Palestine Monetary Authority

Instructions No. (2011/06)

To all banks operating in Palestine

Date: Monday, 05 September, 2011

Subject: Credit Risk Management Instructions

Based on the provisions of Articles (40, 43, 72) of Banking Law No. (9) of 2010, and in alignment with the recommendations of the Basel Committee on Banking Supervision, which emphasize the necessity of having sound foundations for credit risk management within four main axes representing the minimum qualitative principles to be followed for credit risk management, all banks operating in Palestine are requested to comply with the following four main axes:

Axis One: Availability of a suitable environment for credit risk management.
Axis Two: Working according to sound procedures and controls for granting credit.
Axis Three: Availability of competent credit management and procedures for measurement and follow-up.
Axis Four: Verification of the adequacy of credit risk supervision, control, and management.

These instructions shall take effect from the date of their issuance, and all banks are required to take the necessary measures to rectify their status and settle matters to ensure full compliance.

Supervision and Inspection Department
Palestine Monetary Authority

Ramallah - Al Bireh P.O.Box 452 - Tel: 02-2409920 - Fax: 02-2409922 Gaza - P.O.Box 4026 - Tel: 08-2825713 - Fax: 08-2844487 E-mail: info@pma.ps Ramallah - Al Bireh P.O. Box: 452 – Phone: 02-2409920 – Fax: 02-2409922 Gaza – P.O. Box: 4026 – Phone: 08-2825713 – Fax: 08-2844487 www.pma.ps

First: Establishing a Suitable Environment for Credit Risk Management:

Principle One: Board of Directors' Responsibilities

The bank's Board of Directors is responsible for adopting a strategy and policy for credit risk management and evaluating it at least annually. This strategy should reflect all types of credit risks the bank may assume, their respective degrees, and the expected return against them. To achieve this, the following must be considered at a minimum:

1/1

The policy must include authorities, controls, and tasks for granting, renewing, following up, evaluating, and managing credit risks, taking into account variations in these controls according to the type of credit, customer type, economic sectors, geographical regions, local or foreign markets, and credit concentrations, ensuring they align with the nature and degree of risk for each type. Authorities should be restricted to the minimum necessary, and the Board of Directors should supervise credit granting procedures in accordance with the approved policy to verify compliance. The policy should be evaluated periodically based on practical outcomes, ensuring its comprehensiveness, adequacy, and coverage of all credit risk types.

2/1

The strategy must clearly define the targeted credit quality level, return, and growth, as well as acceptable risk levels and their impact on the targeted return and capital burden. The Board of Directors must reassess this strategy annually by comparing the bank's actual performance with targeted results and making necessary adjustments accordingly.

3/1

The strategy must consider long-term economic cycles, and the Board must continue to evaluate and adjust it according to economic developments, market dynamics, and their impact on credit portfolio composition and quality.

4/1

Disseminate the Board-approved credit risk management strategy and policy to relevant management levels and employees, verify their accurate understanding, and hold them accountable for compliance.

5/1

The Board must verify the executive management's ability to manage credit activities and risks according to the approved strategy and policy, and assess compliance. The Board must also reassess the credit granting policy, including objectives, controls, general conditions, authorities, and tasks, at least annually, relying on an evaluation independent of executive management.

6/1

The Board must ensure that incentive and compensation policies do not conflict with the credit risk management strategy, avoiding short-term profit-based incentives (realized or unrealized) when such policies generate risks exceeding approved ceilings and controls.

Principle Two: Executive Management Responsibilities:

Executive management is generally responsible for implementing the Board's strategy and policy on credit risk, developing necessary executive procedures, including identifying, measuring, monitoring, and controlling credit risks. These policies and procedures should cover all credit activities at both the individual activity level and the overall portfolio level. To achieve this, executive management must consider at a minimum:

1/2

Develop written executive procedures governing credit granting, renewal, and evaluation tasks in alignment with the Board's strategy and policy, and consistent with sound practices. They must also verify the existence of an independent internal evaluation of these tasks' performance.

2/2

Develop policies and procedures for identifying, measuring, monitoring, and controlling credit risks. These procedures should cover all aspects of activity execution and risks, including targeted sectors, markets, portfolio diversification, hedging, concentrations, products, early detection of delinquencies, and their resolution, in alignment with the Board's strategy and policy, PMA requirements, and best practices.

3/2

Executive policies and procedures should aim to properly diversify and distribute credit portfolio risks by setting ceilings for customers, affiliated groups, different economic sectors, and geographical regions, within the frameworks and ceilings specified by the PMA, aligning with the Board's strategy and policy.

4/2

For banks conducting international credit and financing activities according to management strategy, the following must be considered:

أ. Accurately identify the legal, legislative, political, economic, and social environment in each country within the bank's operational scope, then determine resulting credit risks, requiring legal and procedural policies for foreign investment and ownership, fund transfers, and market supply/demand and pricing control factors.

ب. Develop appropriate executive policies and procedures for managing credit risks in each country of presence, including identifying, measuring, monitoring, and controlling risk types, such as ownership and investment risks, fund transfer risks, risks arising from litigation and collateral enforcement, as well as risks from economic developments and fluctuations at both the activity and macroeconomic levels. Ceilings and limits for credit risks in each country should be established in alignment with the Board's strategy and PMA requirements.

Principle Three: Identifying and Managing Credit Risks:

Banks must identify the nature of credit risks inherent in each financial product and activity they offer, and how to manage them. Banks must not enter any new products or activities without Board and PMA approval, identify their risk nature, and establish appropriate systems and procedures for management, considering the following:

1/3

Develop appropriate systems, programs, and procedures to identify, analyze, and effectively manage risks inherent in each offered product and financial activity.

2/3

Pay special attention to identifying risks associated with financing new projects, ensuring understanding, analytical capability, and management readiness, and establishing appropriate systems and procedures before deciding to enter such projects.

3/3

Verify the high capabilities and skills of employees responsible for offering financial products and activities, and submitting related studies and recommendations, especially for new products, as well as employees analyzing, monitoring, and evaluating their risks.

Second: Working According to Sound Procedures and Controls for Credit Granting:

Principle Four: Sound Controls for Credit Granting

Banks must operate according to specific rules and controls generally covering the definition and identification of targeted markets and sectors, accurate identification of customers, their groups, surrounding risks, credit granting purpose, credit structure, collateral, and repayment sources. To achieve this, the following must be considered at a minimum:

1/4

Establish clear and specific controls and conditions for approving credit granting across different types and sectors safely and soundly, defining the credit purpose, appropriate credit size, credit type and structure, and required conditions, collateral, and repayment sources.

2/4

The bank must possess sufficient information from reliable and neutral sources about customers, their projects, and affiliated parties, enabling evaluation of the customer's risk nature, including:

أ. The purpose of granting credit.
ب. Repayment sources, their regularity, other beneficiaries, and any existing customer obligations.
ت. Verification that the customer's activity complies with applicable laws.
ج. The customer's financial status and risk structure regarding maturity, nature, size, collateral, and sensitivity to market developments and economic conditions.
د. Adequacy of collateral and guarantees, their sensitivity to economic developments and price forecasts, and enforceability under laws and regulations.
هـ. The borrower's credit history, and where possible, the customer's transaction history regarding regularity in meeting previous obligations, current repayment capacity based on comparing past and current financial indicators and expected cash flows for projects under assumed probabilities and scenarios. و. Information on the customer's experience in financed businesses/projects, market standing, competitive position, plus sufficient information on financed businesses/projects, their terms, commitments, and alignment with credit conditions and ceilings. ي. Conduct field visits to funded customers and their projects to assess the customer's ability to manage obtained credit, complete the project, and thus meet repayment obligations.

3/4

When granting credit to new customers with prior transactions, the bank must additionally prepare for the customer's nature and risks by providing sufficient, accurate information from reliable sources on reputation, financial status, size and nature of existing obligations, and repayment capacity. Necessary investigations must be conducted for individual customers to verify they are not involved in fraud, deception, or embezzlement, and have good reputations free from suspicion. The same applies to individuals managing companies/institutions the bank intends to deal with, ensuring evaluation extends beyond company reputation and financial status to include the backgrounds, experience, and competence of owners, managers, and customers.

4/4

Establish a specific system and procedures for grouping customers into credit groups based on sound criteria relying on the degree of risk linkage, whether regarding ownership, management, projects/businesses, legal/financial/market status, or other significant linking factors. Risks must be evaluated, and credit granting ceilings, controls, and conditions set based on the customer's credit group, without exceeding PMA requirements.

5/4

When participating in joint or syndicated financing with other banks, the bank must rely solely on the thorough study conducted by the lead bank regarding credit and customer risk analysis and presentation. The decision to participate must be based on its own study and evaluation using the same information, bases, and procedures relied upon when granting credit independently.

6/4

Credit granting controls must include evaluating credit risk against realized returns and overall profitability in the bank's relationship with the customer and their credit group, with credit recorded according to multiple assumed probabilities and scenarios.

7/4

Credit granting controls and conditions must allow for netting between debtor and creditor accounts and provide the necessary legal documentation and mechanism for enforcement.

In addition to the above, banks must consider using databases available from the PMA to mitigate credit risks.

Principle Five: Setting Ceilings for Credit Granting:

Banks must set credit ceilings at the individual customer level, for affiliated credit groups, and at the level of credit types, economic activities, sectors, and geographical regions. This must include on-balance sheet and off-balance sheet credit. To achieve this, the following must be considered at a minimum:

1/5

Establish specific bases for setting ceilings for customers and their affiliated credit groups. These bases rely on an approved internal risk assessment methodology for customers and groups, considering the customer's and group's financial status at the bank and the banking system, and potential fluctuations or changes in activity and income. This must be periodically reassessed before credit renewal or modification at intervals not exceeding one year.

2/5

Set ceilings for financing different economic activities, sectors, and geographical regions based on accurate studies of current and expected risks, developments, and conditions. Financing diversification and risk distribution must align with the Board-approved strategy and policy.

Instructions No. 6 of 2011 regarding Credit Risk Management

Palestine Monetary Authority