Capital Adequacy Regulatory Framework for Banks Operating in Lebanon

Intermediary Circular No. 512

For Banks

A copy of Intermediary Decision No. 12947 dated 20/12/2018 concerning the amendment of the Basic Decision No. 6939 dated 25/3/1998 (Regulatory Framework for the Capital Adequacy of Banks Operating in Lebanon) attached to Basic Circular No. 44.

Beirut, December 20, 2018

Governor of the Central Bank of Lebanon

Riad T. Salam

Intermediary Decision No. 12947

Amendment of Basic Decision No. 6939 dated 25/3/1998 Regulatory Framework for the Capital Adequacy of Banks Operating in Lebanon

The Governor of the Central Bank of Lebanon, Pursuant to the Monetary and Loan Law, particularly Articles 174 and 175 thereof, And pursuant to Basic Decision No. 6939 dated 25/3/1998 and its amendments concerning the Regulatory Framework for the Capital Adequacy of Banks Operating in Lebanon, And pursuant to the decision of the Central Bank of Lebanon's Monetary Committee taken in its session held on 28/11/2018,

Decides as follows:

Article One: Article 11 bis is added to Basic Decision No. 6939 dated 25/3/1998 with the following text:

"Article 11 bis: When calculating capital ratios, banks must:

1. Compare the balance of available reserves with the expected losses calculated systematically for the portfolio of financial assets within the balance sheet and financial liabilities outside the balance sheet that entail credit risks, as follows:

• a. Regarding financial assets within the balance sheet and financial liabilities outside the balance sheet that are performing (i.e., classified as Stage 1 and Stage 2 according to International Financial Reporting Standard 9 (IFRS 9)): Annex No. (6) attached to this decision shall be applied.
• b. Regarding financial assets within the balance sheet and financial liabilities outside the balance sheet that are non-performing (i.e., classified as Stage 3 according to IFRS 9): The greater of the following balances shall be applied: • 45% of the total balance of non-performing portfolios (including accrued interest). • The specific reserves available against the total balance of the aforementioned portfolio.

2. In the event of a negative difference between the balance of available reserves and the expected losses calculated systematically for one year, this difference shall be deducted from Common Equity Tier 1.

Article Two: The text of Article 12 of Basic Decision No. 6939 dated 25/3/1998 is repealed and replaced with the following text:

"General provisions and provisions formed against expected credit losses on financial assets within the balance sheet and financial liabilities outside the balance sheet that are performing (Stage 1) within portfolios that have not witnessed a significant increase in credit risk may be considered, up to a maximum cap of 1.25% of the value of assets weighted by credit risk weights adopted in calculating capital ratios."

Article Three: The text of Annex No. (1) and Annex No. (3) attached to Basic Decision No. 6939 dated 25/3/1998 is repealed and replaced by the new text attached to this decision.

Article Four: This decision shall be effective upon its issuance.

Article Five: This decision shall be published in the Official Gazette.

Beirut, December 20, 2018

Governor of the Central Bank of Lebanon

Riad T. Salam

Annex No. 1: Common Equity Tier 1 (CET1) Rights

Common Equity Tier 1 rights consist of the following elements:

1. The nominal value of ordinary shares and other capital instruments that meet the criteria for elements accepted within Common Equity Tier 1 rights.
2. Capital reserves.
3. Premiums on the issuance of ordinary shares and other capital instruments that meet the criteria for elements accepted within Common Equity Tier 1 rights, and merger premiums.
4. Cash advances allocated to capital that bear interest.
5. Earnings allocated to real estate investments referred to in Article Seven of this decision.
6. [Blank/Numbered item missing in source, skipped]
7. Legal and regulatory reserves and other reserves, including a reserve for real estate for liquidation and a special reserve against doubtful and bad debts that have not been settled according to Basic Decision No. 7694 dated 18/10/2000.
8. Retained prior results, current financial year results, and the income and expense account.
9. Reserves related to other comprehensive income elements (Comprehensive Other Accumulated Income), including:

• Differences arising from the revaluation of real estate assets or any other fixed assets.
• Net unrealized profits or losses on financial instruments classified at Fair Value Through Other Comprehensive Income (FVOCI).
• Cumulative valuation differences from converting foreign currency financial assets (Foreign Currency Translation Adjustment).
• Cash Flow Hedge Reserves.
• Own Credit Risk Reserves.
• Other reserves related to other comprehensive income elements.

10. Minority interest share (Minority Interest) accepted within Common Equity Tier 1 rights.
11. "Regulatory Adjustments" (Regulatory Adjustments) which include the following adjustments:

• Current year result if positive, and the income and expense account if positive.
• Total unrealized profits on financial instruments classified as Fair Value Through Other Comprehensive Income (Positive Changes in Fair Value of the Financial Instruments Classified as Fair Value Through OCI).
• Positive cumulative valuation differences from converting foreign currency financial assets (Positive Foreign Currency Translation Adjustments).
• Differences arising from the revaluation of real estate assets or any other fixed assets.
• Negative or positive reserve resulting from the revaluation of cash flow hedge instruments (Cash Flow Hedge Reserves).
• Negative or positive reserve resulting from changes in own credit risk (Own Credit Risk).
• Other positive reserves related to other comprehensive income elements.
• Real estate reserve and liquidation shares, and the shortfall in the reserve that must be formed against these real estate assets and shares.
• The special reserve against doubtful and bad debts that have not been settled according to Basic Decision No. 7694 dated 18/10/2000, and the shortfall in the reserve that must be formed against these debts.
• Ordinary shares and income-bearing bonds repurchased directly or indirectly.
• Goodwill and net other intangible fixed assets (Other Intangible Assets).
• Shortfall in required provisions.
• The negative difference between the available reserve balance and the sum of expected losses calculated systematically for financial assets within the balance sheet and financial liabilities outside the balance sheet, both performing and non-performing.
• Exceeding the provisions of Articles 152 or 153 of the Monetary and Loan Law (whichever is greater).
• Total shares (ordinary shares and related cash advances and other capital instruments that meet the criteria for elements accepted within Common Equity Tier 1 rights) in banks, financial institutions, and insurance companies, deductible from Common Equity Tier 1 rights ("Reciprocal Cross Holdings").

Annex No. 3: Total Capital (Capital Total)

Total capital consists of the following elements: • Basic capital as defined in Annex No. (2) attached to this decision. • Supplementary capital (Tier 2 Capital), which consists of the following elements: - The nominal value of preferred shares and other capital instruments that meet the criteria for elements accepted within supplementary capital. - Premiums on the issuance of preferred shares and other capital instruments that meet the criteria for elements accepted within supplementary capital. - Subordinated loans and the proceeds from the issuance of subordinated debt bonds that meet acceptance criteria within supplementary capital. - Minority interest share (Minority Interest) accepted within supplementary capital. - "Regulatory Adjustments" (Regulatory Adjustments) which include: 1. The following additions: - Differences from the revaluation of real estate assets approved by the Central Bank of Lebanon and accepted in supplementary capital. - 50% of the positive cumulative valuation differences from converting foreign currency financial assets. - 50% of total (Gross) unrealized profits on financial instruments classified as Fair Value Through Other Comprehensive Income. - "General Provisions" (Provisions General) as referred to in Article Twelve of this decision. - Provisions formed against expected credit losses on financial assets within the balance sheet and financial liabilities outside the balance sheet that are performing (Stage 1) within portfolios that have not witnessed a significant increase in credit risk, and accepted within supplementary capital. 2. The following deductions: - The amount consumed from subordinated loans and the proceeds from the issuance of subordinated debt bonds. - The amount consumed from issued preferred shares for a specific period and other capital instruments that meet acceptance criteria within supplementary capital. - Total shares, subordinated loans, proceeds from the issuance of subordinated debt bonds, and other capital instruments in banks, financial institutions, and insurance companies that meet the criteria for elements accepted within supplementary capital and are deductible from supplementary capital ("Reciprocal Cross Holdings").

Annex No. 6

Table of Rates Applied for Calculating Expected Losses Systematically

Applied Rates Investments at the Central Bank of Lebanon in Lebanese Lira: 0% Investments at the Central Bank of Lebanon in Foreign Currency: 0.10% Investments at Central Banks Abroad in Local Currency: 0% Investments at Central Banks Abroad in Foreign Currency:

• In countries rated BBB and above: 0.03%
• In countries rated below BBB and unclassified: 0.72% Investments in Lebanese Treasury Bonds in Lebanese Lira: 0% Investments in Lebanese Treasury Bonds in Foreign Currency: 0.72% Investments in Government Bonds Abroad in Local Currency: 0% Investments in Government Bonds Abroad in Foreign Currency:
• In countries rated BBB and above: 0.03%
• In countries rated below BBB and unclassified: 0.72% Investments at Resident Banks (including issued debt bonds): 0.72% Investments at Non-Resident Banks (including issued debt bonds):
• Rated BBB and above: 0.15%
• Rated below BBB and unclassified: 0.72% Corporate Loan Portfolio (including issued debt bonds): 0.72% SME Loan Portfolio (including issued debt bonds): 0.6% Retail Loan Portfolio including Housing Loans: 0.35%

Portfolio: Includes investments and loans where applicable, and financial liabilities outside the balance sheet after using appropriate Credit Conversion Factors.