28 Amortization Rules

This module discusses the procedure to create rules for Amortization. Two Amortization Methods are supported which are as follows:

• Effective Yield Amortization: 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 a contractual rate, financial institutions are required to pass an additional adjustment entry - Interest Adjustment Entry to be compliant with the IFRS 9 guidelines. The application computes the Interest adjustment entry based on the Effective Interest Rate, Instrument Details, and all transactions against the given instrument. The application computes the Interest adjustment entry based on the Effective Interest Rate, Instrument Details, and all transactions against the given instrument.

  • Effective Interest Rate (EIR):

    EIR is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or the amortized cost of a financial liability.

    When calculating the Effective Interest Rate, an entity must estimate the expected cash flows by considering all the contractual terms of the financial instrument (for example; prepayment, extension, Call, and similar options) but must not consider the Expected Credit Losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.

    IFRS 9 mandates the use of an Effective Interest Rate (EIR) to discount to take into account the Time value of money. The guidelines also mandate the use of the Origination date EIR for Fixed-rate accounts and the Current date (As of 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.

    The IFRS9SCS calculates the EIR as applicable. EIR is computed based on the contractual cash flow generated within this service. Cash flow is triggered through the Amortization Process UI.

    The 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	Original Fees (as of origination)	Deferred Fees (As of current date)
    Premium or Discount	Original Premium or Discount (as of origination)	Deferred Premium or Discount (As of current date)
    Cost	Original Cost (as of origination)	Deferred Cost (As of current date)
    Other parameters (for example, Payment Frequency, Current Rate, and so on)	Constant across both

  • Calculation of EIR:

    The service 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 origination EIR at the origination of the account it is expected the current deferred balances like Cost, Fees, and Premium or Discount need to be populated as same as the Origination balances like Cost, Fees, and Premium or Discount.

    To compute the As of Date EIR, you need the ending deferred balances which are computed in the effective yield amortization process.

    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.

    EIR is calculated for the following Account Type Codes:

    • Assets: 100, 110, 120
    • Liabilities: 300, 310, 320
    EIR is computed by equating the Present Value (PV) of future cash flows with the Adjusted Outstanding Balance. The adjusted Outstanding Balance is calculated as follows:

    • Assets: Adjusted Outstanding Balance=Orig outstanding + Accrued Interest - Fees EIR - Additional Fees EIR + Premium/Discount + Cost + Additional Cost EIR
    • Assets: Adjusted Outstanding Balance=Orig outstanding + Accrued Interest - Fees EIR - Additional Fees EIR + Premium/Discount + Cost + Additional Cost EIR

  • Effective Interest Rate Computation for Purchased or Originated Credit Impaired (IFRS 9) Instruments:

    Under IFRS 9 guidelines, 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. Credit Adjusted Effective Interest Rate is computed using Expected (Recovery) Cash Flows and Purchase Price adjusted for deferred balances. This EIR is used to discount the Cash Flows for the computation of ECL and interest recognition.

  • Calculation of Credit Adjusted EIR:

    The system first adjusts the outstanding amount with fees, specific to EIR, and any cost. After this, the internal rate of return is computed using the adjusted outstanding amount and the Cash Flows.

    EIR for 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 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 at 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 POCI Instrument.

    The adjusted Outstanding Balance is calculated as follows for the POCI account:

    Adjusted Outstanding Balance=Original Book Value – Fees EIR + Cost - ECL DOIR - Additional Fees EIR+ Additional Cost EIR

• Straight-line Method Amortization: Straight-line method amortization is the simplest method for calculating amortization over time. Under this method, the same amount of fees, premiums, discounts, and costs amortized over the life of the instrument.

  Users can apply the above Amortization Methods on a different combination of dimensions based on the selected modelling set.

Note:

For EIR Calculations, the deferred current balances are expected for the first date.