Regulation on Minimum Requirements for Country Risk Management in Commercial Banks and Other Financial-Credit Organizations Licensed by the National Bank of the Kyrgyz Republic

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Creation date: 2024-03-14

Registered with the Ministry of Justice of the Kyrgyz Republic

August 4, 2006. Registration number 86-06

Approved

by the resolution of the Board of Directors

of the National Bank of the Kyrgyz Republic

of June 28, 2006 No. 19/3

REGULATION

on minimum requirements for country risk management in commercial banks and other financial-credit organizations licensed by the National Bank of the Kyrgyz Republic

(In the edition of the resolutions of the Board of Directors of the NBKR of December 23, 2008 No. 49/5, October 12, 2012 No. 40/3, November 16, 2012 No. 43/1, June 15, 2017 No. 2017-P-12/25-7, June 20, 2018 No. 2018-P-12/24-1, January 17, 2024 No. 2024-P-12/1-3)

I. General Provisions

1.1. This Regulation establishes mandatory requirements for compliance by commercial banks (hereinafter - banks) regarding the organization of country risk management.

(In the edition of the resolution of the Board of Directors of the NBKR of January 17, 2024 No. 2024-P-12/1-3)

1.2. The purpose of this Regulation is to establish minimum requirements for policies, procedures, and internal control in banks to form an adequate system of country risk management in banks, including transfer (transfer) risk and sovereign risk, which provide, at a minimum, the following:

• tasks of country risk management;
• procedures for identifying, assessing, determining an acceptable level of country risk, and monitoring the level of country risk, including on a consolidated basis;
• measures to maintain an acceptable level of country risk, including control and/or minimization of risk;
• procedures for information support on country risk issues (procedures for information exchange between departments and employees, procedures and frequency of reporting and other information on country risk management);
• procedures for managing country risk when carrying out foreign exchange banking services, when developing and implementing new forms and conditions for carrying out banking operations and other transactions, financial innovations and technologies, when entering new markets (by type of services, by type of currencies, and by territorial (country) affiliation);
• distribution of powers and responsibilities between the Board of Directors, executive bodies, departments, and employees regarding the implementation of the main principles of country risk management;
• procedures for monitoring the effectiveness of country risk management.

(In the edition of the resolution of the Board of Directors of the NBKR of June 15, 2017 No. 2017-P-12/25-7)

II. Definition of Country Risk

2.1. Country risk is the risk of a bank incurring losses due to changes in economic, social, and political conditions and events in foreign states when conducting international lending, foreign investments, and other cross-border operations, i.e., operations involving counterparties who are residents of a foreign state (see Note 1).

2.2. The bank should take into account the presence of indirect country risk, including when working with clients who are residents of the Kyrgyz Republic.

(In the edition of the resolution of the Board of Directors of the NBKR of June 20, 2018 No. 2018-P-12/24-1)

2.3. The bank must determine which types of country risk its activities are exposed to. The bank may incur losses due to its activities being exposed to various types of country risk, including:

2.3.1. Transfer (transfer) risk - the risk of losses that the bank may incur as a result of the borrower's inability to fulfill its obligations due to actions of a foreign government (see Note 3).

2.3.2. Sovereign risk - the risk of possible direct or indirect losses to which the bank or any of its subsidiaries is exposed as a result of the inability or unwillingness of a foreign government to repay its obligations and service its debts in accordance with the terms stipulated in contracts. Sovereign risk may arise, for example, due to a shortage of foreign currency or unwillingness to service its public debt.

(In the edition of the resolution of the Board of Directors of the NBKR of June 15, 2017 No. 2017-P-12/25-7)

2.3.3. Contagion risk - the risk of losses arising when adverse events in one country lead to the inability of borrowers in another country to fulfill their obligations (see Note 4).

2.3.4. Currency risk - the risk that the borrower's assets and cash flows will become insufficient to service its obligations due to changes in exchange rates.

2.3.5. Macroeconomic risk - the risk of incurring expenses (losses) as a result of significant changes in macroeconomic conditions in the state or in a foreign state, which will affect the borrower's ability to fulfill its obligations (for example, the decision of the Central Bank of a foreign state to raise/lower the refinancing rate, which is aimed at preventing the devaluation/strengthening of its own currency, which may subsequently negatively affect borrowers having business relations with this country).

(In the edition of the resolution of the Board of Directors of the NBKR of June 20, 2018 No. 2018-P-12/24-1)

2.3.6. Indirect country risk - the risk that the borrower's ability to repay debt may deteriorate due to changes in economic, political, or social conditions in a foreign country where the borrower has significant business ties and interests (see Note 2). Indirect country risk must be taken into account when assessing the creditworthiness of the client.

(In the edition of the resolution of the Board of Directors of the NBKR of June 20, 2018 No. 2018-P-12/24-1)

III. Requirements for Country Risk Management Policy

3.1. To ensure effective control of country risk, the bank must create a risk management system. The country risk management system must include the development by the bank of adequate policies and procedures for country risk management, a country risk reporting system, analysis and assessment of country risk, a system of country risk limits, and the consideration of country risk factors in credit risk assessment.

3.2. The bank must have a country risk management policy approved by the Board of Directors. The country risk management policy does not necessarily have to be a separate internal document, especially in small banks, and may be part of the bank's credit risk management policy. The policy must provide for an adequate system of country risk management depending on the size and complexity of the bank's international activities. The minimum requirements established by this Regulation must be complied with by all banks whose activities are exposed to country risk.

(In the edition of the resolution of the Board of Directors of the NBKR of November 16, 2012 No. 43/1)

3.3. The bank's country risk management policy must take into account the level and complexity of the impact of country risk on the bank's activities. The country risk management policy must include:

3.3.1. Description of the process of assessing country risk present in the bank's activities and its subsidiaries;

3.3.2. Standards, criteria, and methods applied in the analysis of risk for operations related to a specific country, and in the country risk rating system, if such is used by the bank;

3.3.3. Definition of country risk factors that must be included in the bank's credit policy;

3.3.4. Limits of country risk concentration, including, the aggregate limit for the bank's cross-border operations and individual limits by countries and/or regions;

3.3.5. Requirements for identifying each participant of a group of interconnected counterparties, in order to comply with country risk concentration limits for one country. This means that the bank must establish procedures that allow it to understand the structure of a certain group of counterparties and identify the ultimate owner of the group for an adequate assessment of the level of country risk;

3.3.6. Requirement that any contract between the bank and a client, which also falls under the jurisdiction of a foreign state, must be analyzed by a lawyer, and for each contract, a conclusion must be given that the agreement is legal and has force taking into account the specifics of the jurisdiction of the foreign state;

3.3.7. Procedure for assessing country risk when creating a reserve to cover potential losses and losses;

(In the edition of the resolution of the Board of Directors of the NBKR of December 23, 2008 No. 49/5)

3.3.8. List of types of cross-border operations that the bank intends to carry out, as well as operations whose implementation is prohibited by the Board of Directors of the bank;

3.3.9. Clear separation of duties between employees (structural subdivisions) responsible for strategic planning and lending from the responsibilities of personnel responsible for establishing country limits;

3.3.10. Clear separation of levels of authority and responsibility in decision-making on country risk management, including, approval of limits for international lending and investments, responsibility for monitoring country risks and preventing excessive concentration of such risks;

3.3.11. Description of the managerial information system. The policy must clearly define the forms of reporting, frequency, and procedure for its submission in order to ensure the integrity and timeliness of information exchange and control over the level of country risk on a regular basis.

3.4. The Board of Directors and the Management Board of the bank must ensure adequate internal control, based on the creation of a corresponding system of interaction between management levels, aimed at ensuring an effective process of country risk management.

IV. Country Risk Management Process

4.1. The country risk management process involves:

• analysis and assessment of risk for each country with which the bank conducts or plans to conduct operations;
• conducting analysis to assess country risk and establish limits for operations exposed to country risk, as well as the size of corresponding reserves, at least once a year;
• monitoring the current situation in countries of interest to the bank from the point of view of the impact of country risk;
• comparing the bank's conclusions on the level of country risk with information obtained from external sources;
• adequate documentation of the results of risk analysis and monitoring in such a way as to present a sufficient basis for determining the type and level of country risk accepted by the bank;
• ensuring adequate resources for country risk analysis taking into account the volume and complexity of the bank's international activities;
• ensuring timely provision to the Board of Directors and Management Board of the bank of information necessary to control compliance with country risk limits and make managerial decisions to restrict it.

4.2. Risk analysis and assessment is conducted at least annually, or more frequently if there is concern about an increase in country risk for each country where the bank and/or its subsidiaries carry out or plan to carry out activities (operations). In forming its conclusions, the bank may rely on such information sources as:

• official data of rating agencies;
• country risk assessments conducted by authoritative international organizations: the World Bank, the International Monetary Fund, the Organization for Economic Cooperation and Development, the European Bank for Reconstruction and Development, and others.

(In the edition of the resolution of the Board of Directors of the NBKR of December 23, 2008 No. 49/5)

4.3. When analyzing country risk, the bank is recommended to take into account both quantitative and qualitative factors for the given country. Among them: economic growth rates, size and structure of the country's external debt, size of international reserves, balance of the state budget, dynamics of the exchange rate of the national currency, trade balance, role of foreign sources of capital, access to international financial markets, level of development of the financial system, legal system of the country, influence of the social and political situation on the bank's interests in this country.

4.4. When assessing risk, the bank should conduct an analysis of how an unstable situation in a specific country may affect economic and political conditions in countries having significant trade relations with this country or significant investments (contagion risk). The possible impact of contagion risk should be taken into account when establishing country risk limits in the case where the country belongs to some intergovernmental association (union) (see Note 5).

4.5. Country risk assessment must be taken into account when the bank makes a decision on issuing a loan and establishing risk limits for individual countries and regions.

4.6. The bank with significant exposure to country risk is recommended to consider the possibility of creating a country risk rating system (see Note 6) and conducting a more detailed analysis of country risk. In case of using ratings of international rating agencies (see Note 7) to assess the level of country risk, the bank must also conduct independent analysis of circumstances indicating a deterioration of the current situation in a specific country, and in connection with this, immediately revise its assessment of the level of country risk regarding those clients who are affected by the change in this country risk, rather than waiting for a change in the rating established by the rating agency.

4.7. The bank must monitor the current socio-economic and political situation and track changes in the legislation system in the country of the counterparty having a high degree of exposure to country risk. For monitoring the current situation in the country, the bank may use information from various sources, including from mass media, reports of rating agencies and independent experts, analytical reports of bank employees, from clients, bank partners, etc.

4.8. As a component of the country risk management process, in order to avoid risk concentration, the bank must implement a system of country risk limits. Country risk limits usually reflect a balance of several factors, including the overall strategy of the bank's international activities and the acceptable level of country risk for the bank, plans regarding business expansion, and the bank's desire to service cross-border operations of its clients.

4.9. Country risk limits must be approved by the Board of Directors of the bank and communicated to all relevant departments and employees. Country risk limits must be reviewed at least once a year, or more frequently if there is concern about an increase in country risk in a particular country.

4.10. The bank with significant cross-border activity is recommended to consider the possibility of establishing sub-limits for country risk exposure. Criteria for establishing sub-limits may include, among other things, maturity term (short-term and long-term); type of borrower (financial organizations, type of business), type of country risk (sovereign, transfer), type of product (trade credit, project financing), presence of collateral accepted outside the Kyrgyz Republic, etc.

(In the edition of the resolutions of the Board of Directors of the NBKR of October 12, 2012 No. 40/3, June 15, 2017 No. 2017-P-12/25-7)

4.11. The bank is recommended to conduct stress testing to assess potential losses associated with country risk, independently determining the methods of conducting stress testing.

4.12. The bank must organize a reliable reporting system for the assessment and analysis of country risks. Reporting must reflect the assessment of risks for all types of operations conducted by the bank. Reporting on the current level of country risk must be regularly submitted for consideration to the Management Board and Board of Directors of the bank.

4.13. The bank must collect and store documents confirming the results of the conducted analysis and assessment of country risk. The package of documents on country risk assessment must contain the established country risk limits and exceptions to them approved by the Board of Directors of the bank, reports on the results of internal analysis of country risk, reports obtained from external sources, and other information confirming the assessment of the level of country risk.

V. Contributions to the Reserve for Covering Potential Losses and Losses

(Section title in the edition of the resolution of the Board of Directors of the NBKR of December 23, 2008 No. 49/5)

5.1. When creating reserves to cover potential losses and losses (RPLU), the bank must assess risks (including indirect) associated with the borrower's activities, placement of assets and collateral for them in foreign states.

(In the edition of the resolution of the Board of Directors of the NBKR of December 23, 2008 No. 49/5)

5.2. When determining the appropriate level of reserves to cover country risk, the bank must apply a three-step process:

• identification of countries whose changes create a threat of losses on the bank's operations;
• regular monitoring of the situation in these countries;
• determination of potential losses from country risk that the bank may incur.

5.3. Reserves for covering potential losses and losses on assets placed in foreign states are created taking into account the classification of countries into the following risk categories and within the corresponding ranges:

1. low-risk countries - from 0 to 2 percent;
2. medium-risk countries - more than 2 to 5 percent;
3. high-risk countries - more than 5 to 25 percent.

The bank has the right not to create a reserve for an asset placed in a foreign state classified as normal in accordance with the Regulation "On Classification of Assets and Corresponding Contributions to the Reserve for Covering Potential Losses and Losses".

(In the edition of the resolution of the Board of Directors of the NBKR of December 23, 2008 No. 49/5)

5.4. The list of countries classified by risk categories, including countries on the territory of which the bank is not allowed to conduct active operations, must be approved by the Board of Directors of the bank. The specified list is reviewed as necessary, but no less than once a year.

(In the edition of the resolutions of the Board of Directors of the NBKR of December 23, 2008 No. 49/5, October 12, 2012 No. 40/3)

VI. Control over the Effectiveness of Country Risk Management

6.1. The Management Board of the bank is responsible for ensuring the effectiveness of the country risk management system, the compliance of the processes of identification, assessment, control, and monitoring of country risks with the needs of the bank.

6.2. The Board of Directors is responsible for ensuring compliance by the Management Board with the country risk management policy and the implementation of appropriate measures to identify, monitor, and control country risk. The Board of Directors must review, at least annually, the bank's policy on country risk management and the creation of reserves to cover potential losses from cross-border credit operations of banks in order to ensure their compliance with the scale and complexity taking into account country risk.

(In the edition of the resolution of the Board of Directors of the NBKR of October 12, 2012 No. 40/3)

6.3. Control over compliance with policies and procedures on country risk is carried out within the internal control system. Control over country risk involves, at a minimum, control:

• over compliance with requirements and procedures established by the bank's policy and internal documents regulating the procedure for assessing country risk;
• over compliance with established limits when carrying out operations and providing services.

VII. Disclosure of Information on Country Risk Management

7.1. The bank must disclose information on measures to reduce country risk within the bank's annual report. The volume of information disclosure must correspond to the degree and level of the bank's exposure to country risk and include indicators of the nature and complexity of cross-border operations carried out by the bank.

Note:

(1) - In particular, country risk includes the possibility of nationalization or expropriation of assets, refusal of a foreign state to fulfill its obligations, changes in foreign exchange control policy, changes in the policy of regulating the exchange rate of the national currency.

(2) - For example, the bank is exposed to indirect country risk in the case where the bank's client is a company that supplies equipment abroad and expects payments in foreign currency.

(3) - For example, the establishment of foreign exchange control or restrictions on the transfer of funds, making it difficult to access payment currency and transfer payment abroad.

(4) - For example, in the case when the default of the government of one country forces investors to withdraw investments from other countries of this region.

(5) - For example, if the country is a member of the Commonwealth of Independent States (CIS) and has close economic ties with other participating countries.

(6) - The bank may decide on the need to use an internal rating system to assess country risk. In this case, a detailed description of the methodology applied by the bank to assess country risk must be set out in internal documents approved by the Board of Directors of the bank. At the same time, the bank may set different ratings for clients representing the public and private sectors. However, the country risk rating for a counterparty operating in the private sector cannot be higher than the country risk rating assigned to a counterparty representing the public sector. Country risk ratings can serve as an information base for determining country risk limits. In the case where the bank uses a country risk rating system, it must be integrated into the asset classification procedure.

(7) - Banks are recommended to use as external sources of sovereign country ratings assessments of such international rating agencies as Moody's Investor Services, Standard and Poor's Rating Group, as well as data on countries published by such international organizations as: the World Bank, the International Monetary Fund, the Organization for Economic Cooperation and Development, the European Bank for Reconstruction and Development, the Bank for International Settlements.

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