Instructions for managing liquidity risks in accordance with Basel III decisions

Central Bank of Egypt

Greetings,

In the context of the Central Bank of Egypt's strategy to implement international best practices in banking supervision, particularly the requirements of the Basel Committee, and with reference to the discussion paper previously issued in March 2011 regarding liquidity risk management, which included a review of the new quantitative methods for measuring them (Liquidity Coverage Ratio LCR, and Net Stable Funding Ratio NSFR), and to the updated paper issued in September 2015 containing models for studying the quantitative impact of their application on banks, in preparation for working with them as binding supervisory instructions.

You will find attached these supervisory instructions regarding the management of Liquidity risks, after approval by the Board of Directors of the Central Bank of Egypt in its meeting held on July 13, 2016, pursuant to the following decision:

"Banks are required to comply with the attached supervisory instructions regarding liquidity risk management from the end of July 2016 as follows:

First: Liquidity Coverage Ratio (LCR)

Maintain a minimum ratio for both the local currency and foreign currencies separately according to the following timeline:

2019	2018	2017	2016
100%	90%	80%	70%

• Maintain a minimum ratio at the aggregate level of 100%.
• Maintain a minimum ratio for both the local currency and foreign currencies separately at a level of 100%.

Compliance with the limits mentioned in item Second must be observed within a maximum period of three months from the date mentioned above.

Please be kind enough to alert us to full compliance with the aforementioned instructions, and to provide us with the email address to which the quantitative forms for these two ratios will be sent to the following address: eg.org.cbe@Unit.Basel, as soon as possible.

Accept our highest regards,

Tarek Amer Central Bank of Egypt Supervision and Oversight Sector

---

Supervisory Instructions Regarding Liquidity Risk Management in accordance with Basel III decisions

"Liquidity Coverage Ratio (LCR)" and "Net Stable Funding Ratio (NSFR)"

Pursuant to Basel III decisions

No.	Description
1-3	Introduction
2-3	Scope of Application
3-5	Second Section: Quantitative Requirements for Liquidity Risk Management
1-5	Liquidity Coverage Ratio (LCR)
1/1-5	High-Quality Liquid Assets
2/1-5	Net Cash Outflows
10-2	Net Stable Funding Ratio (NSFR)
1/2-15	Stable Funding
2/2-15	Required Stable Funding
17-3	Third Section: Qualitative Requirements for Liquidity Risk Management
22-4	Attachments
1	Table No. (1): Components of the Liquidity Coverage Ratio
2	Table No. (2): Components of the Net Stable Funding Ratio
33-

Part One: General Framework

1- Introduction

In light of the Central Bank of Egypt's commitment to applying the latest international practices in the Egyptian banking sector to enhance its competitiveness and protect it from potential financial crises, and to keep pace with the Basel Committee on Banking Supervision's updates in 2013 and 2014 regarding the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), it was decided to apply liquidity risk management instructions within the framework of Basel III decisions. These instructions include the gradual application of the Liquidity Coverage Ratio (LCR) to reach 100% in 2019, and the Net Stable Funding Ratio (NSFR) directly with a minimum of 100%.

2- Scope of Application

These instructions apply to all banks operating in the Arab Republic of Egypt, including branches of foreign banks. Banks are required to prepare both the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) on an individual basis (branches of the bank inside and outside Egypt) during the first two months of each quarter, and on an individual and/or consolidated basis (including the banking group, the bank, all its branches inside and outside Egypt, and all affiliated financial companies except insurance companies) at the end of the quarter. These instructions shall be applied from the end of July 2016.

Banks must apply the Liquidity Coverage Ratio (LCR) gradually for both the local currency and foreign currencies separately according to the following timeline:

2019	2018	2017	2016
100%	90%	80%	70%

As for the Net Stable Funding Ratio (NSFR), banks must comply immediately with a minimum of 100% at the aggregate level for all currencies (local and foreign currencies combined), and for both the local currency and foreign currencies separately within a maximum period of three months from the end of July 2016.

In case of non-compliance with the prescribed limits for the liquidity ratios and failure to take appropriate corrective steps (such as restructuring assets and liabilities) through a time schedule determined by the bank in agreement with the Supervision and Oversight Sector, the following actions will be taken:

• In case of a shortfall in the LCR, funding sources equivalent to the amount of the shortfall must be provided at the level of High-Quality Liquid Assets and invested within those assets.
• In case of a shortfall in the NSFR, the bank is required to form capital equivalent to the amount of the shortfall in the ratio as additional capital in the capital base, leading to compliance with the prescribed limit for the Net Stable Funding Ratio.

Banks will also continue to comply with the current liquidity ratios (20% for local currency and 25% for foreign currencies) in accordance with the Circular Letter issued on September 20, 1990, and its amendments issued on March 20, 2005, with the continued application of the method of maturity ladders according to the Circular Letter issued on March 17, 2005, during the first phase of applying the new liquidity ratios.

Part Two: Quantitative Requirements for Liquidity Risk Management

1- Liquidity Coverage Ratio (LCR)

The Liquidity Coverage Ratio aims to ensure that the bank holds a sufficient amount of unencumbered High-Quality Liquid Assets to cover net cash outflows over a 30-day period under a stress scenario. This ratio is calculated according to the following equation:

Liquidity Coverage Ratio = High-Quality Liquid Assets / Net Cash Outflows over 30 Days

The Liquidity Coverage Ratio must not be less than 100% in all cases (at the end of the gradual application period). In other words, High-Quality Liquid Assets must be at least equal to the estimated Net Cash Outflows. Therefore, the bank must maintain this ratio continuously, be aware of any gaps during the relevant period (30 days), and ensure the availability and sufficiency of High-Quality Liquid Assets to cover any cash flow gap that may arise under adverse conditions during that period.

Components of the Liquidity Coverage Ratio:

1/1 High-Quality Liquid Assets (Numerator). 2/1 Net Cash Outflows (Denominator).

Table No. (1) shows the components of the Liquidity Coverage Ratio and the corresponding weighting factors for the items.

1/1 High-Quality Liquid Assets (Numerator)

High-Quality Liquid Assets are all unencumbered assets sufficient to cover net cash outflows (over 30 days) under a stress scenario. Generally, High-Quality Liquid Assets included in the numerator of the Liquidity Coverage Ratio consist of two main levels (First and Second), and the Second Level is also divided into two sub-levels (A and B) depending on the quality and liquidity of the asset. The total value of items in the Second Level (both sub-levels A and B combined) must not exceed 40% of the total High-Quality Liquid Assets (numerator of the ratio), while the total value of items in the Second Level (B) must not exceed 15% of the total High-Quality Liquid Assets (numerator of the ratio).

Several characteristics must be present in the bank's assets to be considered High-Quality Liquid Assets. These characteristics can be divided into three main groups as follows:

A- Basic Characteristics

Low Risk: Assets with low risk have a high degree of liquidity. High creditworthiness increases the liquidity of the asset, as does the short maturity period of the asset and low legal risks, as well as low inflation risks and exchange rate risks, all of which contribute to increasing the liquidity of the asset.

Ease of Valuation and Credibility: The liquidity of an asset increases as market participants agree on its valuation. Therefore, the asset pricing formula must be easy to measure and not based on complex assumptions. The inputs used in the pricing formula must be publicly available.

Low Correlation with Risky Assets: The liquidity of an asset increases when it is not highly correlated with other risky assets. For example, some assets issued by financial institutions are likely to be illiquid during liquidity crises in the banking sector.

Listing in a Developed and Recognized Securities Market: The liquidity of an asset increases when it is listed in developed and recognized financial markets.

B- Market-Related Characteristics

Active and Large Financial Markets: When historical experience shows that the markets where the assets are listed are large and allow for active trading with a large and diverse number of participants, this leads to a decrease in concentration and increases reliance on the liquidity of the asset.

Low Volatility Rates: Assets with relatively stable prices and less exposure to sharp declines are considered. Volatility in trading prices is considered a reliable measure to meet any liquidity requirements, especially during crises. A historical record confirming the stability of market data and trading volume is required.

High Quality: When historical experience shows a tendency to acquire these types of assets during crises as high-quality assets (e.g., government financial instruments with high credit ratings).

C- Operational Characteristics

High-liquidity assets must be owned by the bank and under the control of the Treasury management to convert them into cash to cover the gap between incoming and outgoing cash flows during times when the bank is exposed to a liquidity crisis. These assets must be unencumbered and free from any restrictions on disposal.

High-liquidity assets must not be used to cover the bank's trading positions or as collateral. These assets must have a clear and single purpose, which is to be used as a source of backup liquidity.

High-Quality Liquid Assets must be under the control of the management or departments responsible for managing liquidity risk in the bank. The bank must periodically liquidate a portion of these assets in the market, either through outright sales or repurchase operations, to test the ability to use these assets as an additional source of liquidity when necessary.

We outline below the components of the numerator of the Liquidity Coverage Ratio with their corresponding weighting factors:

1/1/1 First Level (Weighting factor given: 100%): Includes the following:

1/1/1/1 Cash: This item includes the total cash balance, including cash in vault, cash in transit, auxiliary currencies, and checks.

1/1/1/2 Balances with the Central Bank: This includes balances with the Central Bank of Egypt within the mandatory reserve ratio (including excess reserves, if any) and foreign currency deposits within the 10% ratio at the Central Bank of Egypt.

1/1/1/3 One-night deposits with the Central Bank of Egypt.

1/1/1/4 Debt instruments traded in financial markets with a risk weight of 0%: This includes debt instruments issued or guaranteed by foreign sovereign entities, foreign central banks, the Bank for International Settlements, the International Monetary Fund, the European Central Bank, governments of European Union countries, and multilateral development banks. These instruments must meet the following conditions:

• They are traded in large and active financial markets with a low level of concentration.
• They are not issued by a financial institution or any of its sister or affiliated units.
• They have a historical record confirming they are a reliable source of liquidity in markets, especially under adverse market conditions.

1/1/1/5 Debt instruments (including treasury bills) traded, issued by the Egyptian Government or the Central Bank of Egypt in the local currency: This includes treasury bills (including those for repurchase agreements - Repo and reverse repurchase agreements - Reverse Repo), government bonds, and any other debt instruments issued by these entities and traded in secondary markets. The value of savings certificates with a remaining maturity of 30 days or less is excluded from the balances with the Central Bank.

Treasury bills are valued at present value according to the following equation: Nominal Value * (1 - average yield rate of the last issuance for the same maturity * (Remaining Period / 365))

They must meet the credit rating criteria of the four recognized credit rating institutions within the supervisory instructions regarding "Minimum Capital Adequacy Standard under Basel decisions" issued in December 2012 and the conditions stated therein.

1/1/1/6 Debt instruments (including treasury bills) traded, issued by the Egyptian Government or the Central Bank of Egypt in foreign currencies: This includes treasury bills (with the same treatment for repurchase and reverse repurchase operations as mentioned in item 1/1/1/5), government bonds, certificates of deposit, and any other debt instruments. The value of these instruments is taken to the extent that it corresponds to net cash outflows resulting from the bank's activities in those foreign currencies under adverse conditions.

1/1/1/7 Debt instruments (including treasury bills) traded, issued by the home country of the bank and in the currency of that country, in the case of branches of foreign banks and banks owned by foreign banks: This includes treasury bills (with the same treatment for repurchase and reverse repurchase operations as mentioned in item 1/1/1/5), government bonds, and any other debt instruments issued by sovereign entities or the central bank of the home country, regardless of the risk weight of those instruments.

1/1/2 Second Level (Maximum 40% of the numerator - after applying weighting factors):

First: Second Level (A) (Weighting factor given: 85%): Includes the following:

1/2/1/1 Debt instruments traded in financial markets with a risk weight of 20%: Issued or guaranteed by foreign sovereign entities, foreign central banks, and multilateral development banks. These instruments must meet the following conditions:

• They are traded in large and active financial markets with a low level of concentration.
• They are not issued by a financial institution or any of its sister or affiliated units.
• They have a historical record confirming they are a reliable source of liquidity, especially under adverse market conditions. This means that the maximum decrease in the prices of these instruments did not exceed 10%, or the maximum discount rate applied to them did not exceed 10% over a 30-day period during a parallel period of acute liquidity crisis.

1/2/1/2 Covered bonds and debt instruments issued by public bodies and companies: Must meet the following 4 conditions:

• For debt instruments issued by companies and bodies, they must not be issued by any financial institution or any of its sister or affiliated units.
• For covered bonds, they must not be issued by the bank itself or any of its sister units.
• They are traded in large and active financial markets with a low level of concentration.
• They have a long-term credit rating of AA or higher, or in the absence of a long-term rating, a short-term rating equivalent to the above long-term rating, or no credit rating from a recognized external credit rating institution but classified by the bank as having a failure probability equivalent to a credit rating of at least AA.
• Covered bonds are bonds that ensure the issuer provides legal protection to the holder in case of the counterparty's failure, where the proceeds from them are invested in assets capable of generating cash flows that guarantee the value of those bonds and the return on them.
• This includes banks, exchange companies, companies engaged in real estate financing, securitization companies, companies engaged in financial leasing, and companies operating in the securities and insurance sectors.
• They must meet the credit rating criteria of the four recognized credit rating institutions within the supervisory instructions regarding "Minimum Capital Adequacy Standard under Basel decisions" issued in December 2012 and the conditions stated therein.
• They have a historical record confirming they are a reliable source of liquidity in markets, especially under adverse market conditions. This means that the maximum decrease in the prices of these instruments or the maximum discount rate did not exceed 10% over a 30-day period during a parallel period of acute liquidity crisis.

Second: Second Level (B) (Maximum 15% of the numerator - after applying weighting factors): Weighting factors range between 50% and 75%, as follows:

1/2/1/3 Securitization bonds invested in, arising from residential mortgage loans (Weighting factor: 75%): These bonds must meet the following conditions:

• They are not issued by the bank itself or its sister or affiliated units.
• They are traded in large and active markets with a low level of concentration.
• They have a long-term credit rating issued by a recognized external credit rating institution of at least AA, or in the absence of a long-term rating, a short-term rating equivalent to the aforementioned long-term rating.
• They have a historical record confirming they are a reliable source of liquidity in markets, especially under adverse market conditions. This means that the maximum decrease in the prices of these instruments did not exceed 20%, or the maximum discount rate applied to them did not exceed 20% over a 30-day period during a parallel period of acute liquidity crisis.
• The property owner remains responsible for covering any gap between the sale value of the mortgaged property and the value of the loan granted to him in case of foreclosure. The value of residential loans (from which those bonds were issued) must not exceed 80% of the value of the properties on average at the time of issuing those bonds.
• The issuers of these bonds must commit to monitoring residential mortgage loans to protect the rights of investors in these bonds.

1/2/1/4 Debt instruments issued by public bodies and companies - other than those listed in Second Level (A) (Weighting factor: 50%): Must meet the following conditions:

• They are not issued by a financial institution or any of its sister or affiliated units.
• They are traded in large and active markets with a low level of concentration.
• They have a long-term credit rating issued by a recognized external credit rating institution ranging between +A and -BBB, or in the absence of a long-term rating, a short-term rating equivalent to the aforementioned long-term rating, or no credit rating from a recognized external credit rating institution but classified by the bank as having a failure probability equivalent to a credit rating ranging between +A and -BBB.
• They have a historical record confirming they are a reliable source of liquidity in markets, especially under adverse market conditions. This means that the maximum decrease in the prices of these shares did not exceed 20%, or the maximum discount rate applied to them did not exceed 20% over a 30-day period during a parallel period of acute liquidity crisis.

1/2/1/5 Ordinary shares (Weighting factor: 50%): These shares must meet the following conditions:

• They are not issued by a financial institution or any of its sister or affiliated units.
• They are traded in large and active markets with a low level of concentration.
• They are listed in the main index of the Egyptian Exchange (EGX) or the main index of the home country in the case of branches of foreign banks and banks owned by foreign banks.
• They are issued in Egyptian Pounds or in the currency of the home country of the bank in the case of branches of foreign banks and banks owned by foreign banks.
• They have a historical record confirming they are a reliable source of liquidity in markets, especially under adverse market conditions. This means that the maximum decrease in the prices of these shares did not exceed 40% over a 30-day period during a parallel period of acute liquidity crisis.

2/1 Net Cash Outflows (Denominator)

Net Cash Outflows represent the total expected balance of outgoing cash flows minus the total expected balance of incoming cash flows under a stress scenario during the relevant period (30 days). The total expected balance of outgoing cash flows consists of existing balances for different categories of liabilities weighted by assumed percentages expected to be withdrawn by creditors, as well as weighted by specific percentages expected to be withdrawn for different off-balance sheet items. The total expected balance of incoming cash flows consists of existing balances weighted by percentages reflecting expected incoming flows, under a stress scenario. The total incoming cash flows must not exceed 75% of the total outgoing cash flows.

We outline below the components of the denominator of the Liquidity Coverage Ratio with their corresponding weighting factors:

First: Outgoing Cash Flows: Consist of the following items:

1/2/1 Deposits of Individuals and Micro and Very Small Enterprises: This includes deposits of "natural persons" and deposits of "Micro and Very Small Enterprises" as defined in the Circular Letter dated December 7, 2015, regarding the issuance of a definition for companies and micro, small, and medium enterprises.

1/1/2/1 Deposits with no maturity date (including demand deposits, savings deposits, documentary credit cover) and time/deposit/notice/frozen deposits with a remaining maturity of 30 days or less (or those that include an implicit option leading to a reduction of the maturity to 30 days or less): Divided into:

• Stable deposits (Weighting factor: 5%)
• Less stable deposits (Weighting factor: 15%) The stable and less stable parts of these deposits are calculated according to the standard deviation model for this purpose. The average value over the previous 3 years is calculated automatically according to the model.

2/1/2/1 Savings certificates with a remaining maturity of 30 days or less (Weighting factor: 0%).

3/1/2/1 Various types of deposits / Savings certificates with a remaining maturity of more than 30 days (Weighting factor: 0%).

2/2/1 Unsecured financing (deposits, loans, facilities, etc.) granted by other parties other than individuals and Micro and Very Small Enterprises: This item includes deposits with no maturity date or maturing within 30 days (or those that include an implicit option leading to a reduction of the maturity to 30 days or less), as well as installments of unsecured financing granted to the bank (such as loans) maturing within 30 days. This item can be divided as follows:

1/2/2/1 Deposits for operational purposes (Weighting factor: 25%): Represented by demand deposits for all parties (excluding individuals and Micro and Very Small Enterprises and current accounts due to banks (including the Central Bank of Egypt)).

2/2/2/1 Deposits not for operational purposes and financing granted to the bank: Represented by deposits with no maturity date (including savings deposits and documentary credit cover) and time/deposit/notice/frozen deposits and any other deposits maturing within 30 days (or those that include an implicit option leading to a reduction of the maturity to 30 days or less), as well as installments of unsecured financing granted to the bank (such as loans) maturing within 30 days. These items are from the following parties:

• Non-financial companies, Egyptian and foreign sovereign entities, public bodies, the Central Bank of Egypt, foreign central banks, and multilateral development banks (Weighting factor: 40%).
• Other parties other than those mentioned above, including banks (excluding central banks) and other financial institutions (such as insurance companies, investment fund management, financial leasing, securities, etc.) (Weighting factor: 100%).
• Bonds issued by the bank itself (unsecured) regardless of the holder, maturing within 30 days (Weighting factor: 100%).

4/2/1 Unsecured financing (deposits, loans, facilities, bonds issued, etc.) granted to the bank by the parties mentioned above within item 2/2/1 that mature after 30 days (Weighting factor: 0%).

---

[RegAlert note: the English text above is a translation of the first 24,000 characters of a 212,502-character original (11% of the document). The remainder was not translated. The complete original-language text is stored with this document.]