CENTRAL BANK OF JORDAN

Instructions for Dealing with Locally Systemically Important Banks No. (2/2017)

Issued by the Central Bank of Jordan pursuant to the provisions of Article (41) and Article (99/b) of Banking Law No. (28) of 2000 and its amendments, and Article (4) of the Central Bank of Jordan Law No. (23) of 1971 and its amendments.

First: Introduction: The recent global financial crisis, which began in 2007, revealed that the weakness or failure of large banks had significant negative effects on the stability of the financial system and the real economy in the country and sometimes the world, due to the size of these banks, their high interconnectedness with other banks and financial institutions, the level of complexity of their operations, and the weak ability to cover the gap left by their default on financial services, in addition to their widespread presence across borders. To address these risks, work was intensified at the international level under the auspices of the Group of Twenty (G20), and the Financial Stability Board and the Basel Committee on Banking Supervision were tasked with the mission of establishing a framework for dealing with these risks, to protect financial stability, which would include not only banks and financial institutions of systemic importance at the global level, but also banks and financial institutions of systemic importance at the local level.

In this context, the Central Bank of Jordan has issued these Instructions, which aim to enhance the ability of locally systemically important banks "Domestic Systemically Important Banks (D-SIBs)" to maintain the soundness and robustness of their financial positions and reduce the negative effects that may result from facing fundamental problems on the stability of the financial system and the economy.

Generally, in line with international practices in this regard and within the framework of implementing the decisions of the Basel Committee on Banking Supervision regarding the "Framework for Dealing with Locally Systemically Important Banks."

These Instructions include the following main axes:

• Methodology for identifying systemically important banks
• Additional capital required from systemically important banks
• Specific requirements for systemically important banks and their supervisory procedures
• Reducing the effects of these banks facing fundamental problems.

Second: Methodology for Identifying Systemically Important Banks (D-SIBs):

1. To calculate the systemic importance of D-SIBs, the indicators defined by the Basel Committee on Banking Supervision have been taken into account, which are: Size, Interconnectedness, Substitutability, and Complexity.

2. Equal weights have been given to the four indicators above, and local systemic importance will be calculated based on the annual financial statements of banks starting from the end-of-year 2016 data, taking into account the necessity of updating the calculation of banks' systemic importance by the Central Bank and by the banks themselves annually. The Central Bank will publish the aggregate data necessary for the calculation on its website. For this purpose, banks are required to provide the Central Bank with the data shown in Appendix No. 1 within a maximum period of two weeks from the date of these Instructions for the year 2017 and within a maximum period of 3/15 of each year for future years.

3. Regarding how to measure the above indicators, sub-indicators have been determined according to the table below:

Indicator	Symbol	Measurement Tool (Sub-indicator)¹	Multiplication Factor
Size	A	Total assets of the bank's branches within Jordan	0.8
	B	Total off-balance sheet liabilities for Jordan branches (Issued and confirmed letters of credit, guarantees, acceptances, undrawn limits... etc.)	0.2
Interconnectedness	C	Total balances and deposits of the bank with banks and banking institutions*	0.5
	D	Total deposits of banks and banking institutions with the bank*	0.5
Substitutability	E	Total facilities granted to individuals plus total real estate facilities*	0.25
	F	Total facilities granted to companies*	0.25
	G	Total facilities granted to the government and public sector*	0.25
	H	Volume of transactions in the Jordan National Payments System² RTGS	0.25
Complexity	K	Total assets of the bank outside Jordan (assets of the bank's branches and its subsidiaries outside Jordan)	0.4
	X	Total off-balance sheet liabilities outside Jordan (Issued and confirmed letters of credit, acceptances, undrawn limits... etc.)	0.1
	Y	Total financial assets at fair value through comprehensive income statement* + Total financial assets at fair value through other comprehensive income statement*	0.5

*At the level of consolidated financial data (Jordan branches and subsidiaries inside and outside Jordan).

4. The following equation is used to determine licensed banks of local systemic importance, where SCOREij measures the systemic importance of bank (i), where local systemic importance for a bank begins when the value of SCOREij reaches (0.15), noting that the maximum value of SCOREij is (4) (assuming only one bank exists):

$$SCOREij = \left( 0.8 \frac{Aij}{\sum_{i=1}^{n} Aij} + 0.2 \frac{Bij}{\sum_{i=1}^{n} Bij} \right) + \left( 0.5 \frac{Cij}{\sum_{i=1}^{n} Cij} + 0.5 \frac{Dij}{\sum_{i=1}^{n} Dij} \right)$$ $$+ \left( 0.25 \frac{Eij}{\sum_{i=1}^{n} Eij} + 0.25 \frac{Fij}{\sum_{i=1}^{n} Fij} + 0.25 \frac{Gij}{\sum_{i=1}^{n} Gij} + 0.25 \frac{Hij}{\sum_{i=1}^{n} Hij} \right)$$ $$+ \left( 0.4 \frac{Kij}{\sum_{i=1}^{n} Kij} + 0.1 \frac{Xij}{\sum_{i=1}^{n} Xij} + 0.5 \frac{Yij}{\sum_{i=1}^{n} Yij} \right)$$

¹ Values are filled in as totals, i.e., before deducting provisions, accrued interest, and any other deductions. ² Represents the value of SWIFT messages issued by each bank of all types (MT202, MT103, MT102) which were settled on their central accounts defined in the National Payments System during the year.

Where the numerator represents the total item at the bank, while the denominator represents the total item at all banks, and n refers to the total number of banks during the period (i), and the symbols A, B, C, D, E, F, G, H, K, X, Y are defined in the table on page 3.

Third: Additional Capital Required from D-SIBs:

a. In order to enhance the ability of D-SIBs to absorb losses, those banks will be required to hold additional capital (surcharge), consisting of high-quality ordinary shareholders' equity³ ("CET1" Common Equity Tier 1) as defined in the regulatory capital instructions according to the prevailing Basel III standard and its equivalent for Islamic banks. This will be added gradually, with the additional requirement to be met starting one year after the date of the data on which the calculation was based, as shown in the table below:

Score (Result of applying the above equation)*	Ordinary shareholders' equity percentage addition (as a percentage of risk-weighted assets)²
	First Year	Second Year	Third Year	Fourth Year
From 0.15 up to 0.50	%0.125	%0.25	%0.375	%0.5
Greater than 0.50 up to 1	%0.25	%0.5	%0.75	%1
Greater than 1 up to 1.5	%0.375	%0.75	%1.125	%1.5
Greater than 1.5 up to 2	%0.5	%1	%1.5	%2
Greater than 2 up to 2.5	%0.625	%1.25	%1.875	%2.5

*If the Score of any bank (local systemic importance of the bank) exceeds 2.5, the CET1 percentage will be determined at that time.

b. In the event of a change in the systemic importance of D-SIBs, the additional capital will be dealt with as shown in Appendix No. 2.

Fourth: Specific Requirements for D-SIBs and Their Supervisory Procedures:

In addition to the additional capital required from D-SIBs and what is required from all banks according to the prevailing instructions, D-SIBs must comply with the following:

1. Corporate Governance and Risk Management a. The boards of directors of locally important banks must play a fundamental and pivotal role in the following:

1. Adhering to advanced-level⁴ standards regarding risk culture, risk management, governance, internal control, and compliance, and selecting senior management members in accordance with the nature of the bank's activity and its business model.
2. Adopting a methodology to subject the bank's risk management framework to periodic internal and external review (by specialized consulting bodies). The bank's board of directors and executive management must take into account the observations and recommendations of the review and evaluation process and update the risk framework in line with the bank's strategic direction and business model.
3. Seeking to use advanced⁵ methodologies and methods to measure the main risks facing the bank, commensurate with the bank's size, nature of operations, and level of complexity.
4. Providing separate⁶ units for operational risk management, ensuring that the operational risk management framework is integrated with the general risk management framework in the bank, while giving appropriate attention to business continuity plans and cyber/electronic risks⁷, and keeping pace with the best standards and latest developments in this regard.
5. Developing an internal credit rating system at the bank, linked to the process of pricing credit products offered by the bank and the terms of granting credit.

b. The bank classified as a locally important bank must clarify preventive measures in dealing with suspicious or fraudulent activities, especially in main business lines, and must have a separate compliance committee emanating from the board, consisting of at least three members, the majority of whom are independent members, and continuously develop the capabilities of committee members to allow them to perform their role effectively.

c. Locally systemically important banks, as part of enhancing their ability to manage risks in general and collecting data related to risks and preparing related reports in particular, must provide the Central Bank with an assessment of their compliance with the principles of risk data aggregation and risk reporting [Effective Risk Data Aggregation and Risk Reporting (Risk Principle)]⁸ issued by the Basel Committee on Banking Supervision in January 2013, within a maximum period of one year from the date the bank was classified as a locally systemically important bank, and take all necessary measures and arrangements for full compliance with these principles within a maximum period of three years from the date the bank was classified as a locally systemically important bank.

2. Supervisory Procedures for (D-SIBs)

As part of enhancing the Central Bank's communication with locally important banks and strengthening supervision over them, the Central Bank will: a. Verify the effectiveness of the corporate governance framework of locally important banks, especially regarding the focus of their boards of directors on high-level strategic matters and the main risks faced by the bank. b. Hold periodic meetings with independent members on the boards of directors of locally important banks, and with audit, risk, and compliance committees separately. c. Maintain continuous communication with senior management in locally important banks, especially heads of regulatory units for risk, audit, and compliance. d. The Central Bank may request specific stress tests for each bank classified as a (D-SIB) if necessary.

Fifth: Reducing the Effects of These Banks Facing Fundamental Problems:

a. The bank classified as a locally important bank must have a Recovery Plan to deal with various risks it may face, especially during critical times. The plan must include, at a minimum:

1. Means to reduce the bank's risk volume.
2. Methods to maintain the quantity and quality of capital, clarifying strategic measures to be taken for this purpose, such as selling some subsidiaries, obtaining new capital, stopping some bank operations, not distributing dividends and/or bonuses.
3. A detailed description of how to resolve a liquidity crisis the bank may face upon loss of confidence, as well as the amount of emergency liquidity it may need, its sources, and its costs.
4. Reliable processes and indicators ensuring the implementation of recovery measures at any time (e.g., internal processes, IT systems, clearing and settlement, supplier and employee contracts enabling the bank to continue operations).

b. When preparing recovery plans, the bank must clarify the measures to be taken if the bank faces critical and severe conditions threatening its existence and continuity. For this purpose, the bank must prepare and document a list of measures that can be resorted to in this case, allowing the bank to choose from a list of options (measures) most suitable to solve the problem according to the type and size of the problems it faces. The bank is not required to order the options or measures that can be resorted to when facing problems; rather, the measure taken depends on the nature of the problem.

c. Recovery plans must be included in the bank's overall risk management framework and operations, such that they can be applied in a timely manner when needed.

d. Define the regulatory framework for the recovery plan, ensuring the bank has appropriate governance for recovery plans as well as sufficient resources to support the plans, including:

1. Clearly defining the responsibilities of regulatory units in the bank.
2. Defining the responsibilities of executive management and the board of directors.

e. Develop an appropriate policy within the recovery plans clarifying communication methods with all stakeholders during crises, such as regulatory authorities, the public sector, financial institutions, employees, etc. f. The Central Bank will ensure that locally important banks have recovery plans to deal with unexpected periods of stress, including events that could pose a serious threat to the bank's continuity.

Sixth: These Instructions shall be implemented as of their date, and locally important banks are granted a maximum period of eighteen months to meet the requirements specified in Articles Four and Five of these Instructions.

Please accept our highest regards,

Governor Dr. Ziad Fariz

Appendix 1. Annual Data Required to be Filled by the Bank for Calculating Its Systemic Importance

Bank Name: ____________________ Date: ____________________

Item*	Amount (in thousands of Dinars)
Total assets of the bank's branches within Jordan
Total off-balance sheet liabilities for Jordan branches (Issued and confirmed letters of credit, guarantees, acceptances, undrawn limits... etc.)
Total balances and deposits of the bank with banks and banking institutions**
Total deposits of banks and banking institutions with the bank**
Total facilities granted to individuals plus total real estate facilities**
Total facilities granted to companies**
Total facilities granted to the government and public sector**
Volume of transactions in the Jordan National Payments System RTGS***
Total assets of the bank outside Jordan (assets of the bank's branches and its subsidiaries outside Jordan)
Total off-balance sheet liabilities outside Jordan (Issued and confirmed letters of credit, acceptances, undrawn limits... etc.)
Total financial assets at fair value through comprehensive income statement**
Total financial assets at fair value through other comprehensive income statement**

• Values are filled in as totals, i.e., before deducting provisions, accrued interest, and any other deductions. ** At the level of consolidated financial data (Jordan and foreign branches and subsidiaries inside and outside Jordan). *** Represents the value of SWIFT messages issued by each bank of all types (MT202, MT103, MT102) which were settled on their central accounts defined in the National Payments System during the year.

Appendix 2. How to Deal with Changes in the Systemic Importance of D-SIBs During the Implementation Period

The following example illustrates how to add additional capital requirements for locally systemically important banks, assuming a change in the bank's systemic importance during the implementation period. Table No. (1) shows the gradual addition (addition percentage) of additional capital requirements, while Table No. (2) shows how to calculate the additional capital requirements for Banks A and B after the change in their systemic importance.

Table No. (1)

Date of Implementing Additional Capital Requirements	Financial Data to be Relied Upon	Requirements to be Applied by D-SIBs
2017/12/31	2016 Data	25% of additional capital requirements
2018/12/31	2017 Data	50% of additional capital requirements
2019/12/31	2018 Data	75% of additional capital requirements
2020/12/31	2019 Data	100% of additional capital requirements

Table No. (2)

Date of Implementing Additional Capital Requirements	Financial Data to be Relied Upon	Additional Capital Requirements According to Bank A's Systemic Importance	Additional Capital Requirements to be Applied for Bank A for Each Period	Additional Capital Requirements According to Bank B's Systemic Importance	Additional Capital Requirements to be Applied for Bank B for Each Period
2017/12/31	2016 Data	%1	%0.25=1%*25%	%1	%0.25=1%*25%
2018/12/31	2017 Data	%0.5	%0.25=0.5%*50% (Note here that no additional addition is required from Bank A as it was achieved in the previous year)	%1	%0.50=1%*50%
2019/12/31	2018 Data	%1	%0.75=1%*75% (i.e., additional capital requirements must be raised from 0.25% to 0.75%)	%0.5	%0.375=0.5%*75% (Here the bank can reduce additional capital requirements from 0.50% to 0.375%)
2020/12/31	2019 Data	%1.5	%1.5=1.5%*100% (i.e., additional capital requirements must be raised from 0.75% to 1.5%)	%0	%0=0%*100% (Here the bank has exited the D-SIB list and is no longer required to have any specific additional capital requirements)