12.1.4.1 Approximation of Interest Cash Flows

OFS LRM considers both principal and interest cash flows based on user selection. Calculation of the impact of each business assumption on interest cash flows is supported in two ways:
  • Business assumption values are applied to both principal and interest cash flows.
  • Assumption values are applied to principal cash flows only and interest isapproximated.
If you select the Include Interest Cash flow parameter in the Run Definition window as Yes, both principal and interest cash flows are taken considered for calculations. If you select the Approximate Interest parameter as Yes, then the business assumption is applied only to the principal cash flows, and the interest cash flows are approximated based on changes to the principal. If you select the Include Interest Cash flow parameter is selected as Yes and Approximate Interest parameter is selected as No, the business assumption values are applied to both principal and interest cash flows. However, this application depends on the manner in which the business assumption is defined as follows:
  • If you have selected Cash Flow Type as a dimension in the business assumption and the dimension member as Principal, then the assumption is applied only to the principal cash flows.
  • If you have selected Cash Flow Type as a dimension in the business assumption and the dimension member as Interest, then assumption impacts only Interest cashflows.
  • If you have selected Cash Flow Type as a dimension in the business assumption and the dimension member as Principal and Interest, then the assumption is applied to both principal and interest cash flows.
  • If you have not selected Cash Flow Type as a dimension in the business assumption, then the assumption is applied to both principal and interest cash flows.

If the Include Interest Cash Flow parameter is selected as No, only principal cash flows are considered and interest cash flows are ignored.

The procedure for approximating interest is as follows:

  1. Obtain the principal and interest cash flows under contractual terms.
  2. Bucket the contractual cash flows based on the user-specified time buckets while distinguishing between interest and principal cash flows in each time bucket.
  3. Calculate the outstanding balance in each bucket under contractual terms. The outstanding balance in the first time bucket will be the EOP balance. The formula for calculating the outstanding balance for each subsequent bucket is as follows:

    Figure 12-1 Formula for calculating outstanding balance


    This illustration shows the formula for calculating the outstanding balance for each subsequent bucket.

    Where,

    O/S Balance: Outstanding Balance CF:

    Cash Flows

  4. Apply the business assumption to estimate principal cash flows. For balance-based assumptions, this applies to the EOP balance. In case of cash flow-based assumptions, this applies to the principal cash flows in a given bucket.
  5. Calculate the outstanding balance in each bucket under business-as-usual or stress terms. The outstanding balance in the first time bucket will be the EOP balance. The formula for calculating the outstanding balance for each subsequent bucket is as follows:

    Figure 12-2 Formula for calculating outstanding balance


    This illustration shows the formula for calculating the outstanding balance for each subsequent bucket.

  6. Calculate the impact on interest cash flows in each bucket under business-as-usual or stress terms as per the following formulas:

    Figure 12-3 Formula to calculate the impact on interest cash flows


    This illustration shows the formula to calculate the impact on interest cash flows in each bucket under business-as-usual or stress terms.

    This illustration shows the formula to calculate the impact on interest cash flows in each bucket under business-as-usual or stress terms. image328

    Illustration 1: Impact on Interest Cash Flows under Run-off Assumption

    Table 12-1 Example giving the UI Specification for Run-off Assumption

    Run-off From Bucket To Bucket Assignment Method Assumption Unit Assumption Value Based On Product
     

    1-3

    Months

    1-7

    Days

    		 Selected Percentage 10 Cash Flow Loan

    In the following Illustration both Principal and Interest are downloads.

    Table 12-2 Example showing Impact on Interest Cash Flows under Run-off Assumption

    Measure Contractual Cash Flows
    Overnight 1-7 Days 8-15 Days 16-30 Days 1-3 Months
    Principal 150 250 330 700 610
    Outstanding Balance (Refer Point 3) 2000 1850 (2000-150) 1600 (1850-250) 1270 (1600-330) 570 (1270-700)
    Interest 20 40 45 80 70

    Table 12-3 Example showing Impact on Interest Cash Flows under Run-off Assumption

    Measure Business Assumption
    Overnight 1-7 Days 8-15 Days 16-30 Days 1-3 Months
    Assumption impacted Principal Nil (+) 61 Nil Nil (-) 61 (610*10%)
    Revised Principal CF (post business assumption) 150 (150 + Nil) 311 (250 + 61) 330 (330+Nil) 700 (700 + Nil) 549 {610 + (-)61}
    Outstanding Balance (Refer Point 5) 2000 1850 (2000 – 150) 1539 (1850 – 311) 1209 (1539-330) 509 (1209-700)
    Interest (Refer Point 6) 20 40 43.28 (45/1600*1539) 76.16 (80/1270*1209) 62.5 (70/570*509)

    Illustration 2: Impact on Interest Cash Flows under Growth Assumption

    Table 12-4 Example giving the UI Specification for Growth Assumption

    Run-off From Bucket To Bucket Assignment Method Assumption Unit Assumption Value Based On Product
      1-7 Days Overnight - - 0

    EOP

    Balance

    		 Loan
        16-30 Days Equal Percentage 20    

    In the following Illustration, both Principal and Interest are downloads.

    Table 12-5 Download Data

    Contractual Cash Flows
    EOP Balance 2000

    Table 12-6 Example showing Impact on Interest Cash Flows under Growth Assumption

    Measure Contractual Cash Flows
    Overnight 1-7 Days 8-15 Days 16-30Days 1-3 Months
    Principal 150 250 330 700 610
    Outstanding Balance 2000 1850 1600 1270 570
    (Refer Point 3) (2000- (1850- (1600- (1270-700)
      150) 250) 330)  
    Interest 20 40 45 80 70

    Table 12-7 Example showing Impact on Interest Cash Flows under Growth Assumption

    Measure Business Assumption
    Overnight 1-7 Days 8-15 Days 16-30 Days 1-3 Months
    Assumption impacted Principal Nil -400 200 200

    Cash Flows

    Nil
    Revised Principal CF 150 -150 530 900 610
    (post business assumption) (150 + Nil)

    {250 +

    (-) 400}

    		 (330+200) (700 + 200) (610 + Nil)
    Outstanding Balance 2000 1850 2000 1470 570
    (2000- {1850- (- (2000-530) (1470-900)
    150) 150)}    
    Total Interest 20 40 56.25 92.59 70
    (45/1600*2 (80/1270*1470
    000) )

    Illustration 3: Impact on Interest Cash Flows under Growth Assumption

    Table 12-8 Example giving the UI Specification for Growth Assumption (Cash Flow Based)

    Run-off From Bucket To Bucket Assignment Method Assumption Unit Assumption Value Based On Product
     

    1-7

    Days

    		 Overnight - - 0 Cash Flow Loan
       

    16-30

    Days

    		 Equal Percentage 20    

    In the following Illustration, both Principal and Interest are downloads.

    Table 12-9 Example showing Impact on Interest Cash Flows under Growth Assumption (Cash Flow Based)

    Measure Contractual Cash Flows
    Overnight 1-7 Days 8-15 Days 16-30 Days 1-3 Months
    Principal 150 250 330 700 610
    Outstanding Balance 2000 1850 1600 1270  
    (Refer Point 3) (2000- (1850- (1600- 570
      150) 250) 330) (1270-700)
    Interest 20 40 45 80 70
    Measure Business Assumption
    Overnight 1-7 Days 8-15 Days 16-30 Days Cash Flows1-3Months
    Principal Nil (250*20%) 25 25 Nil
    Revised Principal CF (post business assumption) (150 + Nil) 50} (330+25) (700 + 25) (610 + Nil)
    Outstanding Balance 2000 (2000-150) (1850-200) (1650-355) (1295-725)
    Total Interest 20 40 46.41 (45/1600*1650) 81.57 (80/1270*1295) 70
    Change in Interest Nil Nil

    1.41

    (46.41-45)

    1.57

    (81.57-80)

    		 Nil

    The application supports the inclusion or exclusion of interest cash flows based on the Run parameters selected by the user. This is also impacted by the inclusion or exclusion of cash flow type as a dimension in the business assumption. The next section details multiple scenarios with different combinations of parameters and their impact on interest cash flows.

Scenario 1: When Interest cash flows are approximated:
  1. Do not include Cash Flow Type as a dimension in the business assumption (Principal + Interest will be considered).
  2. In the Run Definition window:
    1. Select Yes in Include Interest Cash Flow
    2. Select Yes in Approximate Interest

    In this scenario, only Principal cash flows will be impacted. Interest cash flows will be approximated based on the change to the principal.

Scenario 2: When interest cash flows are calculated without approximating interest
  1. Do not include Cash Flow Type as a dimension in the business assumption (Principal + Interest will be considered).
  2. In the Run Definition window:
    1. Select Yes in Include Interest Cash Flow
    2. Select Yes in Approximate Interest

    In this scenario, both Principal and Interest cash flows will be impacted.

Scenario 3: When interest cash flows are not considered for computation:
  1. Do not include Cash Flow Type as a dimension in the business assumption (Principal + Interest will be considered).
  2. In the Run Definition window, select No in Include Interest Cash Flow.

    In this scenario, there is no impact on Interest cash flows as they are not considered for computation and reporting.

Scenario 4: When interest cash flows are approximated:
  1. Include Cash Flow Type as a dimension and select Principal in the business assumption.
  2. In the Run Definition window:
    1. Select Yes in Include Interest Cash Flow
    2. Select Yes in Approximate Interest

    In this scenario, only the Principal will be impacted. Interest cash flows will be approximated based on the change to the principal.

Scenario 5: When the Principal is selected as a dimension:
  1. Include Cash Flow Type as a dimension and select Principal in the business assumption.
  2. In the Run Definition window:
    1. Select Yes in Include Interest Cash Flow
    2. Select Yes in Approximate Interest

    In this scenario, the Principal will be impacted because only the Principal is selected as a dimension. There will be no change in the interest cash flow amounts.