Central Bank of Jordan Instructions No. 2020/6: Implementation of AAOIFI Financial Accounting Standards

Page 1 of 58 Central Bank of Jordan Instructions for Implementing the Financial Accounting Standards Issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) Number (2020/6)

• Financial Assets and Liabilities with High Risk Number (30).
• Risk Provisions Number (35).
• Islamic Bank Investments in Sukuk and Equity in Companies' Capital, Shares Number (33).
• Investments in Real Estate Number (26).

Page 2 of 58 Contents Item | Page Number Scope of Application | 3 Item One: Governing Requirements | 4 Item Two: Classification and Measurement | 6 First: Financial Assets | 6 Second: Financial Liabilities | 9 Item Three: Expected Credit Loss (ECL) | 10 First: Scope of Application / Expected Credit Loss | 10 Second: General Framework for Implementing Standard 30 | 12 Third: Credit Risk Measurement and Expected Credit Loss | 17 Item Four: Leased Assets / Present Value | 20 Item Five: Inventory / Goods for Sale | 21 Item Six: Deferred Tax Assets | 21 Item Seven: Statements for Central Bank Purposes | 21 Item Eight: "Risk Provisions" and Implementing Financial Accounting Standard No. (35) | 22 Item Nine: "Investments in Real Estate" and Implementing Financial Accounting Standards No. (26, 30) | 22 Item Ten: Islamic Bank Investments in Sukuk and Equity in Companies' Capital, Shares. Appendix No. (1): Required Quantitative and Qualitative Disclosures for Implementing Financial Accounting Standard No. (30) | 28 Appendix No. (2): Forms Required to be Filled for Financial Data Submission to the Central Bank | 51 Appendix No. (3): Quantitative and Qualitative Disclosures for Risk Provisions | 52 Appendix No. (4): Quantitative and Qualitative Disclosures for Investments in Real Estate | 53 Appendix No. (5): Forms Required to be Filled for Financial Data Submission to the Central Bank Regarding Investments in Real Estate and Investments in Sukuk and Equity in Companies' Capital, Sukuk, and Islamic Investment Funds.

Page 3 of 58 Scope of Application These instructions apply to all general Islamic banks in the Kingdom and all branches as follows:

• Jordan branches.
• Foreign branches.
• Jordan and foreign branches.
• Subsidiary companies.
• The Bank itself.

Page 4 of 58 Item One: Governing Requirements The Financial Accounting Standards No. (35, 33, 30, 26) issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) represent a comprehensive framework for risk management in banks (in addition to the accounting framework), specifically in the areas of (Classification and Measurement) and (Expected Credit Loss/Provisions).

• Standard No. (30) has been updated in the area of provisions to measure Expected Credit Losses through a forward-looking approach based on historical, current, and forecasted information regarding credit exposures, unlike previous standards that relied on incurred losses as in Financial Accounting Standard No. (11) issued by AAOIFI. Furthermore, the implementation of the new standard will have implications and conflicts with other regulatory requirements (such as those of the Islamic Financial Services Board (IFSB) regarding capital adequacy, liquidity, and ICAAP), as well as credit risk management mechanisms within the bank, whether through pricing, collateral, or customer relationships. This highlights the need for effective supervision by the Board of Directors, relevant committees, and senior management to ensure proper implementation and provide adequate resources.

• Financial Accounting Standard No. (33) "Islamic Bank Investments in Sukuk and Equity in Companies' Capital, Shares" replaces Financial Accounting Standard No. (25) issued by AAOIFI. This standard identifies the main types of investments not compliant with Islamic Sharia and defines accounting treatments that reflect the characteristics of the bank's business model under which investments are managed. It provides a basis for classification, recognition, measurement, and disclosure of investments in Sukuk, equity, and similar instruments.

• Financial Accounting Standard No. (35) "Risk Provisions" replaces Financial Accounting Standard No. (11). It aims to harmonize accounting and disclosure of risk provisions in line with global practices for identifying and managing risks faced by investors and shareholders, specifically impairments and losses incurred by Islamic banks. It also provides guidance on provisions, assessment, and accounting for various risks, including the need for consistent levels of provisions reflecting the nature of the risks.

• Financial Accounting Standard No. (26) "Investments in Real Estate" provides accounting rules for the recognition, measurement, and disclosure of investments held by Islamic banks in real estate for the purpose of generating rental income, capital appreciation, or for use.

It is the responsibility of the Board of Directors to provide adequate systems and procedures to ensure the proper implementation of these standards by defining the roles of committees, departments, and work units, ensuring operational continuity, and providing appropriate infrastructure.

It is also the responsibility of the Sharia Supervisory Board to monitor the bank's operations and activities to ensure compliance with Islamic Sharia, review operations to verify the absence of Sharia violations, and approve any losses incurred by the bank on behalf of investors and stakeholders.

In this context, the bank must observe the following:

1. Implementing the general framework for Expected Credit Loss requires a large amount of quantitative and qualitative information, whether historical, current, or forecasting future trends or economic indicators. Therefore, the bank must develop the necessary systems to provide accurate and secure information, enabling the bank to calculate ECL accurately, involving all relevant work units under the supervision of the Board of Directors and relevant committees.
2. As indicated in the text of these instructions, calculating Expected Credit Loss according to Standard (30) requires an automated system. Therefore, the bank must ensure that data quality is high, whether from external sources, internal processes, or extracted results. Accordingly, bank management must commit to not making any modifications to system algorithms and outputs regarding ECL calculation and related variables unless approved by the Board of Directors, which defines the exceptional and justified cases for modifying system outputs. The Board must also designate a competent authority to make such decisions and present these cases to the Board and its committees for approval and verification of calculations.
3. The Board of Directors must adopt the business model(s) through which financial instrument objectives, acquisition criteria, and classification are determined, in accordance with other operational requirements, as indicated in the appendix of these instructions.

Risk Management and Audit Management 4. The Board of Directors is responsible for ensuring that internal supervisory units and compliance management have the necessary resources to verify the validity and integrity of the standards and systems used in implementing these standards, and to provide the necessary information to these supervisory units.

Page 5 of 58 Item Two: Classification and Measurement First: Financial Assets Standard No. (33) requires the classification of financial assets as follows:

A. Equity Instruments: Measured at Fair Value, subject to choosing between the following two options:

1. Equity instruments are always recorded: 1.1 Financial assets at Fair Value through Profit or Loss (FVTPL): Equity instruments are measured at fair value, and changes in fair value are recorded in the Profit or Loss statement. 1.2 Financial assets at Fair Value through Other Comprehensive Income (FVOCI): Equity instruments are measured at fair value, and changes in fair value are recorded in Other Comprehensive Income under the Fair Value Reserve/Investors' Equity.
2. The bank must comply with the requirements of Standard (33) and the following as a minimum: 2.1 In the event of disposal of equity instruments classified under FVTPL or upon derecognition, the accumulated change in fair value is transferred from the Profit or Loss statement to the Retained Earnings reserve under FVTPL (Retained Earnings). In the event of disposal of equity instruments classified under FVOCI or upon derecognition, the accumulated change in fair value is transferred from the Profit or Loss statement to Investors' Equity. 2.2 Gains or losses on equity instruments classified under either of the above options are recorded in the Profit or Loss statement. 2.3 Reclassification of or to the above options is not permitted after initial classification of these financial assets (equity instruments). 2.4 Reclassification of equity instruments from FVTPL is only permitted if the instruments are traded in an active market and there is actual trading activity. In this case, they must be traded within a maximum period of (6) months from the acquisition date; otherwise, they are classified under FVOCI/Investors' Equity upon acquisition. 2.5 Compliance with the requirements of the first General Standard for Financial Reporting (13) (Fair Value), where Standard (33) issued by AAOIFI measures financial instruments at fair value, including those without a market price. 2.6 It is noted that the cost is not considered fair value except in specific cases (e.g., shareholdings in companies providing financing). Therefore, the bank must develop models for measuring fair value and develop the Central Bank's methods for measuring fair value for financial assets without a market price, included in the final financial statements. 2.7 Exchange rate differences are recorded according to the requirements of International Financial Reporting Standards (Exchange Rate Policy). 2.8 Distinguish between the portion related to equity rights and the portion related to investors' equity rights for these instruments.

B. Debt Instruments: Debt instruments are recorded under one of the following three portfolios, in accordance with the requirements of Standard (33):

B/1 First Portfolio: Amortized Cost

1. Financial assets (debt instruments) under this portfolio are recorded at amortized cost and are not subject to fair value measurement requirements.
2. Instruments classified under this portfolio must meet the conditions specified in Standard (33), summarized as follows: 2.1 Contractual Cash Flows: The contractual cash flows from the instruments classified under this portfolio must consist solely of payments of principal and interest on the principal amount. 2.2 Business Model Test: These instruments must be consistent with the bank's business model(s) approved by the Board of Directors.
3. The bank must comply with the requirements of Standard (33) and the following as a minimum: 3.1 The bank must have the intention to hold these instruments until the contractual maturity date, except in specific cases such as significant changes in market or interest rates, or close to maturity. 3.2 If the issuer's call option exists, allowing the issuer to redeem the debt instruments before maturity, this condition prevents the instruments from being classified under the amortized cost portfolio. 3.3 It is noted that risk management data and practices are a primary requirement for implementing Standards (30 and 33). Therefore, cases where the bank is exposed to credit risk levels in these instruments, consistent with the bank's applied risk management standards, are considered a breach; thus, it is permissible to dispose of them before maturity without applying the business model test. 3.4 Instruments in this portfolio are subject to ECL (Expected Credit Loss) calculation as specified in the implementation requirements of Standard (30) and these instructions, with ECL recorded in the Profit or Loss statement. 3.5 Debt instruments issued by the Jordanian Government or the Central Bank are exempt from the calculation of the probability of default (Third Section 4). 3.6 Income earned on these instruments is recorded in the Profit or Loss statement.

Page 6 of 58 3.7 Changes in exchange rates on these instruments are accounted for according to the accounting policy for exchange rates, in accordance with International Financial Reporting Standards. 3.8 Upon the bank's disposal of any debt instruments from this portfolio before their contractual maturity, the bank must attach a statement to the interim and final financial statements detailing these cases, including the reasons for disposal.

B/2 Second Portfolio: Non-Cash Debt Instruments through Fair Value/Other Comprehensive Income/Investors' Equity The bank must comply with the requirements of Standard (33) and the following as a minimum:

1. Debt instruments in this portfolio are those held by the bank either to collect contractual cash flows or for liquidity management purposes, in accordance with the bank's specific business model(s).
2. These instruments are measured at fair value, and changes in fair value are recorded in Other Comprehensive Income under the Fair Value Reserve.
3. Income earned on these instruments is recorded in the Profit or Loss statement, as are changes in exchange rates related to these instruments (Exchange Rate Policy).
4. Instruments in this portfolio are subject to ECL calculation according to the implementation requirements of Standard (30) and these instructions, with ECL recorded in the Profit or Loss statement.
5. Since these instruments are measured at fair value and simultaneously subject to ECL calculation, there is an offset between the change in fair value and the expected credit loss, so that ECL is recognized/recorded only if it exists.
6. As previously mentioned, changes in fair value for these instruments are recorded in Other Comprehensive Income. However, upon disposal or derecognition, the accumulated fair value reserve is reclassified to the Profit or Loss statement upon realization or disposal of these liabilities.

B/3 Third Portfolio: Non-Cash Debt Instruments at Fair Value through Profit or Loss The bank must comply with the requirements of Standard (33) and the following as a minimum:

1. Debt instruments in this portfolio are classified according to the bank's specific business model(s).
2. Changes in fair value for these instruments are recorded in the Profit or Loss statement.
3. Income earned on these instruments is recorded in the Profit or Loss statement, as are changes in exchange rates related to these instruments (Exchange Rate Policy).
4. Instruments in this portfolio are generally not subject to Expected Credit Loss measurement.
5. According to the business model(s) for this portfolio, instruments classified under this portfolio must be traded in an active market and traded within a maximum period of (6) months from the acquisition date.

General Rules for Business Model(s): The bank must comply with the requirements of Standards (30 and 33) and the following as a minimum:

1. It is permissible for the bank to have more than one business model, provided that each meets the conditions specified in these standards and is approved by the Board of Directors.
2. According to the requirements of Standards (30 and 33), internal and external factors may affect the effectiveness of the bank's business model(s), requiring changes to the business model(s). In this case, changes must be present and consistent with the implementation of changes to the business model(s).
3. Reclassification of debt instruments in different portfolios according to the bank's business model(s) is permissible, provided that reclassification occurs in the financial period following the period in which the business model(s) changed.
4. When preparing business model(s), the bank must justify the activities and objectives of risk management from these models, including observing the following conditions or unusual circumstances, liquidity management, capital adequacy, and other regulatory requirements.
5. When performing reclassifications as mentioned, a summary of reclassification changes and their accounting impact must be attached to the interim or final financial statements submitted to the Central Bank, indicating the reclassification and changes made to the bank's business model(s) for practical reasons.
6. It is permissible to include instruments issued by the same counterparty or holding the same rating in more than one portfolio according to the bank's applied business model(s).
7. Distinguish between the portion related to equity rights and the portion related to investors' equity rights for these instruments.

When preparing business model(s) and performing classification of financial instruments into different portfolios, the bank must study the impacts of each option on its various business aspects and other regulatory requirements, including those of the Islamic Financial Services Board (IFSB) regarding capital adequacy, liquidity, and ICAAP.

Second: Financial Liabilities: Financial liabilities are generally recorded and measured at amortized cost. If the bank chooses to measure financial liabilities at fair value through Profit or Loss, these liabilities are measured at fair value, and changes in fair value are recorded in the Profit or Loss statement. However, changes not arising from credit risk associated with these liabilities are recorded in Other Comprehensive Income under the Fair Value Reserve and are not reclassified to the Profit or Loss statement until these amounts are realized or the liabilities are disposed of. Regarding financial liabilities through Other Comprehensive Income/Investors' Equity, they are reclassified to the Profit or Loss statement.

Page 7 of 58 Item Three: Expected Credit Loss (ECL) This item presents the requirements of Standard (30) and the Central Bank's requirements for measuring Expected Credit Loss (ECL/Provisions) for credit exposures not within the scope of Standard (30), specifically regarding the inclusion of debt instruments/credit exposures and the mechanism for calculating Expected Credit Loss, as follows:

First: Scope of Application / Expected Credit Loss According to Standard (30), the Expected Credit Loss measurement model is applied to the following framework (excluding those measured at fair value through Profit or Loss):

• Loans and Goodwill.
• Debt instruments recorded at amortized cost.
• Non-cash debt instruments recorded at fair value through Other Comprehensive Income/Investors' Equity.
• Financial lease contracts and off-balance sheet commitments not recorded at fair value according to Standard (30) requirements.
• Lease receivables.
• Credit exposures to banks and financial institutions [excluding interbank balances used for short-term liquidity operations such as accounts, deposits, etc.].
• Other loans (balances) not measured at fair value.

Page 8 of 58 General Framework Specified According to Standard (30) Requirements for Measuring Expected Credit Loss:

Stage One | Stage Two | Stage Three Non-credit impaired | Significant increase in credit risk | Credit impaired No significant increase in credit risk since initial recognition | Significant increase in credit risk since initial recognition | Default Expected Credit Loss weighted by 12-month probability of default for the credit exposure/debt instrument | Expected Credit Loss for the full life of the credit exposure/debt instrument | Expected Credit Loss for the full life of the credit exposure/debt instrument Interest calculated on gross credit exposure/debt instrument | Interest calculated on gross credit exposure/debt instrument | Interest suspended Non-performing credit exposures/debt instruments | Performing credit exposures/debt instruments | Performing credit exposures/debt instruments with significant increase in credit risk since initial recognition

• Determined at each financial statement preparation date.

Second: General Framework for Implementing Standard No. (30)

1. To implement the general framework, all credit exposures/debt instruments subject to Expected Credit Loss calculation must be classified into one of the following three stages: (This process requires complete preparation of interim and final financial statements).

Stage One: 1.1 Includes credit exposures/debt instruments that have not experienced a significant or substantial increase in credit risk since initial recognition of the exposure/instrument [noting that credit risk can be gradual or sudden], or have credit risk equal to the date of financial statement preparation, and credit risk is considered equal if the following conditions are met: 1.1.1 Default risk is equal. 1.1.2 The borrower has a high short-term ability to meet obligations. 1.1.3 The borrower is not expected to experience adverse changes in the economy or business environment that would negatively affect the borrower's ability to meet obligations (e.g., economic indicators and stress tests). 2. Expected Credit Loss represents the potential loss resulting from default events that may occur within the next 12 months from the date of financial statement preparation (Note: It does not represent a cap on contractual cash flows; i.e., the credit exposure and the amount of loss from the loan are not limited to the expected amount within 12 months of the credit exposure/debt instrument's life). 3. For the purpose of recognizing income for credit exposures classified in this stage, interest is calculated on the gross value of the credit exposure/debt instrument recorded in the books.

Stage Two: 1.1 Includes credit exposures/debt instruments that have experienced a significant/substantial increase in credit risk since initial recognition, but have not reached the default stage, despite the presence of objective evidence indicating that default is likely. 2. Expected Credit Loss is calculated for the full life of the credit exposure/debt instrument, representing the expected credit loss resulting from default events over the remaining life of the exposure/debt instrument [weighted average of credit losses, considering default probabilities, exposure at default, and loss given default for the full life of the credit exposure/debt instrument]. 3. For the purpose of recognizing income for credit exposures classified in this stage, interest is calculated on the gross value of the credit exposure/debt instrument recorded in the books. 4. Standard (30) requires that at the date of financial statement preparation, banks determine whether credit risk has increased significantly, and if so, indicators are used to determine whether a significant increase in credit risk has occurred (indicators of significant negative changes in credit risk): 4.1 Internal credit rating downgrade or expected downgrade for the credit exposure/debt instrument, reflecting the internal rating system applied by the bank. 4.2 Significant downgrade or expected downgrade of the external credit rating for the credit exposure/debt instrument. 4.3 Significant negative changes in customer performance and behavior, such as delay in installment payments or lack of response to the bank. 4.4 The need to restructure the borrower's obligations due to weakened repayment ability or decline in contractual cash flows, or the need to modify contractual terms with the borrower or waive some existing contractual terms due to actual breaches/lack of ability to continue with the bank based on current conditions. For example, the borrower has periods of suspended interest or the existing contractual framework is violated. 4.5 Information about receivables owed by the borrower, either to the bank or to any other creditor. 4.6 Significant negative or expected changes in customer activity, such as (decline in revenues/profit margin, increase in operational risk, lack of capital, decline in asset quality, increase in leverage, weakness and decline in liquidity, management problems, cessation of part of customer activities, etc.), which may fundamentally affect the customer's ability to repay. 4.7 Change in the bank's credit management approach for the credit exposure/debt instrument due to weaknesses and negative changes in credit risk indicators, where credit risk management for the exposure/instrument is expected to become more intensive and maintain it under supervision, or to sell the exposure/instrument to the borrower's counterparty to manage the exposure/instrument. 4.8 General (significant) changes in the terms of the credit exposure/debt instrument (Terms or Rates) that would have been different if the exposure/instrument had been issued (created) at the date of financial statement preparation, such as (strengthening terms, increasing collateral or guarantees, increasing liquidity from the books), due to increased credit risk for the exposure/instrument since initial recognition. 4.9 Significant increase in credit risk for other credit exposures/debt instruments belonging to the customer from other creditors. 4.10 Negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property.

Page 9 of 58 4.11 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.12 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.13 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.14 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.15 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.16 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.17 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.18 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.19 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property. 4.20 Significant negative changes in the value of any collateral, guarantees, or credit enhancements provided by a third party or credit guarantors in exchange for obligations, which may lead to a decline in the customer's economic incentive to meet obligations or negatively affect the probability of default (PD). For example, a decline in the value of the mortgaged property.

Page 10 of 58 Third: Credit Risk Measurement and Expected Credit Loss

1. The bank must calculate Expected Credit Loss (ECL) for all credit exposures/debt instruments within the scope of Standard (30), using a model that reflects:
   • The unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes.
   • The time value of money.
   • Reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions, and forecasts of future economic conditions.
2. The bank must develop and maintain systems and processes to collect, process, and store data required for ECL calculation, ensuring data integrity, accuracy, and completeness.
3. The bank must define the definition of default for its credit exposures/debt instruments, which should be consistent with internal credit rating systems and external ratings, and should reflect the bank's risk appetite and credit risk management practices.
4. The bank must calculate the Probability of Default (PD), Exposure at Default (EAD), and Loss Given Default (LGD) for each credit exposure/debt instrument, using appropriate models and assumptions that reflect the bank's historical experience and forward-looking information.
5. The bank must discount the expected credit losses using the effective interest rate of the credit exposure/debt instrument.
6. The bank must review and update its ECL models and assumptions regularly to ensure they remain relevant and reliable.
7. The bank must disclose information about its ECL calculation methodology, assumptions, and inputs in its financial statements.

Page 11 of 58 [Content continues with detailed appendices and forms as listed in the Table of Contents, including Appendix 1 on Disclosures for Standard 30, Appendix 2 on Forms for Central Bank Submission, Appendix 3 on Risk Provisions Disclosures, Appendix 4 on Real Estate Investment Disclosures, and Appendix 5 on Forms for Real Estate and Sukuk/Equity Investments.]

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