8.2.1.4 Prepayment

Prepayment is a situation where the customer repays the loan in part or full, at any time before the maturity of the loan. Prepayment would lead the bank to lose out on the interest component that it would have received if the loan was not pre-paid. Prepayment results in a cash inflow in a time bucket prior to the original time bucket and reduced cash inflow in the original time bucket. The percentage of prepayment is to be specified by you and the balance is payable only when it is due.

The prepayment supports prepayments on liabilities as well as assets in a single business assumption definition.

If a prepayment is specified on an asset or liability backed by collateral, the encumbrance period of the underlying collateral is re-calculated based on time bucket in which the asset or liability is completely paid up.

See Defining a New Business Assumption, for information on the steps involved in specifying this assumption.

The steps involved in applying the delay in cash flow timing assumption to cash flows are:

1. Identify the original time bucket and calculate the cash outflow occurring in it due to the assumption.
2. Identify the corresponding revised time buckets and the cash inflow occurring in it, including penalties, if any.
3. If time specific or critical obligation, record the delay and indicate a breach.

   Cash flow assignment is done in the following manner:

   
   

   

   
   
   

   

   
   

   An example which explains the Assumption Value Based on Original Cash Flows across Business Assumptions is illustrated below.

   A prepayment of 10% from 8-15 Day bucket to 1-7 Day bucket and a 20% rollover is defined from 1-7 Day bucket to 8-15 Day bucket. The contractual cash flow in 1-7 Day bucket is 5000 and 8-15 Day bucket is 8000. The impact on the 1-7 Day bucket based on original cash flows is illustrated below:

   Table 7-6 Cash Flow Movement Prepayment

   Cash Flow Assignment
   Assumption	Contractual Cash Flow in 1-7 Day Bucket	Impact of Assumption	Post-Assumption Cash Flow
   No Assumption	5000	0	5000 [=5000 – 0]
   Prepayment	5000	800 [= (8000*10%)]	5800 [=5000 + 800]
   Rollover	5800	– 1000 [= – (5000*20%)]	4800 [= 5800 – 1000]

   In this case, even though the cash flow has changed after applying the prepayment assumption, the original cash flow is used for estimating the impact of the rollover assumption.