Regulatory Alerts2024-03-12
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Central Bank of Jordan: Required Stress Tests for Banks Based on End-2023 Data
The Central Bank of Jordan requires banks operating in the Kingdom to perform specific sensitivity and scenario stress tests using data as of December 31, 2023. Banks must apply these tests, covering credit, market, liquidity, climate, geopolitical, and operational risks, at both the branch and consolidated levels by the end of April 2024. The directive mandates the use of attached models and defines specific shock parameters, such as a 15-25% currency devaluation and a 100-200 basis point interest rate shift, to assess impacts on non-performing loans and capital adequacy.
CENTRAL BANK OF JORDAN Central Bank of Jordan
Ref: 2/23 / 4406 Date: 1 / 9 / 1445 AH Corresponding to: 13 / 3 / 2024 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), please find attached the sensitivity analysis tests and scenario tests that banks must perform based on data as of 31/12/2023. Sensitivity tests, including tests on the impact of geopolitical tensions in the world and climate change risk tests, are to be applied at the level of the bank's branches in Jordan and at the level of consolidated financial statements. Scenarios are to be applied according to the attached models by paper and electronic means within a maximum period of the end of April 2024. It is noted that an electronic (Excel) version of these models has been published on the Central Bank's website. 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.
Accept our highest respect,
Governor Dr. Adel Al-Sharkas
Form (1/1/09) P.O. Box 37 Amman 11118 Jordan • Phone: 4630301 • Fax: 4638889 • Website: www.cbj.gov.jo • Email: info@cbj.gov.jo
CENTRAL BANK OF JORDAN Central Bank of Jordan
Required Stress Tests for Banks Based on End-of-Year 2023 Data
First: Sensitivity Tests
A- Credit Risk Tests: Banks must perform the following tests concerning the increase in credit risk, calculating the impact on non-performing loans (NPLs), provisions, profits, regulatory capital adequacy ratio, and Tier 1 capital¹:
Test One: Increase in non-performing direct facilities for all economic sectors.
| Assumption | Increase Percentage |
|---|---|
| Least Severe (Moderate) | 50% |
| Medium Severity (Medium) | 100% |
| Most Severe (Severe) | 150% |
Test Two: Default of a portion of direct facilities granted to the top five economic sectors, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 15% |
Test Three: Default of a portion of direct facilities granted to the real estate sector, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 15% |
¹ According to regulatory capital instructions under the prevailing Basel III standard. 1
CENTRAL BANK OF JORDAN Central Bank of Jordan
Test Four: Default of a portion of direct facilities granted to the individuals sector, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 15% |
Test Five: Default of a portion of personal loans granted by the bank, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 15% |
Test Six: Default of a portion of direct facilities granted to the large non-financial corporate sector, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 15% |
Test Seven: Default of a portion of direct facilities granted to micro, small, and medium enterprises (MSMEs), by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 15% |
Note: Banks must fill out Annex No. (3), which relates to non-performing loan data by borrower entity. 2
CENTRAL BANK OF JORDAN Central Bank of Jordan
Test Eight: Default of a portion of direct facilities granted to the tourism, hotels, and restaurants sector, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 10% |
| Medium Severity (Medium) | 15% |
| Most Severe (Severe) | 25% |
Test Nine: Default of a portion of direct facilities granted to the transport sector, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 10% |
| Medium Severity (Medium) | 15% |
| Most Severe (Severe) | 25% |
Test Ten: Default of a portion of direct facilities granted to companies exposed to a boycott campaign due to the war on the Gaza Strip, by classifying these facilities as non-performing.
| Assumption | Default Percentage |
|---|---|
| Least Severe (Moderate) | 5% |
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 20% |
B- Credit Concentration Risk: Test One: 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 |
|---|---|
| Least Severe (Moderate) | Default of the largest borrower |
| Medium Severity (Medium) | Default of the top 3 borrowers |
| Most Severe (Severe) | Default of the top 6 borrowers |
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CENTRAL BANK OF JORDAN Central Bank of Jordan
Note: Banks must attach a statement of the names and values of facilities granted to the top six borrowers (excluding Jordanian government facilities and facilities guaranteed by the government) used in applying the above tests.
Test Two: Default of the bank's largest borrowers (excluding Jordanian government facilities, facilities guaranteed by the government, and facilities of the Jordanian Refinery Company and electricity companies) by classifying the credit granted to them as non-performing, as follows:
| Assumption | Default |
|---|---|
| Least Severe (Moderate) | Default of the largest borrower |
| Medium Severity (Medium) | Default of the top 3 borrowers |
| Most Severe (Severe) | Default of the top 6 borrowers |
Note: Banks must attach a statement of the names and values of facilities granted to the top six borrowers (excluding Jordanian government facilities, facilities guaranteed by the government, and facilities of the Jordanian Refinery Company and electricity companies) used in applying the above tests.
C- 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 One: Exchange Rate Risk:
- Devaluation of the Dinar:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Devaluation of the Jordanian Dinar by 15% against other currencies |
| Medium Severity (Medium) | Devaluation of the Jordanian Dinar by 20% against other currencies |
| Most Severe (Severe) | Devaluation of the Jordanian Dinar by 25% against other currencies |
- Appreciation of the Dinar:
| Assumption | Increase |
|---|---|
| Least Severe (Moderate) | Appreciation of the Jordanian Dinar by 15% against other currencies |
| Medium Severity (Medium) | Appreciation of the Jordanian Dinar by 20% against other currencies |
| Most Severe (Severe) | Appreciation of the Jordanian Dinar by 25% against other currencies |
| 4 |
CENTRAL BANK OF JORDAN Central Bank of Jordan
Shock Two: Interest Rate Risk: Changes in market interest rates can negatively affect the bank's financial position through their direct impact on the bank's revenues (net interest income) and their 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 all instruments carrying fixed or variable interest rates, whether classified in the banking book or trading book. Gap analysis tests are conducted as follows:
-
Gap Analysis Tests²: These tests aim to determine the bank's position regarding the balance of assets and liabilities sensitive to interest rate risk. The following tests are conducted:
- Increase in Interest Rates:
| Assumption | Increase in Interest Rates |
|---|---|
| Least Severe (Moderate) | Increase in interest rates by 100 basis points |
| Medium Severity (Medium) | Increase in interest rates by 150 basis points |
| Most Severe (Severe) | Increase in interest rates by 200 basis points |
- Decrease in Interest Rates:
| Assumption | Decrease in Interest Rates |
|---|---|
| Least Severe (Moderate) | Decrease in interest rates by 100 basis points |
| Medium Severity (Medium) | Decrease in interest rates by 150 basis points |
| Most Severe (Severe) | Decrease in interest rates by 200 basis points |
² Repricing risk is one of the most prominent interest rate risks, resulting from differences in maturity dates (for fixed interest rates) and repricing dates (for variable interest rates) of banks' assets, liabilities, and off-balance sheet items. For example, if a bank finances a long-term loan with a fixed interest rate using a short-term deposit with a variable interest rate, the bank will face a decrease in future income if interest rates rise. The cause of the decrease is that cash flows from the loan are fixed throughout the loan term, while the interest paid on the deposit is variable. The test begins by determining a schedule to distribute assets, liabilities, and off-balance sheet items sensitive to interest rates into time periods according to maturity dates (for fixed rates) and repricing dates (for variable rates), then determining the impact of a decrease in interest rates on the bank's profits and asset values. 5
CENTRAL BANK OF JORDAN Central Bank of Jordan
Shock Three: Stock Price Decline Risk: The following tests must be conducted:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | 10% decrease in stock prices invested in by the bank |
| Medium Severity (Medium) | 20% decrease in stock prices invested in by the bank |
| Most Severe (Severe) | 30% decrease in stock prices invested in by the bank |
D- 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 conducting cash flow forecasts to determine cash requirements under normal operating conditions, the bank must conduct stress tests by forecasting cash flows based on "What if" scenarios and measuring their impact on the bank's liquidity (legal liquidity ratio and liquidity coverage ratio). In this regard, the bank must conduct the following tests:
Outflows Tests³:
- Withdrawal of a portion of stable individual deposits:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of stable individual deposits by 5% |
| Medium Severity (Medium) | Withdrawal of a portion of stable individual deposits by 10% |
| Most Severe (Severe) | Withdrawal of a portion of stable individual deposits by 20% |
- Withdrawal of a portion of unstable individual deposits:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unstable individual deposits by 10% |
| Medium Severity (Medium) | Withdrawal of a portion of unstable individual deposits by 20% |
| Most Severe (Severe) | Withdrawal of a portion of unstable individual deposits by 30% |
³ The required decrease percentages in these tests are applied after applying cash flow rates according to the Liquidity Coverage Ratio (LCR) instructions No. (2020/5) dated 22/6/2020, and stable deposits are also defined according to these instructions. 6
CENTRAL BANK OF JORDAN Central Bank of Jordan
- Withdrawal of a portion of stable corporate deposits:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of stable corporate deposits by 5% |
| Medium Severity (Medium) | Withdrawal of a portion of stable corporate deposits by 10% |
| Most Severe (Severe) | Withdrawal of a portion of stable corporate deposits by 20% |
- Withdrawal of a portion of unstable corporate deposits:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unstable corporate deposits by 10% |
| Medium Severity (Medium) | Withdrawal of a portion of unstable corporate deposits by 20% |
| Most Severe (Severe) | Withdrawal of a portion of unstable corporate deposits by 30% |
- Withdrawal of a portion of unused limits from individual and small corporate facilities:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unused limits from individual and small corporate facilities by 5% |
| Medium Severity (Medium) | Withdrawal of a portion of unused limits from individual and small corporate facilities by 10% |
| Most Severe (Severe) | Withdrawal of a portion of unused limits from individual and small corporate facilities by 20% |
- Withdrawal of a portion of unused limits from non-financial corporate facilities:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unused limits from non-financial corporate facilities by 10% |
| Medium Severity (Medium) | Withdrawal of a portion of unused limits from non-financial corporate facilities by 20% |
| Most Severe (Severe) | Withdrawal of a portion of unused limits from non-financial corporate facilities by 40% |
- Withdrawal of a portion of unused limits from financial corporate facilities:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unused limits from financial corporate facilities by 40% |
| Medium Severity (Medium) | Withdrawal of a portion of unused limits from financial corporate facilities by 80% |
| Most Severe (Severe) | Withdrawal of a portion of unused limits from financial corporate facilities by 100% |
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CENTRAL BANK OF JORDAN Central Bank of Jordan
- Withdrawal of the largest customer deposits:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of the largest deposit |
| Medium Severity (Medium) | Withdrawal of the top three deposits |
| Most Severe (Severe) | Withdrawal of the top five deposits |
Note: Banks must attach a statement of the names and values of the top five customer deposits at the bank along with the results of applying the "Withdrawal of the largest customer deposits" test.
- Decrease in liquid assets:
| Assumption | Decrease |
|---|---|
| Least Severe (Moderate) | 5% decrease in the bank's liquid assets |
| Medium Severity (Medium) | 10% decrease in the bank's liquid assets |
| Most Severe (Severe) | 20% decrease in the bank's liquid assets |
E- Climate Change Risk Tests: Climate change is one of the most important risks and challenges facing various countries in the world currently due to its wide-ranging impacts on various economic sectors borrowing from banks, increasing the likelihood of rising credit risks. Banks must conduct the following tests related to two main types of climate change risks:
1. Physical Risks These are losses resulting from climate change and extreme environmental events such as earthquakes, volcanoes, floods, droughts, and global warming, etc. The bank must conduct a test on the impact of extreme weather phenomena that could cause the bank to incur material losses.
In addition to the above test, the bank must conduct the following tests related to extreme weather phenomena affecting the following economic sectors: 8
CENTRAL BANK OF JORDAN Central Bank of Jordan
Test One: Default of a portion of facilities granted to the industrial sector due to an increase in physical risk events related to climate change, by classifying credit granted to the sector as non-performing, as follows:
| Assumption | Default Percentage |
|---|---|
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 20% |
Test Two: Default of a portion of facilities granted to the agriculture sector due to an increase in physical risk events related to climate change, by classifying credit granted to the sector as non-performing, as follows:
| Assumption | Default Percentage |
|---|---|
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 20% |
Test Three: Default of a portion of facilities granted to the tourism, hotels, and restaurants sector due to an increase in physical risk events related to climate change, by classifying credit granted to the sector as non-performing, as follows:
| Assumption | Default Percentage |
|---|---|
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 20% |
Test Four: Default of a portion of facilities granted to the three sectors mentioned above (industry, agriculture, and tourism, hotels, and restaurants) due to an increase in physical risk events related to climate change, by classifying credit granted to the three sectors as non-performing, as follows:
| Assumption | Default Percentage |
|---|---|
| Medium Severity (Medium) | 10% |
| Most Severe (Severe) | 20% |
2. Transition Risks These are losses resulting from the transition from a carbon-intensive economy to a low-carbon economy due to increased reliance on renewable energy sources as a result of climate change mitigation efforts. The bank must conduct the following test: 9
CENTRAL BANK OF JORDAN Central Bank of Jordan
Default of a portion of facilities granted to companies with high carbon emissions, such as mining and petrochemical companies, by classifying credit granted to these companies as non-performing, as follows:
| Assumption | Default Percentage |
|---|---|
| Medium Severity (Medium) | 5% |
| Most Severe (Severe) | 10% |
F- World Geopolitical Tensions Tests Banks must conduct the following tests concerning the impact of world geopolitical tensions on banks, calculating the impact of the following scenarios (Multi-Factor Shock) on non-performing loans, provisions, profits, and capital adequacy ratios:
• Medium Severity Scenario:
- Default of 10% of facilities granted to companies exposed to a boycott campaign due to the war on the Gaza Strip.
- Default of 15% of facilities granted to the tourism and transport sectors and wholesale importers of basic goods, by classifying facilities granted to them as non-performing.
- Default of 5% of facilities granted to individuals, by classifying facilities granted to them as non-performing.
- 20% decrease in stock prices invested in by the bank.
- 20% decrease in profits of the bank's branches and subsidiaries abroad, for banks that have foreign branches or subsidiaries.
• Most Severe Scenario:
- Default of 20% of facilities granted to companies exposed to a boycott campaign due to the war on the Gaza Strip.
- Default of 30% of facilities granted to the tourism and transport sectors and wholesale importers of basic goods, by classifying facilities granted to them as non-performing.
- Default of 10% of facilities granted to individuals, by classifying facilities granted to them as non-performing.
- 40% decrease in stock prices invested in by the bank.
- 40% decrease in profits of the bank's branches and subsidiaries abroad, for banks that have foreign branches or subsidiaries. 10
CENTRAL BANK OF JORDAN Central Bank of Jordan
G- 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:
- A test on the likelihood of increased cyberattacks due to the increasing cyber risks resulting from increased reliance on financial technology and the increased use of electronic payment methods accelerated by the coronavirus pandemic.
- Two tests on the likelihood of armed robbery at one of the bank's branches, internal fraud, fire at the bank's 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 supervisory authority in the home or host country due to the bank's fundamental violation of any laws, regulations, or instructions, or engaging in unsafe or unsound banking practices, etc.
H- Additional Stress Tests In addition to the specified tests above, the bank must conduct 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.
Second: Scenario Tests The medium and severe macro scenarios represent hypothetical cases designed to evaluate banks' ability to withstand shocks. Assuming an increase in the intensity of geopolitical tensions in the world and the region, and the challenges they pose to the national economy, the most important of which is the war on the Gaza Strip, and the continuation of the negative repercussions of the Russian-Ukrainian crisis and the resulting rise in basic commodity prices, which may lead to a decline in economic growth rates and an increase in inflation rates compared to expectations, an increase in the unemployment level, and a decline in the financial market. To measure the impact of these assumptions on banks, the Gross Domestic Product (GDP) growth rate (economic growth rate) is usually used as one of the main economic variables affecting non-performing loans, and the impact on the regulatory capital adequacy ratio and Tier 1 capital is measured. Economic research indicates that a decrease in the economic growth rate leads to an increase in non-performing loans due to the decline in economic activity. 11
CENTRAL BANK OF JORDAN Central Bank of Jordan
And thus a decline in customers' ability to repay their debts. Other variables such as the unemployment rate, inflation rate, and interest rates 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: Expected non-performing loan ratio as of the end of 2024. β0: Constant. NPL(-1): Non-performing loan ratio for the previous year (as of the end of 2023). X1-Xn: Macroeconomic variables used to predict the non-performing loan ratio (e.g., economic growth rate, unemployment rate, inflation rate, etc.). β1-βn: Regression Coefficients.
In this regard, banks must conduct the following scenarios, noting that the Central Bank will provide banks with the required scenarios annually, which may differ from year to year.
A- Baseline Scenario: In this scenario, to determine the values of macroeconomic variables, the Central Bank of Jordan's expectations were relied upon, as shown in Annex No. (4).
B- Medium Macro Stress Scenario: A decrease in the economic growth rate in the Kingdom in 2024 to 0.2%, an increase in the unemployment rate to 25.8%, and an increase in the inflation rate to 5.5%.
C- Severe Macro Stress Scenario: A decrease in the economic growth rate in the Kingdom in 2024 to -2.2%, an increase in the unemployment rate to 29.3%, and an increase in the inflation rate to 8.3%.
Note that the following methodology was used to arrive at the above percentages:
Medium Macro Stress Scenario: The expected economic growth rate for 2024 minus one standard deviation of the economic growth rate data during the period (1994-2023), the unemployment rate for 2023 plus one standard deviation of the unemployment rate data during the period (1994-2023), and the expected inflation rate for 2024 plus one standard deviation during the period (1994-2023). 12
CENTRAL BANK OF JORDAN Central Bank of Jordan
Severe Macro Stress Scenario: The expected economic growth rate for 2024 minus two standard deviations of the economic growth rate data during the period (1994-2023), the unemployment rate for 2023 plus two standard deviations of the unemployment rate data during the period (1994-2023), and the expected inflation rate for 2024 plus two standard deviations of the inflation data during the period (1994-2023).
- Annexes 13
CENTRAL BANK OF JORDAN Central Bank of Jordan
Annex No. (1): Sensitivity Test Models
Model No. 1: Credit Risk Tests
| Shock Severity | Profits / Losses | Regulatory Capital | Tier 1 Capital | Provisions | Non-Performing Loans | Risk-Weighted Assets | Regulatory Capital | Tier 1 Capital | Additional Provisions Resulting from Applying the Shock | Profits / Losses | Before Shock | After Shock | Capital Adequacy Ratio | Before Shock | After Shock | Tier 1 Capital Adequacy Ratio |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Test One: Increase in non-performing direct facilities for all economic sectors. | ||||||||||||||||
| Moderate 50 | ||||||||||||||||
| Medium 100 | ||||||||||||||||
| Severe 150 | ||||||||||||||||
| Test Two: Default of a portion of direct facilities granted to the top five economic sectors, by classifying these facilities as non-performing. | ||||||||||||||||
| Moderate 5 | ||||||||||||||||
| Medium 10 | ||||||||||||||||
| Severe 15 | ||||||||||||||||
| Test Three: Default of a portion of direct facilities granted to the real estate sector, by classifying these facilities as non-performing. | ||||||||||||||||
| Moderate 5 | ||||||||||||||||
| Medium 10 | ||||||||||||||||
| Severe 15 | ||||||||||||||||
| Test Four: Default of a portion of direct facilities granted to the individuals sector, by classifying these facilities as non-performing. | ||||||||||||||||
| Moderate 5 | ||||||||||||||||
| Medium 10 | ||||||||||||||||
| Severe 15 | ||||||||||||||||
| Test Five: Default of a portion of personal loans granted by the bank, by classifying these facilities as non-performing. | ||||||||||||||||
| Moderate 5 | ||||||||||||||||
| Medium 10 | ||||||||||||||||
| Severe 15 | ||||||||||||||||
| Test Six: Default of a portion of direct facilities granted to the large non-financial corporate sector, by classifying these facilities as non-performing. | ||||||||||||||||
| Moderate 5 | ||||||||||||||||
| Medium 10 | ||||||||||||||||
| Severe 15 | ||||||||||||||||
| Test Seven: Default of a portion of direct facilities granted to micro, small, and medium enterprises, by classifying these facilities as non-performing. | ||||||||||||||||
| Moderate 5 | ||||||||||||||||
| Medium 10 |