Chapter Two: Instructions for Implementing the International Financial Reporting Standard (9) - Section Two: Final Application

The Board of Directors of the Central Bank of Egypt, in its meeting held on January 17, 2018, obligated banks to prepare financial statements in accordance with IFRS (9) starting from the year 2019 (starting from January 1, 2019) for banks that prepare annual financial statements ending December of each year, and starting from July 1, 2019 for banks that prepare financial statements ending June of each year.

The following are the instructions for preparing banks' financial statements and the requirements of the standard, which were prepared in light of the preliminary financial statements prepared by banks for the year 2018, with reference to the following:

• The International Financial Reporting Standard (IFRS 9) instructions apply to all banks and branches of foreign banks operating in Egypt, and also to the consolidated financial statements of the Central Bank and the branches of Egyptian banks abroad, as well as to the separate, individual, and consolidated financial statements of banks.

• At the beginning of the first application period, the bank must verify the validity, accuracy, and effectiveness of the models
  (Validation) used in the Expected Credit Loss (ECL) calculation, and also engage an independent party (such as an external auditor of the bank's accounts) to assess the effectiveness of the models and the accuracy of the results, with the necessity for the bank to submit to the Central Bank of Egypt a report from the party that conducted the assessment of validity and accuracy before the issuance of the financial statements for the first quarter of the application period, no later than five months. The Central Bank must be notified before agreeing with the party that will conduct the verification of the validity and accuracy of the models used.

• The responsibility of auditors - in the framework of their duties as auditors of the bank's annual and interim financial statements -
  includes verifying the accuracy of the bank's procedures and the validity of the methodologies and methods used to calculate Expected Credit Losses, and the auditors must submit to the Central Bank of Egypt a report confirming the accuracy of the procedures and the validity of the calculation methods before the bank, as well as accompanying the interim and annual financial statements.

• The Central Bank of Egypt will review the procedures for verifying the validity of the methodologies and mechanisms applied by banks in calculating Expected Credit Losses and the business models related to the classification of financial assets and liabilities.

• The bank's Audit Committee and Risk Committee (or those replacing them for foreign bank branches) must hold periodic meetings with the relevant departments for implementation and obtain quarterly reports on

On behalf of the Governor of the Central Bank of Egypt, dated February 26, 2019 1 the application, and in case of need, the results of the application, stages, and obstacles encountered during the application process, as well as to inform the Board of Directors of the Bank (or those replacing them for foreign bank branches) of the data related to the application and to assist them in exercising their supervisory role in this regard.

• The Risk Management Department plays a key role in implementing the requirements of these instructions, particularly regarding the Grouping methodologies for financial assets with similar credit risks, and Rating financial assets,
  and determining the Staging of loans and financing and debt instruments, as well as developing methodologies and criteria for calculating Expected Credit Losses.

The Board of Directors of the Bank (or those replacing them for foreign bank branches) must also exercise direct supervision and close follow-up for the implementation of these instructions, and ensure the verification of the following:

1. The continuous provision of necessary requirements for implementation and follow-up of the implementation of these instructions, and providing any support needed for implementation.

2. Adopting policies and procedures related to the implementation of the requirements of these instructions, including the following:

   • Policies and procedures for classifying and reclassifying financial assets held for trading, held for investment, or those containing credit risk, as well as the three stages for classifying loans and financing, debt instruments, and derivatives at fair value through profit or loss.
   • Policies and procedures for calculating Expected Credit Losses (ECL) on items and elements containing credit risk, and the specific determinants and criteria for historical, current, and forward-looking information used.

3. Adopting Business Models (BM) and Modeling methodologies used in implementation at the bank level, in addition to the importance of adopting the bank's internal credit rating system, which includes Probability of Default (PD) mapped to rating grades, as well as adopting a methodology for calculating Loss Given Default (LGD) and Exposure at Default (EAD) to calculate Expected Credit Loss (ECL), and ensuring the availability and quality of historical and forward-looking data used.

4. Ensuring the adequacy, effectiveness, and availability of IT systems and banking and operational resources.

5. Continuously working on developing the risk management environment, credit granting and monitoring policies, and pricing.

6. Coordinating between the various departments in the bank, including the Finance Department, Risk Management Department, Information Technology Department, Internal Audit, and Business Departments, in this regard.

Scope of Application

The International Financial Reporting Standard (IFRS 9) instructions apply to all banks and branches of foreign banks operating in Egypt, and also to the consolidated financial statements of the Central Bank and the branches of Egyptian banks abroad, as well as to the separate, individual, and consolidated financial statements of banks.

General Considerations

• Financial statements issued for the financial year ending in December 2018 or June 2019 must be prepared by the bank with the application of the requirements of the International Financial Reporting Standard (9) "Financial Instruments" according to the instructions of the Central Bank of Egypt starting from 2019 or July 2019. At the time of issuance, the effective date of application of the rules with those financial statements and the potential financial effects resulting from the application must be stated.

• The measurement of financial assets held must be repeated in the comparative financial statements, and the matter is limited to reclassifying the elements of financial assets and liabilities in the comparative statements to match the presentation style in the financial statements subject to the standard for the first time.

• When preparing financial statements in accordance with the requirements of these instructions, it is necessary to comply with the disclosure requirements contained in the International Financial Reporting Standard (7) and its amendments (Egyptian Accounting Standard No. 40).

• The rules for preparing and presenting banks' financial statements, as well as the accounting and measurement standards issued by the Central Bank of Egypt dated December 16, 2008, apply, except for what is stated in these instructions, and reference is made to Egyptian accounting standards for what is not covered by these rules and instructions.

• The measurement basis for financial assets held in the financial portfolio is fair value, and the measurement basis for financial assets at amortized cost is amortized cost, while the measurement basis for commitments for loan commitments and financial guarantee contracts and off-balance sheet items is provisions related to financial liabilities.

• Banks must, for the purpose of calculating Expected Credit Losses, take into account guarantees and securities issued by the Egyptian Government and the Central Bank to face due claims in local currency.

• Debt instruments issued by the Egyptian Government in local currency must be excluded from the calculation of Expected Credit Losses.

• When calculating the Loss Given Default (LGD) for assets held by banks in Egypt and abroad, and assets held by the Central Bank in foreign currency, and foreign currency bonds, a rate of 45% LGD must be applied.

• The process of calculating provisions must cover all financial assets and off-balance sheet items, except:

  • Deposits with banks due within less than one month from the financial year-end.
  • Current accounts with banks.
  • Balances with the Central Bank in local currency.

• Banks must, for the purpose of calculating Expected Credit Losses, perform reclassification of financial instruments between the three categories defined by the standard (Held for Trading, Fair Value through Profit or Loss, and Fair Value through Other Comprehensive Income) once at the beginning of application, and also to achieve consistency with the application of the standard.

The application of the standard's requirements must also be followed, in addition to what is stated in these instructions, by performing reclassification and re-measurement operations.

• The methodologies currently in force for calculating Expected Credit Losses must not be modified by the systems applied after presentation to the bank's auditors and obtaining the approval of the Central Bank of Egypt.

In case of non-compliance with this, the positive differences resulting from the modification must be recorded in the General Risk Reserve (as per the audit report) as a deduction from Retained Earnings available for distribution.

• Starting from the beginning of application, each bank must submit to the Central Bank of Egypt (the competent authority) an internal assessment report on the adequacy of capital in accordance with the instructions issued in this regard, taking into account the impact of the implementation of these instructions on the capital adequacy standard.

• For the purpose of calculating the minimum capital requirement (the second tier capital), it is considered that the equivalent of the required reserves against debt instruments, loans, and financing classified in the first stage (Stage 1) amounts to 1.25% of the total risk-weighted credit assets calculated according to the standardized method.

• The Internal Audit Department of the bank must conduct a periodic independent assessment (at least annually) for the implementation of the policies and procedures related to the implementation of the standard's requirements in light of these instructions, particularly regarding the adopted policies and procedures for classifying and presenting financial assets, and the implementation of approved business models and methodologies for calculating Expected Credit Losses, Exposure at Default, Loss Given Default, and Probability of Default.

• Embedded Derivatives in a Host Contract or where the Host Contract does not represent a financial asset falling under the category of financial assets according to the International Financial Reporting Standard (9) must be separated.

Considerations for Preparing Financial Statements from the Beginning of Application: The First Day of Application:

• On the date of the beginning of application, the provisions for credit risk, provisions for significant operational risks, and provisions for IFRS 9 risk are merged into one provision: the General Risk Reserve.
• In case the provisions calculated according to the requirements of these instructions are higher than the provisions calculated according to
  (the provisions), the excess is deposited into the General Risk Reserve according to the existing instructions until the end of December 2018 or June 2019, and in case of insufficient retained earnings, the excess is deducted from retained earnings (whether the result is debit or credit for retained earnings).

In the case of the reverse (i.e., provisions calculated according to these instructions are lower than provisions calculated according to existing instructions until the end of December 2018 or June 2019), the balance of the General Risk Reserve is increased by the differences, and in all cases, the balance of the General Risk Reserve is affected, after which the Central Bank of Egypt is consulted.

The balance of this reserve is included in the bank's capital base (Tier 1).

Transitional Periods for Application:

The work of the Central Bank of Egypt's instructions on the basis of assessing the creditworthiness of borrowers and adjusting provisions issued on June 6, 2005, continues with the following exceptions:

• In case the provisions calculated according to the creditworthiness assessment basis are higher than the provisions calculated according to these instructions,
  the excess is deposited into the General Operational Risk Reserve (after adjusting the legal reserve) from the bank's retained earnings and is recorded in shareholders' equity, and in case of insufficient retained earnings, it is deducted from retained earnings.

For these instructions, in case the provisions calculated according to the creditworthiness assessment basis are lower than the provisions calculated according to these instructions, the excess is returned to retained earnings to the extent that it was previously adjusted by calculating the General Operational Risk Reserve.

Business Models:

Business models are defined as the manner in which the bank manages its financial assets to generate cash flows.

Each bank must prepare, document, and adopt Business Models in accordance with the requirements of the International Financial Reporting Standard (9) and in a manner that reflects the bank's adopted strategy for managing financial assets and their cash flows, as follows:

No.	Business Model	Description
1	Hold to Collect Contractual Cash Flows	The objective is to hold assets to collect contractual cash flows consisting of principal and interest. Sale is allowed only in exceptional circumstances relative to this model, and in accordance with the standard, where there is deterioration in the credit capacity of the issuer, and the sale does not result in a fundamental change in the future cash flows expected to be received, and the sale is managed in a way that is not frequent or significant in value.
2	Hold to Collect and Sell	The objective is achieved by both collecting contractual cash flows and selling.
3	Other Business Models	All other financial assets not falling under the above categories.

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