Regulatory Alerts2024-05-27
Added · Updated
Central Bank of Jordan: Required Stress Tests for Banks Based on End-of-2018 Data
The Central Bank of Jordan mandates that banks conduct sensitivity and scenario stress tests based on end-of-2018 data to measure impacts on profitability, core capital, and regulatory capital adequacy ratios. Banks must apply specific shocks across credit, market, liquidity, and operational risks, including a 50% to 150% increase in non-performing loans and a 15% to 25% fluctuation in the Dinar exchange rate. The directive requires reporting under medium and severe macro scenarios, such as a 0.0% GDP growth rate with a 20.3% unemployment rate, and mandates the submission of borrower schedules and additional risk-specific tests commensurate with each bank's profile.
CENTRAL BANK OF JORDAN
Required Stress Tests for Banks Based on End-of-2018 Data
First: Sensitivity Analysis Tests
A. Credit Risk: These tests aim to measure the impact of the economic cycle, as well as bank-specific factors that may increase the bank's credit risk, thereby affecting the bank's profitability and solvency. Consequently, the tests to be prepared must calculate the impact on both profitability and the regulatory capital adequacy ratio and core capital¹.
Shock One: Increase in non-performing direct facilities.
| Hypothesis | Increase Percentage |
|---|---|
| Least Severe (Moderate) | 50% |
| Medium Severity (Medium) | 100% |
| Most Severe (Severe) | 150% |
Shock Two: Increase in non-performing direct facilities for the top five economic sectors receiving direct facilities from the bank.
| Hypothesis | Increase Percentage |
|---|---|
| Least Severe (Moderate) | 10% |
| Medium Severity (Medium) | 25% |
| Most Severe (Severe) | 50% |
Shock Three: Increase in non-performing direct facilities granted to the real estate sector.
| Hypothesis | Increase Percentage |
|---|---|
| Least Severe (Moderate) | 10% |
| Medium Severity (Medium) | 25% |
| Most Severe (Severe) | 50% |
¹ According to the regulatory capital instructions under the prevailing Basel III standard. 1 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Shock Four: Default of the bank's largest borrowers (excluding Jordanian Government facilities and facilities guaranteed by it), by classifying the credit granted to them as non-performing credit, as follows:
| Hypothesis | 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 schedule of the names and values of facilities granted to the top six borrowers (excluding Jordanian Government facilities and facilities guaranteed by it) used in applying the above tests.
Shock Five: Default of the bank's largest borrowers (excluding Jordanian Government facilities, facilities guaranteed by it, and facilities of the Jordanian Oil Refinery Company and electricity companies), by classifying the credit granted to them as non-performing credit, as follows:
| Hypothesis | 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 schedule of the names and values of facilities granted to the top six borrowers (excluding Jordanian Government facilities, facilities guaranteed by it, and facilities of the Jordanian Oil Refinery Company and electricity companies) used in applying the above tests.
Shock Six: Decrease in the value of collateral placed against non-performing facilities, as follows:
| Hypothesis | Decrease Percentage |
|---|---|
| Least Severe (Moderate) | 10% |
| Medium Severity (Medium) | 20% |
| Most Severe (Severe) | 30% |
2 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
B. Market Risk: The primary objective of conducting sensitivity analysis tests for market risk is to determine the impact of potential changes in market prices on profits and losses, and subsequently on the regulatory capital adequacy ratio² and core capital² of the bank. The bank must conduct the following tests:
Shock One: Exchange Rate Risk:
- Decrease in the exchange rate of the Dinar:
| Hypothesis | Decrease |
|---|---|
| Least Severe (Moderate) | Decrease in the Jordanian Dinar exchange rate by 15% against other currencies |
| Medium Severity (Medium) | Decrease in the Jordanian Dinar exchange rate by 20% against other currencies |
| Most Severe (Severe) | Decrease in the Jordanian Dinar exchange rate by 25% against other currencies |
- Increase in the exchange rate of the Dinar:
| Hypothesis | Increase |
|---|---|
| Least Severe (Moderate) | Increase in the Jordanian Dinar exchange rate by 15% against other currencies |
| Medium Severity (Medium) | Increase in the Jordanian Dinar exchange rate by 20% against other currencies |
| Most Severe (Severe) | Increase in the Jordanian Dinar exchange rate by 25% against other currencies |
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) as well as the 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 the trading book. Gap analysis tests are conducted as follows:
² According to the regulatory capital instructions under the prevailing Basel III standard. 3 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
- Gap Analysis Tests³: These tests aim to determine the bank's position regarding the balance of assets and liabilities sensitive to interest rate risks. Within these tests, the following are conducted:
| Hypothesis | Increase/Decrease |
|---|---|
| Least Severe (Moderate) | Increase/decrease in interest rates by 100 basis points |
| Medium Severity (Medium) | Increase/decrease in interest rates by 150 basis points |
| Most Severe (Severe) | Increase/decrease in interest rates by 200 basis points |
Shock Three: Equity Price Decline Risk, where the following tests must be conducted:
| Hypothesis | Decrease |
|---|---|
| Least Severe (Moderate) | 10% decrease in equity prices invested by the bank |
| Medium Severity (Medium) | 20% decrease in equity prices invested by the bank |
| Most Severe (Severe) | 30% decrease in equity prices invested by the bank |
C. Liquidity Risk⁴: Adequate liquidity availability at the bank depends largely on its ability to meet its obligations during financial crises. In addition to the necessity of the bank conducting forecasts of incoming and outgoing cash flows 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. In this regard, the bank must conduct the following tests: Outflow Cash Flow Tests:
³ 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 bank assets 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 within time periods according to maturity dates (for fixed interest rates) and repricing dates (for variable interest rates), then determining the impact of falling interest rates on the bank's profits and asset values. ⁴ Regarding liquidity risk, tests can be expanded when applying Basel 3 guidelines regarding the Liquidity Coverage Ratio. 4 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
- Withdrawal of a portion of stable individual deposits⁵:
| Hypothesis | 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:
| Hypothesis | 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% |
- Withdrawal of a portion of stable corporate deposits:
| Hypothesis | 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:
| Hypothesis | 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 facilities for individuals and small businesses:
| Hypothesis | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unused limits from facilities for individuals and small businesses by 5% |
| Medium Severity (Medium) | Withdrawal of a portion of unused limits from facilities for individuals and small businesses by 10% |
| Most Severe (Severe) | Withdrawal of a portion of unused limits from facilities for individuals and small businesses by 20% |
⁵ The bank may refer to Basel 3 standards to determine stable deposits or use its own methodology, with the necessity of providing the Central Bank with details of the method used by the bank to determine these deposits. 5 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
- Withdrawal of a portion of unused limits from facilities for non-financial companies:
| Hypothesis | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unused limits from facilities for non-financial companies by 10% |
| Medium Severity (Medium) | Withdrawal of a portion of unused limits from facilities for non-financial companies by 20% |
| Most Severe (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:
| Hypothesis | Decrease |
|---|---|
| Least Severe (Moderate) | Withdrawal of a portion of unused limits from facilities for financial companies by 40% |
| Medium Severity (Medium) | Withdrawal of a portion of unused limits from facilities for financial companies by 80% |
| Most Severe (Severe) | Withdrawal of a portion of unused limits from facilities for financial companies by 100% |
- Withdrawal of the largest deposits:
| Hypothesis | 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 schedule of the names and values of the top five deposits at the bank with the results of applying the withdrawal of the largest deposits test.
- Decrease in liquid assets:
| Hypothesis | 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 |
6 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
D. Operational Risk: Regarding operational risk tests, the bank must formulate at least three hypotheses for potential operational events and measure their impact on the bank's profitability and regulatory capital adequacy ratio⁶ and core capital⁶. Examples include a cyber attack on the bank, an armed robbery at one of the bank's branches, internal fraud, fire in the bank's buildings, the bank losing some lawsuits filed against it, changes in correspondent bank behavior, or regulatory actions affecting the bank's reputation, such as imposing penalties on the bank under laws, regulations, or instructions, or engaging in unsafe or unsound banking practices, etc. One of the three hypotheses must relate to the aforementioned cyber attack.
E. 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 Medium and severe macro scenarios represent hypothetical situations designed to evaluate banks' ability to withstand shocks. Assuming the deterioration of regional conditions surrounding the Kingdom, the continuation of the Gulf crisis, falling oil prices, and their greater impact on the financial conditions of Arab Gulf countries, with the effect transferring more to Jordan in the form of a noticeable decline in workers' remittances due to the return of some Jordanian workers from these countries. Additionally, a decline in the volume of aid from Gulf countries and a decrease in tourism income and direct investment, which may lead to a noticeable slowdown in economic growth rates compared to expectations and an increase in the unemployment level. If we also assume a greater and faster-than-expected increase in US Dollar interest rates and the continued raising of interest rates on the Dinar by the Central Bank of Jordan to maintain the Dinar's attractiveness as a savings currency, which may negatively affect economic growth in the Kingdom. To measure the impact of these hypotheses 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 debts.
⁶ According to the regulatory capital instructions under the prevailing Basel III standard. 7 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
And measuring its impact on the regulatory capital adequacy ratio⁷ and core capital⁷ of the bank. Economic research indicates that a decrease in the economic growth rate leads to an increase in non-performing debts due to the decline in economic activity and thus a decline in customers' ability to repay their debts. Other variables such as interest rates, unemployment rate, and inflation rate can also be used to predict the non-performing debt ratio. To predict the non-performing debt ratio for the coming year, a Multiple Regression Analysis methodology is used according to the following model: NPL=β0+β1NPL(-1)+β2X1+β3X2+...+βn+1Xn+e
Where: NPL: Non-performing debt ratio for the coming year. β0: Constant. NPL(-1): Non-performing debt ratio for the previous year. X1-Xn: Macroeconomic variables used to predict the non-performing debt ratio (e.g., economic growth rate, stock prices, interest rates, unemployment rate, etc.). β1-βn: Regression Coefficients.
In this regard, banks must conduct the following scenarios, noting that the Central Bank will provide banks annually with the required scenarios, which may vary from year to year. A- Baseline Scenario: In this scenario, to determine the values of macroeconomic variables, the International Monetary Fund (IMF) forecasts were relied upon, as shown in Appendix No. (3). B- Medium Macro Stress Scenario: Economic growth rate in the Kingdom decreases to 0.0%, unemployment rate rises to 20.3%, and interest rates rise by 100 basis points. C- Severe Macro Stress Scenario: Economic growth rate in the Kingdom decreases to -2.3%, unemployment rate rises to 22.0%, and interest rates rise by 200 basis points.
⁷ According to the regulatory capital instructions under the prevailing Basel III standard. 8 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Note that the following methodology was used to arrive at the above ratios: Medium Macro Stress Scenario: Expected economic growth rate for 2019 minus one standard deviation of economic growth rate data during the period (1994-2018), unemployment rate for 2018 plus one standard deviation of unemployment rate data during the period (1994-2018). Severe Macro Stress Scenario: Expected economic growth rate for 2019 minus two standard deviations of economic growth rate data during the period (1994-2018), unemployment rate for 2018 plus two standard deviations of unemployment rate data during the period (1994-2018).
Regarding interest rates, the percentages were graduated with reference to the hypotheses used in the Jordanian Banks Stress Test Instructions No. (2016/1) dated 2016/12/6, and Basel Committee guidelines regarding the standard shock for interest rate risk.
9 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Appendix No. (1): Sensitivity Test Models
Credit Risk
| Shock Severity | Before Shock | After Shock |
|---|---|---|
| Profit / Loss | Core Capital | |
| Increase in Non-Performing Loans (%) | ||
| Moderate 50 | ||
| Medium 100 | ||
| Severe 150 | ||
| Increase in Non-Performing Loans for Top Five Economic Sectors Receiving Direct Facilities from the Bank (%) | ||
| Moderate 10 | ||
| Medium 25 | ||
| Severe 50 | ||
| Increase in Non-Performing Loans Granted to the Real Estate Sector (%) | ||
| Moderate 10 | ||
| Medium 25 | ||
| Severe 50 | ||
| **Default of Largest Borrowers from the Bank (Excluding Jordanian Government Facilities and Facilities Guaranteed by It) by Classifying Credit Granted to Them as Non-Performing Credit (Number) * ** | ||
| Moderate 1 | ||
| Medium 3 | ||
| Severe 6 | ||
| **Default of Largest Borrowers from the Bank (Excluding Jordanian Government Facilities, Facilities Guaranteed by It, and Facilities of the Jordanian Oil Refinery Company and Electricity Companies) by Classifying Credit Granted to Them as Non-Performing Credit (Number) ** ** | ||
| Moderate 1 | ||
| Medium 3 | ||
| Severe 6 | ||
| Decrease in Value of Collateral Placed Against Non-Performing Loans (%) | ||
| Moderate 10 | ||
| Medium 20 | ||
| Severe 30 |
- Banks must attach a schedule of the names and values of facilities granted to the top six borrowers (excluding Jordanian Government facilities and facilities guaranteed by it) used in applying the default of the largest borrower test. ** Banks must attach a schedule of the names and values of facilities granted to the top six borrowers (excluding Jordanian Government facilities, facilities guaranteed by it, and facilities of the Jordanian Oil Refinery Company and electricity companies) used in applying the default of the largest borrower test.
10 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Market Risk
| Shock Severity | Before Shock | After Shock |
|---|---|---|
| Profit / Loss | Core Capital | |
| 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 | ||
| Equity Price Risk: Decrease in Equity Prices (%) | ||
| Moderate 10 | ||
| Medium 20 | ||
| Severe 30 |
11 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Liquidity Risk
| Shock Severity | Legal Liquidity Ratio | Legal Liquidity Ratio | Legal Liquidity Ratio |
|---|---|---|---|
| Before Shock | After Shock | Before Shock | |
| Withdrawal of a portion of stable individual deposits | Withdrawal of a portion of stable corporate deposits | Withdrawal of a portion of unused limits from facilities for financial companies | |
| Moderate | 5 | 5 | 40 |
| Medium | 10 | 10 | 80 |
| Severe | 20 | 20 | 100 |
| Withdrawal of a portion of unstable individual deposits | Withdrawal of a portion of unstable corporate deposits | Withdrawal of a portion of unused limits from facilities for non-financial companies | |
| Moderate | 10 | 10 | 10 |
| Medium | 20 | 20 | 20 |
| Severe | 30 | 30 | 40 |
| Withdrawal of a portion of unused limits from facilities for individuals and small businesses | Withdrawal of largest deposits * | Decrease in liquid assets | |
| Moderate | 5 | 1 | 5 |
| Medium | 10 | 3 | 10 |
| Severe | 20 | 5 | 20 |
- Banks must attach a schedule of the names and values of the top five deposits at the bank with the results of applying the withdrawal of the largest deposits test.
12 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Appendix No. (2): Scenario Test Model
| Shock Severity | Before Shock | After Shock |
|---|---|---|
| Profit / Loss | Core Capital | |
| Medium Macro Stress Scenario | ||
| Economic Growth Rate 0.0% | ||
| Unemployment Rate 20.3% | ||
| Interest Rate Increase 100 Basis Points | ||
| Severe Macro Stress Scenario | ||
| Economic Growth Rate -2.3% | ||
| Unemployment Rate 22.0% | ||
| Interest Rate Increase 200 Basis Points |
13 Form (09/01/1/1)
CENTRAL BANK OF JORDAN
Appendix (3): Macroeconomic Variables
| Year | Real Economic Growth Rate | Unemployment Rate | Weighted Average of Interest Rates on Credit Facilities (Loans and Advances) | Inflation Rate |
|---|---|---|---|---|
| 1994 | 4.98 | 15.80 | 10.4 | 3.60 |
| 1995 | 6.19 | 15.40 | 10.7 | 2.20 |
| 1996 | 2.08 | 13.10 | 11.6 | 6.60 |
| 1997 | 3.32 | 14.40 | 12.6 | 3.00 |
| 1998 | 3.01 | 13.50 | 12.9 | 3.10 |
| 1999 | 3.38 | 14.38 | 12.7 | 0.60 |
| 2000 | 4.25 | 13.71 | 11.4 | 0.70 |
| 2001 | 5.27 | 14.69 | 10.5 | 1.70 |
| 2002 | 5.79 | 15.33 | 9.9 | 1.90 |
| 2003 | 4.18 | 14.44 | 8.9 | 2.40 |
| 2004 | 8.56 | 14.70 | 7.6 | 2.60 |
| 2005 | 8.14 | 14.80 | 8.1 | 3.50 |
| 2006 | 8.09 | 14.00 | 8.6 | 6.30 |
| 2007 | 8.18 | 13.10 | 8.9 | 4.70 |
| 2008 | 7.23 | 12.70 | 9.5 | 13.90 |
| 2009 | 5.48 | 12.90 | 9.1 | -0.70 |
| 2010 | 2.31 | 12.50 | 9.0 | 5.10 |
| 2011 | 2.59 | 12.90 | 8.7 | 4.40 |
| 2012 | 2.65 | 12.20 | 9.0 | 4.60 |
| 2013 | 2.80 | 12.60 | 9.0 | 5.60 |
| 2014 | 3.10 | 11.90 | 8.8 | 2.90 |
| 2015 | 2.50 | 13.00 | 8.2 | -0.90 |
| 2016 | 2.00 | 15.30 | 7.8 | -0.80 |
| 2017 | 2.00 | 18.3 | 8.6 | 3.3 |
| 2018 | 2.00 | *18.6 | 8.7 | 4.5 |
| 2019 | **2.2 | **2.1 |
- As of 2018/9/30 ** According to IMF estimates
14 Form (09/01/1/1)