Cash Flow Calculations

There are two distinct ways of calculating the ECL under the Cash Flow method depending on how the undrawn portion of a financial instrument is treated. They are:

  • Calculation of ECL with Undrawn amount modeled within the Contractual Cash Flows
  • Calculation of ECL with Undrawn amount treated separately and outside the Cash flow approach

The following sections detail the ECL calculation for accounts in any of the 4 types, that is the 3 stages and POCI accounts, both with and without an undrawn amount.

Stage One Accounts

For accounts in Stage 1, the ECL is computed by considering the cash flows for the entire life of the instrument but only considering the 12-month Probability to default. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The values of Contractual Cash flow and Expected Cash flow are used to calculate the Cash Short Fall.

The ECL is calculated as the Net Present Value of Cash Short Fall.

The Effective Interest rate (EIR) is used for discounting while calculating the ECL.

Note:

The PD for 12 months or 1 year is considered for accounts in Stage one.

Stage Two Accounts

For accounts in Stage 2, the ECL is computed by considering the cash flows and the Probability to default for the entire life of the instrument. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The values of Contractual Cash flow and Expected Cash flow are used to calculate the Cash Short Fall.

The ECL is calculated as the Net Present Value of Cash Short Fall.

The Effective Interest Rate (EIR) is used for discounting while calculating the ECL.

Note:

The PD for the lifetime or until the maturity of the account is considered for accounts in Stage two.

Stage Three Accounts

For accounts in Stage 3, the ECL is computed by considering the cash flows and the PD for the entire life of the instrument. Here the calculation slightly differs from that of Stage 2 accounts. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The Net present value (NPV) of Expected Cash flows is computed.

The ECL is calculated using the Carrying Amount and Net Present Value (NPV) of ECF.

The Effective Interest Rate (EIR) is used for discounting while calculating the ECL.

Note:

The PD for the lifetime or until the maturity of the account is considered for accounts in Stage Three.

For POCI Accounts

For POCI Accounts, the ECL is computed by considering the cash flows and the PD for the entire life of the instrument. The contractual cash flows are adjusted for PD and LGD to compute the Expected Cash flows. The values of Contractual Cash flow and Expected Cash flow are used to calculate the Cash Short Fall.

Note:

The PD for the lifetime or until the maturity of the account is considered for POCI accounts.

After calculating the Contractual Cash Flow, the ECL is calculated as the Present value of Cash Shortfall adjusted for the ECL on Date of Initial Recognition.

For POCI Accounts, instead of EIR, the credit adjusted EIR is used for discounting, while calculating the ECL.

Note:

The PD values used in the Cash flow methodology are Cumulative values.

Assigning the PD Values for Each Cash Flow Date or Bucket

The PD assignment happens within the ECL run as part of the Cashflow or forward exposure methodology. The cumulative PD matches the account's Term structure ID, Account's Rating, or DPD, and the bucket number is populated against the account's cash flow - based on the cash flow's bucket.

Note:

If Cash Flows are provided as a download, via the stage account cash flow table, a single row for principal and interest cash flow each must be provided, on any cash flow date.