Central Bank of Jordan Circular on Stress Testing Requirements for Banks Based on 2020 Data

CENTRAL BANK OF JORDAN

Reference No.: 2/23/5174 Date: 14/1442 AH Corresponding Date: 28/4/2021 AD

Circular to Banks Operating in the Kingdom

Greetings,

Based on the Instructions for Stress Testing of Banks Operating in Jordan No. (2016/1) dated (2016/12/6), attached are the sensitivity tests and scenario tests that banks must perform based on data as of 31/12/2020. Sensitivity tests, including those assessing the impact of the coronavirus pandemic, are to be applied at the level of the bank's branches in Jordan and at the level of consolidated financial statements. Scenario tests are to be applied at the level of the bank's branches in Jordan only. The results of the tests, filled according to the attached templates, must be submitted to us no later than the end of April 2021. The Central Bank will continue to provide banks with the required tests annually, taking into account risk developments at the local, regional, and international levels.

Respectfully,

Governor Dr. Ziad Faris

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CENTRAL BANK OF JORDAN

Required Stress Tests for Banks Based on End-of-Year 2020 Data

First: Coronavirus Pandemic Impact Tests

Banks must perform the following tests regarding the impact of the coronavirus pandemic on banks, calculating the impact on non-performing loans, provisions, profits, regulatory capital adequacy ratio, and Tier 1 capital:

• Test 1: A 100% increase in direct non-performing facilities across all economic sectors.
• Test 2: 15% default of facilities that were subject to installment deferral procedures, restructuring, or rescheduling by the bank due to effects related to the coronavirus pandemic, by classifying these facilities as non-performing.
• Test 3: 30% default of facilities that were subject to installment deferral procedures, restructuring, or rescheduling by the bank due to effects related to the coronavirus pandemic, by classifying these facilities as non-performing.

In addition to the tests mentioned above, banks must calculate the impact of the following scenarios (Multi-Factor shock) on non-performing loans, provisions, profits, and capital adequacy ratios:

• Medium Intensity Scenario:
  1. 25% default of facilities granted to the most affected sectors listed in the list of most affected economic sectors and activities issued by the Ministry of Labor, as shown in Appendix No. (4), by classifying facilities granted to them as non-performing.
  2. 5% default of facilities granted to individuals, by classifying facilities granted to them as non-performing.
  3. 20% decrease in stock prices invested in by the bank.
  4. 20% decrease in profits of the bank's branches and its foreign subsidiaries, for banks that have foreign branches or subsidiaries.

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CENTRAL BANK OF JORDAN

• Severe Intensity Scenario:
  1. 50% default of facilities granted to the most affected sectors listed in the list of most affected economic sectors and activities issued by the Ministry of Labor, as shown in Appendix No. (4), by classifying facilities granted to them as non-performing.
  2. 10% default of facilities granted to individuals, by classifying facilities granted to them as non-performing.
  3. 40% decrease in stock prices invested in by the bank.
  4. 40% decrease in profits of the bank's branches and its foreign subsidiaries, for banks that have foreign branches or subsidiaries.

Second: Credit Concentration Risk Tests

Test 1: Default of the bank's largest borrowers (excluding Jordanian government facilities and facilities guaranteed by the government) by classifying the credit granted to them as non-performing, as follows:

Assumption	Default
Moderate	Default of the largest borrower
Medium	Default of the largest 3 borrowers
Severe	Default of the largest 6 borrowers

Note: Banks must attach a statement of the names and values of facilities granted to the largest six borrowers (excluding Jordanian government facilities and facilities guaranteed by the government) used in applying the above tests.

Test 2: Default of the bank's largest borrowers (excluding Jordanian government facilities, facilities guaranteed by the government, and facilities of the Jordanian Petroleum Refinery Company and electricity companies) by classifying the credit granted to them as non-performing, as follows:

Assumption	Default
Moderate	Default of the largest borrower
Medium	Default of the largest 3 borrowers
Severe	Default of the largest 6 borrowers

Note: Banks must attach a statement of the names and values of facilities granted to the largest six borrowers (excluding Jordanian government facilities, facilities guaranteed by the government, and facilities of the Jordanian Petroleum Refinery Company and electricity companies) used in applying the above tests.

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CENTRAL BANK OF JORDAN

Test 3: Increase in direct non-performing facilities for the top five economic sectors receiving direct facilities from the bank.

Assumption	Increase Percentage
Moderate	10%
Medium	25%
Severe	50%

Test 4: Increase in non-performing facilities granted to the real estate sector.

Assumption	Increase Percentage
Moderate	10%
Medium	25%
Severe	50%

Third: Market Risk Tests

The primary objective of conducting market risk sensitivity analysis tests is to determine the impact of potential changes in market prices on profits and losses, and subsequently on the bank's regulatory capital adequacy ratio and Tier 1 capital. Banks must perform the following tests:

Shock 1: Exchange Rate Risk:

• Decrease in the dinar exchange rate:

Assumption	Decrease
Moderate	15% decrease in the Jordanian dinar exchange rate against other currencies
Medium	20% decrease in the Jordanian dinar exchange rate against other currencies
Severe	25% decrease in the Jordanian dinar exchange rate against other currencies

• Increase in the dinar exchange rate:

Assumption	Increase
Moderate	15% increase in the Jordanian dinar exchange rate against other currencies
Medium	20% increase in the Jordanian dinar exchange rate against other currencies
Severe	25% increase in the Jordanian dinar exchange rate against other currencies

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CENTRAL BANK OF JORDAN

Shock 2: Interest Rate Risk:

Changes in market interest rates can negatively affect the bank's financial position through direct impact on bank revenues (net interest income) and medium-to-long-term impact on the market value of the bank's assets and liabilities, which are affected by the interest rate.

Sensitivity tests regarding interest rates are applied to both variable and fixed-rate instruments, whether classified in the banking book or trading book. Gap analysis tests are performed as follows:

• Gap Analysis Tests: These tests aim to determine the bank's position regarding the balance of assets and liabilities sensitive to interest rate risks. The following tests are performed:

Assumption	Increase/Decrease
Moderate	100 basis points increase/decrease in interest rates
Medium	150 basis points increase/decrease in interest rates
Severe	200 basis points increase/decrease in interest rates

Shock 3: Stock Price Decline Risk, where the following tests must be performed:

Assumption	Decrease
Moderate	10% decrease in stock prices invested in by the bank
Medium	20% decrease in stock prices invested in by the bank
Severe	30% decrease in stock prices invested in by the bank

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CENTRAL BANK OF JORDAN

Fourth: Liquidity Risk Tests

Adequate liquidity availability at the bank depends largely on its ability to meet obligations during financial crises. In addition to the necessity of projecting cash inflows and outflows to determine cash requirements under normal operating conditions, the bank must perform stress tests by projecting cash flows based on "What if" scenarios and measuring their impact on the bank's liquidity. In this regard, the bank must perform the following tests:

Outflow Tests:

• Withdrawal of a portion of stable individual deposits:

Assumption	Decrease
Moderate	Withdrawal of a portion of stable individual deposits by 5%
Medium	Withdrawal of a portion of stable individual deposits by 10%
Severe	Withdrawal of a portion of stable individual deposits by 20%

• Withdrawal of a portion of unstable individual deposits:

Assumption	Decrease
Moderate	Withdrawal of a portion of unstable individual deposits by 10%
Medium	Withdrawal of a portion of unstable individual deposits by 20%
Severe	Withdrawal of a portion of unstable individual deposits by 30%

• Withdrawal of a portion of stable corporate deposits:

Assumption	Decrease
Moderate	Withdrawal of a portion of stable corporate deposits by 5%
Medium	Withdrawal of a portion of stable corporate deposits by 10%
Severe	Withdrawal of a portion of stable corporate deposits by 20%

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CENTRAL BANK OF JORDAN

• Withdrawal of a portion of unstable corporate deposits:

Assumption	Decrease
Moderate	Withdrawal of a portion of unstable corporate deposits by 10%
Medium	Withdrawal of a portion of unstable corporate deposits by 20%
Severe	Withdrawal of a portion of unstable corporate deposits by 30%

• Withdrawal of a portion of unused limits from facilities for individuals and small companies:

Assumption	Decrease
Moderate	Withdrawal of a portion of unused limits from facilities for individuals and small companies by 5%
Medium	Withdrawal of a portion of unused limits from facilities for individuals and small companies by 10%
Severe	Withdrawal of a portion of unused limits from facilities for individuals and small companies by 20%

• Withdrawal of a portion of unused limits from facilities for non-financial companies:

Assumption	Decrease
Moderate	Withdrawal of a portion of unused limits from facilities for non-financial companies by 10%
Medium	Withdrawal of a portion of unused limits from facilities for non-financial companies by 20%
Severe	Withdrawal of a portion of unused limits from facilities for non-financial companies by 40%

• Withdrawal of a portion of unused limits from facilities for financial companies:

Assumption	Decrease
Moderate	Withdrawal of a portion of unused limits from facilities for financial companies by 40%
Medium	Withdrawal of a portion of unused limits from facilities for financial companies by 80%
Severe	Withdrawal of a portion of unused limits from facilities for financial companies by 100%

• Withdrawal of the largest deposits:

Assumption	Decrease
Moderate	Withdrawal of the largest deposit
Medium	Withdrawal of the largest three deposits
Severe	Withdrawal of the largest five deposits

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CENTRAL BANK OF JORDAN

• Decrease in liquid assets:

Assumption	Decrease
Moderate	5% decrease in the bank's liquid assets
Medium	10% decrease in the bank's liquid assets
Severe	20% decrease in the bank's liquid assets

Fifth: Operational Risk Tests

Regarding operational risk tests, the bank must set at least three assumptions for potential operational events and measure their impact on the bank's profitability, regulatory capital adequacy ratio, and Tier 1 capital. These tests must include:

1. A test regarding the probability of worsening the pandemic situation due to the spread of the coronavirus inside and/or outside the Kingdom, measuring its impact on the bank, with an assumption of short-term business disruption (1-5 days) and a more severe assumption of long-term business disruption (more than 5 days).
2. The probability of increased cyberattacks due to the likelihood of increasing cyber risks resulting from increased reliance on financial technology and increased use of electronic payment methods accelerated by the pandemic.
3. Armed robbery at one of the bank's branches, internal fraud, fire at bank buildings, or the bank losing some lawsuits filed against it, or changes in correspondent bank behavior or supervisory actions affecting the bank's reputation, such as imposing a penalty on the bank by the home or host country regulatory authority due to the bank's fundamental violation of any laws, regulations, or instructions, or engaging in unsafe or unsound banking practices, etc.

Sixth: Additional Stress Tests

In addition to the tests specified above, the bank must perform additional tests commensurate with the size and nature of the risks it faces, with no less than one additional test for each type of risk mentioned above.

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CENTRAL BANK OF JORDAN

Seventh: Scenario Tests

The medium and severe macro scenarios represent hypothetical situations designed to evaluate banks' ability to withstand shocks. Assuming an increase in negative repercussions resulting from the new coronavirus and the challenges it poses to the national economy, which may lead to a significant decline in economic growth rates compared to expectations, an increase in the unemployment rate, and a decline in the financial market. If we assume an increase in interest rates to maintain the attractiveness of the Jordanian dinar as a savings currency, measuring the impact of these assumptions on banks usually involves using the Gross Domestic Product (GDP) growth rate (economic growth rate) as one of the main economic variables affecting non-performing loans and measuring the impact on the regulatory capital adequacy ratio and Tier 1 capital. Research indicates that a decrease in the economic growth rate leads to an increase in non-performing loans due to reduced economic activity and thus reduced customer ability to repay debts. Other variables such as interest rates, unemployment rate, and inflation rate can also be used to predict the non-performing loan ratio.

To predict the non-performing loan ratio for the coming year, a Multiple Regression Analysis methodology is used according to the following model:

NPL = β0 + β1NPL(-1) + β2X1 + β3X2 + ... + βnXn + e

Where: NPL: Non-performing loan ratio for the coming year. β0: Constant. NPL(-1): Non-performing loan ratio for the previous year. X1-Xn: Macroeconomic variables used to predict the non-performing loan ratio (e.g., economic growth rate, stock prices, interest rates, unemployment rate, etc.). β1-βn: Regression Coefficients.

In this regard, banks must perform the following scenarios, noting that the Central Bank will provide banks with the required scenarios annually, which may vary from year to year.

a- Baseline Scenario: In this scenario, to determine the values of macroeconomic variables, the Central Bank's and International Monetary Fund's forecasts were relied upon, as shown in Appendix No. (3).

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CENTRAL BANK OF JORDAN

b- Medium Macro Stress Scenario: Economic growth rate in the Kingdom decreases to -3.0% in 2021, unemployment rate increases to 28.3%, and interest rates increase by 100 basis points.

c- Severe Macro Stress Scenario: Economic growth rate in the Kingdom decreases to -5.5% in 2021, unemployment rate increases to 30.8%, and interest rates increase by 200 basis points.

Note that the following methodology was used to arrive at the above percentages: Medium Macro Stress Scenario: Expected economic growth rate for 2021 minus two standard deviations of economic growth rate data during the period (1994-2020); 2020 unemployment rate plus two standard deviations of unemployment rate data during the period (1994-2020).

Severe Macro Stress Scenario: Expected economic growth rate for 2021 minus three standard deviations of economic growth rate data during the period (1994-2020); 2020 unemployment rate plus three standard deviations of unemployment rate data during the period (1994-2020).

Regarding interest rates, the percentages were graduated with reference to the assumptions used in the Instructions for Stress Testing of Banks Operating in Jordan No. (2016/1) dated 2016/12/6, and Basel Committee guidelines regarding the standard shock for interest rate risk.

• Appendices

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CENTRAL BANK OF JORDAN

Appendix No. (1): Sensitivity Test Templates

Coronavirus Pandemic Impact Tests

Shock Intensity	Before Shock	After Shock	Additional Provisions Resulting from Applying the Shock
	Profits / Losses	Regulatory Capital	Tier 1 Capital
100%
Test 2: 15% default of facilities subject to installment deferral, restructuring, or rescheduling due to coronavirus effects, classified as non-performing.
15%
Test 3: 30% default of facilities subject to installment deferral, restructuring, or rescheduling due to coronavirus effects, classified as non-performing.
30%
Medium Intensity Scenario
Medium Intensity Scenario
Severe Intensity Scenario
Severe Intensity Scenario

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CENTRAL BANK OF JORDAN

Credit Concentration Risk Tests

Shock Intensity	Before Shock	After Shock	Additional Provisions Resulting from Applying the Shock
	Profits / Losses	Regulatory Capital	Tier 1 Capital
Default of largest borrowers (excluding Jordanian government facilities and guarantees) classified as non-performing (number) *
Moderate 1
Medium 3
Severe 6
Default of largest borrowers (excluding Jordanian government facilities, guarantees, Jordanian Petroleum Refinery Company, and electricity companies) classified as non-performing (number) **
Moderate 1
Medium 3
Severe 6
Increase in NPLs for top five economic sectors receiving direct facilities from the bank (%)
Moderate 10
Medium 25
Severe 50
Increase in NPLs granted to the real estate sector (%)
Moderate 10
Medium 25
Severe 50

• Banks must attach a statement of the names and values of facilities granted to the largest six borrowers (excluding Jordanian government facilities and guarantees) used in applying the largest borrower default test. ** Banks must attach a statement of the names and values of facilities granted to the largest six borrowers (excluding Jordanian government facilities, guarantees, Jordanian Petroleum Refinery Company, and electricity companies) used in applying the largest borrower default test.

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CENTRAL BANK OF JORDAN

Market Risk Tests

Shock Intensity	Before Shock	After Shock	Impact on Profits / Losses	Capital Adequacy Ratio Before Shock	Tier 1 Capital Adequacy Ratio
	Profits / Losses	Regulatory Capital	Tier 1 Capital	Risk-Weighted Assets	Profits / Losses
Exchange Rate Risk, Decrease in Dinar Exchange Rate (%)
Moderate 15
Medium 20
Severe 25
Exchange Rate Risk, Increase in Dinar Exchange Rate (%)
Moderate 15
Medium 20
Severe 25
Interest Rate Risk: Gap Analysis Test: Interest Rate Increase/Decrease (basis points)
Moderate 100
Medium 150
Severe 200
Stock Price Risk: Decrease in Stock Prices (%)
Moderate 10
Medium 20
Severe 30

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CENTRAL BANK OF JORDAN

Liquidity Risk Tests

Shock Intensity	Legal Liquidity Ratio Before Shock	Legal Liquidity Ratio After Shock	Legal Liquidity Ratio Before Shock	Legal Liquidity Ratio After Shock	Legal Liquidity Ratio Before Shock	Legal Liquidity Ratio After Shock
	Withdrawal of portion of stable individual deposits	Withdrawal of portion of stable corporate deposits	Withdrawal of portion of unused limits from financial company facilities
Moderate	5	5	10	10	40	40
Medium	10	10	20	20	80	80
Severe	20	20	30	30	100	100
	Withdrawal of portion of unstable individual deposits	Withdrawal of portion of unstable corporate deposits	Withdrawal of portion of unused limits from non-financial company facilities
Moderate	10	10	10	10	10	10
Medium	20	20	20	20	20	20
Severe	30	30	30	30	40	40
	Withdrawal of portion of unused limits from individual and small company facilities	Withdrawal of largest deposits *	Decrease in liquid assets
Moderate	5	5	1	3	5	5
Medium	10	10	3	3	10	10
Severe	20	20	5	5	20	20

• Banks must attach a statement of the names and values of the largest five deposits at the bank along with the results of applying the largest deposit withdrawal test.

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CENTRAL BANK OF JORDAN

Appendix No. (2): Scenario Test Template

Shock Intensity	Before Shock	After Shock	Additional Provisions Resulting from Applying the Shock	Capital Adequacy Ratio Before Shock	Tier 1 Capital Adequacy Ratio
	Profits / Losses	Regulatory Capital	Tier 1 Capital	Risk-Weighted Assets	Non-Performing Loans
Baseline Scenario
Economic Growth Rate 2.0%
Unemployment Rate 23.2%
Interest Rates 7.2%
Medium Macro Stress Scenario
Economic Growth Rate -3.0%
Unemployment Rate 28.3%
Interest Rate Increase 100 basis points
Severe Macro Stress Scenario
Economic Growth Rate -5.5%
Unemployment Rate 30.8%
Interest Rate Increase 200 basis points

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CENTRAL BANK OF JORDAN

Appendix No. (3): Macroeconomic Variables

Year	Real Economic Growth Rate	Unemployment Rate	Weighted Average Interest Rate on Credit Facilities (Loans and Advances)
1994	5.0	15.8	10.4
1995	6.2	15.4	10.7
1996	2.1	13.1	11.6
1997	3.3	14.4	12.6
1998	3.0	13.5	12.9
1999	3.4	14.4	12.7
2000	4.3	13.7	11.4
2001	5.3	14.7	10.5
2002	5.8	15.3	9.9
2003	4.2	14.4	8.9
2004	8.6	14.7	7.6
2005	8.1	14.8	8.1
2006	8.1	14.0	8.6
2007	8.2	13.1	8.9
2008	7.2	12.7	9.5
2009	5.5	12.9	9.1
2010	2.3	12.5	9.0
2011	2.6	12.9	8.7
2012	2.7	12.2	9.0
2013	2.8	12.6	9.0
2014	3.1	11.9	8.8
2015	2.5	13.0	8.2
2016	2.0	15.3	7.8
2017	2.0	18.3	8.6
2018	2.0	18.6	8.7
2019	2.0	19.1	8.5
2020	-2.0	23.2	7.2
2021	2.0

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CENTRAL BANK OF JORDAN

Appendix No. (4): List of Most Affected Sectors and Activities

1. Licensed tourism establishments under the Tourism Law and its issued regulations and instructions, including Hajj and Umrah offices and tourism establishments within the boundaries of the Aqaba Special Economic Zone Authority.
2. Employment establishments licensed under the Labor Law and its issued regulations and instructions.
3. Establishments for recruiting and employing domestic workers licensed under the Labor Law and its issued regulations.
4. Air, land, and sea passenger transport establishments, including specialized international passenger transport companies, aircraft supply and catering establishments, aircraft maintenance services, free markets, and branches of any establishments operating in airports and border crossings.
5. Public transport vehicle establishments.
6. Establishments organizing parties, festivals, conferences, and exhibitions.
7. Wedding halls and establishments renting wedding and event supplies.
8. Tourist car rental establishments.
9. Vocational and technical training academies and centers.
10. Recreational places and public parks. 1