Regulatory Alerts2018-01-31
Added · Updated
Circular on Stress Testing Requirements for Banks in Jordan Based on 2017 Year-End Data
The Central Bank of Jordan requires banks operating in the Kingdom to perform sensitivity and scenario stress tests on data as of December 31, 2017. Banks must submit results using attached forms no later than the end of March 2018, applying sensitivity tests at both branch and consolidated levels, while scenario tests apply only to branches. The directive mandates specific shocks for credit, market, liquidity, and operational risks, including defined percentage increases in non-performing loans, exchange rate fluctuations, and interest rate changes, alongside macroeconomic scenarios for medium and severe stress conditions.
1 1614/02/23 1439/05/14 AH 2018/01/31 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 2016/12/06, attached are the sensitivity analysis tests and scenario tests that banks must perform on data as of 2017/12/31. Sensitivity tests must be applied at the level of the bank's branches in Jordan and at the level of consolidated financial statements, while scenario tests must be applied at the level of the bank's branches in Jordan only. The results of the required tests must be submitted to us, filled according to the attached forms, no later than the end of March 2018. 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.
Sincerely, Governor Dr. Ziad Fariz
2 Stress Tests Required from Banks Based on Year-End 2017 Data
First: Sensitivity Analysis Tests
A. Credit Risk: These tests aim to measure the impact of the economic cycle in addition to bank-specific factors that could increase the bank's credit risk, thereby affecting its profitability and capital adequacy. The tests must be prepared such that the impact is calculated on both profitability and the regulatory capital adequacy ratio and Tier 1 capital.
Shock 1: Increase in non-performing direct facilities.
| Assumption | Increase Percentage |
|---|---|
| Moderate | 50% |
| Medium | 100% |
| Severe | 150% |
Shock 2: Increase in non-performing direct facilities for the top five economic sectors receiving direct facilities from the bank.
| Assumption | Increase Percentage |
|---|---|
| Moderate | 10% |
| Medium | 25% |
| Severe | 50% |
Shock 3: Increase in non-performing direct facilities granted to the real estate sector.
| Assumption | Increase Percentage |
|---|---|
| Moderate | 10% |
| Medium | 25% |
| Severe | 50% |
Shock 4: 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 |
|---|---|
| Moderate | Default of largest borrower |
| Medium | Default of top 3 borrowers |
| Severe | Default of top 6 borrowers |
Shock 5: Decrease in the value of collateral placed against non-performing direct facilities as follows:
| Assumption | Decrease Percentage |
|---|---|
| Moderate | 10% |
| Medium | 20% |
| Severe | 30% |
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 ratio and Tier 1 capital. The bank must conduct the following tests:
Shock 1: Exchange Rate Risk:
-
Decrease in the exchange rate of the Dinar: Assumption | Decrease --- | --- Moderate | Decrease in the Jordanian Dinar exchange rate by 15% against other currencies Medium | Decrease in the Jordanian Dinar exchange rate by 20% against other currencies Severe | Decrease in the Jordanian Dinar exchange rate by 25% against other currencies
-
Increase in the exchange rate of the Dinar: Assumption | Increase --- | --- Moderate | Increase in the Jordanian Dinar exchange rate by 15% against other currencies Medium | Increase in the Jordanian Dinar exchange rate by 20% against other currencies Severe | Increase in the Jordanian Dinar exchange rate by 25% against other currencies
Shock 2: Interest Rate Risk: Changes in market interest rates can negatively affect the bank's financial position through direct impact on the bank's revenues (net interest income) and 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 trading book. Gap analysis tests are conducted as follows:
- Gap Analysis Tests: These tests aim to determine the bank's position regarding the balance of assets and liabilities sensitive to interest rate risk. Within these tests, the following are performed: Assumption | Increase/Decrease --- | --- Moderate | Interest rate increase/decrease by 100 basis points Medium | Interest rate increase/decrease by 150 basis points Severe | Interest rate increase/decrease by 200 basis points
Shock 3: Stock Price Decline Risk: The following tests must be conducted:
| Assumption | Decrease |
|---|---|
| Moderate | 10% decrease in stock prices invested in by the bank |
| Medium | 20% decrease in stock prices invested in by the bank |
| Severe | 30% decrease in stock prices invested in by the bank |
C. Liquidity Risk: The availability of sufficient liquidity at the bank depends largely on its ability to meet obligations during financial crises. In addition to the necessity of forecasting cash inflows and outflows 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:
Outflows Tests:
-
Withdrawal of a portion of stable individual deposits: Assumption | Decrease --- | --- Moderate | Withdrawal of 5% of stable individual deposits Medium | Withdrawal of 10% of stable individual deposits Severe | Withdrawal of 20% of stable individual deposits
-
Withdrawal of a portion of unstable individual deposits: Assumption | Decrease --- | --- Moderate | Withdrawal of 10% of unstable individual deposits Medium | Withdrawal of 20% of unstable individual deposits Severe | Withdrawal of 40% of unstable individual deposits
-
Withdrawal of a portion of stable corporate deposits: Assumption | Decrease --- | --- Moderate | Withdrawal of 5% of stable corporate deposits Medium | Withdrawal of 10% of stable corporate deposits Severe | Withdrawal of 20% of stable corporate deposits
-
Withdrawal of a portion of unstable corporate deposits: Assumption | Decrease --- | --- Moderate | Withdrawal of 10% of unstable corporate deposits Medium | Withdrawal of 20% of unstable corporate deposits Severe | Withdrawal of 40% of unstable corporate deposits
-
Withdrawal of a portion of unused limits from facilities for individuals and small businesses: Assumption | Decrease --- | --- Moderate | Withdrawal of 5% of unused limits from facilities for individuals and small businesses Medium | Withdrawal of 10% of unused limits from facilities for individuals and small businesses Severe | Withdrawal of 20% of unused limits from facilities for individuals and small businesses
-
Withdrawal of a portion of unused limits from facilities for non-financial companies: Assumption | Decrease --- | --- Moderate | Withdrawal of 10% of unused limits from facilities for non-financial companies Medium | Withdrawal of 20% of unused limits from facilities for non-financial companies Severe | Withdrawal of 40% of unused limits from facilities for non-financial companies
-
Withdrawal of a portion of unused limits from facilities for financial companies: Assumption | Decrease --- | --- Moderate | Withdrawal of 40% of unused limits from facilities for financial companies Medium | Withdrawal of 80% of unused limits from facilities for financial companies Severe | Withdrawal of 100% of unused limits from facilities for financial companies
-
Withdrawal of the largest deposits: Assumption | Decrease --- | --- Moderate | Withdrawal of the largest deposit Medium | Withdrawal of the top 3 deposits Severe | Withdrawal of the top 5 deposits
-
Decrease in liquid assets: Assumption | Decrease --- | --- Moderate | 10% decrease in the bank's liquid assets Medium | 20% decrease in the bank's liquid assets Severe | 40% decrease in the bank's liquid assets
D. Operational Risk: 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 and regulatory capital adequacy ratio and Tier 1 capital. Examples include internal fraud, fire in bank buildings, loss of legal cases against the bank, or changes in correspondent bank behavior or regulatory actions affecting the bank's reputation, such as penalties imposed by the supervisory authority in the home or host country due to fundamental violations of laws, regulations, or instructions, or engaging in unsafe or unsound banking practices.
E. Additional Stress Tests: In addition to the tests specified 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 situations designed to evaluate banks' ability to withstand shocks. Assuming the deterioration of regional conditions surrounding the Kingdom, specifically the Gulf crisis and falling oil prices, and their impact on Jordan's financial situation in the form of a noticeable decline in remittances due to the return of a larger number of Jordanian workers from these countries, in addition to a decline in aid from Gulf countries, lower tourism income, and lower direct investment, which may lead to a noticeable slowdown in economic growth rates compared to expectations and an increase in unemployment. If we also assume an increase in US dollar interest rates and the Central Bank of Jordan continuing to raise interest rates on the Dinar faster and higher than expected to maintain the Dinar's attractiveness as a savings currency, this may negatively affect economic growth in the Kingdom.
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 measuring its impact on the regulatory capital adequacy ratio and Tier 1 capital. 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 and thus the 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 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 = ß0 + ß1NPL(-1) + ß2X1 + ß3X2 + … + ßn+1Xn + e
Where: NPL: Non-performing loan ratio for the coming year. ß0: Constant. NPL(-1): Non-performing loan ratio for the previous year. X1-Xn: Macroeconomic variables used to predict the non-performing loan ratio (e.g., economic growth rate, stock prices, interest rates, unemployment rate, etc.). ß1-ßn: 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 vary from year to year.
A- Baseline Scenario: In this scenario, to determine the values of macroeconomic variables, International Monetary Fund (IMF) forecasts were relied upon, as shown in Appendix No. (3).
B- Medium Stress Macro Scenario: Economic growth rate in the Kingdom decreases to 0.3%, unemployment rate increases to 19.9%, and interest rates increase by 100 basis points.
C- Severe Stress Macro Scenario: Economic growth rate in the Kingdom decreases to -1.9%, unemployment rate increases to 21.4%, and interest rates increase by 200 basis points.
Note that the following methodology was used to arrive at the above percentages: Medium Stress Macro Scenario: The expected economic growth rate for 2018 minus one standard deviation of economic growth rate data during the period (1994-2017), with one standard deviation added to the unemployment rate for 2017 for unemployment rate data during the period (1994-2017). Severe Stress Macro Scenario: The expected economic growth rate for 2018 minus two standard deviations of economic growth rate data during the period (1994-2017), with two standard deviations added to the unemployment rate for 2017 for unemployment rate data during the period (1994-2017). Regarding interest rates, they were derived by reference to the instructions used in the "Stress Testing of Banks Operating in Jordan" No. (2016/1) dated 2016/12/6 and Basel Committee guidelines regarding the standard shock for interest rate risk.
Appendix No. (1): Sensitivity Test Forms
Credit Risk
| Shock Intensity | Before Shock | After Shock |
|---|---|---|
| Provisions resulting from applying the shock | Impact on Profits/Losses | Capital Adequacy Ratio |
| Before Shock | After Shock | Before Shock |
Increase in Non-Performing Loans (%) Moderate | 50 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |......
(Note: The tables in the original text are complex grid structures. The translation preserves the column headers and row labels as accurately as possible in text format.)
Market Risk
| Shock Intensity | Before Shock | After Shock |
|---|---|---|
| Impact on Profits/Losses | Capital Adequacy Ratio | Tier 1 Capital Ratio |
| Before Shock | After Shock | Before Shock |
Exchange Rate Risk, Decrease in Dinar Exchange Rate (%) Moderate | 15 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |......
Interest Rate Risk: Gap Analysis Test: Interest Rate Increase/Decrease (basis points) Moderate | 100 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |......