Lending-2022- Circular No. 158: Updated Version of the Borrowers' Credit Classification System

Palestine Monetary Authority PALESTINE MONETARY AUTHORITY

Circular No. (158 / 2022) To all lending institutions operating in Palestine Date: Thursday, July 21, 2022

Subject: Updated Version of the Borrowers' Credit Classification System (Version V)

In the context of the Palestine Monetary Authority's efforts to enhance access to financing for the small and medium-sized enterprises (SMEs) sector, as well as youth and entrepreneurs, with the aim of empowering and developing their credit capabilities—which are considered the most fundamental pillars of the financial inclusion strategy in Palestine—and in reference to Circular No. (2016/93) dated 2016/05/31 concerning the fourth version of the credit classification system, the Authority has developed the currently applied version. Below, you will find the main key amendments made to the updated version of the system (Version V):

First: Individuals

1. To empower women and enhance their capacity to establish entrepreneurial projects through access to financing, a variable based on the borrower's gender has been added, granting positive points to females compared to males, noting that analysis results showed higher credit risks for males than for females.
2. To encourage youth and enhance their capabilities by enabling access to financing, the weighting factors for the age variable have been adjusted to lower the risk for the age group (under 25), and the weighting for age groups over 25 years has been eliminated, as data analysis results indicated lower risks for these groups.
3. In line with the Authority's policy to support small and medium-sized enterprises (SMEs) and enhance their access to financing, the following measures were implemented:
   • Higher points are granted to individuals for repaying loans (F004) and Murabaha (F011) under the SM facility category with a disbursement period exceeding 36 months, compared to loans and Murabaha granted for other purposes such as real estate or residential (MO/HO) or personal (SI), provided these facilities are not in arrears.
   • Given that most SMEs are unable to provide strong or any collateral for their required financing, the SME sector has been exempted from the variable concerning the number of facilities granted with weak collateral.
4. In commitment to the Authority's policy aimed at encouraging customers to rectify their credit status, and to address customer complaints regarding the lack of improvement in their credit classification despite repaying their arrears facilities, a distinction has been made between arrears facilities and settled facilities, by reducing customer risk upon repayment of these facilities, considering that customer risk decreases to a greater extent if they close all their arrears facilities compared to closing only a portion of them.
5. To alleviate the burden on guarantors resulting from borrower defaults, guarantor risk weighting is now applied only when the borrower is in arrears and has outstanding installments due, while giving the guarantor the opportunity to reduce their risk immediately upon the borrower's repayment of the outstanding unpaid installments.
6. To encourage customers to shop around for the best borrowing terms, and in alignment with the implementation of the Annual Percentage Rate (APR) calculation program which enables citizens to know the annual borrowing cost of required financing before obtaining it, the variable concerning the number of credit inquiries conducted on the customer over the last six months has been eliminated.
7. The variable concerning the value of unpaid outstanding installments has been replaced with a variable that weights the risk of the utilized balance for all facilities that are past due.

Second: Companies

1. To mitigate risks that may arise from companies using the uncovered current account facility (F003), a variable has been added to weight the risk of obtaining this facility.
2. To encourage companies to fulfill their financial obligations and to address company complaints regarding the lack of improvement in their credit classification despite repaying their arrears facilities, a variable has been added reflecting the number of months elapsed since the company repaid its arrears facilities, granting positive points to companies that have fully closed their arrears facilities.
3. To support the SME category and enhance their access to financing, new variables have been added concerning the number of facilities obtained by enterprises over the last 12 months, granting a lower risk weighting to enterprises (SM facility category) if they obtained different types of facilities over the last 12 months compared to companies (CO facility category).
4. Several variables that do not align with the reality of the Palestinian banking environment and variables with weak predictive capacity, based on sample analysis results, have been removed, such as the number of facilities granted over the last 6 months.
5. The classification of companies acting solely as guarantors and not holding any facilities has been suspended, with evaluation to commence upon their obtaining any facilities.

It is worth noting that the section concerning facility closure has been amended, so that the effect of facility repayment is reflected immediately upon closure, without waiting for the financial file to be rolled over to the Authority's website for the month in which the facility was closed.

Risk Score Table The following is the risk score table, which has undergone no modifications as shown below:

(Individuals)

Risk Score	Probability of Default - Individuals
A	Probability of Default over the last 12 months between 0% and 4.08%
B	Probability of Default over the last 12 months between 4.09% and 8.37%
C	Probability of Default over the last 12 months between 8.38% and 19.99%
D	Probability of Default over the last 12 months between 20.00% and 61.07%
E	Probability of Default over the last 12 months between 61.08% and 100.00%

(Companies)

Risk Score	Probability of Default - Companies
A	Probability of Default over the last 12 months between 0% and 4.08%
B	Probability of Default over the last 12 months between 4.09% and 7.61%
C	Probability of Default over the last 12 months between 7.62% and 18.38%
D	Probability of Default over the last 12 months between 18.39% and 61.07%
E	Probability of Default over the last 12 months between 61.08% and 100.00%

Based on the foregoing, all institutional management is requested to disseminate the contents of this Circular to users of the Credit Information System, noting that the updated version of the Credit Classification System will take effect as of July 31, 2022.

Financial Stability Group Palestine Monetary Authority