Palestine Monetary Authority

PALESTINE MONETARY AUTHORITY

Circular No. (2016/93)
To all lending institutions operating in Palestine
Date: Tuesday, May 31, 2016

Subject: Updated Version of the Borrower Credit Classification System (Version IV)

In the context of the Palestine Monetary Authority's continuous efforts to develop tools for reducing credit risk to preserve the quality of the banking facilities portfolio, and in reference to our Circular No. (2013/155) dated December 4, 2013 concerning the development of the third version of the classification system, the Authority has developed the currently implemented version after conducting a comprehensive review of all related variables that determine 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 the proposals of banks and lending institutions related to borrowers and their guarantors. It should be noted that the most important main amendments made to the fourth developed version of the system (Version IV) are:

First: Amendments Made to the Variables

The developed version of the credit classification system is based on separating the credit classification score card for individuals from the score card for companies and institutions, taking into account the differences in the nature and terms of facilities granted to individuals compared to those granted to 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 contractual terms.
2. To encourage the credit shopping policy to obtain the best lending terms and rates, the variable related to evaluating the number of institutions queried about the client was amended. The risks associated with the number of inquiries conducted for companies were 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, considering that a client with less than 25 years of age and limited credit experience is a higher credit risk compared to borrowers in older age groups.

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Based on the recommendations of the Basel Committee regarding the classification of distressed customers, a distinction was made between customers who are late in payments (from one day up to 89 days) and those who have entered distress stages (90 days or more), and the risks associated with borrowers were redistributed.

5. In compliance with the Palestine Monetary Authority's policy aimed at encouraging borrowers to rectify their credit status, the following was done:

• Positive evaluation grades were allocated to customers who resumed regular payments, which is reflected in the probability of default, thereby reducing the risk grade by a specific percentage in favor of the borrower, without conflicting with the system's operational mechanism based on evaluating the borrower's historical credit behavior.
• The classification of distressed borrowers was amended by taking into account the ratio of the distressed facility to the total value of existing facilities, especially in cases where the borrower resumes regular payments after distress.
• The number of distress incidents is considered relative to the number of facilities granted to the borrower, so that lower risk grades are allocated as the number of distress incidents decreases relative 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 was excluded if the borrower has already paid them, as the risk is calculated on them in the variables related to distress evaluation.
• To reduce the burden on the guarantor resulting from assigning high risk grades to the guarantor in case of borrower distress, the guarantor's evaluation is maintained negatively for existing facilities and excluded from it in case of facility repayment.
• Due to the specificity of Palestinian society and the reliance of most of its segments on monthly salary transfers to banks, which may experience delays in salary 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, and it is sufficient to add a specific explanation indicating that the borrower is a public sector employee, to guide the credit report user regarding the borrower's status as a public sector employee.
• The variable for measuring the credit commitment ratio of companies to their authorized capital was amended, considering that exceeding the company's Leverage Ratio by 5 times the total capital is an indicator of high credit risk for companies and an increased probability of default, as it serves as an indicator for measuring corporate risk and exposure to credit risk.
• To promote 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, but the customer's evaluation becomes negative in case of delay or default in payment when the utilization ratio exceeds 10% of the granted limit.
• To address risks arising from the phenomenon of over-indebtedness among individuals in Palestinian society and the phenomenon of high density of other people's loans for public and private sector employees, and to address the expansion of consumer loans granted with personal guarantees (cars, educational loans, personal loans, etc.), the risk weights were amended so that customers are evaluated negatively if they guarantee consumer facilities, with a reduced risk grade in case of guaranteeing investment loans such as guarantees for small and medium enterprises, corporate guarantees, and housing and real estate loans.
• Due to the specificity of Palestinian society and the fact that many companies guarantee subsidiaries and provide 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, but the company's evaluation becomes negative as soon as one of the facilities guaranteed by the company defaults.
• The mechanism for calculating risk grades related to the value of unpaid due installments was amended to distinguish between unpaid due installments and small amounts represented by credited fees and commissions in the customer's account as due installments.
• The risk grades related to customer classification on the bounced checks system were redistributed to reflect the reason for the customer's transition from one classification to another (penalty completion, amicable settlement), which is reflected in the variable related to customer classification on the bounced checks system and the determination of risk weights for customer classifications on the bounced checks system.

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

Second: Amendment of the Risk Grades Table

Based on the results of the study sample analysis from the portfolios 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 the separation of the credit classification score card for individuals from that for companies, reflecting the amendments to the risk grades for related variables that align with the overall facilities portfolio, as follows:

Individuals:

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

Companies:

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

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Third: Amendment of Evaluation Explanations

Since the "evaluation explanation" indicates the variables that help the institution 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 the evaluation explanations related to companies to align with the process of separating the credit classification score card for individuals from that for companies, by adding the code (I) to evaluation explanations related to individuals and the code (C) to evaluation explanations related to 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 monitor the existence of credit behavior requiring supervision. This version continues to disclose up to five explanations for evaluating the borrower and guarantor, with no evaluation explanation appearing for low-risk borrowers (customers classified as grade A) or customers with no data.
3. To distinguish between customers who are late/defaulting on existing facilities and customers who are late/defaulting on paid facilities, the evaluation explanations related to distress were amended to guide the credit report user to the time duration of the distress.

Based on the foregoing, all departments are requested to disseminate this circular to users of the Credit Information System regarding its contents, noting that the updated version of the credit classification system will take effect as of June 5, 2016.

Market Supervision Department
Palestine Monetary Authority

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