As per IFRS 9 guidelines, financial institutions are required to recognize interest income using the Effective Interest Rate computed for the given instrument, instead of the Contractual Rate. Due to this change in the interest recognition process, in addition to the current practice of recognizing the interest using contractual rate, financial institutions are required to pass an additional adjustment entry - Interest Adjustment Entry to be compliant with the IFRS 9 guidelines.
OFS Loan Loss Forecasting and Provisioning application compute the interest adjustment entry based on the Effective Interest Rate, Instrument Details, and all transactions against the given instrument.
This also allows the financial institutions to amortize the fees, premiums or discounts, and costs associated with the given instrument over the expected life.
The EIR-based interest adjustment, Deferred Balance Amortization, process is executed post the computation of the Expected Credit Losses (ECL Run). Only those accounts that are classified as Amortized Cost and the ones identified for Fee Amortization are considered for this process:
· Amortized Cost Classification - This happens as part of the Classification Process or Run.
· Identifying Accounts for EIR Adjustment - This selection is enabled using a Rule within the Expected Credit Loss Run of the application.
These two filters help in identifying the accounts for which EIR-based interest adjustments have to be computed. Transactions related to Loans, Money Markets, and Investments are considered for EIR Based Interest Adjustments.
NOTE:
For initial execution, the IFRS Reporting Run Info table needs to be populated with the following default values:
V_BATCH_RUN_ID: -1
N_RUN_SKEY: -1
FIC_MIS_DATE: The current execution date for EIR Adjustment Run
LAST_ACCRUAL_DATE: The last accrual/execution date for EIR Adjustment Run
This section contains detailed information about the Effective Interest Rate (EIR) Based Interest Adjustments process.
Topics
Movement of Data into Processing Area
Identify and Obtain Information from Last Accrual Date
Transaction Level Data Population
Aggregation Account Level and Adjustment Computation
There are two processing areas, one for processing account-level information and the other for processing transaction-level information. Upon triggering the process, the given set of accounts along with the corresponding instrument information are moved from the results area of the ECL computation process into the account level processing area.
The various instrument parameters that are migrated are the fact tables:
· Account Number, Classification
· Stage
· Carrying Amount (As of Previous MIS Date)
· Deferred Fees (As of Previous MIS Date)
· Deferred Premium or Discount (Def Bal) (As of Previous MIS Date)
· Prepayment Indicator, Restructured Indicator, Accrual Basis Code
· Compounding Frequency
· MIS Date, Actual Interest Accrued Till Date (Core Banking Interest)
· PV of Future Cash Flow Discounted at EIR
· Account Start Date, Financial Year Start Date
· EIR (%), Allowance
· ECL DOIR, and New Account from the Account Summary Fact tables.
For the given Run ID, the Previous Execution Date is considered as the Last Accrual Date. Based on the Last accrual date, the following account level information is obtained:
· Ending Net Book Value or the Modified Net Book Value, based on the Modified Flag as of the Last Accrual Date.
· Compounded Interest
· Ending Deferred Balances
· Cumulative EIR Interest recognized till date (till Last Accrual Date)
· Cumulative Interest Adjustment recognized till date (Last Accrual Date)
If the account is new (originated between the Last Accrual Date and Current MIS Date), then these values are computed as follows:
· Book Value = First Transaction Amount + Deferred Balance (Fees + Premium or Discount - Cost of Interest Subvention)
· Compounded Interest = 0
· Ending Deferred Balances = Deferred Balance (Fees + Premium or Discount - Cost of Interest Subvention)
· Cumulative EIR Interest recognized till date (till Last Accrual Date) = 0
· Cumulative Interest Adjustment recognized till date (Last Accrual Date) = 0
NOTE:
During the initial Run, historical data for the last accrual date will not be available for computation. You need to ensure that historical data is manually populated for the last accrual date for each EIR-based adjustment Run that are available. The FSI EIR-based Income Adjustment Accounts (FSI_ACCT_EIR_ADJUSTMENT) table needs to be populated with this date. The last accrual date is the date from which interest adjustments have to be made for the initial Run.
Historical data needs to be populated to the columns of the FSI_ACCT_EIR_ADJUSTMENT table.
For the given accounts, the Transaction data is populated from the following Stage - Transaction tables to the Transaction Level Processing table - Transaction EIR Adjustment table. The following conditions are applied to filter and move the transactions:
· The transaction value date must fall between the Last Accrual Date and the MIS Date.
· All transactions with Canceling Indicator = Y and with Reversal Date not null are ignored.
· Transactions with Debit Credit indicator = C are made Negative while transactions with D are made positive.
For each account in Account Level, based on the compounding frequency, the Compounding Dates between the Last Accrual Date and Current MIS Dates are identified. For these compounding dates, additional transactions are included in the table with TXN Amount equal to ZERO. Compounding dates arrive from the Financial Year Start date. For example, if an instrument is compounding Monthly and the Financial Year start is 15-MMM-YYYY, the process will create a transaction on the 15th of every month. If the account has originated post the Last accrual date, then the compounding dates are considered between the Account Start date and the current MIS Date.
NOTE:
All financial transactions outflow or inflow are required; those that affect the outstanding and computation of interest.
Outflow > Loan Disbursement, Withdrawal, and so on.
Inflow > EMI, Prepayment, and so on.
If transactions are marked as reversed or canceled, the application.
The first transaction of a new account is assumed to be a Disbursement.
These Compounding Dates are marked with Compounding Flag = Y.
Once the transactions for the compounding dates are inserted, for every account, a transaction is included for a given MIS Date, the TXN amount is ZERO.
NOTE:
If a transaction already exists for a Compounding date, that is, Source TXN Date = Compounding Date, the same transaction is used with only the compounding flag made Y. If the transaction already exists for an MIS Date, that is, Source TXN Date = MIS Date, then no new transaction is included. If there are multiple transactions for a given date, then the values are added up to form a single transaction.
The transactions are then sorted in ascending order of Transaction Dates.
The transactions are now ready for Interest computation. Subsequently, the process parses through each of the transactions, one by one, to compute the Interest amounts for every transaction. To enable this, the process requires the following data:
· Accrual Basis Code
· Number of days
For the first transaction; Txn Date - Last Accrual date
For all subsequent transactions: Current Txn date - Previous Txn Date
· Starting Net Book value (for the first transaction):
If the Modification flag (on Last accrual date) = N; Ending Net Book Value (on Last Accrual date)
If the Modification flag (on Last accrual date) = Y; Modified Net Book Value (on Last Accrual Date)
After these steps, the Effective Interest Amount, Compounded Effective Interest Amount, and the Ending NetBook values are computed for each transaction, by taking EIR, Number of Days for Interest accrual, Accrual basis code (for Number of days in a year), Compounding Flag, Starting Book value, and Transaction amount into consideration.
Once the Ending Book value is computed for a given transaction, the same is used as the Beginning Net Book Value for the next transaction.
The Effective Interest Amount for different stages are calculated as follows:
· If Stage 1 or 2: EIR Interest Amount = NBV * Days * (EIR % or Days in Year)
· If Stage 3: EIR Interest Amount = (NBV - Allowance) * Days * (EIR % or Days in Year)
· If Stage 4: EIR Interest Amount = (NBV - Allowance - ECL DOIR) * Days * (EIR % or Days in Year)
The Compounded Effective Interest Amount is computed by compounding the interest computed for each transaction to the previous compounded amount. If the transaction is marked as a compounding one, that is, the Compounding Flag = Y, then the Compounded interest is made as ZERO. The total compounded interest to date will be added back to the Net Book Value.
The Ending Net Book value for each transaction is computed as:
If Compounding Flag = N, Ending Net Book Value = Starting Net Book Value + Transaction Amount
If Compounding Flag = Y, Ending Net Book Value = Starting Net Book Value + Transaction Amount + Effective Interest amount + Compounded Effective Interest Amount to date.
NOTE:
The transaction amount must be adjusted for signage depending upon Db Cr Indicator.
Once the transaction level computations are over, the final computed values are aggregated back to the account level for the final computations. The following values are considered:
· Ending Net Book Value: Value from the last transaction
· Effective Interest Amount: Sum of all Effective Interest Amounts across all transactions
· Compounded Effective Interest Amount: Value from the last transaction
Once the values are aggregated, the final computations to arrive at the Interest Adjustment are done.
· Step 1: The Cumulative Effective Interest Amount is calculated as the sum of the Current Effective Interest Amount and Cumulative Effective Interest Amount of the previous MIS Date.
· Step 2: The Cumulative Interest Adjustment is calculated by subtracting the Actual Interest Accrued to date, Core Banking Interest, from Cumulative Effective interest accrued to date.
· Step 3: The Current Interest Adjustment is calculated by subtracting the Cumulative Interest Adjustment of Previous MIS Date from Cumulative Interest Adjustment of Current MIS Date.
This value, Current Interest Adjustment, is the adjustment entry that needs to be passed to the accounting systems and reflects the amount of deferred balance that needs to be amortized for the given period.
In addition to the preceding steps, if an account undergoes a Prepayment or restructuring, the application computes the Modification Gain Loss, as specified by the IFRS 9 guidelines. The modification gain loss is calculated as the difference between the Modified Net Book Value and the Ending Net Book Value. Modified Net Book value is equal to the Net Present Value of all future cash flows discounted at the given Effective Interest Rate.
Prepayments and Restructuring are identified based on the Prepayment Date or Restructured date. OFS Loan Loss Forecasting and Provisioning application checks if these dates fall between Last Accrual Date and Current Date, FIC MIS DATE.
The Ending Deferred Balance for the current MIS Date is calculated by subtracting the Modification Gain Loss and Current Interest Adjustment from Ending Deferred Balance of Previous MIS Date.
As a continuation of Aggregation Account Level and Adjustment Computation and Ending Deferred Balance, the Interest Adjustment and the Ending Deferred balances are split up to compute the ending balances of the individual components. These components are, considered for the computation of Effective Interest Rate as well:
· Fee
· Premium or Discount
· Cost
The LLFP application first computes the ratio of Fee, Premium or Discount, and Cost based on their values as on the date of initial recognition of the given account. Using this ratio, the application then splits the Interest Adjustment into individual components. The result of this split is the individual adjustment values:
· Fee Adjustment
· Premium or Discount Adjustment
· Cost Adjustment
Post the computation of the individual adjustment values, the individual componentized ending deferred balances are computed by subtracting the individual beginning balances with their corresponding adjustment amounts.
NOTE:
Whenever the ending deferred balance becomes zero, the computation of interest adjustments is stopped forthwith.