Chapter Five: Foundations of Assessing Customers' Creditworthiness (1) and Provisioning

The Board of Directors of the Central Bank of Egypt, in its sessions held on May 24 and 2005, approved the rules contained in the booklet titled "Foundations of Assessing Customers' Creditworthiness and Provisioning," which is issued as an appendix to the booklet "Foundations for Asset Classification and Provisioning" issued by the Central Bank of Egypt on December 19, 1991, as Circular Booklet No. 321. The Board of Directors of the Central Bank of Egypt deemed it necessary for banks to review their internal procedures for applying these rules, as well as when establishing provisions for customers' creditworthiness when granting loans or increasing these bases, which include managing credit risk, foundations of assessing creditworthiness, and provisioning for all institutional, corporate, and medium-sized enterprise customers, as well as short-term and medium-term loans, loans for investment purposes, loans for financing trade, short-term loans for the Central Savings Bank, and long-term loans for the Central Savings Bank.

The rules for establishing provisions shall apply to the financial statements of banks for the fiscal year ending on December 31, 2005, or the first fiscal year of each bank starting from the date of applying these rules, and the Central Bank of Egypt shall be notified of the percentage of compliance with these standards within three months from the beginning of the banking year of applying these rules. The Board also decided the following:

1. Banks are required to apply these rules from the first banking day of the fiscal year.

2. Banks are required to conduct studies on various industries and access indicators that demonstrate the industry's performance, highlighting the role of the Industrial Union in this regard.

3. Each bank must establish a system for each indicator determining the customer's creditworthiness before granting loans, and the bank's compliance with the Central Bank of Egypt's institutional standards.

The rules mentioned below:

The foundations of assessing creditworthiness when granting loans, increasing them, or renewing them, and when establishing provisions, apply to all short-term and medium-term loans granted to:

1. Institutional, corporate, and medium-sized enterprise customers, and related commitments.

2. Loans for investment purposes, loans for financing trade, short-term loans for the Central Savings Bank, and long-term loans for the Central Savings Bank, as detailed in the booklet.

First: Credit Risk Management and Foundations for Assessing Creditworthiness of Institutions, Companies, and Medium-Sized Enterprises

1-1 Credit Risk Management:

The following must be observed:

(a) The existence of an approved credit risk policy by the Board of Directors, which outlines the manner in which the bank's credit risk policy is implemented, including the foundations for determining the degree of creditworthiness of customers for granting, renewing, and establishing provisions. It also includes standardizing the concepts and foundations of assessment across all management departments within the bank, and clearly defining the credit and management responsibilities of the customer, and standardizing the model used.

The policy must include the following guidelines:

• The assessment of credit risk for institutional, corporate, and medium-sized enterprise customers must be linked to the One Obligor Concept as defined by the Central Bank of Egypt.

• Credit risk reviews for customers granted to all customers must be conducted at least once a year, in accordance with the rules stated in clause (a) of paragraph 2/b contained in the booklet.

• Reviews of non-performing customers must be prepared on a quarterly basis and presented to the Executive Committee and the Board of Directors or the Foreign Branch Management, as appropriate.

• Frequent visits to the customer must be conducted.

• The availability of a preliminary feasibility study before disbursement, which is confirmed before disbursement regarding the availability of conditions, guarantees, and the customer's ability to repay.

(b) The existence of guidelines for credit risk modeling, which enables the bank to predict the changes that may occur in the customers' situations.

(c) The existence of new guidelines for assessing credit risk, prepared based on the quality of credit relative to the position of each facility, and also relative to the loan portfolio, taking into account concentration relative to a single customer and related parties, the industry, the loan, the term, and the weighted average assessment over the previous period, and updating the credit risk level according to the bank's policy. These guidelines must include the necessary data required for assessment and establishing provisions.

(d) The availability of prerequisites for granting loans from the first preliminary feasibility study, as well as internal monitoring to ensure the implementation of the policy placed by the bank's management and the implementation of credit compliance conditions, and reporting any deviations from the policy and conditions mentioned to the bank's management and the necessary actions.

(e) The following factors must be considered when determining creditworthiness:

• Analysis of the institution's technical cadres and staff, as well as its management strategy and its means of control.

• Analysis of the industry/market, the competitiveness of the institution, and the institution's market share.

If the prevailing conditions have remained stable for at least three consecutive years, the results of the analysis of the customer's financial position must be considered, taking into account the Central Bank of Egypt's guidelines regarding the stability of the prevailing conditions for the main customers. The analysis must include:

• The degree of financial balance of the customer, taking into account the duration of the approved loans and the average from the bank or the Egyptian banking sector as a whole (excluding the interbank credit risk of the Central Bank of Egypt) and the customer's debt capacity.

• The customer's profitability and liquidity indicators.

• The operating cash flow generated from the operating activity and its sufficiency in addition to other repayment sources.

• Recent customer statements from other banks and the conducted visits.

• The customer's commitment position to the government, such as the compensation for damages and the social insurance fund.

In addition:

• The total debt of the customer and related parties is detailed.

• The extent of the customer's commitment to the contracts concluded with the bank or other banks.

• The terms and conditions of repayment, and the history of repayment.

• The legal actions taken by the bank or other banks against the customer or the referral of the customer to the enforcement authority or the endorsement of the customer for legal actions against the bank.

• The extent to which the group of customers with related parties has repaid their commitments to the bank, as well as the history of their default from other banks, excluding the statements and the total debt from the Central Bank of Egypt.

• Analysis of the customer's transaction history with the bank, which must include:

• The extent to which the loans granted to the customer exceed the approved limits and their duration, if any.

• The type and degree of guarantees provided to the bank, and their acceptability for the facility, and the availability of insurance on these guarantees to protect the bank, as well as the approach used in assessing these guarantees and the extent to which the value of the assets granted to the customer exceeds the value of the facility for these guarantees, if any.

• The customer's account movement with the bank during the current reporting period.

• The extent of the activity of the deposit and withdrawal movement from the pledged items, and the extent to which the pledged items exceed the period for which they were pledged, and the possibility of their deterioration or depreciation, and the possibility of their disposal.

• The ratio of the deducted commissions to the total commissions provided as collateral.

• The ratio of the deducted commissions to the total commissions provided as collateral if the proceeds from them are expected to be used to repay the customer's commitments.

• The amount and ratio of the deducted and paid commissions to the customer's total commissions.

In addition to the current assessment element, the degree of creditworthiness of the customer is determined (Risk Obligor/ORR) (as mentioned in paragraph 3).

1-2 Classification Foundations:

The study of the loan portfolio for institutional, corporate, and medium-sized enterprises to determine the provisions for creditworthiness classification must be conducted during the inspection period when preparing the financial statements.

On a quarterly or annual basis, by inspecting the loan portfolio for institutional, corporate, and medium-sized enterprise customers, as well as related commitments, from the first of the following:

(a) Conduct a detailed study of the loan portfolio and related commitments by the committee that includes representatives from the bank's management departments, which shall be responsible for:

1. Establishing provisions on a quarterly basis for the total branches of the bank, so that if any changes occur in these rules, the committee must be notified of this change, and the report must be submitted to the review committee, the executive committee, and the board of directors or the foreign branch management, as appropriate.

(b) The study must include the inspection of:

• The loans of non-performing customers, and at least a sample study representing at least 1% of the total loan portfolio of the bank granted to institutional, corporate, and medium-sized enterprises.

• A sample of the remaining non-performing loans, and a special study must be conducted so that these loans are covered by the annual review.

• A sample of the loans granted during the inspection period.

• The loans classified as non-performing, and at least a sample study.

• The loans granted to groups of customers and related parties.

• The loans granted to related parties to the bank, which includes major shareholders, executive management, affiliated companies, and any other party that has a fundamental effect on the prevailing policy and operating activity of the bank.

• The loans to customers who hold any share in the bank's capital with an effective percentage.

1-3 Degree of Creditworthiness of Customers and Required Provisions:

The degree of creditworthiness when granting, increasing, or renewing (Risk Obligor Rate/ORR) is determined on an annual basis, and when establishing provisions, a minimum degree is considered, as follows:

No.	Degree of Creditworthiness	Minimum Provisioning Percentage
1	Low Risk (Low)	1%
2	Modest Risk (Modest)	1%
3	Satisfactory Risk (Satisfactory)	1%
4	Adequate Risk (Adequate)	2%
5	Acceptable Risk (Acceptable)	2%
6	Marginally Acceptable Risk (Marginally Acceptable)	3%
7	Watch List Risk (Watch List)	5%
8	Substandard Risk (Substandard)	20%
9	Doubtful Risk (Doubtful)	50%
10	Loss Risk (Loss)	100%

For the details in the following tables, taking into account that the main indicators for the current rating and each bank must review and adjust for each category of these categories to determine the creditworthiness for each customer:

1. Industry stability.
2. Institution stability.
3. The institution's competitiveness.
4. Operational indicators and results.
5. Operating cash flow.
6. Financial position.
7. Management and internal control.
8. Compliance with legal requirements.
9. All financing and loans.
10. Outstanding balances due.

Note: The creditworthiness rating in this category must not continue for more than five years.

Indicator	Category 1	Category 2	Category 3	Category 4	Category 5	Category 6	Category 7	Category 8	Category 9	Category 10
	Low Risk	Modest Risk	Satisfactory Risk	Adequate Risk	Acceptable Risk	Marginally Acceptable Risk	Watch List Risk	Substandard Risk	Doubtful Risk	Loss Risk
Industry Stability	Stable and growing	Stable and growing	Stable and growing	Stable and growing	Stable and growing	Stable and growing	Stable and growing	Deteriorating	Deteriorating	Deteriorating
Institution Stability	Strong and stable	Strong and stable	Strong and stable	Strong and stable	Strong and stable	Strong and stable	Strong and stable	Weak and unstable	Weak and unstable	Weak and unstable
Competitiveness	Strong competitive position	Strong competitive position	Strong competitive position	Strong competitive position	Strong competitive position	Strong competitive position	Strong competitive position	Weak competitive position	Weak competitive position	Weak competitive position
Operational Indicators	Excellent	Good	Good	Good	Good	Fair	Fair	Poor	Poor	Poor
Operating Cash Flow	Sufficient	Sufficient	Sufficient	Sufficient	Sufficient	Insufficient	Insufficient	Insufficient	Insufficient	Insufficient
Financial Position	Strong	Strong	Strong	Strong	Strong	Weak	Weak	Weak	Weak	Weak
Management and Internal Control	Excellent	Good	Good	Good	Good	Fair	Fair	Poor	Poor	Poor
Compliance with Legal Requirements	Fully compliant	Fully compliant	Fully compliant	Fully compliant	Fully compliant	Non-compliant	Non-compliant	Non-compliant	Non-compliant	Non-compliant
All Financing and Loans	Well-managed	Well-managed	Well-managed	Well-managed	Well-managed	Poorly managed	Poorly managed	Poorly managed	Poorly managed	Poorly managed
Outstanding Balances Due	Current	Current	Current	Current	Current	Overdue	Overdue	Overdue	Overdue	Overdue

The main indicators for the current rating and each bank must review and adjust for each category of these categories to determine the creditworthiness for each customer:

1. Industry stability.
2. Institution stability.
3. The institution's competitiveness.
4. Operational indicators and results.
5. Operating cash flow.
6. Financial position.
7. Management and internal control.
8. Compliance with legal requirements.
9. All financing and loans.
10. Outstanding balances due.

The main indicators for the current rating and each bank must review and adjust for each category of these categories to determine the creditworthiness for each customer:

1. Industry stability.
2. Institution stability.
3. The institution's competitiveness.
4. Operational indicators and results.
5. Operating cash flow.
6. Financial position.
7. Management and internal control.
8. Compliance with legal requirements.
9. All financing and loans.
10. Outstanding balances due.

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