Instruction No. 215 on the Procedure for Forming and Using the Reserve and Fund for Covering Potential Asset Losses

1 « «registered» Ministry of Justice of the Republic of Tajikistan under No. 558 “e” dated January 29, 2020 Instruction No. 215 “On the Procedure for Forming and Using the Reserve and Fund for Covering Potential Asset Losses” Instruction No. 215 “On the Procedure for Forming and Using the Reserve and Fund for Covering Potential Asset Losses” (hereinafter – the Instruction) is developed in accordance with Article 28 of the Law of the Republic of Tajikistan “On Banking Activity” and Article 24 of the Law of the Republic of Tajikistan “On Microfinance Organizations” for the purpose of managing and supervising the quality of assets in banks, non-banking credit organizations, and microcredit deposit organizations (hereinafter – credit organizations) and establishes a unified procedure for forming and using the reserve of credit risks and the Fund for covering potential losses on loans. CHAPTER 1. GENERAL PROVISIONS

1. Concepts used in this Instruction: − reserve of credit risks – an amount intended to cover potential losses on credit risks determined in accordance with regulatory requirements established by the «registered» Ministry of Justice of the Republic of Tajikistan under No. 558 “g” dated June 03, 2016. «approved» By Resolution of the Board of the National Bank of Tajikistan dated April 13, 2016 No. 50 «approved» By Resolution of the Board of the National Bank of Tajikistan dated November 08, 2018 No. 147 «registered» Ministry of Justice of the Republic of Tajikistan under No. 558 “d” dated December 11, 2017. «approved» By Resolution of the Board of the National Bank of Tajikistan dated December 26, 2019 No. 171

2 National Bank of Tajikistan, and in addition to the Fund for covering potential losses on assets; − fund for covering potential losses on assets (hereinafter – Fund) - an amount intended as a general fund or special fund to cover potential losses on loans, securities, collateral obtained for sale, and other assets in accordance with the requirements of this Instruction, other relevant normative legal acts of the National Bank of Tajikistan, and International Financial Reporting Standards; − related party – a person recognized as such in accordance with the Law of the Republic of Tajikistan “On Banking Activity”; − loans – implies loans, overdraft, financial leasing, interbank loans, term placements, accrued unpaid interest, unused client credit lines, guarantees issued by a credit organization, and others; − overdraft – an operation arising on the basis of a contract between a credit organization and a client in case of temporary shortage of funds in the client's account, providing the client with the opportunity to use the credit organization's funds under certain conditions; − loan restructuring - revision of the terms of a loan agreement (agreement, transaction); − non-performing loan – a loan, the principal and/or interest of which is not repaid in accordance with the requirements of the contract and is classified into one of the groups of non-standard, doubtful, and bad loans; − general fund – an amount that is formed for standard loans and loans under observation (active); − special fund - an amount that is formed for non-performing assets (loans), i.e., assets of non-standard, doubtful, and bad groups. 2. Compliance with the requirements of this Instruction is mandatory for credit organizations. 3. To maintain the liquidity of a credit organization, to assist in protecting the interests of its shareholders and clients, a credit organization must timely identify non-performing assets to take necessary measures to prevent associated losses.

3 4. A credit organization must have an appropriate management structure for identifying, measuring, monitoring, and controlling the credit risk of banking operations. 5. In case there is reason to believe that a loan, including the principal and accrued interest, will not be repaid in accordance with the loan agreement and/or the client's financial position is poor, then non-performing loans are classified as “non-standard”, “doubtful”, and “bad”. 6. Credit organizations must develop rules and processes for identifying asset quality and managing them, which must provide for the adoption of the following measures: − assessment and classification of assets; − regular review of non-performing assets; − timely creation of adequate and reliable levels of the Fund; − write-off of bad assets and reflection of actual repayment of assets, and recovery of expectations taking into account market and macroeconomic conditions. 7. The classification system and Fund creation in credit organizations must take into account on-balance and off-balance sheet liabilities. Off-balance sheet liabilities that can be unilaterally cancelled by a credit organization in accordance with contractual requirements must not be taken into account in classification and Fund creation; otherwise, off-balance sheet liabilities must be considered in classification and Fund creation. Credit organizations must have appropriate information to ensure classification and Fund creation. 8. Credit organizations must have necessary mechanisms for conducting regular assessment of the value of collateral, including guarantees. The assessment of the value of collateral must reflect its real realization cost, taking into account existing market conditions, expenses associated with the realization of collateral, and the period during which these expenses may affect the value of the collateral. 8

1. An automated banking system of a credit organization must be organized in such a way that a) classify each loan and each client obligation in accordance with the requirements of this Instruction, b) assess the need for Fund creation for each loan and client obligation depending on classification groups, presence and adequacy of collateral, c) conduct analysis of the loan portfolio to assess its quality, d) prepare periodic reports submitted to the National Bank of Tajikistan, e) prepare appropriate information for management, and f) prepare other necessary reports (including one-time) for management and stress testing.
2. Management of credit organizations must receive timely and appropriate information about the state of assets, loan portfolio, including their classification, levels of Funds and reserves, and major non-performing assets. The information received must include at least the following: − conclusion on the latest results of asset assessment; − comparative trends of overall quality of non-performing assets; − assessment of existing or expected deterioration in asset quality and possible losses that will be incurred in normal and stress situations; − level and adequacy of the credit organization's funds.
3. Credit organizations must have necessary material and intellectual resources for early identification of deterioration in asset quality, for constant monitoring of non-performing loans, as well as for collecting overdue obligations. CHAPTER 2. CLASSIFICATION OF LOANS
4. Assessment of asset quality, assessment of the client's financial condition, classification, determination of the realization value of provided collateral, and Fund creation must be conducted on an individual basis, especially regarding related loans, loans of related parties, all non-performing loans, and loans exceeding the established limit. Such assessment must be conducted by a credit organization on a constant basis, and the results must be contained in credit files. Within the framework of this Instruction, loans exceeding the established limit are those where the total debt amount of the borrower exceeds 100,000 (one hundred thousand) somoni or exceeds 2 percent of the regulatory capital of the credit organization (depending on which amount is smaller).

5 12. Loans of a credit organization, depending on the client's financial condition, as well as the number of days overdue, are classified into 5 groups: − standard; − under observation; − non-standard; − doubtful; − bad. 13. If during the client's activity it is determined that force majeure circumstances regarding the loan are inevitable, they must be classified as “under observation” or another high-risk group in accordance with paragraph 16 of this Instruction. 14. Credit organizations are obliged to classify their loans monthly and form a Fund according to the group of credit risk. Also, depending on the specifics of activity, have a procedure and rules for internal monitoring of their assets. 15. In case of change in the client's financial condition and availability of information about risks in their activity, a credit organization is obliged to reclassify the client's loans. The client's financial condition is determined based on the analysis of the balance sheet, income statement, cash flow statement, taking into account the industry and sphere of activity of the client in accordance with methodologies and indicators stipulated by internal documents of the credit organization. 16. Credit organizations must classify all loans into 5 groups in accordance with the following requirements: a) The first group “standard” includes loans if: − the client's financial condition is good; − principal and interest are repaid on time in accordance with the loan agreement and there is no overdue amount; − loan repayment has not been revised or restructured. The client's financial condition can be considered good if a comprehensive analysis of the client's operational, financial, and economic activity (as well as other information related to the borrower, including information about the external environment) indicates that the client has stable activity, has a positive net asset value, good profitability level, and is solvent. The client must not have negative trends, including a significant drop in production volumes not related to seasonal factors, profit decline, significant increase in accounts receivable or payable (creditor and/or debtor debt), as well as other probable events that could potentially affect the client's financial stability. In special cases, due to the fact that obligation repayment is not under the borrower's control, a credit organization may take into account an overdue payment of such a loan for up to 8 days. A Fund for standard loans is created as a general fund in national currency in an amount of not less than 2%, and in foreign currency not less than 3% of the outstanding debt amount. b) The second group “under observation” includes loans if: − the client's financial condition is satisfactory; − payments on principal and/or interest on the loan are overdue from 8 to 30 days; − loans have been restructured in the established order once. The client's financial position can be recognized as satisfactory if a comprehensive analysis of the client's operational, financial, and economic activity (as well as other information related to the client) indicates that the presence of any negative trends in the borrower's activity does not pose direct threats to their current financial condition, and in the foreseeable future (a year or less) they may lead to financial difficulties if the borrower does not take appropriate action. A Fund for loans under observation is created as a general fund; in national currency, it is created in an amount of not less than 5%, and in foreign currency, it is created in an amount of not less than 10% of the outstanding debt amount. The general fund created for standard loans and loans under observation will be used to calculate the capital adequacy ratio up to a level of 1.25% of risk-weighted assets. An example of the procedure for creating a general fund and its calculation when calculating the capital adequacy ratio is presented in Appendix 1 of this Instruction. c) The third group “non-standard” includes loans if:

7 − payments on principal and/or accrued interest are overdue from 30 to 90 days; − the loan is not overdue or if the overdue period is less than 30 days, but the borrower's financial condition is assessed as doubtful. The client's financial condition is assessed as doubtful if there are direct threats to their solvency. If the borrower does not take measures to improve the financial condition, the client's activity, taking into account negative trends, may be subject to financial difficulties. A Fund for non-standard loans is created as a special fund in national currency in an amount of not less than 30% and in foreign currency not less than 40% for the secured part of the loan and 100% for the unsecured part of the loan, determined in accordance with paragraph 38 of this Instruction. d) The fourth group “doubtful” includes loans if: − payments on principal and/or interest are overdue from 90 to 180 days; − the loan is not overdue or the overdue period is less than 60 days, but the client's financial condition is assessed as unsatisfactory. The client's financial condition is assessed as unsatisfactory in the following cases: − unstable solvency of the client; − negative trends threatening the client's economic activity (loss-making operations, reduction of net assets, decrease in production volumes, and real growth in accounts receivable and/or payable). A Fund for doubtful loans is created as a special fund in national currency in an amount of not less than 75%, and in foreign currency in an amount of not less than 85% for the secured part of the loan and 100% for the unsecured part of the loan, determined in accordance with paragraph 38 of this Instruction. e) The fifth group “bad” includes loans if: − payments on principal and/or accrued interest are overdue for 180 days or more; − the loan is not overdue or the overdue period is less than 180 days, but the client's financial condition is assessed as poor. The client's financial condition is assessed as poor in the following cases if:

8 − the client is constantly in an unstable financial condition or declared bankrupt in accordance with legislation; − analysis of the client's operational, financial, and economic activity (as well as other information related to the borrower) indicates that the client's activity has negative trends that will lead to the client's permanent insolvency or bankruptcy. Threatening negative trends in the client's activity include: − loss-making activity; − negative value or significant decrease in the value of net assets; − significant decrease in productivity and substantial increase in accounts receivable or accounts payable. A Fund for bad loans is created as a special fund in national and foreign currency in an amount of 100% of the outstanding debt amount. 18. Brief information on loan classification and requirements for creating funds for loans is presented in Appendix 2 of this Instruction. CHAPTER 3. UNIFIED CLASSIFICATION 19. In case a borrower receives several loans from a credit organization, and if one of the loans is classified as non-standard, doubtful, or bad, then in such a case, all loans of this borrower are classified into a higher credit risk category. Consequently, the amount of the Fund created by the credit organization must be calculated taking into account all credit obligations due to this borrower. 20. In case a credit organization provides loans to a group of related borrowers and a loan of one of the borrowers is classified as non-standard, doubtful, or bad, then the credit organization carries out classification taking into account the financial condition of other related borrowers, and the loan is transferred to the highest risk category of these related loans. 201. In case of group loans issued to individuals within microcredit, a credit organization classifies such loans in accordance with paragraph 20 of this Instruction or, if the loan of each group member is less than 25,000 somoni, may classify them as unrelated loans. CHAPTER 4. OVERDRAFT 21. The overdraft agreement must specify the maximum amount of account balance excess, interest rate, and term of overdraft use. Overdraft is included in the group of loans and is reflected in the active part of the balance sheet in accordance with the rules. A credit organization may conclude a contract according to which the maximum size of the overdraft limit is determined based on the average monthly credit turnover on the client's account. 22. If the overdraft amount according to the contract is not repaid within the established terms, then after 30 days of overdue, the credit organization must classify it as a bad loan and form a special fund for overdraft in an amount of 100% in national and foreign currency. CHAPTER 5. RECLASSIFICATION AND RESTRUCTURING OF LOANS 23. Reclassification of non-performing loans and their transfer to the group of standard loans with a possible corresponding reduction of the Fund is produced only after full fulfillment by the client of their overdue obligations (on principal and accrued interest), as well as fulfillment by the client of their obligations under the contract without violations for the next 6 months. 24. Due to changes in external factors and uncontrollable reasons, when clients may face temporary/short-term difficulties in servicing their loans, a credit organization may economically revise the loan terms or reassess its interest (hereinafter – debt restructuring). Credit organizations may restructure loans after conducting a thorough analysis of factors affecting the client's ability to service loans, the client's sustainability, and expected future cash flows of the client for debt repayment. If the client experiences financial difficulties in meeting financial obligations and considering that the client has no opportunity to repay their obligations without concessions, a credit organization may provide concessions to such a borrower. 25. Cases where clients experience financial difficulties include: a) if they have overdue debt on any obligations to a credit organization; b) if they currently do not have overdue debt on any obligations, but there is a probability that in the foreseeable future they will have loan overdue without restructuring; c) if based on actual activity, calculations, and forecasts of the client's current abilities, a credit organization forecasts that all attracted/available cash flows of clients will be insufficient to service the entire amount of debt (principal and interest) in accordance with the terms of the current contract in the foreseeable future. 26. The most common concessions provided by credit organizations during loan restructuring include: a) extension of the repayment or return term of the loan; b) revision of the term for payment of principal or interest; c) provision of new or additional grace periods (grace period); d) reduction of the interest rate, as a result of which the effective interest rate becomes lower than the current interest rate of existing loans of the credit organization on this date and/or the current market interest rate in other credit organizations; e) debt forgiveness; f) revision or deferral of principal, interest, or corresponding service fees and others. 261. During loan restructuring, if a credit organization provides a concession, it must (a) discount the value of future cash flows in accordance with the changed conditions using the original interest rate, (b) compare the discounted value of future cash flows of the restructured loan with the book value of the loan, and (c) subtract the resulting difference from the book value of the loan. In case of providing concessions, usually, the cost of discounted future cash flows of the restructured loan is less than the book value of the loan. 27. If a standard loan is restructured, the credit organization, by writing off from the account (writing off from the balance) the reduced part of the loan value (the difference between the discounted value of the restructured loan and the book value of the loan), transfers the restructured loan to the group under observation or, in case of its compliance with the requirements of other classification groups, transfers it to the corresponding group. 28. If a classified loan of one of the groups - under observation, non-standard, doubtful, or bad - is restructured for the first time, the credit organization must write off the reduced part of the value of such a loan from the balance and, if the restructured loan meets the classification requirements of its group, leave it in the same group. 29. If a loan is restructured for the second time or more, in addition to writing off its reduced part of the value from the balance, it, depending on each subsequent restructuring, must be transferred to one risk group higher. A sample of loan restructuring is provided in Appendix 3 of this Instruction. 30. A restructured loan can be transferred to the “standard” category only if the client makes payments or services interest payments on time for 6 months in accordance with the revised terms, (loan payments and interest servicing monthly) and for 12 months in accordance with the revised terms, (loan payments and interest servicing quarterly) without violations of assumed obligations. 301. For the purpose of risk management and reporting to the National Bank of Tajikistan, a loan is considered restructured until it meets the following requirements: − when all payments are made in accordance with the changed terms of the contract, for at least 12 months after the first payment, regardless of whether the loan is performing or non-performing; − the borrower has overcome their financial difficulties.

12 CHAPTER 6. ACQUISITION OF COLLATERAL ON BAD LOANS AND THEIR CLASSIFICATION 31. A credit organization, in case of non-fulfillment by clients of their loan obligations, in accordance with legislation, in exchange for its claims may acquire collateral, which is accounted for on balance sheet account No. 15935 “Collateral obtained for sale”. A credit organization accounts for acquired property at its real market value taking into account potential costs. The difference between the book value of the loan and the value of the acquired property, at which the property is accounted for in the books, must be adjusted with the Fund created by the credit organization and, in case of reduction of the Fund, be reflected in the income statement. 32. Upon acquisition of collateral on the balance sheet in exchange for a non-performing loan, it is classified as “non-standard” and for these accepted collateral, the credit organization is obliged to form a Fund in the amount of 30%. If the property accepted on the balance sheet for sale is not sold within 6

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