Central Bank of Jordan Responses to Banks' Inquiries and Comments on the Internal Capital Adequacy Assessment Process (ICAAP) Instructions

Central Bank of Jordan CENTRAL BANK OF JORDAN

Responses to Banks' Inquiries/Comments Regarding the Internal Capital Adequacy Assessment Process (ICAAP) Instructions

#	Article Number	Inquiries/Comments	Answer
1	Chapter One (First/B/2)	Do the minimum limits referred to in Chapter One (First/B/2) represent the approved limits within the Risk Appetite Statement, and are there specific ratios to be provided at the aggregate banking level to be complied with?	• The Article indicates that the Central Bank expects banks to operate with capital adequacy ratios higher than the prescribed minimum limits, requiring banks to operate with capital adequacy ratios exceeding those limits at the level of each bank individually and/or at the aggregate banking level.<br>• Furthermore, Article (First/B/6) of Chapter One indicates that based on the results of the Supervisory Review Process (SRP), the Central Bank will take appropriate corrective measures, and the bank may be subject to additional capital increases (Bank-Specific Pillar II Capital add-on) as determined by the Central Bank, which increases the minimum capital requirements required from banks and for each bank individually.<br>• In addition to the above, banks must comply with Article (7.4) regarding the minimum capital requirements to be complied with, and Articles (7.5) and (7.6) regarding the bank's retention of a Management Buffer during planning and capital adequacy assessment.<br>The Risk Appetite Statement is an internal tool established by each bank within its risk governance framework, and it is expected to include target ratios covering the aforementioned limits, reflecting the level of risk the bank wishes to bear, and ensuring the maintenance of sufficient capital levels even under negative scenarios or stressful conditions.
2	Chapter One / Second	Regarding comments related to the request to define quantitative criteria and indicators when applying the Proportionality principle.	Banks vary in their models, business size, operational complexity, and risks exposed. Furthermore, the Internal Capital Adequacy Assessment Process is an internal process for which each bank is responsible for ensuring its comprehensiveness and proportionality to the nature, size, and complexity of its activities, without affecting the importance and effectiveness of this process. Four main aspects have been included to be considered when determining proportionality at the bank level. It is worth noting that the Supervisory Review process will take the relative importance of each bank/activity into consideration, and the bank's implementation of the proportionality principle will be evaluated for each bank individually.
3	Chapter Two / 1, 2	Regarding inquiries related to the scope of application of the Internal Capital Adequacy Assessment Process.	The instructions included that the scope of application be at the following levels:<br>1. Banking Group (Internal Capital Adequacy Assessment for the bank and its subsidiaries).<br>2. Jordan and Foreign Branches (Internal Capital Adequacy Assessment for branches inside and outside the Kingdom).<br>3. Jordan Branches (Internal Capital Adequacy Assessment for the bank inside the Kingdom).<br>This scope came to meet Basel Committee requirements and aligns with international best practices in this regard.
4	Chapter Two / 2, 1	Regarding the periodicity of providing the Central Bank with the Internal Capital Adequacy Assessment document and requesting a transitional period for the start of the instructions' application.	The Central Bank will be provided with all requirements contained in these instructions in full starting from the final financial statements of 2025, whereby the Internal Capital Adequacy Assessment document will be provided according to the periodicities stipulated in the instructions (no later than the end of April of each year). Banks may apply to the Central Bank for an extension of the document submission period for the first time only, stating the reasons for the request.

Central Bank of Jordan CENTRAL BANK OF JORDAN

| 5 | Chapter Two / 4, 4 | Regarding inquiries about the (Internal Liquidity Adequacy Assessment Process, "ILAAP") instructions | As indicated in Chapter One (First/B/4), within the framework of the Supervisory Review Process (SRP), the Central Bank will assess risks related to the bank's liquidity and funding (Assessment of Risks to Liquidity and Funding), and regulatory requirements regarding them will be provided later. Currently, international best practices can be relied upon in this regard. | | 6 | Chapter Two / 4, 4 | Regarding the inquiry about providing us with (Recovery Plan, ILAAP) reports with the (ICAAP) document. | Annex No. (2) of the instructions shows the components of the report to be complied with. The Central Bank has requested any additional information, reports, or working papers related to the Internal Capital Adequacy Assessment Process. | | 7 | Chapter Two / 4, 5, 6, 3 | Regarding the inquiry "Will the calculation be according to the Central Bank's external instructions with consistency in calculation between foreign branches and subsidiaries?" | For example, technical assumptions related to risk measurement methods should be consistent across different types of risks at the banking group level (such as confidence levels, discount rates, etc.), in addition to what Article stipulates (that strategies and risk management processes and decision-making, as well as the assumptions and methodologies relied upon in the internal capital adequacy assessment process, are also consistent among all presence locations).<br>Furthermore, if this process differs for certain locations and requires their implementation using methodologies different from those applied to the rest of the banking group, the bank must document this difference and reflect any significant effects resulting from its application to the Internal Capital Adequacy Assessment prepared at the banking group level. | | 8 | Chapter Two / 4, 6, 8, 2 | Clarification of the extent to which Articles "4, 6, 8, 2" apply to foreign banks operating in the Hashemite Kingdom of Jordan. | Yes, they apply. | | 9 | Chapter Two / 5, 1 | Determining the mechanism by which material risks are identified and a (Risk inventory) is prepared? | The Internal Capital Adequacy Assessment Process is a self-assessment process.<br>Each bank must, based on its business model, size, complexity, and risks exposed, and relying on the Internal Definition of Materiality, identify Material Risks within its various operations and activities, according to clear and methodological criteria, including: the size of the potential financial impact, the degree of likelihood of occurrence, and the implications for capital, liquidity, and reputation.<br>This entails the bank preparing a comprehensive Risk Inventory containing a list of all identified material risks, clarifying their nature, sources, level of importance, and their connection to other risks. This inventory serves as the primary reference upon which the capital adequacy assessment is built. | | 10 | Chapter Two / 6, 5 | Whether the bank must adopt an internal methodology for calculating Pillar 1 risks (Credit, Market, and Operational) or if the bank can rely on the Standardized Methodology | The bank must, within the Internal Capital Adequacy Assessment Process, measure Pillar 1 risks using its internal methodologies based on its risk assessment. The bank may use the Standardized Methodology if it reaches a conviction of its suitability for risk measurement, subject to review by the Central Bank. |

Central Bank of Jordan CENTRAL BANK OF JORDAN

| 11 | Chapter Two / 6, 4 | Clarification of the meaning of the Article "When measuring risks, risk diversification should not be taken into consideration, and efforts should be made to evaluate the cumulative effects of individual risks"? | Risk measurement must be based on individual risks independently, meaning the bank must evaluate the cumulative effect of risks as if they occur simultaneously, to ensure obtaining a conservative and objective estimate of the total risk level, away from any mitigation that may arise from diversification among different types of risks.<br>The effect of risk diversification and the degree of correlation between them (Correlation) can be taken into consideration when calculating economic capital, and reference can be made to best practices for guidance on its definition and measurement. | | 12 | Chapter Two / 6, 9, 9, 2, 7 | Regarding inquiries related to the role of the Independent Validation body that will verify risk measurement methodologies | As the Article indicated, the responsible validation body must be an independent internal body (different structures can be adopted to ensure independence), ensuring no Conflict of Interest.<br>Its main role is to possess specialized technical knowledge to do the following:<br>1. Verify the credibility and suitability of adopted measurement methods, models, and their results by comparing them with actual results, and reach a conviction of their sufficiency based on the bank's specific circumstances, risk system, and size and complexity of its operations.<br>2. Subject the design of stress testing to regular internal review to ensure its suitability and comprehensiveness for all bank locations and material risks.<br>This body actively participates in all risk management processes (such as limit setting, risk measurement, stress test design) as well as capital planning.<br>Any body within the Second Line of Defense (even if within the same department/departments concerned with the internal capital adequacy assessment process or designing/building measurement models) can perform this task, emphasizing that the internal validation function is a fundamental pillar in the Internal Capital Adequacy Assessment Process (ICAAP) framework.<br>The Second Line of Defense must be in a position to continuously challenge the First Line of Defense.<br>This body must be independent of Internal Audit (i.e., not within the Third Line of Defense), where the Third Line of Defense works with greater independence by conducting periodic reviews of the entire ICAAP process framework, including evaluating the role and effectiveness of the Second Line of Defense and periodic review tasks.<br>The Central Bank has deemed it appropriate for the body to be internal to enhance banks' capabilities to possess, build, and maintain specialized knowledge, as the bank is the most suitable entity to assess, estimate, and measure its risks (Risk Culture). | | 13 | Chapter Two / 7, 7 | Regarding Economic Capital requirements, and the inquiry "Can Tier 2 components of regulatory capital be considered as covering economic capital since they represent additional resources the bank can rely on to cover unexpected losses as the main goal of economic capital is to cover unexpected losses?" | The instructions stipulate that the bank must ensure capital adequacy from an Economic Capital perspective, considering its size, operational complexity, and risk model. It is incumbent upon banks to determine the application mechanism and its comprehensiveness, and they may refer to best practices and Basel Committee guidelines. The instructions included a reference to the Basel paper issued specifically on this matter.<br>There is a fundamental difference between regulatory capital and economic capital: |

• Regulatory Capital: Calculated according to specific standards and instructions issued by the Basel Committee and the Central Bank, aiming to ensure the minimum supervisory requirements - Tier 2 (Tier 2) instruments are considered additional tools allowed to be recognized within regulatory capital.
• Economic Capital: An internal concept relying on the bank's models to estimate the size of capital needed to cover unexpected losses resulting from various risks over a specific period (usually one year) at a certain confidence level. It is a measure of the size of capital required to cover these risks and not a measure of the amount of capital actually held.

• The concept of economic capital adequacy aims to ensure that the financial resources available to the bank (available internal capital) are sufficient - from an economic perspective - to cover its economic risks and maintain the continuity of its operations. This concept takes into account the impact of risks on the bank's economic value.
• Economic risks are those risks that may affect the bank's economic value, and thus the adequacy of economic capital. When identifying, assessing, and measuring these risks, the bank is expected to consider economic value considerations when preparing its estimates.
• The concept of economic value relies on the value of assets and liabilities from an economic perspective, and economic value does not rely on accounting or regulatory standard requirements. However, according to applied accounting standards, the concept of economic value may be similar to the concept of fair value used in the accounting valuation of certain assets and liabilities. Accordingly, economic value/fair value can be defined as the estimated price at which an asset can be sold to a third party or a liability settled in an orderly transaction under relevant market conditions.
• In addition to the above, economic capital must be available for direct use to cover risks/losses (similar to Common Equity Tier 1 (CET1) capital), and accordingly, it must be defined based on conservative assumptions and methodologies, specifically excluding unrecognized losses and balance sheet items that cannot be considered available to absorb losses and support going concern.

| 14 | Chapter Two / 7, 7, 6 | What is meant by documenting the differences between measurement results according to the standardized perspective and the economic perspective of Pillar 1 risks? | In light of what was clarified above, the bank must document the differences between risk measurement results according to the standardized perspective (regulatory requirements) and the internal economic perspective based on the bank's internal models and estimates for economic capital and actual risks it faces.<br>These differences must be clearly and explicitly highlighted in the Internal Capital Adequacy Assessment Process document, allowing the Board of Directors, senior management, and the Central Bank to view the significant differences between what regulatory capital requirements impose and the bank's assessment of its internal economic capital. |

Central Bank of Jordan CENTRAL BANK OF JORDAN

| 15 | Chapter Two / 7, 4 | Regarding inquiries about the minimum capital requirements to be maintained. | As stated in the instructions (Article 7.4), the bank must meet minimum capital requirements at all times, as follows:<br>Minimum requirements according to the Baseline Scenario must include:<br>• Minimum requirements for Pillar 1 risks (9.5%),<br>• Additional capital for Pillar 2 risks (result of the Supervisory Review Process) (Pillar 2),<br>• Capital buffers required under the Central Bank's instructions regarding minimum regulatory capital adequacy requirements [Conservation Buffer, foreign presence instructions, and instructions for dealing with Domestic Systemically Important Banks (D-SIBs)], and any additional buffers requested later either by the Central Bank or the Basel Committee on Banking Supervision.<br>It is worth noting that the bank may, in certain cases, apply to the Central Bank for approval to be exempted from the foreign presence buffer requirement of 2% or part of it, provided the bank can prove that the risks of its presence outside the Kingdom are adequately covered within the additional Pillar 2 capital.<br>We list below an example of capital requirements that banks must comply with:<br>• Minimum requirements for Pillar 1 risks (9.5%)<br>• Conservation Buffer (2.5%)<br>• Minimum for a locally important bank requires an additional capital buffer (0.5%)<br>• Foreign branch requires (2%)<br>• Result of the Supervisory Review Process required additional capital (Bank-Specific Pillar II Capital add-on) valued at (1%)<br>Therefore, the minimum capital requirements to be complied with within the Internal Capital Adequacy Assessment document will be (15.5%).<br>In the event the bank can prove that the risks of its presence outside the Kingdom are adequately covered within the additional Pillar 2 capital, the minimum will be (14.5%).<br><br>Minimum requirements when conducting stress tests must include:<br>• Minimum requirements for Pillar 1 risks (9.5%) (Pillar 1),<br>• Additional capital for Pillar 2 risks (result of the Supervisory Review Process) (Pillar 2),<br>We list below an example of capital requirements that banks must comply with:<br>• Minimum requirements for Pillar 1 risks (9.5%)<br>• Result of the Supervisory Review Process required additional capital (Bank-Specific Pillar II Capital add-on) valued at (1%) |

Central Bank of Jordan CENTRAL BANK OF JORDAN

Therefore, the minimum capital requirements to be complied with will be (10.5%).

| 16 | Chapter Two / 9, 2, 1 | Regarding the inquiry "Including all bank locations (subsidiaries and branches) in stress tests, and whether they are conducted at the level of each location individually or at the level of each location individually?" | All bank locations (subsidiaries and branches) and all material risks regarding them must be included in stress tests, such that stress tests are conducted at the group level as a whole and not at the level of each location individually for the purpose of complying with these instructions. | | 17 | Chapter Two / 10, 1, 3 | Who is the body responsible for preparing policies and procedures for the periodic review of capital adequacy since the review process will involve the three lines of defense? Can these policies and procedures be included in the policies and procedures of the Internal Capital Adequacy Assessment Process referred to in items (3.5) and (3.4) of the instructions? | There is no prohibition, whether:<br>A separate policy and procedure concerning the periodic review is prepared, or<br>The policies and procedures for the periodic review are included in the policies and procedures related to the Internal Capital Adequacy Assessment Process referred to in items (3.3) and (3.4), so that each body includes in its policy and procedure the tasks related to the periodic review.<br>And the policies and procedures must define roles and specifically the responsibilities of the three lines of defense to ensure comprehensiveness, to reach a unified and integrated framework for the assessment process and its periodic review. | | 18 | Chapter Two / 11, 1 | In the event of a material change, is recalculation performed on the same data on which the (ICAAP) was based? | In the event of a material change during the year and after completing the Internal Capital Adequacy Assessment Process, recalculation is performed according to the last quarterly financial data with review by the external auditor. | | 19 | Annex No. (1) | Regarding inquiries related to Annex No. (1) concerning risks to be measured. | We emphasize what was stated in the instructions regarding the necessity of referring to papers issued by the Basel Committee on Banking Supervision and any subsequent papers issued by it, and observing international best practices in this regard.<br>The Central Bank will verify the suitability and comprehensiveness of the measurement methods used with the bank's risk system.<br>Regarding concentration risks, the bank should measure them at the level of each location individually to be able to assess risks effectively (including credit concentration risks). Banks should measure them at the level of each "significant" location individually, as concentrations that may appear immaterial at the group level can threaten the continuity of the standalone location. | | 20 | - | Regarding branches of foreign banks operating in the Kingdom | Except as specified in the instructions, any requirement stipulated in the instructions to be performed by or submitted to the Board of Directors of the Jordanian bank or its committees returns to the management of branches of foreign banks operating in the Kingdom to determine the bodies/committees that will fulfill these requirements according to policies approved by the parent bank, and this is stated wherever necessary within the "Report Components" required according to Annex No. (2). |