Own credit adjustment under IFRS9

This query is : Resolved

Rahul (Querist)
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05 February 2022 Can you share how the own credit is calculated on financial instruments issued by the firm and how the changes in own credit is calculated for the change in own credit from date of issuance of the financial instruments to the reporting date (production date). One way to measure it is change in own credit = TV (Mt, Ft) - TV (Mt, Fi) [i] where, TV(Mt,Ft) : theoretical value of the financial instruments using backbone curve on the production date Libor + Own credit spread on the production date TV(Mt, Fi) : theoretical value of the financial instruments using backbone curve on the production date Libor + Own credit spread on the issuance date. But, the above approach has limitation in following hypothetical scenarios : let us assume Own credit curve on the production date and issuance date remain same but it's constituent changes. In that cases, the calculation will not correctly capture the own credit change: Production Date Own credit : 5% Libor : 4% own credit spread : 1% issuance Date own credit:5% libor : 3% own credit spread :2% in the above hypothetical scenario, if we put in the equation [i], the issuance date TV will be based on 6% (4% + 2%) your response and sharing will be highly appreciated.

Read more at: https://www.caclubindia.com/forum/own-credit-adjustment-treatment-under-ifrs9-586310.asp

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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09 July 2024 Calculating the change in own credit for financial instruments involves assessing the impact of changes in the firm's own credit spread from the issuance date to the reporting (production) date. Here’s how you can approach this calculation, considering the hypothetical scenario provided:

### Approach to Calculate Change in Own Credit

1. **Identify Inputs:**
- **Own Credit Spread:** This is the spread over the risk-free rate (such as LIBOR) that reflects the credit risk specific to the firm issuing the financial instruments.
- **LIBOR Rates:** These are the benchmark rates for interbank lending, which provide the risk-free rate component used in discounting future cash flows.

2. **Theoretical Value Calculation:**
- **On Issuance Date (Fi):** Calculate the theoretical value of the financial instrument using the LIBOR rate and own credit spread as of the issuance date.

\[ TV(Mt, Fi) = \text{LIBOR (Fi)} + \text{Own Credit Spread (Fi)} \]

- **On Production Date (Ft):** Calculate the theoretical value of the financial instrument using the LIBOR rate and own credit spread as of the production date.

\[ TV(Mt, Ft) = \text{LIBOR (Ft)} + \text{Own Credit Spread (Ft)} \]

3. **Calculate Change in Own Credit:**
- The change in own credit is then determined by comparing these theoretical values:

\[ \text{Change in Own Credit} = TV(Mt, Ft) - TV(Mt, Fi) \]

### Considerations for Hypothetical Scenarios

In scenarios where the own credit spread changes while the LIBOR rates remain the same, the calculation can still accurately capture the change using the above method. Here’s how it addresses your hypothetical scenario:

- **Scenario Recap:**
- **Issuance Date:** Own Credit Spread = 2%, LIBOR = 3%, Total Rate = 5% (3% + 2%)
- **Production Date:** Own Credit Spread = 1%, LIBOR = 4%, Total Rate = 5% (4% + 1%)

- **Calculation:**
- **On Issuance Date (Fi):**
\[ TV(Mt, Fi) = 3% (LIBOR) + 2% (Own Credit Spread) = 5% \]

- **On Production Date (Ft):**
\[ TV(Mt, Ft) = 4% (LIBOR) + 1% (Own Credit Spread) = 5% \]

- **Change in Own Credit:**
\[ \text{Change in Own Credit} = 5% (Production Date) - 5% (Issuance Date) = 0 \]

### Conclusion

The approach outlined ensures that the change in own credit is accurately calculated by using the current LIBOR rates and own credit spreads as of both the issuance and production dates. This method accounts for changes in the firm's credit spread over time, providing a clear measure of how own credit impacts the theoretical value of financial instruments from issuance to the reporting date.