The Manual Reassignment step in the Stage Determination run has to undergo approval processes before the values can be used in ECL Run. Only those Manual Reassignment changes that are approved by the Checker will be used in ECL Run. Any overridden values in the Draft, Pending approval, the Rejected status will not be considered. The ECL Run uses the results from the Manual Reassignment process with any Approved changes.
The ECL process computes the Expected Credit Loss, including the Allowance and Provision values. Generally, the Allowance is calculated for the drawn amount and the Provision is calculated for the Undrawn amount.
There are five major ready-to-use Methodologies available in the product. You can choose the methodology that is applicable for every set of accounts or instruments based on the Customer Type, Product Type, and Default status (the rule can be modified to include any combination of dimensions). The five ready-to-use methodologies are:
· Cash Flow
· Forward Exposure
· Provision Matrix
· Specific Provision
· Roll Rate
Similarly, there are four submethods applicable for accounts in each of the stages (Stage 1, Stage 2, and Stage 3 plus POCI) within these methodologies. Stage one calculates the ECL for 12 months whereas all the other three stages, stage two, stage three, and stage four, calculate the ECL for a lifetime, but use different calculation approaches.
Collective Assessment: The ECL run can also determine the stage, collectively, at an aggregated level. For more information about collective assessment, see the Collective Assessment section.
For ECL calculation:
· Segments, via the Segmentation Run and applicable only for the Roll Rate methodology.
· Account Classification and Stage, via the Classification & Stage Determination Run.
· EIR, depending on the methodology.
· Transition matrices, either via the Historical Transition matrix run or UI, and applicable only for Roll Rate methodology.
· Loss rates (via the Historical Loss rate run, and applicable only for Roll Rate methodology), PD term structure (either as download or through execution of PD Model), and LGD Values, as a download, are required.
The methodology selection is dependent on three factors, which are, Customer Type, Product Type, and Defaulted Flag. The bank can modify the methodology selection process by either adding more parameters or modifying the existing ones. Based on these parameters, a different methodology can be assigned to different accounts, products, and so on.
The Cash Flow method makes use of the Contractual Cash Flow, taking into consideration any prepayments, behavior patterns, and so on. The Contractual cash flow is adjusted for Probability of Default (PD) and Loss Given Default (LGD) to compute the Expected Cash Flow (ECF).
The first step in the cash flow methodology is to validate if the contractual cash flows are available for the specific account. The Contractual cash flows can either be generated by the engine or obtained as a download.
NOTE:
If the Cash Flow is not available, the account is processed through the Provision Matrix methodology.
Before following the Contractual Cash Flow method, ensure that the following prerequisites are met:
· Contractual Cash Flows are expected to be available before the ECL computation process is executed. It can be either generated by Oracle's Cash Flow engine or by an external engine or provided as a download. While providing cash flow as a download in Stage Account Cash Flows, a given financial element must not be repeated for an account and cash flow date combination. For example, for any particular cash flow date, there can only be one Principal and Interest Cash Flow each.
The internal cash flow engine used is common across other OFSAA applications. For more details about Oracle's Cash Flow engine, see the OFS Asset Liability Management User Guide.
· PD and LGD values are expected either as a model output from the models hosted in the Enterprise Modeling Framework or directly as an input.
· PD Interpolation Batch.
There are two distinct ways of calculating the ECL under the Cash Flow method depending on how the undrawn portion of a financial instrument is treated. They are:
· Calculation of ECL with Undrawn amount modeled within the Contractual Cash Flows
· Calculation of ECL with Undrawn amount treated separately and outside the Cash flow approach
The following sections detail the ECL calculation for accounts in any of the 4 types, that is the 3 stages and POCI accounts, both with and without undrawn amount.
Stage One Accounts
For accounts in Stage 1, the ECL is computed by considering the cash flows for the entire life of the instrument but only considering the 12-month Probability to default. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The values of Contractual Cash flow and Expected Cash flow are used to calculate the Cash Short Fall.
The ECL is calculated as the Net Present Value of Cash Short Fall.
The Effective Interest rate (EIR) is used for discounting while calculating the ECL.
NOTE:
The PD for 12 months or 1 year is considered for accounts in Stage one.
Stage Two Accounts
For accounts in Stage 2, the ECL is computed by considering the cash flows and the Probability to default for the entire life of the instrument. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The values of Contractual Cash flow and Expected Cash flow are used to calculate the Cash Short Fall.
The ECL is calculated as the Net Present Value of Cash Short Fall.
The Effective Interest Rate (EIR) is used for discounting while calculating the ECL.
NOTE:
The PD for the lifetime or until the maturity of the account is considered for accounts in Stage two.
Stage Three Accounts
For accounts in Stage 3, the ECL is computed by considering the cash flows and the PD for the entire life of the instrument. Here the calculation slightly differs from that of Stage 2 accounts. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The Net present value (NPV) of Expected Cash flows is computed.
The ECL is calculated using the Carrying Amount and Net Present Value (NPV) of ECF.
The Effective Interest Rate (EIR) is used for discounting while calculating the ECL.
NOTE:
The PD for the lifetime or until the maturity of the account is considered for accounts in Stage Three.
For POCI Accounts
For POCI Accounts, the ECL is computed by considering the cash flows and the PD for the entire life of the instrument. The contractual cash flows are adjusted for PD and LGD to compute the Expected Cash flows. The values of Contractual Cash flow and Expected Cash flow are used to calculate the Cash Short Fall.
NOTE:
The PD for the lifetime or until the maturity of the account is considered for POCI accounts.
After calculating the Contractual Cash Flow, the ECL is calculated as the Present value of Cash Shortfall adjusted for the ECL on Date of Initial Recognition.
For POCI Accounts, instead of EIR, the credit adjusted EIR is used for discounting, while calculating the ECL.
NOTE:
The PD values used in the Cash flow methodology are Cumulative values.
Assigning the PD Values for Each Cash Flow Date or Bucket
The PD assignment happens within the ECL run as part of the Cashflow or forward exposure methodology. The cumulative PD matching the account's Term structure ID, Account's Rating, or DPD, and the bucket number is populated against the account's cash flow - based on the cash flow's bucket.
NOTE:
If Cash Flows are provided as a download, via the stage account cash flow table, a single row for principal and interest cash flow each must be provided, on any cash flow date.
The forward exposure methodology involves the computation of the Forward Exposures, that is, forward-looking Exposure at Defaults or Forward EADs, at a different point in time in the future till the maturity of the instrument and then compute the Expected Credit Loss from them. The Forward Exposure values are calculated by the application using the Contractual cash flows, which can either be generated by Oracle's CFE or by an external engine.
The application also has a feature to obtain Forward Exposure values and the corresponding forward dates directly as a download. If both Cash Flows and Forward Exposure values are not available, then the account is processed through the Provision Matrix methodology.
This section details the steps involved in forwarding Exposure calculation for various stages.
Forward Exposure on each cash flow date is calculated from the cash flows generated or obtained as a download. The LLFP application calculates the Forward Exposure on each cash flow date as the Net present value of all future and current cash flows, discounted using the Effective Interest Rate (EIR) of the account or Cohort. Forward exposures are calculated till the last cash flow of the account.
Stage One Accounts
For Stage 1 accounts, the forward exposures up to the maturity or life term of the account are considered but only the 12 month PD is taken into account. The Per Period Loss is calculated from the Forward exposure, PD, and LGD values.
NOTE:
The Marginal PD for 12 months or 1 year is considered for Stage one accounts.
After calculating the Per Period Loss, the ECL is calculated as the present value of Per Period losses.
The Effective Interest Rate (EIR) is used for discounting while calculating the ECL.
Stage Two accounts
For Stage 2 accounts, the forward exposures and the PD up to the maturity of the account are considered. The Per Period Loss is calculated using Forward Exposure, Marginal PD, and LGD.
NOTE:
The Marginal PD for an entire lifetime of the account is considered for Stage Two accounts.
After calculating the Per Period Loss, the ECL is calculated as the Present value of Per period losses.
The Effective Interest rate (EIR) is used for discounting while calculating the ECL.
Stage Three accounts
The Forward Exposure approach for accounts in Stage 3 is similar to that of Stage 2.
POCI accounts
For POCI accounts, the forward exposures and the PD up to the maturity of the account are considered. Per Period Loss is calculated using the Forward Exposure, Marginal PD, and LGD.
NOTE:
The Marginal PD for the entire lifetime of the account is considered for POCI accounts.
After calculating the Per Period Loss, the ECL can be calculated as the Net Present Value of Per Period Losses adjusted for the Expected Credit loss as of Initial recognition.
The Credit adjusted EIR is used for discounting while calculating the ECL.
Assigning the PD Values for Each Cash Flow Date or Bucket
The PD assignment happens within the ECL run as part of the Cashflow or forward exposure methodology. First, the cumulative PD matching the account's Term structure ID, Account's Rating, or DPD, and the bucket number is populated against the account's cash flow - based on the cash flow's bucket. Next, based on the current and previous bucket numbers, the difference in the period, the marginal PD values are computed.
The LLFP application calculates the Forward Exposure on each cash flow date as the Net present value of all future and current cash flows, discounted using the Effective Interest Rate (EIR) of the account or cohort. The discounting period is as per the Cash flow dates and not as per the buckets.
That is, Forward Exposure on each cash flow date is calculated as the Sum of Present Value of all the Future Cash Flows and the Current date Cash Flow, that is, Cash flow corresponding to that date.
The forward exposures are then adjusted for PD and LGD to calculate the Per Period losses and the Expected Credit Loss of the account.
Present Value of Cash Flows in FSI_ACCOUNT_INCEPTION_RATES table is computed during EIR computation. If the EIR is obtained as a download, the PV of cash flows is also expected as a download. These values need to be updated in the FSI_ACCOUNT_INCEPTION_RATES table, for all features dependent on this value.
The Provision Matrix subprocess is separated into two tasks:
· Allowance Calculation
· Provision Calculation
In the Allowance Calculation task, the application uses the Provision Matrix method to calculate the Allowance for all accounts classified under the provision matrix methodology and accounts for which Allowance calculation was skipped by previous methods. This calculation is done on the Carrying Amount or the drawn amount. That is, the Allowance calculation is formulated using Carrying Amount and Provision Rate.
In the Provision Calculation task, the application uses the Provision Matrix method to calculate the Provision for all accounts that have an undrawn portion. This calculation is done on the undrawn amount. The Provision is calculated using Undrawn Amount, Credit Conversion Factor (CCF), and Provision Rate.
The provision matrices are provided by the banks as input into the staging tables. These provision matrices provide the provision rate that is applicable for a particular group of accounts based on the input factors associated with that account.
In the ready-to-use product, different Provision matrices are assigned to different groups of accounts based on the following factors:
· Customer Type
· Product type
Financial institutions must provide both Twelve-month and Lifetime provision rates.
For Corporates and Retail, there are different ways of assigning the Provision Rates.
The provision rates can be computed for different instrument groups based on the historical data and adjusted for forward-looking factors using the Enterprise modeling framework.
Assigning Provision Rates for Corporate accounts
The Provision Rates for Corporate accounts may be assigned using the ratings provided and the corresponding rates assigned are in percentage terms.
For example:
Rating |
12-month Provision Rate (in %) |
Lifetime Provision Rate (in %) |
|---|---|---|
AAA |
0.2% |
1% |
AA |
1% |
3% |
A |
1.1% |
5% |
BBB |
3% |
10% |
BB |
5% |
20% |
B |
9% |
30% |
CCC |
14% |
40% |
CC |
28% |
50% |
C |
35% |
60% |
D |
97% |
100% |
Assigning Provision Rate for Retail accounts
The Provision Rates for Retail accounts are assigned using Delinquency Past Due (DPD) bands and the rates are in percentage terms.
Dates (DPD) |
12-month Provision Rate (in %) |
Lifetime Provision Rate (in %) |
|---|---|---|
0-30 Days |
0.2% |
1% |
31-60 Days |
1.1% |
5% |
91-120 Days |
9% |
30 % |
The application uses Rules to determine the rates applicable for an account, based on the Stage, Product Type, and Customer Type. Rates are picked from matrices as in the examples provided.
The LLFP application calculates stage-specific ECL values for all accounts, as per the IFRS 9 guidelines. According to the guidelines, it is required to calculate the 12 months ECL for accounts in Stage 1 and Lifetime ECL for accounts in Stage 2, Stage 3, and for POCI accounts. Within the specific provision method, to distinguish between these stages, the application calculates the 12 month PD and Lifetime PD, from the given PD term structures.
For accounts in Stage 1, Allowance is calculated as the product of Carrying Amount, 12 Month PD, and LGD. Also, Provision is calculated as the product of Undrawn Amount, CCF, 12 Month PD, and LGD.
For accounts in Stage 2, Stage 3, or POCI accounts, Allowance is calculated as the product of Carrying Amount, Lifetime PD, and LGD. Also, Provision is calculated as the product of Undrawn Amount, CCF, Lifetime PD, and LGD.
The ECL is derived as the sum of Allowance and Provision.
The PD values are calculated from the interpolated PD term structures.
For accounts with Maturity greater than 12 months, four quarters, two half years, one year, and so on, the 12 Month PD corresponds to the Cumulative PD at the end of the 12th Month and the Lifetime PD corresponds to the Cumulative PD of the period corresponding to the account's maturity date.
For accounts with Maturity less than 12 Months, the 12 Month PD and the Lifetime PD both correspond to the Cumulative PD of the period corresponding to the account's maturity date.
NOTE:
Both the 12 Month PD and the Lifetime PD are calculated for all accounts irrespective of the stage. This is required to compute both the 12 Month and Lifetime Expected Credit Losses, however, only one among those is used for reporting, depending on the Stage.
The LGD value that is used in the Specific Provision method is obtained from the interpolated LGD term structure. The input LGD term structures are processed to calculate the LGD values at the bucket frequency. This processing is applied for accounts under the Specific Provision methodology as well. After the LGD term structures are processed, each account is associated with an LGD value against the current period. As mentioned in the section on LGD processing, the current period value corresponds to the 0th period or the 0th bucket.
This value, corresponding to the zeroth period or bucket, is assigned as the LGD value that is used in the Specific Provision method.
The 12 Month PD, Lifetime PD, and LGD values are stored for reporting.
The roll rate methodology involves the computation of the Default Roll Rate and the Gross loss rate for an account based on the given Rating or Delinquent days band and its maturity.
NOTE:
To compute the ECL through the roll rate methodology, it is required to execute the Segmentation, Historical Transition Matrix, and Historical Loss Rate runs. If the Transition Matrices are provided as a download, the Historical Transition Matrix Run can be ignored.
The Expected Credit Loss of an account is computed as follows:
· 12 Month Allowance = Outstanding Amount * 12-month DRR * Gross Loss Rate
· Lifetime Allowance = Outstanding Amount * Lifetime DRR * Gross Loss Rate
· 12 Month Provision = Undrawn Amount * CCF * 12-month DRR * Gross Loss Rate
· Lifetime Provision = Undrawn Amount * CCF * Lifetime DRR * Gross Loss Rate
During the Expected Credit Loss Run, the system computes the Roll Rate of an account by projecting the given transition matrices, computed or created through UI - as selected by you, into the future until the maturity of an account using the matrix multiplication process.
The probability of an account moving into the default rating on maturity from the current rating as of the given MIS Date is considered as the Default Roll Rate.
In the case of a 12-month computation, the matrix is projected only for a 12 month (or 1 year) period, depending upon the matrix frequency.
You can either execute the Historical Transition Matrix Run or use the Transition Matrix UI to generate a Transition Matrix. For more information about generating Transition Matrix through UI, see the Transition Matrix Definitions section.
During the Expected Credit Loss run, the gross loss rate is computed as the average of the historical loss rates over a given period. The period over which the average is taken is based on the preferences set in the Application Preference table.
The Historical Loss Rate run needs to be executed for the calculation of the Gross Loss Rate.
The Collateral Value Based (CVB) method enables allowance computation for collateral-dependent assets as per CECL requirements. Computation of allowance for credit loss for collateral dependent assets are performed using the following steps:
Identification of collateral dependent financial asset: Following conditions must be met to set the collateral dependent loan flag to Yes:
Threshold, the value of collateral post adjustment for Haircut and Recovery Cost, must be more than 70% of the book value, this is required to meet the Substantial criteria. Also, DPD for Retail Portfolio must be greater than 90 days, for DPD for Wholesale Internal Rating Rank must be less than 20, or Credit Score for Retail Portfolio (Fico Score) must be less than 575, this is required to meet the financial difficulty criteria.
1. Computation of collateral value, adjusted for the cost to sell, if applicable: LLFP computes the adjusted value of the collateral based on the following formula - Adjusted Collateral Value = {(1-Haircut)*Collateral Value-Recovery Cost}.
2. Computation of amortized cost of the financial asset: Amortized cost is calculated based on the following formula - Amortized Cost = (N_CARRYING_AMOUNT_RCY-((N_FEES_EIR+N_DEFERRED_CUR_BAL)*N_RCY_CONVERSION_FACTOR))).
3. Computation of allowance for credit loss: The allowance is computed based on the following formula - If Adjusted Collateral Value is greater than or equal to the Amortized Cost of the financial asset, then Allowance is calculated as zero. Otherwise, Allowance is calculated as the difference between the Amortized Cost of the financial Asset and Adjusted Collateral Value.
Mitigant Effect on Expected Credit Loss enables you to calculate the Effective Loss Given Default (ELGD). The ELGD is calculated as the product of LGD and the Mitigant Effect. Mitigant Effect is calculated using the following formula:
Mitigant Effect = {(Exposure - ((1- HairCut for Collateral)*Collateral Value) + Recovery Cost) or Exposure}
Specific Provision and Forward Exposure methods used for Expected Credit Loss (ECL) calculation in OFS Loan Loss Forecasting and Provisioning application are in the scope of the Mitigant Effect.
Specific Provision uses Effective LGD at the bucket frequency to obtain the reduced ECL due to Mitigant Effect. For this, the application expects the LGD value as a download.
In Forward Exposure Method, the Mitigant term structure is expected as download and the Haircut value is assumed to be constant.
To enable the calculation of both 12 months and Lifetime ECL, with the primary difference being the Probability of default values computed against each of these, the run-in LLFP application now computes two different calculations starting from the PD computation step.
The Data Model has also been enhanced to capture all intermediate computations which enable this feature.
The following processes are involved in this calculation:
· PD Interpolation: The PD interpolation process computes both 12 Month Cumulative PD and Lifetime Cumulative PD before populating the same against corresponding Cash flow or Forward Exposure.
· Marginal PD computation: In the case of Forwarding Exposure methodology, both 12 Month and Lifetime Marginal PDs are computed against each cash flow or forward exposure date.
· Expected Cash Flow Rate and Expected Cash Flow Calculation: The Expected Cash Flow rate and the Expected Cash flows are computed for both the 12 Month and the Lifetime PD values against each cash flow date.
· Cash Shortfall Calculation: The Cash Shortfall is computed for both the 12 months and Lifetime Expected Cash Flows against each cash flow date.
· Per Period Loss Computation: The Per Period Loss is computed for both the 12 month and Lifetime values against each Forward Exposure date.
· Present Value of Expected Cash Flow and Cash Shortfall calculation: The present values of Cash Shortfall and Expected Cash flow parameters are computed for both the 12 Month and Lifetime components.
· Present Value of Per Period Loss: The present value of Per Period Loss is computed for both the 12 Month and Lifetime components.
· Provision Matrix Assignment: Every account is assigned with a Provision Matrix, based on the Provision Matrix assignment rule. To enable the assignment of a 12 month and Lifetime Provision rate, the rule needs to change as highlighted in the subsequent section of this requirement.
· Provision Rate Assignment: The provision Rate Assignment is enhanced to populate both 12 months and Lifetime Provision rate against each account based on the Rating or DPD band of the account and the Matrix assigned to it.
· 12 Month and Lifetime PD computation - Specific Provision
· Expected Credit Loss calculation - Cash Flow and Forward Exposure: This step entails the calculation of both the 12 Month and Lifetime Expected Credit loss from the 12 month and Lifetime Cash Shortfalls or Per Period losses respectively.
The Provision matrix data model holds both Twelve-month as well as lifetime provision rates against each Rating or DPD bands, within a matrix. To compute the 12 month and Lifetime losses through a Provision matrix approach, it is required to provide both the 12-month provision rate as well as the Lifetime rate, for each combination, that is, each Rating or DPD band.
The ready-to-use Provision Matrix assignment Rule considers Product Type and Customer Type but may be reconfigured to consider other requisite account dimensions, Stage as a source dimension is not required, to assign a Provision Matrix.
After the consolidated ECL is calculated through any one of the multiple methodologies available, the Allowance and Provision values are determined. The Allowance and Provision values are calculated based on the Drawn and Undrawn portions of the accounts. For every Product type and Customer type, the application checks whether the Undrawn flag is Y or N. A Rule namely, the Undrawn Flag Assignment Rule handles the flag set for the Undrawn portion.
Under Cash Flow or forward Exposure methodology, depending on the inclusion of the undrawn portion in either the Cash flow or Forward exposure, the Expected Credit Loss value is apportioned as Allowance and Provision values, considering the carrying amount.
The Undrawn Flag Assignment Rule performs the check for the Undrawn flag across all the methodologies. After the check, depending on the value of the Undrawn flag, the following calculations are made:
· If the Undrawn flag is Y and the ECL > Carrying Amount, then:
§ Allowance = Carrying Amount
§ Provision = ECL - Carrying Amount
· If the Undrawn flag is Y and the ECL < Carrying Amount, then:
§ Allowance = ECL
§ Provision = 0
· If the Undrawn flag is N and the ECL > Carrying Amount, then:
§ Allowance = Carrying Amount
· If the Undrawn flag is N and the ECL < Carrying Amount, then:
§ Allowance = ECL
If the Undrawn flag is N, the Provision is calculated using the Provision Matrix method.
· Cash Flow and Forward Exposure - when Undrawn Flag is Y or N the 12 Month and Lifetime Allowance is computed as follows:
§ 12 Month Allowance = IF (12 Month ECL > Carrying Amount, Carrying Amount, 12 Month ECL)
§ Lifetime Allowance = IF (Lifetime ECL > Carrying Amount, Carrying Amount, Lifetime ECL)
· Cash Flow and Forward Exposure - when Undrawn Flag is Y the 12 Month and Lifetime Provision is computed as follows:
§ 12 Month Provision = IF (12 Month ECL > Carrying Amount, 12 Month ECL - Carrying Amount, 0)
§ Lifetime Allowance = IF (Lifetime ECL > Carrying Amount, Lifetime ECL - Carrying Amount, 0)
· Cash Flow and Forward Exposure - when Undrawn Flag is N the 12 Month and Lifetime Provision is computed as follows:
§ 12 Month Provision = Undrawn * CCF * 12 Month Provision Rate
§ Lifetime Provision = Undrawn * CCF * Lifetime Provision Rate
· Provision Matrix Approach - when Undrawn flag Y or N the 12 Month and Lifetime Allowance and Provision are computed as follows:
§ 12 Month Allowance = Carrying Amount * 12 Month Provision Rate
§ Lifetime Allowance = Carrying Amount * Lifetime Provision Rate
§ 12 Month Provision = Undrawn * CCF * 12 Month Provision Rate
§ Lifetime Provision = Undrawn * CCF * Lifetime Provision Rate
· Specific Provision - when Undrawn flag Y or N the 12 Month and Lifetime Allowance and Provision are computed as follows:
§ 12 Month Allowance = Carrying Amount * LGD * 12 Month PD
§ Lifetime Allowance = Carrying Amount * LGD * Lifetime PD
§ 12 Month Provision = Undrawn * CCF * LGD * 12 Month PD
§ Lifetime Provision = Undrawn * CCF * LGD * Lifetime PD
· Expected Credit Loss Calculation
For all accounts, the 12 Month and Expected Credit Loss is calculated as follows:
§ 12 Month ECL = 12 Month Allowance + 12 Month Provision
§ Lifetime ECL = Lifetime Allowance + Lifetime Provision
· Apportioning ECL, Allowance, and Provision values from Cohorts to Individual accounts
The apportioning of all following the six parameters are performed:
§ 12 Month values of ECL, Allowance, and Provision
§ Lifetime values of ECL, Allowance, and Provision
· Computation of final Reporting Values
The Reporting ECL, Reporting Allowance, and Reporting Provision values are computed as follows:
IF STAGE = 1
§ Reporting ECL = 12 Month ECL
§ Reporting Allowance = 12 Month Allowance
§ Reporting Provision = 12 Month Provision
IF STAGE = 2 or 3
§ Reporting ECL = Lifetime ECL
§ Reporting Allowance = Lifetime Allowance
§ Reporting Provision = Lifetime Provision
The bucket-wise LGD values are assigned to the corresponding cash flows using the bucket ID stamped against those cash flows.
The final ECL is computed from Allowance and Provision values as mentioned in the previous section. The Impairment Gain or Loss for the current period is computed by comparing the current reporting date's Allowance and Provision values with the previous reporting dates' Allowance and Provision values.
Impairment Gain or Loss = (Current Allowance + Current Provision) - (Previous Allowance + Previous Provision) + Current Write-off - Current Recovery
Dedicated transaction-based tables are introduced for Write-offs and Recovery. As a result, the incremental values between individual periods are calculated, instead of calculating the cumulative values from the start date to the end date.
The Collective Assessment feature of the IFRS 9 Run of LLFP application enables you to form Cohorts (that is, group a set of accounts) based on various parameters or dimensions such that, accounts with similar characteristics are grouped and treated uniformly as a single account while determining the stage as well as computing the Expected Credit Loss (ECL) values.
The Cohort Formation or Collective assessment feature as part of the ECL run of the LLFP application addresses the following two aspects:
· Treat accounts with similar (Risk) characteristics in a similar manner
· Improvement in Performance by reducing the total number of records to be treated
The application enables Collective Assessment by following the subsequent processes:
· Dimensions and filters that define the eligibility of accounts to form Cohorts - Records satisfying these dimensions are eligible to form Cohorts (groups).
· Dimensions that define the Formation of Cohorts - These dimensions decide which set of records form a group and also in that sense decide the total number of groups as well.
· Cohort level Parameters for ECL calculation - Arrive at values for Parameters, associated with the Cohort, that is required for ECL calculation. This includes grouping cash flows or forward exposures, PD, and LGD.
· ECL Calculation for Cohorts - using any of the methodologies
· Apportion calculated metrics - Redistribute the metrics or values calculated at the cohort level to individual accounts.
· Maintain Audit trail - Store the cohorts formed during the run for future reference.
The system stores the Minimum number of accounts that are required for a cohort to be formed as a setup parameter - MIN_ECL_COHORT_SIZE. This is to prevent the formation of groups with fewer accounts, thereby creating a large number of small-sized cohorts, which eventually leads to an increase in processing time and a decrease in accuracy. In the ready-to-use product, the MIN_ECL_COHORT_SIZE parameter is set to 50.
One preprocessing step required is to arrive at the Remaining Time to Maturity band for each account, with each band having a six-month gap. The remaining time to maturity band for the accounts is calculated as the difference between MIS Date and the Original or Revised maturity date.
If the Revised Maturity date is available, Time to Maturity = Revised Maturity Date -MIS Date else Time to maturity = Original Maturity Date -MIS Date.
The calculated Time to Maturity is then converted to a specific band.
The next step in the process decides the set of accounts that are eligible to form Cohorts. Following are the two eligibility types:
· Filters
The filters decide the set of accounts that are eligible to form groups or Cohorts and are mandatory. Accounts are filtered based on the following factors:
§ Stage: 1 and 2
§ Default Flag: N
§ Impaired Flag: N
· Eligibility Dimensions
The following filters are based on an extendable rule with a default set of dimensions that allow you to decide which set of accounts are eligible to form cohorts. By default the following dimensions are considered:
§ Basel Customer Type
§ Basel Product Type
§ Methodologies
You can add or modify the list of dimensions.
The application creates Cohorts, based on homogeneous values across the following dimensions. The total number of Cohorts formed is equal to the total number of such unique combinations across these dimensions. However, if the number of accounts in any Cohort is less than the minimum size set in the parameter ECL_MIN_COHORT_SIZE, the Cohort is disbanded and all related accounts are treated individually.
The dimensions considered to group Cohorts are the following:
· Basel Customer Type
· Basel Product Type
· IFRS Stage
· Methodology
· Cash Flow Undrawn Flag
· Current Internal Rating for non-Retail accounts or DPD Band for Retail accounts
· Time to Maturity band
· Currency
The Cohort-level parameters, required for ECL calculation, are determined using the parameters of the accounts belonging to that Cohort. This is determined in two steps:
The first step includes identifying the parameters or values for dimensions that define the formation of a Cohort; these values are unique across all the accounts of a Cohort.
The second step includes identifying the parameters or values for dimensions that are derived from the account level values these values differ across the accounts of a Cohort and logic is used to arrive at Cohort level values, for example, Sum, weighted average, and so on.
· Step 1: Dimensions used for Cohort Formation are the following:
§ Basel Customer Type
§ Basel Product Type
§ IFRS Stage
§ Methodology
§ Cash Flow Undrawn Flag
§ Current Internal Rating for non-Retail accounts or DPD Band for Retail accounts
§ Time to Maturity band
§ Currency
For these dimensions or parameters, the unique values of each Cohort formed are populated as the value against this Cohort.
· Step 2: Other parameters required for ECL Calculation are the following:
The other set of parameters that are specific to ECL calculation and the values are arrived at a group level using the logic, as provided in the following table:
Columns |
For Cohort |
Formula |
|---|---|---|
Account Start Date |
Y |
MIN |
Original Maturity Date |
Y |
MAX |
Revised Maturity Date |
Y |
MAX |
Cash Flow Undrawn Flag |
Y |
As per Cohort |
Collective Individual Flag |
Y |
G |
Basel Asset Class |
Y |
As per Cohort |
Basel Customer Type |
Y |
As per Cohort |
Basel Product Type |
Y |
As per Cohort |
Carrying Amount in Natural Currency |
Y |
Sum |
CCF Percent |
Y |
Average |
Counterparty Rating |
Y |
As per Cohort |
Delinquency Band |
Y |
As per Cohort |
IFRS Stage |
Y |
As per Cohort |
Issuer Rating |
Y |
As per Cohort |
LGD Percent |
Y |
Weighted Average |
ECL Computation Methodology |
Y |
As per Cohort |
MIS Date |
Y |
As per Run |
Run |
Y |
As per Run |
Undrawn Amount in Local Currency |
Y |
Sum |
Currency |
Y |
As per Cohort |
Remaining Maturity Band |
Y |
As per Cohort |
Grouping Contractual Cash Flows: In the case of a Cohort with Cash Flow methodology, the cash flows related to all accounts within the given Cohort are grouped based on the Bucket IDs assigned. All the cash flows of all related accounts are considered in this. At a bucket level, the Principal and Interest values of all related cash flows are summed up. After grouped, the bucket start date, bucket end date, or data corresponding to the middle of the bucket is assigned as the cash flow date for that specific bucket.
Weighted average Loss Given Default: The Loss Given Default of the Cohort is calculated as the weighted average of LGD values of individual accounts which are part of the Cohort.
NOTE:
The weighted average of Cohorts is done at a term structure level.
Weighted average Effective Interest Rate: The Effective Interest rate of the Cohort is calculated as the weighted average of EIR values of individual accounts which are part of the Cohort.
Grouping Forward Exposures: If a Cohort has been assigned with a Forward Exposure methodology, the forward exposure values related to all accounts within the given Cohort are grouped based on the Bucket IDs assigned earlier. All the Forward Exposures of all related accounts are considered for this. At a bucket level, the forward exposures are summed up. After grouped, the bucket start date, bucket end date, or the data corresponding to the middle of the bucket is assigned as the cash flow date for that specific bucket. For more information about the Forward Exposure method, see the Forward Exposure section.
Once the preceding steps are performed, the Cohorts are treated as individual accounts and the ECL values are computed based on the methodology that has been assigned to each Cohort.
Once the Expected Credit Loss, Allowance, and Provision values for the Cohorts and individual accounts are computed, the Cohort level values are apportioned back to each account that is part of every Cohort. While apportioning the values, the carrying amount of each account is considered as the weighing factor.
To ensure that the reporting layer does not treat the Cohorts as separate accounts and to maintain data for audit purposes the Cohorts and the corresponding values are copied into another table, Collective Assessment, and then are removed from the Account Details fact table.
The LGD Term Structure feature in the LLFP application allows you to change the LGD values over different periods by reflecting the changes in Loan value, collateral value, lien, and so on at an account level granularity. This also helps in obtaining more accurate ECL numbers while calculating the lifetime losses.
The processing of LGD Term Structures has the following four phases:
· Obtaining LGD Data in Staging
· Movement of LGD Data into Processing
· Processing LGD Data as Required for ECL Calculation
LLFP application consists of a staging table to obtain the LGD term structures at an account level granularity, that is, every account is provided with a series of LGD values over a period of time at a specific frequency. However, within a series, the values must be of constant frequency. In certain cases, there could be accounts with only a single LGD value which assumes LGD is constant. The single LGD is considered as the current period LGD.
Because the LGD values are bound to change over every period, the term structure is expected to be given at every MIS Date.
The LGD Term Structures are transferred to the processing area and adjusted as required for ECL computations, simultaneously. While the LGD series, term structure, in the staging table could be at any given frequency, the same is converted to the bucket frequency and during this process, the number of periods for which the LGD values have to be calculated or interpolated and extrapolated is dependent on the time to maturity of the account.
The processing table contains the number of buckets as per the cash flow buckets in the Cash flow table, rounded to the nearest multiple of the LGD term structure frequency. For example, if the account has cash flows till the 45th Monthly bucket and the LGD term structure has four yearly periods, the number of periods in the LGD processing table is rounded off to 48.
NOTE:
Unlike PD; LGD does not start from Zero percentage from the initial period.
Interpolation of LGD for intermediate periods follows a linear interpolation method. Initially, the LGD of the current date, provided as the 0th period LGD, is considered. If there is no LGD against the 0th period, then the 1st-period LGD is made applicable to the 0th period. Then the LGD for the first period is taken into consideration and then the values are interpolated for the intermediate periods. The LGD for the first period applies to the last bucket of the first period and the LGD value for the second period applies to the last bucket of the second period. By using the linear interpolation technique, the LGD values are increased linearly from the 0th bucket to the last bucket of the first period and then further to the last bucket of the second period and so on.
In the case of any Cohorts being formed, a set of processed LGD term structures are created in the processing table corresponding to each of the Cohort. The number of periods or buckets for a given Cohort is the maximum value of those individual accounts which are part of that Cohort. For the Cohort related series, the LGD against each period (Bucket ID) is calculated as the weighted average of the individual LGD values against the corresponding bucket ID with the carrying amount of the account being used as the weight.
NOTE:
You need to load data to the LLFP LGD Term Structure Staging table.
In Scenario-based ECL Computation, Probability of Default, Loss Given Default, and Forward Exposures, through stage management forecasts, are provided for multiple scenarios. As the first step, you need to add the required additional scenarios in the Expected Credit Loss Scenarios table and modify the Probability Weights in such a way that the cumulative of all the weights is 100.
Subsequently, the PD Codes in the PD, LGD, and Forward Exposures tables must match with the values that you have defined in the Expected Credit Loss Scenarios table.
The number of different PD, LGD, and Forward Exposure sets must be equal to the number of Scenarios defined. While executing the ECL Run, OFS Loan Loss Forecasting and Provisioning application replicates the account information for the given number of Scenarios. For each set, the corresponding PD, LGD, and Forward Exposure values are used.
NOTE:
Scenario-based Forward Exposure is used only in the case of forwarding Exposure methodology, where Forward Exposure is obtained as a download. In the case of the Forwarding Exposure method where Forward Exposures are computed using Cash Flows, within the application, or Cash Flow methodology, the same set of Cash Flows are used, thereby making ECL across all Scenarios equal. Also, Roll Rate and Provision Matrix Methodologies yield the same ECL across all Scenarios.
Using the aforementioned different Scenarios, different ECLs are computed within the processing area. While moving data into the reporting structure, the weighted average of ECLs and other related values are computed based on the weights defined in the Expected Credit Loss Scenarios table.
NOTE:
For multiple scenarios, the existing data for an MIS Date from the PD Term Structure Detail, Periodic PD Rates, and Interpolated PD term tables must be removed. After this, the SCDs and Batches must be re-executed.
Following are the implications of using a Scenario-based ECL Computation method:
· Scenario-based ECL Computation is applicable only for Forward Exposure and Specific Provision methodologies.
· For Cash Flow, Roll Rate, and Provision Matrix methodologies, ECL for different Scenarios are the same.
· PD Model only generates a weighted average PDs. This may not be used for Scenario-based ECL Computations.
· ECL Reconciliation cannot be performed on ECL runs, which are Scenario-based.
· Performance for ECL is impacted.