Agreement No. 006-2021: Parameters and Guidelines for Determining Provisions for Modified Special Mention Credits

Republic of Panama Banking Superintendence AGREEMENT No. 006-2021 (December 22, 2021) "By which parameters and guidelines are established for the determination of provisions applicable to credits in the Modified Special Mention category and other provisions are issued"

THE BOARD OF DIRECTORS In exercise of its legal powers, and

CONSIDERING:

That as a result of the issuance of Decree-Law No. 2 of February 22, 2008, the Executive Branch prepared a systematic ordering in the form of a Single Text of Decree-Law No. 9 of February 26, 1998, and all its modifications, which was approved by Executive Decree No. 52 of April 30, 2008, hereinafter the Banking Law;

That in accordance with numerals 1 and 3 of Article 5 of the Banking Law, the objectives of the Banking Superintendence are to ensure the solidity and efficiency of the banking system; as well as to promote public confidence in the banking system;

That numeral 5 of Article 11 of the Banking Law provides within the technical attributions of the Board of Directors, the fixing within the administrative scope, the interpretation and the scope of legal or regulatory provisions in banking matters;

That by Agreement No. 4-2013 of May 28, 2013, provisions on credit risk management and administration inherent to the credit portfolio and off-balance sheet operations are established;

That by Agreement No. 2-2021 of June 11, 2021, new parameters and guidelines applicable to modified credits granted by banking entities as a consequence of the economic effects of COVID-19 are established, and the existence of the modified credit classification category named "Modified Special Mention" is recognized, within which modified credits up to June 30, 2021 are included;

That Article 8 of Agreement No. 2-2021 establishes the provisioning requirements applied for credits classified in the "Modified Special Mention" category;

That by General Resolution of the Board of Directors No. SBP-GJD-0003-2021 of June 11, 2021, the Banking Superintendence established the parameters and guidelines for the reporting of modified credits included in the "Modified Special Mention" category;

That Articles 2 and 3 of General Resolution of the Board of Directors No. SBP-GJD-0003-2021, establish as an identification mechanism for the reporting of modified credits included in the "Modified Special Mention" category the codifications of normal modified, special mention modified, subnormal modified, doubtful modified, and irrecoverable modified, as well as the corresponding reporting parameters for each of these codifications;

That in the face of the foreseeable increase in the deterioration of modified credits that remain under the "Modified Special Mention" category, it is imminent and necessary to update the provisions for these credits with the purpose of covering the increase in credit risk or their deterioration, ensuring compliance with the International Financial Reporting Standards (IFRS); as well as the prudential regulations established by this Superintendence;

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That the adequate application of the International Financial Reporting Standards (IFRS) allows banking entities to obtain a more effective record, classification, and measurement of the credit risk they hold on the modified credit portfolio, and with it, better management of the expected loss of credits classified in the "Modified Special Mention" category;

That the timely and correct constitution of provisions according to the credit risk classification is a necessary tool for banks to cover possible losses in the value of their assets and guarantee the sustainability of their operations, as well as the solidity of the banking system;

That in working sessions of this Board of Directors, the need and convenience of establishing guidelines and parameters for the determination of provisions applicable to credits that are still classified in the "Modified Special Mention" category has been highlighted.

AGREES:

ARTICLE 1. OBJECTIVE. The provisions of this Agreement have as their objective to update guidelines and parameters for the determination of provisions for losses in the credit portfolio classified in the "Modified Special Mention" category.

ARTICLE 2. SCOPE OF APPLICATION. This Agreement shall be applicable to banking entities that maintain credits classified in the "Modified Special Mention" category.

ARTICLE 3. SIGNIFICANT INCREASE IN RISK OF THE MODIFIED SPECIAL MENTION PORTFOLIO. For the coverage of credit risk applicable to credits that are classified in the "Modified Special Mention" category, banking entities must ensure compliance with the International Financial Reporting Standards (IFRS) taking into consideration the significant increase in risk, as follows:

1. Loans that have had a significant increase in risk with respect to their initial recognition and that do not show objective evidence of incurred loss;
2. Loans that have had a significant increase in risk with respect to their initial recognition and that also present objective evidence of incurred loss (impaired credits).

With respect to the aforementioned loans, at each accounting closing, banks will measure the value correction for losses by an amount equal to the expected credit losses during the life of the asset.

ARTICLE 4. PROVISIONING REQUIREMENT FOR THE MODIFIED SPECIAL MENTION CATEGORY. For the coverage of credit risk, banks must constitute provisions on the portfolio of modified credits, including accrued but uncollected interest, classified in the "Modified Special Mention" category, ensuring compliance with the International Financial Reporting Standards (IFRS), as well as the prudential standards established in Article 5 of this Agreement. The same accounting treatment must be given to accrued interest receivable that has been transferred to other asset accounts. Once the bank has written off the principal balance of any credit (principal) classified in the "Modified Special Mention" category, the accrued interest receivable must also be written off, and therefore cannot be transferred to other asset accounts.

The Senior Management and the Board of Directors of banks must ensure the use of adequate procedures to record sufficient provisions for the coverage of loss risk. Likewise, it will be the responsibility of external auditors to satisfy themselves of the reasonableness of the provisions accounted for as part of their audit process. The foregoing, without prejudice to the Banking Superintendence making observations or requiring adjustments to provisions, as a result of its supervisory function set forth in Article 7 of this Agreement.

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ARTICLE 5. PROVISION ESTABLISHED IN AGREEMENT No. 2-2021 FOR THE MODIFIED SPECIAL MENTION CATEGORY. For the purposes of this Agreement, the provisions of Article 8 of Agreement No. 2-2021 are hereby repealed. Taking into consideration the new circumstances derived from COVID-19 and the significant increase in risk derived from the passage of time, banking entities will not be able to reverse the provisions previously constituted (through results or equity) as of the cut-off date of November 2021 for the entire modified portfolio as of that date, in accordance with what was established in Article 8 of Agreement No. 2-2021.

Notwithstanding the foregoing, in the event that a modified credit is reinstated to the application of Agreement No. 4-2013 in the normal category, banking entities may use from the previously constituted provision the portion corresponding to it to constitute the required IFRS provision. This provision will be in effect until the Superintendence determines otherwise, based on the future behavior of the modified portfolio.

PARAGRAPH. Although banks are obligated to use IFRS in the preparation of accounting records and the presentation of financial statements as provided by Agreement No. 6-2012, exceptionally and only for those banks where there is an excess of previously constituted provision as indicated in the first paragraph of this article over the IFRS provision and that difference is material, they will temporarily use the accounting basis, as follows: "International Financial Reporting Standards as modified by prudential regulations related to the provisions of the modified special mention portfolio, issued by the Banking Superintendence of Panama for supervisory purposes."

ARTICLE 6. INTERESTS RECEIVABLE. Starting January 2022, banking entities will suspend the recognition of interest, for income purposes, in the accounts of interest receivable and interest earned for modified credits that have had a significant increase in risk with respect to their initial recognition and that also present objective evidence of incurred loss (impaired credits), and those loans included in the modified special mention, modified doubtful, and modified irrecoverable categories, to which General Resolution of the Board of Directors No. SBP-GJD-0003-2021 refers.

Until the Superintendence manifests otherwise for the modified portfolio presenting the characteristics indicated in the previous paragraph, the provisions of General Resolution of the Board of Directors SBP-GJD-0003-2013 will not be applicable, and the bank must maintain interest receivable starting January 1, 2022, in off-balance sheet accounts, recognizing them as income only when they are effectively paid by the debtor.

ARTICLE 7. SUPERVISORY FUNCTION OF THE BANKING SUPERINTENDENCE. As part of its functions, the Banking Superintendence will proceed to review the provisions accounted for by banks in compliance with Article 4 of this Agreement. For this purpose, supervisors will take into account different techniques and reference elements that include, but are not limited to, the following:

1. Selective analysis of the location of credits in accordance with the guidelines established in Article 3 of this Agreement.
2. Inquiries regarding the factors of the calculation of provisions (probability of default, exposure to default, loss given default, post-model adjustments (overlays), and others).
3. Selective review of the supporting documentation of modified credits.
4. Comparison of results with reference tables individualized by banking entity, prepared by the Superintendence based on information available in its databases for the entire banking system, taking into account the admissible guarantees established in Article 42 of Agreement No. 4-2013 and excluding those modified credits guaranteed with pledged deposits in the same bank up to the guaranteed amount.

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In the event that the provisions calculated by the Superintendence exceed those accounted for by the bank, it will be determined whether the adjustments must affect results (objective evidence of non-compliance with accounting standards and prudential regulations) or be adjusted in a regulatory reserve in equity that is credited to the retained earnings account (difference with supervisory judgment). For the purposes of calculating the capital adequacy ratio, limits on concentration in a single borrower or related parties, and any other prudential relationship, the balance of this regulatory reserve will not be considered as capital funds.

ARTICLE 8. DISCLOSURES IN FINANCIAL STATEMENTS. For the purposes of preparation and presentation of annual audited financial statements (EFA), reviewed financial statements (EFS), and interim financial statements (EFT), banks must ensure compliance with the provisions established in Article 9 of Agreement No. 2-2021.

ARTICLE 9. CAPITALIZATION OF INTEREST ON MODIFIED CREDITS. Banking entities may offer their clients the option of capitalizing interest receivable, with the prior express acceptance of the client and always provided that their economic situation and current and/or prospective payment capacity meet the characteristics for credit restructuring established in Article 7 of Agreement No. 2-2021.

In these cases, the bank must ensure compliance with the provisions of Article 13 of Agreement No. 2-2021 regarding transparency and protection of the banking client, and therefore must explain clearly and in detail to the client the implications of interest capitalization with the modalities offered by the bank.

In the cases of modified credits reinstated to Agreement No. 4-2013, the client may request increases in their monthly payments with the purpose of equating them to their pre-modification installments (before the pandemic) without this involving penalties by the banking entity.

ARTICLE 10. SANCTIONS. Non-compliance with the provisions of this Agreement will be sanctioned in accordance with what is provided in Title IV of the Banking Law.

ARTICLE 11. VALIDITY. This Agreement will begin to govern from December 27, 2021.

Given in the city of Panama, on the twenty-second (22) day of the month of December of two thousand twenty-one (2021).

NOTIFY, PUBLISH, AND COMPLY.

THE PRESIDENT THE AD-HOC SECRETARY, Rafael Guardia Joseph Fidanque III