Cairo: March 28, 2024

Dear Mr. Chairman,

Greetings,

In the context of the Central Bank's commitment to applying international best practices for risk management to support the safety and stability of the Egyptian banking sector, and to establish an effective, integrated framework for stress tests that banks are required to conduct when preparing their Internal Capital Adequacy Assessment Process (ICAAP) report, with the aim of evaluating banks' ability and flexibility to handle various risks, the Board of Directors of the Central Bank decided in its meeting held on March 19, 2024 the following:

Issuance of the attached supervisory instructions regarding "Requirements for the Stress Test Report for Banks," to be complied with when conducting stress tests for the ICAAP report, and submitting the aforementioned report to the Central Bank annually within a maximum period of 90 days from the end of the financial year, starting from the end of the financial year for 2024.

Please be kind enough to alert regarding full compliance with the attached instructions.

Yours faithfully,

Hassan Abdullah

Requirements for the Stress Test Report for Banks

Table of Contents
Foreword
1 - Scope of Application.
2 - General Definitions.
3 - Objectives of Stress Tests.
4 - Requirements for Stress Test Programs.
5 - Stress Tests According to Risk Types
6 - Selection of Scenarios and Methodologies.
7 - Review and Evaluation of Stress Test Programs.
8 - Governance Requirements Regarding Stress Test Programs
9 - Requirements of the Egyptian Central Bank Regarding Stress Tests...

Stress tests are considered one of the most important risk management tools used to evaluate a bank's ability to face shocks and crises under unfavorable conditions. Therefore, it has become necessary for all banks to have comprehensive and detailed stress test programs. These instructions were prepared in light of international best practices and in accordance with the provisions of the Central Bank and Banking System Law No. 194 of 2020, with the aim of enhancing the supervisory role of the Egyptian Central Bank and achieving financial stability through evaluating banks' financial adequacy, liquidity position, and their ability and flexibility to handle risks under stressed conditions and crises, which are evaluated through stress test programs. The results of these tests contribute to making appropriate proactive decisions regarding the general risk framework, developing emergency plans, business continuity plans, and recovery plans, as well as the bank's strategy and action plan. They also play a key role in enhancing precautionary measures against sudden shocks and crises, and help banks estimate future capital and liquidity requirements to face various risks.

It is worth noting that these instructions define a general framework for stress tests conducted by banks periodically as part of the risk management process. Therefore, compliance with these instructions is required, particularly regarding the requirements stated in Item 9 when preparing the stress test section of the ICAAP report, and submitting this report to the Central Bank annually.

1. Scope of Application

These instructions apply to all banks registered with the Egyptian Central Bank – including branches of foreign banks – as follows:

1-1 On an individual basis (including bank branches inside and outside Egypt): For banks that do not have a banking group.

2-1 On an individual and consolidated basis: For banks that have a banking group.

2. General Definitions

The following terms have the meanings indicated next to each of them in the application of the provisions of these instructions:

1-2 Stress Tests: A risk management tool used to measure the impact of shocks and unfavorable conditions on the continuity of the bank's business, and thus measure its ability to face risks and shocks.

2-2 Sensitivity Tests: Applying a shock to one variable while keeping other variables constant. These tests provide an initial assessment of the sensitivity of the bank's financial position to a specific risk factor.

3-2 Scenario Tests: Applying multiple shocks to multiple variables simultaneously, taking into account specific assumptions and based on historical and/or hypothetical bases as follows:

1-3-2 Historical Scenario Tests: Rely on fundamental market events that occurred in the past. This type of test does not take into account unknown future risks.

2-3-2 Hypothetical Scenario Tests: Rely on setting up hypothetical scenarios for exceptional adverse conditions, with a low but possible probability of occurrence. These tests take into account unknown future risks (for example, risks associated with new products).

4-2 Reverse Stress Tests: In this test, scenarios are prepared by assuming negative outcomes to deduce the assumptions that could lead to these results. An example is preparing scenarios that lead to breaches in certain regulatory ratios (capital adequacy ratio, liquidity ratios, etc.) beyond the prescribed limits.

5-2 Scenario Preparation: The process of envisioning potential unfavorable developments and conditions and assumptions that may negatively affect the bank's financial position during a hypothetical period.

6-2 Scenario Plausibility: Refers to the realism of the designed scenario, such that assumptions align with the current situation of variables based on historical events and economic and financial conditions, taking into account the likelihood of the scenario actually materializing based on fluctuations and historical events that reflect the diversity and intensity of risks surrounding the bank, not just the volatility of variables.

7-2 Model Risks: Losses that may arise from preparing or using models that are not sufficiently accurate, especially when preparing such models assuming stability and stability of assumptions and data used, under conditions that may be unstable (changes in interest rates, default, price differences, etc.), which may affect the validity of the expected results of those models. This requires periodic evaluation of model accuracy by comparing the results obtained from the model with the actual results for the same time period.

8-2 Contagion and Rapid Spread Risks: Financial risks that may threaten the continuity of the bank's business and may result in an impact on other banks or the financial system as a whole.

9-2 Strategic Risks: Negative effects on the bank's profits and capital resulting from incorrect business policies or decisions, improper implementation of decisions, changes in the business environment, or failure to respond quickly to changes in the surrounding environment.

3. Objectives of Stress Tests

Stress tests are considered important in risk management, and their application aims to:

1-3 Conduct a forward-looking risk assessment to anticipate the extent of the impact of negative developments on the bank's financial position, either due to changes within the bank or due to external changes related to the economic environment in which the bank operates.

2-3 Contribute to determining the required capital level and managing liquidity risks.

3-3 Provide the necessary data and information for the Board of Directors to enhance strategic decisions regarding determining the types and levels of risks, as well as identifying latent risks and reviewing acceptable limits for them.

4-3 Contribute to developing risk mitigation methods, emergency plans, business continuity plans, and recovery plans.

5-3 Disseminate the culture of risk management across all bank departments, contributing to enhancing the ability to handle unfavorable conditions and crises.

6-3 Adopt risk management governance systems and procedures to support rapid response in case the bank is exposed to shocks and crises.

7-3 Enhance internal and external communication for the bank, especially with foreign counterparts, banks, and other relevant parties.

4. Requirements for Stress Test Programs

1-4 Banks must have policies approved by the Board of Directors, as well as written work procedures for stress test programs approved by the competent executive committee and submitted to the Risk Committee. Assumptions used and stress test results must be documented, and those assumptions must be reviewed periodically in light of significant changes, such as those affecting the complexity of banking activities, IT infrastructure, market conditions, and the economic environment.

2-4 Banks must prepare and apply stress test programs periodically, and the Central Bank must be notified of the report on stress test programs annually or whenever necessary, as stated in Item 9. When designing stress test programs, the views of different sectors within the bank must be considered, especially the Risk and Treasury sectors.

3-4 Banks must use a set of methods aimed at achieving comprehensive coverage of all risks, with special attention to fundamental risks and other relevant risk factors, including quantitative and qualitative methods to support risk management and sound strategic decision-making by the Board of Directors.

4-4 The bank must have suitable infrastructure to apply stress test programs, characterized by sufficient flexibility to conduct various stress tests and any additional or new requirements, ensuring ease of data collection and the ability to retrieve test results for comparison over specific periods and preparing necessary reports for the Board of Directors and senior management when necessary.

5-4 Stress test programs must cover both sensitivity tests and scenario tests to include all fundamental risks the bank may be exposed to.

6-4 Stress test programs must be provided with accurate data in a timely manner, commensurate with the objectives of the applied tests, to ensure the identification of fundamental risks the bank may be exposed to, ensuring the validity of the results of those tests.

7-4 Stress test programs must be commensurate with the size and nature of the bank, the complexity of its activities and business models, and the risks it is exposed to. Therefore, the following factors must be considered at a minimum when conducting stress tests:

1-7-4 The total size of the bank's assets and its subsidiaries, within the scope of consolidated supervision.

2-7-4 The bank's strategy and action plan and their consistency with its organizational structure.

3-7-4 The risk policy, including the bank's acceptable risk level.

4-7-4 The ownership structure and the bank's financing structure.

5-7-4 The classification of the bank's credit portfolio in terms of the nature of customers (individuals, institutions, SMEs, or government entities) and economic sectors, non-banking financial activities, etc.

6-7-4 Outsourcing service providers, their procedures, services, activities, and their distribution channels.

7-7-4 The existing IT systems in the bank and related emergency and business continuity plans.

8-4 Stress tests must be integrated with the bank's risk management culture and the policy applied by providing recommendations, proposals, and necessary corrective actions, ensuring the continuity of the bank's business under unfavorable conditions.

9-4 Stress test programs must include scenarios that vary in intensity, including severe scenarios (such as periods of acute and continuous recession, major natural disasters, etc.), to evaluate banks' ability to respond quickly within a suitable time frame, with special attention to liquidity and funding risks that may threaten the continuity of the bank's business.

10-4 Stress test programs must include scenarios related to recovery plan tests, which involve serious events that threaten the continuity of the bank's business, while considering the periodic review and updating of recovery plans in light of the results of those tests.

11-4 Reverse stress tests must be conducted to identify a scenario or set of scenarios that may negatively affect the continuity of the bank's business (e.g., negative impact on the bank's reputation, rapid increase in non-performing loan ratios, cyberattacks, etc.). Measures and procedures to be taken in this regard must be determined, which may require re-evaluating the acceptable risk level by the Board of Directors.

12-4 In case of relying on outsourcing service providers, corresponding risks must be evaluated and included in stress test programs at the individual bank level and at the banking group level as a whole. The emergency and business continuity plans, as well as recovery plans of outsourcing service providers, must be evaluated in light of stress test results to assess the effectiveness of communication with them. It is also necessary to emphasize the availability of necessary data for crisis management and business continuity.

13-4 The impact of stress tests on certain financial indicators of the bank must be measured, considering that they are commensurate with the type of test, its objective, the types of risks under test, and the application time frame. They must include at least the following:

1-13-4 Values of assets and liabilities.

2-13-4 Impaired assets, credit rating degree, and the ratio of non-performing loans to total non-performing loans.

3-13-4 Net profits or losses and their impact on the bank's financial position.

4-13-4 Prescribed ratios for capital adequacy and liquidity.

5-13-4 Current and cumulative liquidity gaps and funding gaps (taking into account the maximum limits of these gaps as a percentage of total liabilities).

5. Stress Tests According to Risk Types

Stress tests must include the risks the bank may be exposed to and evaluate the following risks at a minimum and include them in the report on stress test programs submitted to the Central Bank (as mentioned in Item 9):

1-5 Credit Risk and Counterparty Risk:

The bank must use several levels of shocks when applying stress test scenarios to evaluate credit risk and counterparty risk at the bank, starting from sensitivity tests (which are less complex) to scenario tests. For example:

1-1-5 Scenarios related to market conditions (such as an acute recession or economic depression that may negatively affect the quality of the credit portfolio).

2-1-5 Scenarios at the level of the bank's customers (such as the failure of the most influential credit customers of the bank).

3-1-5 Scenarios at the level of affected economic sectors or geographic areas where the bank's activities are concentrated.

4-1-5 Scenarios related to the present value of bank customers' assets and collateral, taking into account factors that may negatively affect them, such as deterioration of the borrower's credit rating, sharp decrease in liquidity, or changes in market factors (exchange rates and yield rates, etc.).

5-1-5 Aggregated scenarios prepared to evaluate the quality of the credit portfolio, estimating the volume of expected losses resulting from those scenarios.

2-5 Market Risk:

1-2-5 Stress tests for market risk include, for example, losses resulting from unfavorable changes in the present value of the bank's financial investment positions in equities and debt instruments due to changes in interest rates and yield rates. These tests must include financial instruments carried at fair value through profit or loss, and those carried at fair value through other comprehensive income.

2-2-5 Severe scenarios must be applied, including measuring the impact of exceptional changes in interest rates or market factors, lack of market liquidity, and failure of major market participants, taking into account the correlation between different markets and negative changes resulting from those correlations when conducting the test.

3-5 Liquidity Risk:

1-3-5 Stress tests for liquidity risk aim to evaluate the bank's ability to meet current and future obligations.

2-3-5 Stress tests must include liquidity risk factors related to assets and liabilities, off-balance sheet commitments, and derivatives. They must also include weaknesses in the bank's financing structure at different maturities, the deposit withdrawal rate under normal conditions which may worsen under stress, concentration in funding sources, and the currency in which assets and liabilities are denominated, which may reflect conversion risks and difficulties in liquidation.

3-3-5 The bank must prepare the following scenarios when conducting stress tests, as well as a scenario combining both:

1-3-3-5 Internal scenarios related to the bank individually and the banking group as a whole (e.g., increase in non-performing loans, erosion of the deposit base, decrease in collateral value, deterioration of the bank's credit rating and its resulting increase in funding costs, failure of the largest customer at the level of funding sources or incoming cash flows).

2-3-3-5 External scenarios related to liquidity conditions, assuming that several banks, the banking sector, or the entire financial system are affected (e.g., deterioration in funding markets, decrease in the credit rating of countries where the bank's activities are concentrated, economic contraction with increasing default cases, lack of interbank market liquidity, or unfavorable changes in interest rates and yield rates).

4-3-5 The tests must include a set of behavioral assumptions for the bank's customers, depositors, borrowers, or other parties to funding sources.

5-3-5 When conducting liquidity risk stress tests, the bank must use different time horizons starting from the next day up to a year at a minimum. Short-term tests on liquidity conditions can also be conducted within a single working day.

6-3-5 The bank may use the methodology of expected net cumulative cash flows or negative cash flows to estimate the degree of impact of liquidity risk within stress tests, by identifying the time period that shows the minimum net cash flows for the scenario used.

7-3-5 The bank must use mandatory liquidity ratios (liquidity coverage ratio, net stable funding ratio, and the prescribed minimum for the average liquidity ratio) when conducting stress tests.

8-3-5 Emphasize the availability of the following when preparing scenarios for liquidity risk in the stress test programs report:

1-8-3-5 Policies approved by the Board of Directors including maximum and acceptable liquidity risk levels.

2-8-3-5 Policies approved by the Board of Directors including the ability of the bank's subsidiaries to obtain liquidity and the limits prescribed for that, in accordance with the maximum and acceptable liquidity risk levels at the bank. In case of exceeding prescribed limits, the results thereof and how to address those breaches must be presented to the Board of Directors.

4-5 Operational Risk:

Stress tests for operational risk include preparing scenarios to measure high risks the bank may face due to deficiencies arising from failures in internal processes, people, or systems, including IT risks and legal risks, or external events such as cyberattacks, or reliance on outsourcing service providers to perform some of the bank's important activities, as well as internal or external fraud, which may affect all the bank's products and activities or its ability to continue providing its products.

5-5 Concentration Risk:

Concentration risk is evaluated within stress tests at the level of exposures to counterparties of the bank (including the single customer, the single customer and related parties, parties related to the bank and their related parties), as well as types of credit facilities and concentration in the credit rating of customers, concentration in maturities, concentration in local and foreign currencies, concentration in deposits, bank products, industries and economic sectors, geographic areas, countries, correspondents, and outsourcing service providers.

6-5 Interest Rate Risk for Non-Trading Positions (IRRBB):

Stress tests for interest rate risk include preparing scenarios to measure risks arising from unfavorable movements in interest rates prevailing in the market during a certain period, which may negatively affect the bank's profitability and/or the economic value of its equity, and thus its financial position. These risks relate to positions included in the non-trading portfolio.

In addition to the aforementioned risks, any other risks deemed important by the bank must be considered when conducting stress tests, such as contagion and rapid spread risks, reputation risk, risks resulting from providing a new product or service, compliance risk, model risk, strategic risk, or climate change risks.

6. Selection of Scenarios and Methodologies

1-6 Banks must conduct hypothetical scenario tests to cover any changes not included when conducting historical scenario tests. When conducting those tests – whether historical or hypothetical scenario tests – the gradation in terms of scenario intensity must be considered, including basic assumptions related to the size of shocks and correlations between risk factors resulting from those shocks.

2-6 When preparing scenarios, changes in the size of the bank and the complexity of its activities and any other factors must be considered, in addition to the following:

1-2-6 The bank must conduct stress tests before issuing new products, entering into new investments, or opening external branches, and evaluate the risks that may arise to determine potential negative impacts and what may affect the general risk framework.

2-2-6 The results of those tests must be taken into account to make necessary adjustments to existing stress test programs.

3-2-6 The Board of Directors must be notified immediately if the assessment mentioned above reveals fundamental risks, to be taken into account when making strategic decisions, especially regarding any potential modification in maximum and acceptable risk levels, and the Central Bank must be informed of those decisions.

3-6 Internal models used to calculate capital requirements – for internal bank purposes – may be used to prepare stress test scenarios. Banks may also design and implement internal models specifically for conducting stress tests, provided that these models meet the following requirements:

1-3-6 They must include the fundamental risks the bank is exposed to and correlations between risk factors.

2-3-6 They must be comprehensively and clearly documented in terms of data sources, IT infrastructure, assumptions, inputs and outputs, and reciprocal relationships and correlations between risk factors.

3-3-6 They must be reviewed periodically and independently to ensure that assumptions used are reconsidered in light of unfavorable movements and shocks the bank may face.

7. Review and Evaluation of Stress Test Programs

Review and evaluation processes for stress test programs are necessary to support the effectiveness of risk management. Therefore, the Risk Sector, in coordination with the Internal Audit Sector in banks, must do the following:

1-7 Evaluate the efficiency and effectiveness of applying the general framework for stress test programs periodically, the methodologies used, the intensity of scenarios and applied assumptions, types of risks, and governance systems for stress tests.

2-7 Periodically evaluate and update emergency plans, business continuity plans, and recovery plans in light of stress test results.

3-7 Evaluate the efficiency and effectiveness of stress test programs quantitatively by evaluating the quality and accuracy of data, as well as scenarios and assumptions used, and qualitatively by evaluating test objectives, governance requirements, systems used in preparing tests, and development methods.

4-7 Update the general framework for stress test programs and review and re-evaluate those programs periodically at least once a year, or whenever necessary, taking into account that some events and market conditions may require an immediate and comprehensive evaluation of stress test programs during the year. Procedures and processes of review and evaluation must be documented.

5-7 Update stress test scenarios, assumptions, and methodologies used by conducting effective market monitoring by reviewing best practices and methods applied related to evaluating potential unfavorable conditions and assessing their impact on the bank.

6-7 Periodically evaluate the effectiveness of corrective actions and their feasibility in light of tests and scenarios conducted.

8. Governance Requirements Regarding Stress Test Programs

1-8 Role of the Board of Directors:

The Board of Directors of the bank is responsible for overseeing the effectiveness of applying stress test programs through the following:

1-1-8 Ensure the availability of comprehensive stress test programs covering all types of risks the bank may be exposed to, and ensure their application at the individual bank level and at the banking group level as a whole.

2-1-8 Approve policies for stress test programs prepared by the Risk Sector, as well as any significant changes or developments introduced to those programs, and ensure compliance with them. Additionally, ensure the dissemination of those policies to enhance the risk management culture at the bank level.

3-1-8 Ensure the availability of suitable information systems infrastructure and qualified human resources to conduct stress tests and prepare related reports.

4-1-8 Coordinate with senior management through the Risk Committee regarding the coverage of all types of risks the bank may be exposed to and the adequacy of the number of scenarios and documented assumptions used.

5-1-8 Determine the acceptable risk level for the bank according to conducted stress tests, which is done through the following:

1-5-1-8 Direct obtaining all necessary information to conduct stress tests.

2-5-1-8 Request regular reports to display the main results shown by stress tests and their impact on the risk level at the bank.

3-5-1-8 Use stress test results as one of the inputs for the strategic decision-making process.

4-5-1-8 Approve the risk policy and review it periodically.

6-1-8 Coordinate with senior management to take necessary corrective actions regarding the results of stress test programs.

2-8 Role of Senior Management:

It is the responsibility of the heads of the Risk Sector in the bank, in coordination with heads of relevant sectors, to prepare and monitor the implementation of stress test programs, as follows:

1-2-8 Review stress test programs and determine potential scenarios that may affect the bank's activities and business continuity, ensuring they are clear and documented.

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