

Leap years and AER: For AER calculation purposes, the Practice Note states the divisor should be 365 in all years, even when the bank uses 365 or 366 for actual interest calculation. This means AER is always on an Actual/365 basis.

Conditional vs unconditional bonuses: An "AER including conditional bonuses" may be advertised but only alongside the standard AER, with equal prominence, and must be labelled as such.

Products shorter than one year: AER assumes reinvestment at the same rate for the remainder of the year (A4). A 6-month product at 6% → AER of 6.09%, not 6%. This prevents underquoting.

Variable rates: Only the rate at the time of advertisement is used. No forecasting. If the rate changes, a new AER must be calculated and advertised within one month (A6).

Tiered rates: For a monthly savings product with tiered rates, the appropriate rate is used as the balance builds (A2).

6. Implications for go-luca

AER as a derived value

AER should be a computed output, not a stored field. Given:

  • The gross annual rate on the account
  • The compounding frequency (daily for go-luca's engine, but the product may credit monthly/quarterly/annually)
  • The product term (if fixed)

The AER can be calculated using formula (d) for simple cases, or formula (a) for complex multi-rate/multi-deposit products.

Consistency check

go-luca should be able to verify that the effective return from its daily interest engine (with the 4dp accumulator) matches the advertised AER to 2dp. This means running a year of daily interest on a test balance and checking:

effective_return = (final_balance / initial_balance - 1) × 100
round_2dp(effective_return) == advertised_AER

Interest posting frequency matters

The Practice Note makes clear that the payment frequency determines the AER, not the calculation frequency. go-luca calculates interest daily but may post (credit to the account) monthly or annually. The AER depends on the posting schedule:

  • Daily posting: AER = (1 + gross/365)^365 - 1
  • Monthly posting: AER = (1 + gross/12)^12 - 1
  • Annual posting: AER = gross rate

Rounding implementation

For AER display: use decimal.Round(2) or equivalent at the final step only. Intermediate calculations should carry full precision.

For daily interest: the 4dp accumulator approach from the interest research is compatible with achieving the advertised AER. The key is that accumulated rounding error over a year must not push the effective rate below the AER rounded to 2dp.

7. Sources

Primary sources consulted

  • UK Finance / BSA, "Annual Equivalent Rate (AER) Practice Note", January 2025. Full 19-page PDF read. This is the authoritative industry guidance. https://www.ukfinance.org.uk/system/files/2025-02/Annual%20Equivalent%20Rate%20AER%20practice%20note_0.pdf

  • FCA Handbook, BCOBS — Banking Conduct of Business Sourcebook. BCOBS 2.2 (fair/clear/not misleading rule), BCOBS 2.2A (summary box), BCOBS 2.3 (cross-reference to industry Code), BCOBS 4.1 (rate prominence). https://www.handbook.fca.org.uk/handbook/BCOBS/

  • Payment Services Regulations 2017 (SI 2017/752). Schedule 4 (pre-contractual information). Reg 48 (framework contracts). Does not define AER. https://www.legislation.gov.uk/uksi/2017/752/contents

  • Payment Accounts Regulations 2015 (SI 2015/2038). Schedule 2 para 3(1)(f)-(g) (credit interest in statement of fees). Does not mention AER. https://www.legislation.gov.uk/uksi/2015/2038

  • FCA CP15/24 and PS15/27 — Cash Savings Market Study remedies. Introduced BCOBS summary box. Discussed but declined to incorporate AER into FCA rules. https://www.fca.org.uk/publications/consultation-papers/cp15-24-cash-savings-remedies https://www.fca.org.uk/publications/policy-statements/ps15-27-cash-savings-remedies-feedback-and-policy-statement-cp15-24

  • BCAP Code Rule 14.7 — Broadcast advertising of savings rates. Requires AER per the BBA/BSA Code (now Practice Note). https://www.asa.org.uk/type/broadcast/code_section/14.html

  • CAP Code Rule 14.3 — Non-broadcast advertising basis of interest calculation. https://www.asa.org.uk/type/non_broadcast/code_section/14.html

  • Consumer Credit Act 1974 — Confirmed: applies to lending/credit only, not savings deposits. Defines APR not AER. https://www.legislation.gov.uk/ukpga/1974/39