This section provides information about the calculation of the effective interest rate.
IFRS 9 mandates the use of Effective Interest Rate (EIR) to discount to take into account the Time value of money. The guidelines also mandate the use of Origination date EIR for Fixed-rate accounts and Current date EIR for Variable rate accounts.
Additionally, the guidelines require the banks to use Credit Adjusted Effective Interest Rate (CAEIR) if any Purchase or Originated Credit Impaired (POCI) accounts. As mentioned, for fixed-rate POCI accounts, the Origination date Credit Adjusted EIR is used, and for variable rate accounts, the Current date Credit Adjusted EIR is used.
The LLFP application calculates the Effective interest Rates as applicable. The application also gives an option to provide the EIR value as a download.
NOTE:
EIR computation is applicable for products under ODs, Cards, Loans, Investments, Money Market instruments, Borrowing, Repo Contracts, Annuity Contracts, Term Deposits, Commitment Contracts, and Retirement Accounts. In the case of Leases, the Lease rate is used as the discount rate. And for Letter of Credits and Guarantees, the discount rate is provided as a download. These rates have to be provided as a download through the Account Inception Rates Stage table. The following details must be noted for EIR computation:
· Holiday Calendar is not supported for EIR Computation.
· Credit Adjusted EIR is not computed.
The computed EIR is dependent on the payment frequency, constant value, provided as part of the account details. In the case of patterns, the payment frequency for each cash flow date is equal to the number of days between the current cash flow date and the previous cash flow date or FIC MIS date.
If the value is provided as a download through the Account Inception Rates Stage table, then the application populates the same into the processing area.
In the case of a fixed rate account, the application checks the availability of the corresponding to the given Account ID as per the account start date (MIS Date = Account Start Date).
In the case of a variable rate account, the application checks the availability of the EIR corresponding to the given Account ID as per the given MIS Date.
NOTE:
If the EIR for the required data is not available in the Account Inception Rates table, then EIR on the MIS Date, which is nearest to the required data is used.
The following two approaches are used to compute the EIR within the application:
· Cash Flows Generated by Oracle's Cash Flow Engine
· Cash Flows Provided as Download
In this scenario, the application requires OFS Asset Liability Management (OFS ALM) as a prerequisite and you need to populate all the relevant columns mandated by the cash flow engine. For more information about the Asset Liability Management application, see the OFS Asset Liability Management User Guide in Oracle Help Center Documentation Library.
Also, there are certain columns required for computing the EIR as of Origination date, such as original deferred balances, and so on. These columns are identified in LLFP's download specifications.
Execution: You must use the EIR Preference window where you can identify the process created in the OFS ALM application to generate the cash flows (As-of-Date or Origination date). After the process(es) are identified, the relevant Batches need to be executed to compute EIR.
In this scenario, the application requires cash flows to be provided in the staging area and account-related attributes to be provided in the corresponding columns in the product processors.
Execution: The relevant Batches need to be executed to compute EIR.
NOTE:
When Cash Flows are provided as a download, the application computes EIR solely for assets and only cash in-flows are considered.
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.
NOTE:
If Cash Flows are provided as a download via stage account cash flow table, a single row for principal and interest cash flow each must be provided, on any cash flow date.
The EIR EIS Calculation Flag determines the need to recalculate the Origination Date EIR.
NOTE:
EIR as of the current date is computed every time, irrespective of the Flag.
· If the flag is Y in the Product Processor table, the application computes or recomputes the Origination Date EIR value.
· If the flag is NULL in the Product Processor table and the EIR is not available for the given account, then the application computes the same.
The application requires the following values for the calculation of EIR:
· If Cash Flows are given as download - Cash Flows as of Origination date for fixed-rate accounts and Cash Flows on As-of-Date for Variable rate accounts.
· If Cash Flows are to be generated by OFS ALM - Account related attributes (As required by OFS ALM's Cash Flow Engine).
Data Prerequisites for EIR Computation |
|||
|---|---|---|---|
Key Parameters |
Fixed-Rate |
Floating Rate |
|
Outstanding |
Original Outstanding |
Current Outstanding |
|
Cash Flows |
As of Origination Date |
As of the given date |
|
Fees (Applicable for EIR) |
Original Fees (as of origination) |
Deferred Fees (As of current date) |
|
Premium or Discount |
Original Premium or Discount |
Deferred Premium or Discount |
|
Cost |
Original Cost |
Deferred Cost |
|
Other parameters (for example, Payment Frequency, Current Rate, and so on) -Detailed data requirements are mentioned separately. |
Constant across both |
|
|
NOTE:
This table is only to indicate the Origination Date versus As of Date data requirements, for Origination date EIR and As of Date EIR.
The application first adjusts the outstanding amount with fees, specific to EIR, any premium or discount, and any cost. After this, the internal rate of return is computed using the adjusted outstanding amount and the Cash Flows.
To compute the As of Date EIR, you need the ending deferred balances which are computed in the EIR adjustment process. To enable this, after the execution of the EIR adjustment process, the end-of-period deferred balances, fee, premium or discount, and cost, have to be updated back to the staging area or FSI_D tables. The As of Date EIR process needs to be executed after this.
EIR engine is enhanced to capture the effect of additional fees or new fees received. Additionally, the calculation logic is modified for Floating Rate Instruments, by considering the Repricing Date.
Net Present Value (NPV) of Current Date Cash Flows are determined for both Fixed and Floating rate accounts. Then the Cash Flows are discounted using the EIR to compute the NPV. This Net Present Value of Cash Flows is used to compute Modification Gain / Loss. For more information about Modification Gain or Loss, see the Modification Gain or Loss section.
The EIR Preferences section enables you to select processes for Effective interest Rate (EIR) calculation. EIR is calculated using both Origination Date Cash Flows and As of Date Cash Flows and the Cash Flows are discounted over the life-cycle of the financial asset.
For EIR computation, be it Origination Date or As of Date, ALM is used to the extent of generating the cash flows. Subsequent calculation of EIR is only within LLFP. Therefore, it is required to set up the required Static Deterministic Processes within ALM, ideally, these can stop with cash flow generation.
After this, everything is controlled from inside LLFP. You will need to schedule or execute an LLFP-Engine - this engine will internally trigger the CFE; after the CFE completes, the cashflows are picked up and EIR is computed for each account.
NOTE:
There can be multiple ALM processes used for Cashflow Generation in LLFP. But for EIR calculations, there must not be any common instruments, source hierarchies, among the selected ALM processes in the EIR Preference window.
Once the required number of ALM processes are set up within ALM, the EIR Preferences section can be used to specify which ALM processes are used for As of Date and which are used for Origination Date.
You can access the EIR Preferences window by clicking Loan Loss Forecasting and Provisioning, then LLFP Maintenance, EIR Preferences link from the LHS menu of the application.
The EIR Preference window is displayed as depicted in the following figure:
Figure 7: The EIR Preference Window
For EIR calculation, the OFS Loan Loss Forecasting and Provisioning application provide you the option to select multiple processes. Various processes can be marked for Origination Date Cash Flows and As of Date Cash Flows.
NOTE:
You must ensure that the same set of account(s) is not included across multiple processes.
This section details the process of selecting processes from the list of available processes, in the OFS Loan Loss Forecasting and Provisioning application for the Origination Date Cash Flow process.
Perform the following procedure to select the required processes:
1. In the Origination Date Cash-flow Process table, click Add to open the Process Selection window.
Figure 8: The Process Selection Window
2. Populate the Process Selection form as tabulated.
Field |
Description |
|---|---|
Folder |
Select a folder from the drop-down list. |
Generate Cash Flow |
For Origination Date Cash Flows, this checkbox is selected by default. |
Process Selection |
Click Select adjacent to this field to select a process. |
3. Click Apply.
The selected processes are saved and are displayed under the Origination Date Cash-flow Process table.
This section details the process of selecting processes from the list of available processes, in the OFS Loan Loss Forecasting and Provisioning application for As of Date Cash Flow process.
Perform the following procedure to select the required processes:
1. In the As-Of-Date Cash-flow Process table, click Add to open the Process Selection window.
Figure 9: The Process Selection Window
2. Populate the Process Selection form as tabulated.
Field |
Description |
|---|---|
Folder |
Select a folder from the drop-down list. |
Generate Cash Flow |
For Origination Date Cash Flows, this checkbox is selected by default. |
Process Selection |
Click
Move |
3. Click the Apply.
The selected processes are saved and are displayed in the As-Of-Date Cash-flow Process table.
There are the following batches, which are used in EIR calculation, for Origination Date and As of Date:
· Batch Name: <Infodom>_LLFP_EIR_INST_DATA_POP
This Batch is for Origination Date Cash Flow Generation and EIR computation.
· Batch Name: <Infodom>_IFRS_AOD_CF_EIR
This batch is for Current Date Cash Flow Generation and EIR computation.
NOTE:
This batch expects the instrument data in all the FSI_D tables to be sliced and available in the DATA_SLICE_ID column. If the data is not sliced, then you need to update the value in the V_COMPONENT_VALUE column for the corresponding V_COMPONENT_CODE column in the LLFP_SLICE_COUNT table to the required number of slices.
· Batch Name: <Infodom>_LLFP_CF_EIR_INST_DATA_POP
This batch loads data from the product processor tables into the respective instrument tables (FSI_D_*).
When Cash Flows are provided as a download, you need to modify the Batch parameters. To know more about these modifications, see OFS Loan Loss Forecasting and Provisioning Run Chart in OHC Documentation Library.
To know more about Batches and Batch Execution, see the Operations chapter in the OFS Analytical Applications Infrastructure User Guide.
The behavior of the IFRS EIR engine is controlled by six execution properties present in the FSI_LLFP_LOOKUP_PROPS_EIR table. The parameter names are; PARALLEL_TABLES, NUM_EIR_THREADS, NUM_ACCOUNTS, OFSRM_EXECUTOR, EIR_CALC_SCRIPT, and IGNORE_CFE_ERROR.
Under CECL and IFRS 9 guidelines, Purchased Credit Deteriorated or a Purchased or Originated Credit Impaired instrument requires the computation of the EIR using a different approach. In the case of IFRS 9, this rate is called Credit Adjusted EIR.
· CECL: Effective Interest Rate is computed using Expected (Recovery) Cash Flows and Purchase Price adjusted for deferred balances. Additionally, the application computes a non-credit discount.
· IFRS 9: Credit Adjusted Effective Interest Rate is computed using Expected (Recovery) Cash Flows and Purchase Price adjusted for deferred balances. Additionally, the application computes a non-credit discount.
This EIR is used to discount the Cash Flows for the computation of ECL and interest recognition.
The application first adjusts the outstanding amount with fees, specific to EIR, any premium or discount, and any cost. After this, the internal rate of return is computed using the adjusted outstanding amount and the Cash Flows.
To compute the As of Date EIR, you need the ending deferred balances which are computed in the EIR adjustment process. To enable this, after the execution of the EIR adjustment process, the end-of-period deferred balances, fee, premium or discount, and cost, have to be updated back to the staging area or FSI_D tables. The As of Date EIR process needs to be executed after this.
EIR for PCD or POCI instruments has the following data requirements:
· Expected or Recovery Cash Flows
· Purchase Price
· Deferred Balances except for Discount (Fees and Cost)
· Instrument details such as Outstanding, Current Net Rate, and so on
The first step involved in the computation of EIR for PCD or POCI instruments is to determine the Adjusted Purchase price which is computed as the difference between the actual Purchase Price and the given Deferred Balance.
Subsequently, the recovery cash flows are discounted with a rate such that its net present value is equal to the adjusted purchase price. This rate is considered as the EIR for the given PCD or POCI Instrument.
NOTE:
EIR for PCD or POCI instruments are computed only once, that is on the origination date.
Once the EIR for PCD or POCI instruments are computed the Expected Credit Loss will be computed using any one of the available methodologies including the Cash Flow approach, where the expected Cash Flows are the same as the recovery Cash Flows provided as a download.
If other methodologies are followed, then the corresponding data requirements are applicable. For more details about Expected Credit Loss, see Expected Credit Loss (Allowance and Provision) Calculation in IFRS 9 section.
NOTE:
While the computation of EIR requires Recovery Cash Flows as a mandatory input, ECL computation does not require the same.
The application also computes the Non-Credit discount. In general, discounts are of two types: Credit and Non-Credit. While the Credit-related discount can be assumed to be equal to the ECL, the Non-Credit value needs to be determined using the Deferred Balance approach.
The first step for Non-Credit discounts is to determine the amortized cost as the sum of the Adjusted Purchased Price and the ECL. The difference between the amortized cost and the outstanding or carrying amount is the Total Deferred Balance.
Total Deferred Balance is comprised of Fee, Cost, and Non-Credit Discount. This Non-Credit Discount is computed as the residual of the Deferred Balance deducted for Fee and Cost.
