Every Product is identified based on its Balance Sheet Category as one of the following:
· Asset
· Liability
· Off-Balance Sheet
Topics:
This section describes the types of cash flows.
Topics:
· Mitigant Cash Flow or Collateral Cash Flow
· Principal and Interest Cash Flows
Account cash flows consist of inflows and outflows that occur from a particular account periodically under contractual terms. The account can be either an asset or a liability. For example, a bank could disburse a bullet loan where interest payments occur periodically, on say a quarterly basis, while the principal is repaid as a single bullet payment at the maturity of the loan. Also, a bank could disburse a loan on an EMI basis where both principal and interest are repaid in equal monthly installments across the life of the loan.
Mitigant or collateral cash flows are cash flows received from the underlying collateral given to the bank by its counterparty, provided, the ownership of the underlying collateral has been transferred to the bank. For example, if a bank has received bonds as collateral against a 5-year loan that it has disbursed, and if the ownership of the collateral is transferred to the bank, then the bank has the right to receive the periodic coupon payments on the underlying bonds till the maturity of the loan. If the ownership of the underlying collateral is not transferred to the bank, then the periodic coupon payments are not payable to the Bank but will remain with the owner of the collateral.
Similarly, in case of collateral posted by a bank to its counterparty, if the ownership of such an asset is transferred then the cash flows occurring on the collateral will not be considered by the bank during the encumbrance period of the collateral. If the ownership of the collateral is not transferred, then all cash flows from the underlying asset are considered by the bank for its computations.
Contractual cash flows could either be inflows or outflows. Inflows and outflows can occur for both assets and liabilities. For instance, a forward-starting liability transaction can have one or multiple inflows signifying the start of the transaction and one or multiple outflows including principal and interest payment signifying repayment of the liability.
These inflows and outflows are categorized based on the Cash Flow Type in the Account Cash Flows Staging table. An inflow is identified by the Cash Flow Type ‘I’. However, if the Cash Flow Type is ‘O’, then it is classified as an Outflow.
Further, these inflows and outflows are categorized as either Principal or Interest cash flows based on the Financial Element Code in the Account Cash Flows Staging table. If the Financial Element Code is ‘I’, then it is identified as an Interest Cash Flow. However, the Financial Element Code is ‘P’, then it is classified as a Principal Cash Flow.
OFS LRM considers both principal and interest cash flows based on user selection. Calculation of the impact of each business assumption on interest cash flows is supported in two ways:
· Business assumption values are applied to both principal and interest cash flows.
· Assumption values are applied to principal cash flows only and interest is approximated.
If you select the Include Interest Cash flow parameter in the Run Definition window as Yes, both principal and interest cash flows are taken considered for calculations. If you select the Approximate Interest parameter as Yes, then the business assumption is applied only to the principal cash flows, and the interest cash flows are approximated based on changes to the principal. If you select the Include Interest Cash flow parameter is selected as Yes and Approximate Interest parameter is selected as No, the business assumption values are applied to both principal and interest cash flows. However, this application depends on the manner in which the business assumption is defined as follows:
· If you have selected Cash Flow Type as a dimension in the business assumption and the dimension member as Principal, then the assumption is applied only to the principal cash flows.
· If you have selected Cash Flow Type as a dimension in the business assumption and the dimension member as Interest, then assumption impacts only Interest cash flows.
· If you have selected Cash Flow Type as a dimension in the business assumption and the dimension member as Principal and Interest, then the assumption is applied to both principal and interest cash flows.
· If you have not selected Cash Flow Type as a dimension in the business assumption, then the assumption is applied to both principal and interest cash flows.
If the Include Interest Cash Flow parameter is selected as No, only principal cash flows are considered and interest cash flows are ignored.
The procedure for approximating interest is as follows:
1. Obtain the principal and interest cash flows under contractual terms.
2. Bucket the contractual cash flows based on the user-specified time buckets while distinguishing between interest and principal cash flows in each time bucket.
3. Calculate the outstanding balance in each bucket under contractual terms. The outstanding balance in the first time bucket will be the EOP balance. The formula for calculating the outstanding balance for each subsequent bucket is as follows:
Where,
O/S Balance: Outstanding Balance
CF: Cash Flows
4. Apply the business assumption to estimate principal cash flows. For balance-based assumptions, this applies to the EOP balance. In case of cash flow-based assumptions, this applies to the principal cash flows in a given bucket.
5. Calculate the outstanding balance in each bucket under business-as-usual or stress terms. The outstanding balance in the first time bucket will be the EOP balance. The formula for calculating the outstanding balance for each subsequent bucket is as follows:
6. Calculate the impact on interest cash flows in each bucket under business-as-usual or stress terms as per the following formulas:
Illustration 1: Impact on Interest Cash Flows under Run-off Assumption
Run-off |
From Bucket |
To Bucket |
Assignment Method |
Assumption Unit |
Assumption Value |
Based On |
Product |
|---|---|---|---|---|---|---|---|
|
1-3 Months |
1-7 Days |
Selected |
Percentage |
10 |
Cash Flow |
Loan |
In the following Illustration both Principal and Interest are downloads.
Measure |
Contractual Cash Flows |
||||
|---|---|---|---|---|---|
Overnight |
1-7 Days |
8-15 Days |
16-30 Days |
1-3 Months |
|
Principal |
150 |
250 |
330 |
700 |
610 |
Outstanding Balance (Refer Point 3) |
2000 |
1850 (2000-150) |
1600 (1850-250) |
1270 |
570 |
Interest |
20 |
40 |
45 |
80 |
70 |
Measure |
Business Assumption |
||||
|---|---|---|---|---|---|
Overnight |
1-7 Days |
8-15 Days |
16-30 Days |
1-3 Months |
|
Assumption impacted Principal |
Nil |
(+) 61 |
Nil |
Nil |
(-) 61 |
Revised Principal CF (post business assumption) |
150 (150 + Nil) |
311 (250 + 61) |
330 (330+Nil) |
700 (700 + Nil) |
549 {610 + (-)61} |
Outstanding Balance (Refer Point 5) |
2000 |
1850 (2000 - 150) |
1539 (1850 - 311) |
1209 (1539-330) |
509 (1209-700) |
Interest (Refer Point 6) |
20 |
40 |
43.28 |
76.16 |
62.5 (70/570*509) |
Illustration 2: Impact on Interest Cash Flows under Growth Assumption
Run-off |
From Bucket |
To Bucket |
Assignment Method |
Assumption Unit |
Assumption Value |
Based On |
Product |
|---|---|---|---|---|---|---|---|
|
1-7 Days |
Overnight |
- |
- |
0 |
EOP Balance |
Loan |
|
|
16-30 Days |
Equal |
Percentage |
20 |
|
|
In the following Illustration, both Principal and Interest are downloads.
Contractual Cash Flows |
|
|---|---|
EOP Balance |
2000 |
Measure |
Contractual Cash Flows |
||||
|---|---|---|---|---|---|
Overnight |
1-7 Days |
8-15 Days |
16-30 Days |
1-3 Months |
|
Principal |
150 |
250 |
330 |
700 |
610 |
Outstanding Balance (Refer Point 3) |
2000 |
1850 (2000-150) |
1600 (1850-250) |
1270 |
570 |
Interest |
20 |
40 |
45 |
80 |
70 |
Measure |
Business Assumption |
||||
|---|---|---|---|---|---|
Overnight |
1-7 Days |
8-15 Days |
16-30 Days |
1-3 Months |
|
Assumption impacted Principal |
Nil |
-400 |
200 |
200 |
Nil |
Revised Principal CF (post business assumption) |
150 (150 + Nil) |
-150 {250 + (-) 400} |
530 (330+200) |
900 (700 + 200) |
610 (610 + Nil) |
Outstanding Balance |
2000 |
1850 |
2000 |
1470 |
570 |
Total Interest |
20 |
40 |
56.25 |
92.59 |
70 |
Change in Interest |
Nil |
Nil |
11.25 ( 56.25-45) |
12.59 |
Nil |
Illustration 3: Impact on Interest Cash Flows under Growth Assumption (Cash Flow based)
Run-off |
From Bucket |
To Bucket |
Assignment Method |
Assumption Unit |
Assumption Value |
Based On |
Product |
|---|---|---|---|---|---|---|---|
|
1-7 Days |
Overnight |
- |
- |
0 |
Cash Flow |
Loan |
|
|
16-30 Days |
Equal |
Percentage |
20 |
|
|
In the following Illustration, both Principal and Interest are downloads.
Measure |
Contractual Cash Flows |
||||
|---|---|---|---|---|---|
Overnight |
1-7 Days |
8-15 Days |
16-30 Days |
1-3 Months |
|
Principal |
150 |
250 |
330 |
700 |
610 |
Outstanding Balance (Refer Point 3) |
2000 |
1850 (2000-150) |
1600 (1850-250) |
1270 |
570 |
Interest |
20 |
40 |
45 |
80 |
70 |
Measure |
Business Assumption |
||||
|---|---|---|---|---|---|
Overnight |
1-7 Days |
8-15 Days |
16-30 Days |
1-3 Months |
|
Assumption impacted Principal |
Nil |
(-) 50 |
25 |
25 |
Nil |
Revised Principal CF (post business assumption) |
150 (150 + Nil) |
200 {250 + (-) 50} |
355 (330+25) |
725 (700 + 25) |
610 (610 + Nil) |
Outstanding Balance
|
2000 |
1850 |
1650 |
1295 |
570 |
Total Interest
|
20 |
40 |
46.41 |
81.57 |
70 |
Change in Interest |
Nil |
Nil |
1.41 |
1.57 |
Nil |
The application supports the inclusion or exclusion of interest cash flows based on the Run parameters selected by the user. This is also impacted by the inclusion or exclusion of cash flow type as a dimension in the business assumption. The next section details multiple scenarios with different combinations of parameters and their impact on interest cash flows.
Scenario 1: When Interest cash flows are approximated:
1. Do not include Cash Flow Type as a dimension in the business assumption (Principal + Interest will be considered).
2. In the Run Definition window:
a. Select Yes in Include Interest Cash Flow
b. Select Yes in Approximate Interest
In this scenario, only Principal cash flows will be impacted. Interest cash flows will be approximated based on the change to the principal.
Scenario 2: When interest cash flows are calculated without approximating interest:
1. Do not include Cash Flow Type as a dimension in the business assumption (Principal + Interest will be considered).
2. In the Run Definition window:
a. Select Yes in Include Interest Cash Flow
b. Select No in Approximate Interest
In this scenario, both Principal and Interest cash flows will be impacted.
Scenario 3: When interest cash flows are not considered for computation:
1. Do not include Cash Flow Type as a dimension in the business assumption (Principal + Interest will be considered).
2. In the Run Definition window, select No in Include Interest Cash Flow.
In this scenario, there is no impact on Interest cash flows as they are not considered for computation and reporting.
Scenario 4: When interest cash flows are approximated:
1. Include Cash Flow Type as a dimension and select Principal in the business assumption.
2. In the Run Definition window:
a. Select Yes in Include Interest Cash Flow
b. Select Yes in Approximate Interest
In this scenario, only the Principal will be impacted. Interest cash flows will be approximated based on the change to the principal.
Scenario 5: When the Principal is selected as a dimension:
1. Include Cash Flow Type as a dimension and select Principal in the business assumption.
2. In the Run Definition window:
a. Select Yes in Include Interest Cash Flow
b. Select No in Approximate Interest
In this scenario, the Principal will be impacted because only the Principal is selected as a dimension. There will be no change in the interest cash flow amounts.
The application buckets the cash flows at the granularity of the level 0 buckets specified as part of the selected time bucket. Once bucketed, the account cash flows are aggregated at the granularity of the combination of user-specified and mandatory dimensions selected as part of the Application Preferences window. Refer to the Mandatory Dimension Configuration section for more information. Cash flows are aggregated as part of the contractual Run, based on the dimensional attributes of each account. Further, business assumptions are applied to the aggregated cash flows and not at the individual cash flow level.
Cash flows, account balances, and other input data are captured and stored in terms of the natural currency of the account. The application converts cash flows and balances from its natural currency to the local or reporting currency based on the prevailing spot rates or forward rates, as specified by you. Local currency is provided for each legal entity as a download while the reporting currency is selected at the time of Run execution.
The features of currency conversion in the LRM Application are as follows:
· Option to select forward exchange rate or spot rate for currency conversion.
· The forward exchange rate is interpolated to the cash flow date using linear or log linear interpolation method, as specified by you.
· If a direct quote between currencies is not available then an indirect quote is used. For currency pairs that do not have a quotation against each other, either direct or indirect, the cross-exchange rate is calculated using the direct quotes available against US Dollar (USD) for each currency, as USD is considered as the base currency in each quote. The base currency can be configured in the SETUP MASTER table.