7.1.3.5 Ratings Downgrade
This assumption supports both rating based, and notch-based downgrade. These downgrades are specified for each legal entity within the bank’s organizational structure. This can come from multiple sources such as Moody’s, S&P, and can be both short term and long term or a combination thereof. Since these rating downgrades are defined at a legal entity level, the legal entity is a mandatory dimension for this assumption. If the downgrade is the same across all legal entities, no individual legal entity is required to be selected.
For some financing transactions or derivatives with embedded triggers for downgrade, a downgrade of the bank’s rating by a recognized credit rating institution requires the bank to post additional collateral. This will increase the cash outflow for all the accounts that are triggered based on the corresponding downgrade impact amount and downgrade impact value specified by the bank. The downgrade trigger and the corresponding downgrade impact amount are available as part of the account information. For calculation of downgrade impact amount see the Modified Liquidity Coverage Ratio Calculations, section Other Calculations in the OFS Liquidity Risk Regulatory Calculations for US Federal Reserve User Guide Release 8.1.2.0.0.
Note:
The assumption specification and computation method for thi subcategory correspond to that available as part of the Addition Collateral - Rating Downgrade Cash Flow Increase assumption type. This assumption is renamed as Ratings Downgrade in this version.See Defining a New Business Assumption for information on the steps involved in specifying this assumption.
The following steps are involved in applying the delay in cash flow timing assumption to cash flows:
- If time-specific or critical obligation, record the delay and indicate a breach. Cash flow assignment is done in the following manner:
Figure 7-16 Formula for Cash flow assignment
The following example illustrates the impact of a notch-based downgrade. Suppose legal entity 1 has 3 accounts whose downgrade triggers are specified as follows:
Table 7-21 Illustration - Impact of a Notch Based Downgrade
Account Rating Type Rating Source Downgrade Trigger Trigger Type Impact Amount Account 1 Short Term Moody’s P-3 And 1000000 Long Term Moody’s A3 Or Long Term S&P A- Account 2 Short Term Moody’s P-2 And 250000 Long Term S&P BBB+ Account 3 Short Term Internal A-3 Or 3000000 Long Term Moody’s Baa2 Account 4 Long Term Moody’s Baa1 750000 Account 5 Short Term Moody’s P-2 1250000 The downgrade assumption is specified as follows:
Table 7-22 Downgrade Assumption Specification
Rating Type Rating Source Downgrade Trigger Impact % Time Bucket Short Term Moody’s 2-Notches 100% 7 Days Long Term Moody’s 3-Notches The new rating post downgrade is assessed as follows:
Table 7-23 New Rating Post Downgrade Assessment
Rating Type Rating Source Current Rating Rating Post Downgrade Short Term Moody’s P-1 P-3
[= P-1 – 2 Notches]
Long Term Moody’s Aa3 A3
[= Aa3 – 3 Notches]
The impact of the downgrade assumption, considering weekly time buckets, is calculated as follows:
Table 7-24 Incremental Cash Flow - Ratings Downgrade
Account Applicability of Assumption Reason Cash Outflow / Encumbrance Outflow Bucket Account 1 Applicable Both parts of the first condition are fulfilled. The 1000000 [=1000000*100%] 5 – 5 Week
[=(7+15 Days)/5
second condition is Or, Business Days] hence not required to be fulfilled if the first one is. Account 2 Not Applicable The second part of the condition is not fulfilled. Account 3 Not Applicable Either of the conditions is not fulfilled. Account 4 Not Applicable The condition is not fulfilled. Account 5 Applicable The condition is fulfilled as the quantum of downgrade specified as part of the 1250000 [=1250000*100%] 3 – 3 Week
[=(7+5 Days)/5
assumption is greater than the downgrade trigger set Business Days] for this instrument. The total impact of this assumption is a cash outflow or asset encumbrance of 2250000.