Instructions for Implementing IFRS 9

10/1/ / /1439 AH / /2018 AD Instructions for Implementing International Financial Reporting Standard (IFRS) 9 No. ( /2018)

Greetings,

Based on the provisions of Article (99/b) and Article (42/a – 2, 3) of Banking Law No. (28) of 2000 and its amendments, and referring to our circular No. (10/1/7037) dated 18/5/2016 regarding the requirements of the general framework for implementing Standard (9), and our circulars No. (10/1/15583) dated 23/11/2017 and No. (10/1/1359) dated 25/1/2018 and their attachments, which requested our comments on the draft instructions for implementing Standard (9), and subsequently to the meeting held on 14/12/2017 attended by heads of boards of directors and general managers of banks, and the meeting held on 24/12/2017 attended by risk managers and financial managers in banks to discuss the implementation of Standard (9) and its requirements, we attach herewith a compact disc (CD) containing the instructions for implementing Standard (9), noting the following:

First: The implementation of International Financial Reporting Standard (IFRS) 9 essentially represents (in addition to the accounting framework) a methodology for risk management, specifically credit risk management, aimed at preserving the safety and solidity of the bank's financial position. This requires the bank's board of directors and related committees to verify the existence and application of appropriate credit risk management policies, which entails the existence and application of effective internal control systems, internal credit rating systems, and automated systems for calculating expected credit losses, along with appropriate inspection and verification procedures. This system must be capable of achieving results that ensure adequate hedging against expected credit risks. Therefore, the board of directors must provide the appropriate governance structure to ensure the proper implementation of the requirements of Standard (9).

Second:

The impact of applying Standard (9) for the first time is recorded in the opening balance of equity accounts/retained earnings item as of 1/1/2018.

The accumulated balance of the general banking risk reserve item as of 31/12/2017 is transferred to the retained earnings item as follows:

• The surplus balance of the general banking risk reserve item (if any) remains restricted and cannot be distributed as dividends to shareholders, nor can it be used for any other purposes without prior approval from the Central Bank.

• For the purpose of calculating regulatory capital (Tier 2 Capital), an amount equivalent to the required provisions for debt instruments/credit exposures classified in Stage 1 is taken into account, not exceeding (1.25%) of the total risk-weighted credit assets calculated according to the standardized method. The value of these provisions shall not be deducted from the credit exposure amount (capital adequacy ratio denominator), except for the amount exceeding (1.25%) of the total risk-weighted assets according to the standardized method.

• Islamic banks are required to apply the above to financings and receivables (credit exposures) funded from the bank's own funds.

• As for financings and receivables (credit exposures) funded from joint investment accounts, expected credit losses against them are calculated and the results are provided to the Central Bank to take the appropriate decision regarding them.

• The Central Bank's instructions No. (47/2009) dated 10/12/2009 and its amendments remain in effect, and the more stringent results are taken into account [by comparing the results for provisions calculated for Stage 2 and Stage 3 separately (total of each stage) through a mapping between Stage 2 and Stage 3 according to the requirements of Standard (9) with supervised credit exposures and non-performing credit exposures respectively according to instructions No. (47/2009)].

• Reclassification of financial instruments between the three categories specified in Standard (9) [Amortized Cost, Fair Value through Profit or Loss, Fair Value through Other Comprehensive Income] is permitted once at the beginning of 2018 for the purpose of achieving proper implementation of the requirements of Standard (9), and thereafter complying with the requirements of Standard (9) as stated in the instructions regarding transfers and reclassifications.

• Any adjustment in the expected credit loss balance resulting from a change in the methodology and systems applied by the bank is recorded as a difference in the retained earnings balance/equity.

• It is the responsibility of the external auditor to verify the bank's procedures regarding the methodology and calculation of expected credit losses, and to provide the Central Bank with a certificate from the external auditor regarding the safety of procedures and the sufficiency of the expected credit loss amount calculated by the bank with each financial statement.

• The Central Bank will take necessary measures to verify the safety of methodologies and mechanisms applied by banks to calculate expected credit losses through field visits to banks, where each bank will be informed of the arrangements to be followed.

• It is necessary to comply with the quantitative and qualitative disclosures attached with the instructions and any other disclosures required by International Financial Reporting Standards, as well as providing the Central Bank with the schedules attached with these instructions with each financial statement.

Third:

The implementation of our circulars No. (10/1/1359) dated 25/1/2018 and No. (10/1/15583) dated 23/11/2017 is repealed.

Please accept our highest regards,

The Governor Dr. Ziad Farez

Attachments:

• Instructions for Implementing International Financial Reporting Standard (IFRS) 9.
• Required Quantitative and Qualitative Disclosures.
• Required Schedules for Central Bank Purposes.