Palestine Monetary Authority

PALESTINE MONETARY AUTHORITY

Circular No. (2016/92)

To all banks operating in Palestine

Date: Tuesday, May 31, 2016

Subject: Updated Version of the Borrowers' Credit Scoring System (Version IV)

In the framework of the Palestine Monetary Authority's continuous efforts to develop credit risk reduction tools to preserve the quality of the banking facilities portfolio, and in reference to our Circular No. (2013/154) dated 4/12/2013 concerning the development of the third version of the scoring system, the Authority has developed the currently implemented version after conducting a comprehensive review of all related variables specified for risk grades to align with the requirements of the Palestinian banking environment and the updates made to the credit information system in its third and fourth versions, taking into account proposals from relevant banks and lending institutions regarding borrowers and their guarantors. Below are the main amendments made to the fourth developed version of the system (Version IV):

First: Amendments Made to the Variables

The developed version of the credit scoring system is based on separating the credit scoring card for individuals from the credit scoring card for companies and institutions (Score Card), taking into account the differences in the nature and terms of facilities granted to individuals versus companies. The version was developed according to the following procedures:

1. To provide compliant borrowers with the opportunity to expand their access to new facilities, the risk weights for paid facilities were reduced in case of compliance with contract terms.

2. To encourage market policy (Credit Shopping) to obtain the best lending terms and rates, the variable related to evaluating the number of institutions inquiring about the client was amended. The risk associated with the number of inquiries conducted for companies was eliminated, and the number of inquiries for the individual variable was adjusted.

3. The age of an individual borrower is an important determinant for assessing credit risk. Therefore, a specific variable for the age of individual borrowers was added. A client with less than 25 years of lending experience is considered to have higher credit risk than borrowers in older age groups.

4. Based on Basel Committee recommendations regarding the classification of distressed customers, a distinction was made between customers overdue on payments (from 1 to 89 days) and those who have entered delinquency stages (90 days or more), with a redistribution of risks associated with borrowers.

5. In compliance with the PMA's policy aimed at encouraging borrowers to rectify their credit status, the following was implemented:

• Allocation of positive evaluation grades for customers who resumed regular payments, reflected in the probability of delinquency, thereby reducing the risk grade by a specific percentage in favor of the borrower, without conflicting with the system's mechanism based on evaluating the borrower's historical credit behavior.

• Amending the classification of distressed borrowers by taking into account the ratio of distressed facilities to the total value of existing facilities, especially in case the borrower resumes regular payments after delinquency.

• Considering the number of delinquency instances relative to the number of facilities granted to the borrower, such that risk grades are allocated inversely to the number of delinquency instances compared to the number of granted facilities, and vice versa.

• When calculating the variable related to unpaid due installments, the existence of unpaid due installments in the borrower's historical data is excluded if the borrower has already paid them, as the risk is calculated in the variables related to delinquency evaluation.

6. To alleviate the burden on the guarantor by assigning high risk grades to the guarantor in case of borrower delinquency, the guarantor's evaluation is maintained as negative for existing facilities and excluded from it in case of facility repayment.

7. Due to the specificity of Palestinian society and the reliance of most of its segments on monthly salaries transferred to banks, which may experience delays in disbursement for several days, the variable for calculating the risk of delayed installment payments for public sector employees was not amended. No risk grades are assigned to them for delays not exceeding 30 days, with the addition of a specific explanation indicating that the borrower is a public sector employee, to guide the credit report user regarding the borrower's status.

8. Amending the variable for measuring the ratio of corporate credit commitment to authorized capital, where exceeding a company's debt by 5 times the total capital is considered an indicator of high corporate credit risk and increased probability of delinquency, serving as a measure for corporate risk and exposure to credit risk.

9. To enhance the use of plastic cards as an alternative to cash, given their security advantages in transactions, ease of use, and international acceptance by all financial and service institutions, the variable for evaluating the utilization ratio to the granted limit was amended. Compliant customers are awarded positive points for using plastic cards, with negative evaluation starting in case of delayed or delinquent payments when the utilization rate exceeds 10% of the granted limit.

10. To address risks arising from the phenomenon of over-indebtedness among individuals in Palestinian society and the practice of guaranteeing loans for others by public and private sector employees, and to address the expansion of consumer loans granted in specific forms (cars, educational loans, personal loans...), the risk weights were amended. Customers are evaluated negatively if they guarantee consumer facilities, with risk grades reduced for guaranteeing investment loans, guaranteeing small and medium enterprises, corporate guarantees, and housing and real estate loans.

11. Due to the specificity of Palestinian society and the practice of many companies guaranteeing subsidiaries and providing nominal guarantees for their board members, and given that multiple guarantees provided by companies often reflect the company's financial solvency, the variable for corporate guarantees for other facilities was amended. Companies guaranteeing regular facilities are evaluated positively, with negative evaluation starting as soon as one of the facilities guaranteed by the company becomes delinquent.

12. Amending the mechanism for calculating risk grades related to the value of unpaid due installments, distinguishing between unpaid due installments and small similar amounts resulting from crediting fees and commissions to the customer's account as due installments.

13. Redistributing risk grades related to customer classification on the returned checks system to reflect the reason for the customer's transition from one classification to another (completion of penalty, execution of a settlement agreement), thereby reflecting this on the variable related to customer classification on the returned checks system and determining the risk weights for customer classifications on the returned checks system.

14. Reviewing the risk weights distributed by guarantee type, reconsidering the possibility of classifying salary guarantees for public and private sector employees as medium-risk guarantees instead of calculating them as high-risk guarantees for all borrower categories.

Second: Amendment of the Risk Grades Table

Based on the results of analyzing a study sample from the banking facilities portfolio of banks and lending institutions, the risk grades table and risk weights were amended to align with the new amendments, the most important of which is separating the credit scoring card for individuals from the credit scoring card for companies, reflecting the amendments to risk grades for related variables that align with the total facilities portfolio of the banking environment, as follows:

Individuals

Risk Grade	Probability of Delinquency
A	Probability of delinquency during the last 12 months between 0% and 4.08%
B	Probability of delinquency during the last 12 months between 4.09% and 8.37%
C	Probability of delinquency during the last 12 months between 8.38% and 19.99%
D	Probability of delinquency during the last 12 months between 20.00% and 61.07%
E	Probability of delinquency during the last 12 months between 61.08% and 100.00%

Companies

Risk Grade	Probability of Delinquency
A	Probability of delinquency during the last 12 months between 0% and 4.08%
B	Probability of delinquency during the last 12 months between 4.09% and 7.61%
C	Probability of delinquency during the last 12 months between 7.62% and 18.38%
D	Probability of delinquency during the last 12 months between 18.39% and 61.07%
E	Probability of delinquency during the last 12 months between 61.08% and 100.00%

Third: Amendment of Evaluation Explanations

Since the "Evaluation Explanation" indicates variables that help the bank make credit decisions, the evaluation explanations were amended to align with the amendments made to the variables, the most important of which are:

1. Separating evaluation explanations for individuals from those for companies to align with the separation of the credit scoring card for individuals from that for companies, by adding the code (I) to evaluation explanations for individuals and the code (C) to evaluation explanations for companies, taking into account the differences in the nature and calculation method of variables for individuals and companies.

2. Emphasizing the objective of the evaluation explanation as an indicator to observe credit behavior requiring monitoring. This version continues to disclose up to five explanations for evaluating the borrower and guarantor, with no explanation appearing for low-risk borrowers (good customers classified as Grade A) or customers with no data.

3. To distinguish between customers overdue/delinquent on existing facilities and customers overdue/delinquent on paid facilities, the evaluation explanations related to delinquency were amended to guide the credit report user to the chronological age of the delinquency.

Based on the foregoing, all bank administrations are requested to disseminate this circular to users of the credit information system regarding its contents. Please note that the updated version of the credit scoring system will take effect starting from June 5, 2016.

Market Regulation Department
Palestine Monetary Authority

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