Central Bank of Jordan

Transcription

1 Central Bank of Jordan Ref. : 10/5/12390 Date : 11/10/1430 AH corresponding to 30/9/2009 A.D. Instructions on Stress Testing No. (46/2009) Issued pursuant to article (99/B) of the Banking Law No. (28) for 2000, as amended Introduction: Stress Testing is considered an important tool used by banks as part of their risk management process. Due to its significant impact in alerting the regulatory authorities and the banks managements to the impacts of the unexpected adverse events related to various types of risks, and in light of the present global financial and economical crisis, stress testing has recently become more important. In addition, such testing provides these managements with indicators to the volume of the capital required to face the losses resulting from significant financial shocks. In addition, they are complementary to the methods and tools used in risk management. Stress testing has forward-looking assessments of risk, as opposed to the historical data - based models, which do not consider unexpected future events. Based on the above, banks should consider the following: First: General Guidelines on Stress Testing: 1. Stress testing is a key supplementary part in the corporate governance and risk management system at the banks. It should have an impact on the decisionmaking process at the proper administrative level, including the strategic decisions of the board of directors and executive management. For this purpose, both the board of directors and executive management should have a key role in such testing, including setting up the testing goals, identifying scenarios, assessing the results, and identifying the actions to be taken based on the testing results. 2. Stress testing is used to achieve the following goals: - Enhance risk identification and control. - Provision of risk management tools supplementary to the other risk management tools, such as value at risk, and economic capital, in order to achieve overall risk assessment. - Improvement of the bank's management of both its capital and liquidity. 3. The process of defining the appropriate stress scenarios, applying the stress testing, and the optimum utilization of the testing results requires cooperation, coordination and the exchange of opinions among all concerned parties at the bank such as the senior officers of risk departments, economic analysts, business unit managers, and the treasury department staff. 4. The bank should have written approved policies and procedures governing the stress testing program, including proper documentation of such testing.

2 5. The bank should have the infrastructure necessary to ensure the effective preparation of stress testing, including systems, qualified staff, and accurate comprehensive data. 6. The bank should: Evaluate the stress testing program on a periodical basis; Evaluate the testing effectiveness and ability to achieve the desired goals; Evaluate the appropriateness of the scenarios used in the testing in relation to the bank size and the complexity of its operations Use the evaluation results to update the testing to ensure considering changes in the risks at the bank's level in particular, and at the level of the banking sector and economy in general. 7. The stress testing should consistently and comprehensively cover all risks the bank may be exposed to, taking into consideration the interrelations between these risks. For example, if the correlation coefficient between two scenarios is (+0.75) or more, one of these two scenarios should be neglected and its impact should not be calculated on the bank's financial position. 8. The stress testing should include scenarios that vary from the lowest to the highest impact, including the scenarios that define the bank solvency and ability to continue operating, in order to identify the uncovered inherent risks and consider the impact level of potential scenarios on the bank's financial position either through the expected loss and/or the impact on its reputation. 9. The bank to consider, as part of the stress testing, a number of simultaneous stress scenarios related to -and including but not limited to - market value decline of the bank's assets, the bank's inability to obtain financing from the market whether such financing is secured by acceptable collaterals or not, and the deterioration of the bank's clients' capacity and the effect of this on the bank's asset quality. The bank needs to assume these scenarios taking place individually and collectively and examine the impact on its financial status. 10. The bank to use the results of stress testing in setting up contingency plans to deal with the different risks, activating the use of risk mitigation tools such as hedging, netting of balance sheet items, and acceptable collaterals. Simultaneously, the effectiveness of using such tools during hard financial and economical circumstances must be assessed. 11. The bank should consider the stress testing results when it undertakes capital planning to reach the capital that is consistent with the bank's strategy and risk profile, as well as in the internal capital adequacy assessment process (ICAAP), noting that the testing results will be used by the Central Bank upon evaluation of the Bank's capital adequacy. 12. The bank to develop methodologies to measure the impact of reputation risks expressed by other risks such as credit risks, market and liquidity risks by including some reputation risk-related scenarios in the stress testing. Second: Scenarios to be prepared: - Stress testing for credit risks, credit concentrations risks, market risks, liquidity risks and operational risks should be prepared as follows: 1. Scenarios with One Variable (Single-Factor Shocks): Assuming that other variables remain constant, in order to evaluate the sensitivity of the bank's financial position to a certain variable and compare it with the sensitivity to other variables. Using the one variable (single-factor shocks)

3 approach will show the impact of each variable on the bank s financial position separately, below are the required scenarios to be conducted using this approach: A. Credit Risk Scenarios 1. Increasing the direct non-performing facilities by (50%) 2. Increasing the direct non-performing facilities by (100%) 3. Increasing the direct non-performing facilities by (200%) 4. Increasing the direct non-performing facilities by (5%) over the balance of the direct performing facilities. 5. Increasing the direct non-performing facilities by (10%) over the balance of the direct performing facilities. 6. Increasing the direct non-performing facilities by (25%) over the direct performing facilities balance granted to construct or buy a real estate. 7. Increasing the direct non-performing facilities by (25%) over the direct performing facilities balance granted to buy shares. B. Scenarios related to Credit Concentrations Risks: 1. Default of the Largest three borrowers (except the Government of Jordan) * by classifying the credit** granted to them as non-performing credit. 2. Default of the Largest six borrowers (except the Government of Jordan)* by classifying of the credit** granted to them as non-performing credit. 3. Bank's loss of the Largest three of its deposits at banks (Inter-bank exposures). C. Scenarios related to Market Risks: 1. (25%) drop in prices of equities held by the bank. 2. (50%) drop in prices of equities held by the bank. 3. (25%) drop of bonds prices held by the bank which are 4. (50%) drop of bonds prices held by the bank which are 5. (15%) decrease in the Jordanian Dinar exchange rate against all other currencies. 6. (15%) increase in the Jordanian Dinar exchange rate against all other currencies D. Scenarios related to Liquidity Risks: * Government of Jordan means the ministries and public authorities qualified to 0% risk-weight per the capital adequacy instructions in accordance with the applied Basel II standard. ** Credit is defined in accordance with the definition provided for in the applied credit limits instructions "Credit Concentrations".

4 1. Withdrawal of (15%) of the clients, banks and other banking institution deposits from the bank within a period of one month. 2. Withdrawal of (30%) of the clients, banks and other banking institution deposits from the bank within a period of one month. 3. (20%) drop in the bank s liquid assets. E. Scenarios related to Operational Risks: 1. Increase in operational risks [at a rate of 25%] calculated by using the Basic Indicator Approach or any other approach that might be approved by the Central Bank in the future. 2. Increase in operational risk [at a rate of 50%] calculated by using Basic Indicator Approach or any other approach that might be approved by the Central Bank in the future - In addition to the scenarios described in item (Second/1) above, the bank should assume additional scenarios commensurate with the size and nature of the risk facing the bank, whereby there is no less than one scenario for each type of the above-mentioned risks. 2. Scenarios with Numerous Variables (Macroeconomic Scenarios): - This type of stress testing aims to assess the impact of many variables on the bank's financial position related to the different risks facing the bank. Below are the required scenarios as a result of using this approach: A. First Scenario: - Increase of direct non-performing facilities by (5%) from the balance of direct performing facilities. - (25%) decrease in prices of equities held by the bank. - (25%) decrease of bonds prices held by the bank which are B. Second Scenario: - Increase of direct non-performing facilities by (10%) from the balance of direct performing facilities. - (50%) decrease in prices of equities held by the bank. - (50%) decrease of bonds prices held by the bank, which are classified within the trading portfolio or available for sale. Third: Calculating the Scenarios Impact on the Bank's Financial Position: The impact of the scenarios required in item Second above is calculated as follows: 1. In relation to the scenarios related to credit risks, credit concentrations risks, and market risks (including the macroeconomic scenarios), the impact is calculated on the bank's profits / losses (the expected losses) and the capital adequacy ratio. 2. In relation to the scenarios related to liquidity risks, the impact is calculated on the legal liquidity ratio and the liquidity per the maturity schedule.

5 3. In relation to the scenarios related to operational risks, the impact is calculated on the capital adequacy ratio. Fourth: These instructions shall be part and parcel of the second pillar of Basel II regulations to be issued later on. Fifth: The banks should provide the Central Bank with the results of the scenarios required in item Second herein at the level of the statements of the banks branches in Jordan and the consolidated financial statements (the banks branches and subsidiaries inside and outside of Jordan) on a semiannual basis starting from the statements of December 2009, and not later than the thirtieth of the month following the month s statement. Best regards, Governor Dr. Umayya Toukan