Circular No. 157: Updated Version of the Borrowers' Credit Classification System

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Palestine Monetary Authority PALESTINE MONETARY AUTHORITY

Circular No. (151 / 2022) To all banks operating in Palestine Date: Thursday, July 21, 2022

Subject: Updated Version of the Borrowers' Credit Classification System (Version V)

In the context of the Palestine Monetary Authority's efforts to enhance access to financing for the small and medium-sized enterprises (SME) sector, youth, and entrepreneurs, with the aim of empowering and developing their credit capabilities—which are considered the most fundamental pillars of the financial inclusion strategy in Palestine—and in addition to Circular No. (2016/92) dated 2016/05/31 concerning the fourth version of the credit classification system, the Authority has developed the currently implemented version. Below you will find the main amendments made to the updated version of the system (Version V):

First: Individuals

1. To empower women and enhance their capacity to establish entrepreneurial projects through access to financing, a variable based on the borrower's gender has been added, granting positive points to females compared to males, noting that analysis results showed higher credit risks for males than for females.
2. To encourage youth and enhance their capabilities through access to financing, the weighting for the age variable has been adjusted to lower the risk for the age group (under 25), and the risk weighting for age groups over 25 has been eliminated, as data analysis results indicated lower risks for these groups.
3. In line with the Authority's policy to support small and medium-sized enterprises (SMEs) and enhance their access to financing, the following has been implemented:
   • Higher points are granted to individuals for repaying loans (F004) and Murabaha facilities (F011) under the SM facility category with a disbursement period exceeding 36 months, compared to loans and Murabaha facilities granted for other purposes such as commercial or residential (MO/HO) or personal (SI), provided these facilities are not in default.
   • Given that most SMEs are unable to provide strong or any collateral for their required financing, the SME sector has been exempted from the variable related to the number of facilities granted with weak collateral.
4. In commitment to the Authority's policy aimed at encouraging customers to rectify their credit status, and to address customer complaints regarding the lack of credit classification improvement despite settling their defaulted facilities, a distinction has been made between defaulted and settled facilities, by reducing customer risk if they close all their defaulted facilities compared to closing only a portion of them.
5. To alleviate the burden on guarantors resulting from borrower defaults, guarantor risk weighting is now applied only when the borrower defaults and has outstanding installments, while giving the guarantor the opportunity to reduce their risk immediately upon the borrower's settlement of the outstanding unpaid installments.
6. To encourage customers to shop around for the best borrowing terms, and in alignment with the implementation of the Annual Percentage Rate (APR) calculation program that enables citizens to know the annual borrowing cost of required financing before obtaining it, the variable related to the number of credit inquiries conducted on the customer over the last six months has been eliminated.
7. The variable related to the value of outstanding unpaid installments has been replaced with a variable that weights the risk of the utilized balance for all facilities that are past due.

Second: Companies

1. To mitigate risks that may arise from companies using the uncovered current account facility (F003), a variable has been added to weight the risk of obtaining this facility.
2. To encourage companies to meet their financial obligations and to address company complaints regarding the lack of credit classification improvement despite settling their defaulted facilities, a variable has been added reflecting the number of months elapsed since companies settled their defaulted facilities, granting positive points to companies that have fully closed their defaulted facilities.
3. To support SMEs and enhance their access to financing, new variables have been added regarding the number of facilities obtained by enterprises over the last 12 months, granting a lower risk weighting to enterprises (SM facility category) if they obtained different types of facilities over the last 12 months compared to companies (CO facility category).
4. Certain variables that do not align with the reality of the Palestinian banking environment and variables with weak predictive capacity, based on sample analysis results, have been removed, such as the number of facilities granted over the last 6 months.
5. The classification of companies acting solely as guarantors and not holding any facilities has been suspended, with evaluation to commence upon obtaining any facilities.

It is worth noting that the section related to facility closure has been amended, such that the effect of facility settlement is reflected immediately upon closure, without waiting for the financial file to be rolled over to the Authority's website for the month in which the facilities were closed.

Risk Rating Table The following is the risk rating table, which remains unchanged as shown below:

(Individuals)

Risk Rating	Probability of Default - Individuals
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 Rating	Probability of Default - Companies
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%

Based on the foregoing, all bank administrations are requested to disseminate the contents of this circular to users of the credit information system, noting that the updated version of the credit classification system will take effect as of July 31, 2022.

[Signature and Stamp] Financial Stability Group Palestine Monetary Authority

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