Central Bank of Jordan Capital Adequacy Instructions No. 2016/67 under Basel III

Central Bank of Jordan
Capital Adequacy Instructions
According to Basel III Standard
No. (2016/67)

Table of Contents
Chapter One: Scope of Application ............................................................................. 4
Chapter Two: Regulatory Capital Requirements ................................................................. 7
First: Components of Regulatory Capital ................................................................... 7
Second: Capital Elements ............................................................................. 7
Third: Eligible Elements for Capital Components .............................................................. 8
Fourth: Regulatory Adjustments (Deductions from Capital) 18...................................................
Fifth: Application of Instructions 23..........................................................................
Chapter Three: Additional Capital Requirements 24...............................................................
Chapter Four: Risk Coverage 26..........................................................................
First: Credit Risks (Standardized Approach) 26..................................................................
Second: Credit Risk Mitigations Mitigations Risk Credit39.........................................
Third: Operational Risks 58..................................................................................
Fourth: Market Risks (Standardized Approach) Approach Standardized – Risk Market 64...........
Chapter Five: Leverage Ratio (Ratio Leverage )79....................................................

List of Appendices:
Appendix (1): Investments in Banks, Securities Companies, and Other Financial Institutions with Unconsolidated Accounts 80
Appendix (2): Illustrative Example for Calculating Minority Interests ............................................................. 81
Appendix (3): Deduction Corresponding Approach (APPROACH DEDUCTION CORRESPONDING)................................. 85
Appendix (4): Illustrative Example for Deduction Limits................................................................... 86
Appendix (5): Regulatory Capital............................................................................... 88
Appendix (6): Steps the Central Bank Will Follow Regarding Capital to Address Cyclical Fluctuations .......... 90
Appendix (7): Alignment of External Credit Ratings............................................................... 91
Appendix (8): Ministries and Institutions Eligible for Preferential Risk Weights for the Jordanian Government (0%) .... 92
Appendix (9): Enterprises and Institutions Eligible for Preferential Risk Weights for Banks ....................... 94
Appendix (10): Enterprises and Institutions Eligible for Preferential Risk Weights for Companies.................... 96
Appendix (11): Conditions Required for Small Enterprises to be Included in the Regulatory Retail Portfolio .............. 97
Appendix (12): Eligible Residential Loans ....................................................................... 98
Appendix (13): Specialized Lending 100...........................................................................
Appendix (14): Business Lines According to the Standardized Method 104.........................................................
Appendix (15): Specific Risks for Debt Instruments Subject to Interest Rate Risks 105...................................
Appendix (16): General Risks for Instruments Subject to Interest Rate Risks 106..........................................
Appendix (17): General Risks for Debt Instruments Subject to Interest Rate Risks 107....................................
Appendix (18): Market Risks for Equity Instruments Held for Trading 109.............................................
Appendix (19): Market Risks for Foreign Currency Exchange Rates and Gold 110...........................................
Appendix (20): Simplified Method for Calculating Commodity Risks 111.....................................................
Appendix (21): Market Risks Arising from Derivative Contracts Held for Trading 112.................................
Appendix (22): Counterparty Risks for Repurchase Agreements and Reverse Repos and Securities Lending and Borrowing 113.......
Appendix (23): Counterparty Risks for Securities Received / Delivered and Not Yet Settled 114.................
Appendix (24): Leverage Ratio (RATIO LEVERAGE) 115....................................................

Chapter One: Scope of Application
First: These Instructions apply to all banks operating in the Kingdom on a unified basis, as well as at the levels indicated below, such that the Central Bank of Jordan is provided with capital adequacy models for these levels as follows:

1. The Banking Group
   Including affiliated financial companies and holding companies (except insurance companies).
2. Jordanian and Foreign Branches.
3. Jordanian Branches.
4. Foreign Branches individually.
5. Affiliated Banking Companies individually.

Second: Consolidation Mechanism for the Purposes of Applying the Capital Adequacy Standard

1. Banks and Other Financial Companies Consolidated within the Banking Group:
   1.1 The data of financial companies shall not be consolidated if they are held with the intent of disposal or held temporarily for sale, or if they are subject to special legislation that does not allow consolidation.
   1.2 In the event of non-consolidation for capital adequacy calculation purposes, and if the financial statements of the company are consolidated for accounting purposes, the value of the Bank's investment in the unconsolidated company must be deducted from the regulatory capital of the banking group. Simultaneously, for the purposes of calculating capital adequacy, the assets, liabilities, and minority interests (related to the unconsolidated company) must be deducted from the financial data of the banking group.

2. Investments in Banks, Securities Companies, and Other Financial Companies:
   1.2 Banks, securities companies, and other financial companies owned or controlled by the Bank must have their accounts consolidated to the maximum extent possible. In all cases, the accounts of banks, securities companies, and other financial companies owned at a percentage exceeding 50% of their capital must be consolidated, except in cases where this cannot be achieved due to impracticality, such as cases where the share is temporary in nature or where non-consolidation is a legal requirement of the host regulatory authority. In the event of non-consolidation, the book value

The Banking Group refers to Jordanian banks.

(Value Carrying) of the Bank's share in the capital of these companies shall be deducted from regulatory capital, as indicated in Appendix No. (1).
2.2 When consolidating the accounts of banks, securities companies, and other financial companies owned by majority (>50%) or controlled (according to the definition of control provided in the standards issued by the Bank with its financial statements), and for the purposes of capital calculation, the recognition of the capital of these companies in the parent bank's capital is subject to the guidelines regarding the recognition of minority interests provided in Item (Third 4/) of Chapter Two.
3.2 In the case of affiliated companies (which are consolidated) that have a capital account deficit determined by the supervisory authority (host authority), the concerned licensed bank must immediately inform the Central Bank of Jordan of this deficit. The Central Bank of Jordan will monitor the measures taken by that affiliated company to rectify its situation. If the company fails to rectify within the period granted to the bank, this deficit will be deducted from the regulatory capital of the licensed bank (the parent bank).

3. Investments in the Capital of Banks, Financial Companies, and Non-Consolidated Insurance Companies within the Banking Group:
   1.3 Investments
   in the capital of banks, financial companies, and insurance companies that are less than 10% of the capital of these companies are treated as indicated in Item (Fourth 10/) of Chapter Two.
   2.3 Investments
   in the capital of banks, financial companies, and insurance companies that exceed 10% of the capital of these companies are treated as indicated in Item (Fourth 11/) of Chapter Two.
   3.3 When consolidating the accounts of insurance companies owned by majority and/or controlled by the Bank, the Central Bank of Jordan will only allow the recognition of the surplus from the capital of insurance companies (which is the amount exceeding the regulatory capital required from the insurance company) under certain conditions
   within the regulatory capital of the licensed bank, as indicated in the minority interests item No. (Third 4/) of Chapter Two. Banks that have recognized a surplus in the capital of their affiliated insurance companies must disclose to the public the amount of this recognized surplus within their capital. It should be noted that if the Bank's ownership in the capital of the insurance company is (more than 50% and less than 100%), the recognized surplus

Includes direct and indirect investments, whether classified within the banking portfolio or the trading portfolio.
The amount deducted from investments in equity and other investments in regulatory capital will be subject to adjustment to reflect the surplus in the capital of these companies that exceeds regulatory requirements. That is, the deducted amount will be equal to the investment and/or the regulatory capital requirements of the consolidated affiliated companies, whichever is less as mentioned in Item (Third 4). The surplus (the difference between the investment in these companies and their regulatory capital) will be given a preferential risk weight like any other investment.

must be proportional to the ownership percentage. However, the surplus in the capital of insurance companies in which the Bank holds minority interests and which are not material to the Bank will not be recognized, as the Bank does not have the ability to transfer the surplus in the capital of those companies due to its lack of control over that.
4.3 In the case of affiliated insurance companies (which are consolidated) that have a capital account deficit determined by the supervisory authority (host authority), the concerned licensed bank must immediately inform the Central Bank of Jordan of this deficit. The Central Bank of Jordan will monitor the measures taken by that affiliated company to rectify its situation. If the company fails to rectify within the period granted to the bank, this deficit will be deducted from the regulatory capital of the licensed bank (the parent bank).

Chapter Two: Regulatory Capital Requirements
First: Components of Regulatory Capital
This item addresses the definition of the components of regulatory capital for banks. Eligible capital is used alongside risk-weighted assets to calculate the Capital Adequacy Ratio (CAR). This part will outline the criteria and characteristics of each component of eligible capital.

Second: Capital Elements

1. Eligible regulatory capital consists of the following elements:
   1.1 Tier 1 Capital (Going Concern), which consists of the following:
   1.1.1 Common Equity Tier 1 (CET1).
   1.1.2 Additional Tier 1 (AT1).
   1.2 Tier 2 (T2), which is capital used in the event of non-continuity
   4 (Gone Concern), as indicated in Item (Third 3/) of this Chapter.

2. Each of the three types of capital (T2, AT1, CET1) has a specific set of criteria that the financial instrument must meet before being included in the relevant category, as detailed later.

3. All capital elements are after deducting regulatory adjustments (deductions) specified in Item (Fourth/) of this Chapter, such that the total regulatory capital does not fall below 12% of risk-weighted assets for credit, market, and operational risks at all times, with the components of the ratio as follows:
   1.3 Common Equity Tier 1 (CET1) must not be less than 6% of risk-weighted assets for credit, market, and operational risks at all times.
   2.3 Additional Tier 1 (AT1) must not exceed 1.5% of risk-weighted assets for credit, market, and operational risks at all times.

Instructions have been issued requiring these instruments to absorb losses.
The Central Bank has the right, in the event the bank faces fundamental financial problems, to

3.3 Tier 2 (T2) must not exceed 2% of risk-weighted assets for credit, market, and operational risks at all times.
4.3 The Capital Conservation Buffer is 2.5% of risk-weighted assets and must be composed of CET1.

4. For the purposes of classifying a bank within the "Well Capitalized" category, its capital adequacy ratio must not be less than 14%. However, if the bank is classified as a Domestic Systemically Important Bank (D-SIB) and for the purposes of classifying it within the "Well Capitalized" category, its capital adequacy ratio must not be less than 14% plus the capital required from locally important banks according to the category to which the bank belongs and according to the time frame for dealing with locally systemically important banks as stated in the effective instructions.

5. Regarding banks with foreign presence, if the host regulatory authorities impose a higher capital adequacy ratio than 12%, the bank, when consolidating its financial data for capital adequacy purposes, must increase the risk-weighted assets for its foreign presence proportionally to reflect the capital adequacy ratio required for its foreign presence. For example, if the bank has an external subsidiary and the capital adequacy ratio required for this company is 16%, and the risk-weighted assets for this company amount to 1 billion dinars, then the capital required for this company according to the host regulatory authority's instructions is 160 million dinars, whereas the capital required according to the Central Bank's instructions is 120 million dinars. To reflect the increase in the capital adequacy ratio for this company, the risk-weighted assets for the subsidiary when consolidating financial data will equal (160 million x 1 billion) / 120 million = 1.333 billion dinars.

Third: Eligible Elements for Capital Components

1. Common Equity Tier 1 (CET1)
   5 1.1 Common Equity Tier 1 (CET1) consists of the sum of the items listed below ] after regulatory adjustments (deductions) used to calculate Common Equity Tier 1 (CET1) and listed in Item (Fourth/) of this Chapter [ :
   1.1.1 Common Shares (Common Shares) issued by the Bank that meet the necessary criteria to be considered common shares for regulatory purposes.
   1.1.2 Retained Earnings (Losses).

Proposed distributions are not included in CET1.

1.1.3 Other Accumulated Comprehensive Income Items, which include the accumulated change in fair value in full, foreign currency translation differences, and the cash flow hedge reserve for assets
6 not valued at fair value.
1.1.4 General Reserves:
Including the legal reserve, optional reserve, premium (discount) of issuance, and premium on treasury shares issuance.
1.1.5 Any other unrestricted reserves subject to the prior approval of the Central Bank of Jordan.
1.1.6 Minority Interests, which are common shares issued by affiliated companies of the Bank and consolidated with the Bank's accounts and held by a third party, which meet the criteria for inclusion in Common Equity Tier 1 (CET1) as explained in Item (Third 4/) of this Chapter.

2. Net carried-forward profits after tax and deducting expected distributions are included in CET1, while period losses are deducted.

3. Qualification Criteria for Common Shares Issued by the Bank:
   To include any financial instrument within Common Equity Tier 1 (CET1), it must meet all the following criteria:
   1.3.1 It must represent the lowest priority claim among capital instruments in the event of the Bank's liquidation.
   2.3.1 It has the right to claim remaining assets in proportion to its share in capital after paying off all senior debts in the event of liquidation (i.e., it has the right to an unlimited and non-fixed claim, not fixed or capped).
   3.3.1 The nominal value is permanent and cannot be paid except in the event of liquidation (regardless of the existence of a repurchase option or any means of reducing capital on an optional basis allowed by prevailing laws).
   4.3.1 The Bank must not create any expectation at the time of issuance that it will repurchase, redeem, or cancel the instrument, and the contractual terms must not contain any feature that could be understood as such.
   5.3.1 Distributions are paid from distributable items (including retained earnings) and are not linked in any way to the value paid at issuance, nor are they subject to a contractual cap.

If the reserve results from assets not valued at fair value, this reserve is not recognized, such as credit facilities.

6.3.1 There is no case in which the distribution is mandatory, and therefore non-payment is not considered a default event.
7.3.1 Distributions are paid only after settling all contractual and legal obligations, as well as paying what is due on capital instruments with the highest priority.
8.3.1 They bear any losses that may occur first.
9.3.1 The paid value is considered part of equity (i.e., not a liability) for the purpose of determining insolvency in the balance sheet, and is classified as equity according to the relevant accounting standards.
10.3.1 They must be issued directly and paid in full, and the Bank must not have financed the purchase of the instrument directly or indirectly.
11.3.1 The paid value is not guaranteed or covered by a guarantee from the issuer or any related party, nor is it subject to any arrangements that enhance its legal or economic priority.
12.3.1 They must be issued only with the approval of the Bank's owners, whether granted directly by the owners themselves or by persons authorized by these owners.
13.3.1 They must be clearly and separately disclosed in the Bank's balance sheet.

2. Additional Tier 1 (AT1)
   1.2 Additional Tier 1 capital consists of the sum of the items listed below ]after regulatory adjustments (deductions) used to calculate Additional Tier 1 (AT1):
   1.1.2 Financial instruments issued by the Bank that meet the inclusion elements in Additional Tier 1 (AT1) and are not included in Common Equity Tier 1 (CET1), such as the nominal value of perpetual non-cumulative preferred shares (dividends) and similar instruments.
   1.2.2 Premium (discount) of issuance resulting from the issuance of financial instruments included in Additional Tier 1 (AT1);
   1.3.2 Minority Interests, which are instruments issued by affiliated companies of the Bank and consolidated with the Bank's accounts and held by a third party, which meet the inclusion elements in Additional Tier 1 (AT1) and are not included in Common Equity Tier 1
   .(CET1)

2.2 For the recognition of financial instruments issued by the Bank that meet the criteria for inclusion in Additional Tier 1 (AT1), they must meet the following criteria as a minimum or exceed them:
1.2.2 Issued and paid in full.
2.2.2 Support depositors, general creditors, and subordinated loans to the Bank.
3.2.2 Unsecured and not covered by a guarantee from the issuer or any related party, or containing any arrangements that could enhance their economic or legal priority against other creditors of the Bank.
4.2.2 Perpetual, meaning they have no maturity date and their value cannot be modified.
5.2.2 They can be redeemed at the issuer's request only after a minimum of 5 years from the date of issuance. In the event of a call option for the issuer, the following must apply:

• Obtain prior approval from the Central Bank of Jordan for implementation.
• Not create any expectation that it will exercise the call option. It should be noted that the Bank may not exercise the call option unless:
  a. It replaces the redeemed instrument with capital of similar or better quality, and the replacement is done under terms that maintain the Bank's ability to maintain sustainable income 8. b. The Bank proves that its capital level after exercising the call option is higher than the limit set by the Central Bank of Jordan 9.

The replacement of the new instrument with the extinguishment of the old instrument may be synchronized, but it cannot occur after.
If the extinguishment option is executed, the process of evaluating the bank's capital adequacy is subject to verification by the Central Bank of Jordan.

6.2.2 Any repayment of the principal amount (through repurchase or redemption) must be done with the prior approval of the Central Bank of Jordan, and the Bank must not hint to the market or assume that the Central Bank of Jordan's approval is guaranteed.
7.2.2 Dividend Distribution / Interest Payment Option:

• The Bank has the right at all times to cancel dividend distributions/interest payments.
• Non-payment does not mean in any case that there is a default event at the Bank.
• The Bank has the right to use unpaid dividends/interest to settle obligations that have matured.
• Cancellation of dividend distributions/interest payments does not result in imposing any legal or regulatory restrictions on the Bank.
  8.2.2 Dividends/interest are distributed through distributable items.
  9.2.2 The distribution of dividends/payment of interest for the instrument must not be linked to a change in the Bank's credit rating (i.e., the distribution of dividends or payment of interest is not reviewed in the event of a downgrade of the Bank's or the banking group's credit rating).
  10.2.2 Instruments classified as liabilities for accounting purposes (such as long-term bonds and classified
  within (AT1) must contain a loss-absorption feature either by:
• Conversion to common shares after a period of time based on a loss indicator in CET1
  such that the conversion occurs when losses reach 30% of CET1 or
• A write-off mechanism for part of the financial instrument, such that this part covers losses, and the write-off has the following effects:
  a. Reduction of the claim value on the instrument in the event of liquidation. b. Reduction of the paid value if the call option is used.
  c. Partial or full reduction of the interest value or distributions on the instrument.
  11.2.2 The Bank or any related party controlled by the Bank or having effective influence over it must not have purchased the instrument, and the Bank must not have financed the purchase of the instrument (directly or indirectly).
  12.2.2 The instrument must not contain any features requiring the issuer to compensate shareholders if a new instrument is issued at a lower price within a certain time frame.
  13.2.2 If the instrument is not issued by an operating unit established by the Bank or within the holding company in the banking group (for example, issued by a special purpose vehicle (SPV)), the returns must be available without restrictions to any operating unit or to the holding company in the banking group in a manner that meets all the bases for inclusion or exceeds them within Additional Tier 1 (AT1).

3.2 Premium (discount) of issuance resulting from the issuance of financial instruments included in Additional Tier 1 (AT1):

Permits the inclusion of non-qualifying issuance premium (discount) as part of Common Equity Tier 1 (CET1) within Additional Tier 1 (AT1) if this premium (discount) resulted from instruments included in Additional Tier 1 (AT1).

3. Tier 2 (T2)
   1.3 Tier 2 capital consists of the sum of the items below after regulatory adjustments (deductions) used in calculating Tier 2 (T2):
   1.1.3 Instruments issued by the Bank that meet the inclusion conditions within Tier 2 and are not included in Tier 1 capital.
   1.2.3 Premium (discount) of issuance resulting from the issuance of instruments included in Tier 2
   .(Tier 2)
   1.3.3 Minority Interests, which are financial instruments issued by affiliated companies that consolidate their data with the Bank, owned by a third party, and meet the bases for inclusion in Tier 2 and are not included in Tier 1.
   1.4.3 General banking risk reserve: not exceeding 1.25% of the total risk-weighted assets for credit calculated within the Standardized Method, noting that any provisions or reserves deducted by the Bank to cover losses that have occurred are not recognized.

2.3 Financial instruments issued by the Bank that meet the criteria for inclusion in Tier 2 (T2):
The objective of Tier 2 is to provide capital instruments that absorb losses on a gone-concern basis. To consider any instrument within Tier 2, it must meet the minimum criteria as follows:
1.2.3 Issued and paid in full.
2.2.3 The financial instrument must not have priority in claiming the funds of depositors and other creditors of the Bank.
3.2.3 The financial instrument must not be secured or covered by a guarantee from the issuer or any related party, nor be subject to any arrangements that could enhance its economic or legal priority compared to the rights of depositors or other creditors of the Bank.

4.2.3 Maturity:

• Its original maturity must not be less than five years;
• The portion recognized within capital during the remaining five years of the financial instrument's life is subject to amortization ratios as follows:
  Remaining Maturity Period Weight
  One year or less 0%
  More than one year – two years 20%
  More than two years – three years 40%
  More than three years – four years 60%
  More than four years – five years 80%
  More than five years 100%
• The financial instrument must not be subject to modifications that increase its value or any conditions encouraging early repayment.
  5.2.3 They can be redeemed at the issuer's request only after a minimum of 5 years from the date of issuance. In the event of a call or redemption option, the Bank must:
• Obtain prior approval from the Central Bank of Jordan for implementation; and
• Not create any expectation that it will exercise the call option. It should be noted that the Bank may not exercise the call option unless:
  a. It replaces the redeemed instrument with capital of similar or better quality, and the replacement is done under terms that maintain the Bank's ability to maintain sustainable income 10. b. The Bank proves that its capital level after exercising the call option is higher than the limit set by the Central Bank of Jordan 11.
  6.2.3 The investor (holder of the financial instrument) must not have the right to accelerate future financial payments (interest or principal amount) except in the event of bankruptcy or liquidation.

The replacement of the new instrument with the extinguishment of the old instrument may be synchronized, but it cannot occur after. 10 If the extinguishment option is executed, the process of evaluating the bank's capital adequacy is subject to verification by the Central Bank of Jordan. 11

7.2.3 The distribution of dividends/payment of interest must not be linked to a change in the Bank's credit rating (i.e., the distribution of dividends or payment of interest is not reviewed in the event of a downgrade of the Bank's or the banking group's credit rating).
8.2.3 The Bank or any related party controlled by the Bank or having effective influence over it must not have purchased the instrument, and the Bank must not have financed the purchase of the instrument (directly or indirectly).
9.2.3 If the instrument is not issued by an operating unit established by the Bank or within the holding company in the banking group (for example, issued by a special purpose vehicle (SPV)), the returns must be available without restrictions and in a manner that meets all the bases for inclusion within Tier 2 of capital.

3.3 Premium (discount) of issuance resulting from the issuance of financial instruments within Tier 2 (T2):
Permits the inclusion of non-qualifying issuance premium (discount) within Tier 1, within Tier 2 if it