تجاوز إلى المحتوى الرئيسي

Article 9: Classification and Provisioning

C 3/2024-STD
Classification Principles
 
9.1
Each LFI must establish a process to assess, monitor and determine a classification to reflect the current and expected credit worthiness of each Credit Facility and/or each portfolio of Facilities, except for those measured at fair value. Upon this classification, LFIs must determine provisions based on the application of this regulation and these standards. This process must be proactive, forward-looking and supported by adequate policies, systems, data, analytical tools and by adequately trained employees.
 
9.2
The classification process must be fully documented based on the provisioning policy approved by the Board, or in the case of foreign entities, the Board of the head office or the Senior Management committee of the branch.
 
9.3
The classification process must be based on the assignment of internal risk ratings. LFIs must develop and utilize internal risk rating systems to manage Credit Risk. Where external credit assessments are used, the LFI must exercise appropriate due diligence to ascertain that the rating reflects the Risk Profile of the Obligor and the Facility. Particular attention must be paid to Credit Facilities that have been restructured and/or for which the outstanding Interest is capitalized. LFIs must be in a position to present evidence of undertaking this classification process to the CBUAE upon request.
 
9.4
At a minimum, this classification process must incorporate the following elements:
 
a.
The principles presented in these standards.
 
b.
The regular review of exposure creditworthiness performed at Facility level, Obligor level and/or portfolio level, depending on the nature of the Obligor and the product type.
 
c.
The regular update of internal ratings, at a minimum every 12 months. Such a review should take place more frequently in the case of credit related events. For Wholesale Obligors, such rating update must be performed at Facility level or Obligor level.
 
d.
The early identification of deteriorating credit worthiness of a Credit Facility and the continuous oversight of such Credit Facilities.
 
e.
The timely record of past-due information for all Facilities.
 
9.5
LFIs must classify each Facility according to the three Stages and sub-Stages outlined below, inferred from accounting principles, whereby the likelihood of Default increases through the Stages. The classification described in these standards does not preclude LFIs from developing their own more granular and robust grading system, which must be clearly mapped to the categories outlined herein. The onus will be on the LFI to justify their assessment.
 
a.
Stage 3: Defaulted Credit Facilities as per the definition of Default included in Article 6. In addition, this Stage is further split into three sub-categories as defined below, where each Obligor must be allocated based on his number of Days-Past-Due. Such a split is required for CBUAE reporting purposes.
 
 
Table 1: Stage 3 sub-categories, based on Days-Past-Due (DPD)
 
 
Stage
Wholesale Obligors
Retail Obligors
3.a
Not Past Due but unlikely to pay
Not Past Due but unlikely to pay
91 to 180 DPD
91 to 120 DPD
3.b
181 to 365 DPD
121 to 180 DPD
3.c
365+ DPD
180+ DPD

 

b.
Stage 2: Credit Facilities subject to deterioration in credit worthiness as explained in the section on the SICR, included in these standards.
 
c.
Stage 1: Any financial instrument not allocated to Stage 2 or Stage 3, that is currently fully performing and with robust expectation regarding the Obligor’s future credit worthiness.
 
9.6
LFIs must establish a policy governing the criteria to allow migration between Stages. These must follow accounting principles, the principles articulated in Article 7 dedicated to SICR, and the rules as set out in this Article.
 
9.7
Stage 3 to Stage 2: Credit Facilities must remain in Stage 3 until all arrears are settled. In addition, for Wholesale Obligors, at least 3 instalments must have been made for monthly Repayment schedule, and at least 1 instalment for any other Repayment schedule of longer intervals. Instalments must be composed of principal and/or Interest as per the original applicable Facility agreement, and must not be funded via a new Facility provided by the LFI or other means than the Obligor’s own cash flows.
 
9.8
Stage 2 to Stage 1: For Wholesale Obligors, Credit Facilities must remain in Stage 2 until SICR criteria, as defined in Article 7, are no longer observed. In addition, each financial instrument subject to migration to Stage 2 must be monitored closely and remain in Stage 2 until the following Repayments of principal and/or Interest as per the original applicable Facility agreement have been met. This is referred to as the probation period. After completion of this period, the Facility can return to Stage 1. Interest-only payments are sufficient to migrate back to Stage 1 only if the original Facility agreement provided for a period allowing service of Interest only. The following minimum Repayment frequencies must be applied as from the date of last overdue instalment payment:
 
a.
6 instalments in the case of monthly Repayment (i.e. 6 months),
 
b.
2 instalments in the case of quarterly Repayment (i.e. 6 months),
 
c.
2 instalments in the case of half yearly Repayment (i.e. 12 months),
 
d.
2 instalments in the case of yearly Repayment (i.e. 2 years),
 
e.
12 months minimum in the case of any other frequency.
 
9.9
For step-up Repayment structures and working capital lines, the LFI must apply the above principles to formulate relevant staging criteria, including at a minimum: (i) longer periods may be considered for step Repayments, and (ii) a revolving working capital line would need to remain as Stage 2 until the renewals have been successfully completed during a minimum period of 12 months. However, in all cases, the LFI must re-evaluate the presence of SICR based on the criteria outlined in Article 7 and determine the staging accordingly.
 
9.10
Where an Obligor or Facility was migrated from Stage 1 to Stage 2 for other reasons than missed instalments, then the minimum Repayment frequencies defined in Article 9.8 above do not apply for a migration from Stage 2 back to Stage 1. Instead, the LFI must methodically re-evaluate the presence of SICR based on the criteria outlined in Article 7 and determine the staging accordingly.
 
9.11
Stage 3 to Stage 1: For Wholesale Obligors, financial instruments subject to SICR and allocated to Stage 3 must not be upgraded from Stage 3 to Stage 1 directly. Instead, the Obligor must be upgraded to Stage 2 initially and be subject to continuous monitoring for a minimum period corresponding to the Repayment intervals defined in Article 9.8.
 
9.12
For Retail Obligors, LFIs must define minimum periods to govern the migrations between Stages for cases where their credit worthiness improves: (a) Stage 3 to Stage 2 (all arrears must be settled), (b) Stage 3 to Stage 1 and (c) Stage 2 to Stage 1. These minimum periods must be documented and justified based on the LFI’s business model.
 
9.13
While the Stage 1, 2 and 3 defined above do not apply to derivatives transactions, LFIs must review and classify derivative transactions according to their associated Counterparty Credit Risk. LFIs must create their own appropriate classification based on counterparties’ credit worthiness and potential exposure. Such classification must enable the LFI to manage CCR in a proactive manner, with adequate early warning to manage credit deterioration.
 
Provisioning
 
9.14
All LFIs must implement a process to estimate and document provisions associated with each Credit Facility in all Stages and in all credit portfolios, in compliance with CBUAE regulations, standards and/or guidance. Such provision must be estimated during the life of the Credit Facility and assessed annually or more frequently in light of new information and the evolution of the economic and business environment. LFIs are required to book provisions in line with these standards and deduct them from the profit and loss account, at least by the end of each quarter and not delay them till the end of the financial year.
 
9.15
Determining provisions in the context of Islamic Financial Services may impact the Investment Account holders’ profit as provisions are deducted from profit. Consequently, LFIs performing Islamic Financial Services must ensure that the Internal Shari’ah Supervision Committee approves the provisioning policies. In addition, the determination of provisions must be approved by the committee responsible for profit and loss allocation in accordance with the Central Bank’s standard regarding profit equalization for Islamic Banks.
 
9.16
The provisioning process must be documented, organised and approved by Senior Management and the Board. At a minimum, it must incorporate the following components:
 
a.
The history of classifications of existing Facilities and/or Obligors,
 
b.
Robust methodologies and rating systems for the continuous assessment of Credit Risk arising from all financial instruments,
 
c.
A process for the appropriate estimation of provisions supported by robust analytical solutions and systems commensurate with the size and complexity of the LFI,
 
d.
A process to manage the quality of data used as inputs to the assessment of Credit Risk and provisions.
 
e.
The regular estimation and reporting of key performance indicators (KPIs) relating to provisions and expected credit loss (ECL).
 
f.
Regular back testing of expected credit loss (ECL) against historical losses.
 
9.17
Retail Obligors: A provision of 100% of the Credit Facility net of collateral is required if the Obligor has permanently left the country where the Credit Facility was issued, without leaving sufficient funds with the LFI available to ensure the Repayment of the total outstanding. The above may not apply automatically and the LFI must evaluate the need for a provision for an Obligor who continues to service the Credit Facility from overseas and is not Past Due.
 
9.18
Off-balance sheet items: For Wholesale Obligors, the LFI must undertake the following process, at a minimum.
 
a.
Each LFI must estimate the likelihood that unfunded Facilities become on-balance sheet funded Facilities. For the purpose of provision estimations, it must then convert off-balance sheet Credit Facilities to on-balance sheet Credit Facilities. This process should be achieved by using credit conversion factors (“CCF”) at a minimum as prescribed in the CBUAE Capital Adequacy standards. Deviations are permitted once fully documented and approved by the appropriate governance level for each LFI. For Stage 3, if the LFI has determined that an unfunded Facility will not become an on- balance sheet Facility, then the LFI must document robust evidence supported by legal opinion to confirm such treatment.
 
b.
Each LFI must identify and estimate its exposure to off-balance sheet Credit Facilities in the form of derivative contracts. Thereafter, the LFI must assess the net marked-to- market exposure to the Obligor, considering any enforceable netting arrangements in place and cash collateral received. The Counterparty Credit Risk arising from derivative transactions should be captured through the estimation of a fair value Credit Value Adjustment (CVA) reserve, in compliance with accounting principles. LFI must ensure that CVA is included in their Risk Appetite framework and CCR management process.
 
9.19
Interest and fees in arrears: For all Credit Facilities with any instalments (including principal, Interest and other fees) more than 90 Days-Past-Due, the LFI must immediately set aside full provision at 100% of any Interest and fees not received. The provision must be deducted from current year income and the Interest and fees must not be included in income eligible for distribution. The income not received must be separately tracked and identifiable as a component of the gross outstanding along with the related provisions.
 
9.20
Minimum provision for Stage 1 and 2: LFIs are permitted to estimate expected credit loss (ECL) and provisions via the quantification of probability of Default (PD) and loss given Default (LGD) incorporating CRM as determined by the LFI, but limited to the collateral and associated haircuts listed in the column labelled ‘up to 24 months’ of table 2 in Article 10. The quantification of PD and LGD must reflect the Risk Profile of each Credit Facility and/or portfolio and the experience of the LFI in terms of Default, collateral management and recovery collections. If the LFI incorporates risk mitigation as described in Article 10 for provision estimation, such mitigation must be based on robust and documented methodologies supported by data.
 
9.21
LFIs must ensure that the total provision corresponding to all Stage 1 and Stage 2 Credit Facilities is not less than 1.50% of the LFI’s Credit Risk weighted assets as computed under the CBUAE capital regulations.
 
a.
If the provision computed under 9.20 above is less than the aforementioned floor, the shortfall in provision must be deducted from current year income, similarly to all other provision requirements in this standard.
 
b.
Alternatively, the shortfall amount in provision compared to the above-mentioned floor in this Article may instead be held in a dedicated non-distributable balance sheet reserve called the ‘impairment reserve-general’. The amount held in the impairment reserve-general must be deducted from the capital base (Tier 1 capital for Banks) when computing the regulatory capital.
 
9.22
The CBUAE may impose a floor higher than that of 1.50% of Credit Risk weighted assets mentioned above at its discretion, for reasons including but not limited to:
 
a.
Open high-risk observations from CBUAE regarding the models used in the estimation of expected credit loss (ECL); or
 
b.
Insufficient assurance regarding the reliability or accuracy of relevant expected credit loss (ECL) models, such as due to shortcomings in compliance with the CBUAE Model Management standards or accounting standards.
 
9.23
Minimum provision for Stage 3 (Wholesale Obligors): LFIs must implement a dedicated process and a methodology for the computation of provisions associated to Facilities allocated in Stage 3. The approach must incorporate the following elements.
 
a.
The LFI must compute provisions after deducting, from the principal amount outstanding, the following items:
 
 
i.
Eligible collateral as detailed in Article 10 after applying the relevant haircuts, and
 
ii.
Any recoveries derived from expected cash flows supported by robust documentation and legal agreements as detailed in Article 10.
 
b.
The provision computation must be based on the recovery and loss specific to each non-performing Credit Facility. For this purpose, the LFI is not permitted to use LGD derived from statistical models based on the LFIs generic recovery rates.
 
c.
The calculation process, the methodology and the results must be reviewed and approved by the committee responsible for the oversight of provisions. This requires a formal review and support of the CRO at that committee. Ultimately, such provisions should be presented to the Board or delegated body of the Board, in accordance with the internal escalation policy of the LFI.
 
d.
In addition, the LFI must ensure that minimum provision levels computed above are maintained against the principal of each defaulted Credit Facility and cannot be lower than the floors discussed below. (This excludes the income not yet received, which requires 100% specific provision). The application of the floors is defined separately for unsecured and secured exposures. These floors apply irrespective of the haircuts applied on collateral.
 
i.
An unsecured exposure refers to an unsecured Facility or the unsecured portion of a secured Facility. A secured exposure refers to the portion of a Facility that is covered by an eligible collateral after haircut, as defined in Article 10 on CRM. The secured portion also means the part of the Facility equal to the value of the collateral after haircut.
 
ii.
CBUAE Classification: PublicThe application of the minimum provision is organised as shown in the table below. The unsecured portion is split in two sub-portions: (1) one part covered by expected cash flows (ECF), and (2) one part not covered by ECF. For the unsecured portion, the minimum provision floor is the higher of the minimum provision floor calculated based on the sub-portions and the minimum provision floor calculated for the unsecured portion as a whole1.
 
 
Table 2: Stage 3 minimum provision for Wholesale Obligors
 
 
Exposure portions
Exposure sub-portion
Portions
Min provision floor
Sub-portions
Min provision floor
Unsecured portion
25% for 4 years and 100% thereafter
Covered by expected cash flows
No floor
Not covered by expected cash-flows
100%
Secured portion
No floor for 4 years and 25% thereafter
  

 

iii.
First, the LFI must apply a minimum provision of 100% corresponding to the unsecured portion that is not covered by expected cash-flows. Second, the LFI must apply minimum provision on the unsecured portion and secured portion respectively, as defined below.
 
iv.
For each unsecured exposure, the provision must not be less than 25% of the unsecured exposure up to 4 years of becoming Stage 3, or from the date of issuance of these standards if it is already in Stage 3. After that date, any unsecured exposure must be fully provisioned at 100%.
 
v.
For each secured exposure, the provision must not be less than 25% of the secured exposure after 4 years of becoming Stage 3. In this context, secured means mitigated by collateral as detailed in Article 10 on CRM.
 
e.
The LFI must book provisions from the profit and loss account, at least by the end of each quarter and not delay them till the end of the financial year.
 
f.
Provisions already held for Stage 3 accounts classified prior to the issuance of these standards may not be reduced, if the provision computed based on the requirements of these standards is lower.
 
9.24
Minimum provision for Stage 3 (Retail Obligor): For Retail Obligors as defined in the standards, each LFIs must put in place a dedicated process and a methodology for the estimation of provisions for Facilities allocated in Stage 3. Each LFI must ensure that minimum provision levels are maintained against the principal of each defaulted Facility.
 
 
Table 3: Stage 3 minimum provision for Retail Obligors net of collateral, as per Article 10
 
 
 
Days-Past-Due / Classification
Unlikely to pay and not Past Due
91 to 120
121 to 180
180 +
Sub-Stage
3.a
3.b
3.c
Minimum provision
25% or higher
25% or higher
50% or higher
100%

 

Stage 3 provisions and accounting standards
 
9.25
If Stage 3 provisions computed under this standard exceed the provision computed under accounting standards, this shortfall in provision is required to be taken against current year income similarly to all other provision requirements in this standard.
 
9.26
Prior to the issuance of this regulation, differences between the CBUAE regulatory provisions and accounting provisions were held in a dedicated reserve (‘impairment reserve – specific’). This methodology is now removed and not permissible. An LFI that has an amount in this reserve upon this regulation coming into force, must recalculate the provisions as per the requirements of this regulation and document for each of the exposures the changes relating to this regulation coming into force. The provisions calculated as per this regulation must then be charged fully through current year income, while simultaneously transferring the full balance of the aforementioned reserve back to retained earnings.
 
Restructured Credit Facilities
 
9.27
LFIs must pay particular attention to the classification of Restructured Credit Facilities as per the additional requirements articulated in the subsequent articles.
 
Classification of distressed restructuring
 
9.28
All distressed Restructured Credit Facilities for which the unlikely to pay criteria have been met, or that are Past Due more than 90 days at the conclusion of the restructuring process must be classified as Stage 3. Subsequently, staging transition rules must be applied as for any other Facilities.
 
9.29
Any Credit Facility that has been restructured 3 times or more in a context of financial difficulty as defined under the SICR section of these standards must be migrated to Stage 3.
 
9.30
All other distressed Restructured Credit Facilities not captured above must be allocated to Stage 2 or Stage 3. These also include Facilities where the restructuring has permitted payment of Interest only, whereby the requirement of principal Repayment has been removed; such Facilities remain as Stage 2 until such time that principal Repayment is resumed.
 
Classification of non-distressed restructuring
 
9.31
All non-distressed Restructured Credit Facilities with a Repayment moratorium exceeding 6 months must be classified as Stage 2, unless the LFI can demonstrate that no SICR has occurred, in which case the same process as outlined under Article 7.10 must be followed. These Facilities must be reviewed annually by the CRO and any necessary action must be documented.
 
9.32
All non-distressed Restructured Credit Facilities greater than 3 years in tenor after the restructuring and with a bullet Repayment, must be classified as Stage 2 at the start of the restructuring period, if any of these features are met:
 
a.
For the purpose of these standards, a Repayment structure should be considered as bullet (balloon) Repayment if a material proportion of the principal Repayment is allocated at the end of the maturity of the Facility, in such a way that the ability of the Obligor to meet these annuity Repayments with its current cash flows is uncertain.
 
b.
The bullet Repayment (or balloon Repayment) exceeds 40% of the outstanding. For the purposes of this limit, the bullet/balloon must be computed by combining any of the 3 largest Repayment amounts throughout the tenor. This does not apply to Facilities with formal UAE Local/Federal government guarantee or a UAE local Bank or bank guarantee rated AA or above.
 
c.
Any non-distressed restructuring, without a bullet Repayment and without any Repayment moratorium can be allocated to Stage 1.
 
Applicable to all restructuring
 
9.33
Subsequent to all distressed and non-distressed restructuring, the Facility/Obligor must be classified as Stage 3 if the definition of Default explain in these standards is met, at any time until the end of the restructured Facility.
 
Staging transitions for restructured Facilities
 
9.34
Stage 2 to Stage 1: Restructured Credit Facilities are subject to the same rules applicable to any other Credit Facilities for migration from Stage 2 to Stage 1.
 
9.35
Stage 3 to Stage 2: For Restructured Credit Facilities classified in Stage 3, a return to Stage 2 is dependent on the proportion of the bullet Repayment:
 
a.
Where a bullet Repayment (or balloon Repayment) represents 40% or less of the outstanding, the Facility will remain in Stage 3 until 3 instalments have been made and all arrears are settled. Instalments must be composed of principal and Interest. For the purposes of this limit, the bullet/balloon must be computed by combining the 3 largest Repayment amounts throughout the tenor.
 
b.
Where a bullet Repayment (or balloon Repayment) represents more than 40% of the outstanding, under no circumstances may such a Credit Facility be migrated to Stage 1 even after being migrated to Stage 2. The Stage 3 classification will remain until the following Repayment of principal and Interest have been fully met by the Obligor (from its own funds without borrowing or financing from the LFI) and may then be reclassified as Stage 2.
 
i.
6 instalments in the case of monthly Repayment (i.e. 6 months),
 
ii.
2 instalments in the case of quarterly Repayment (i.e. 6 months),
 
iii.
2 instalments in the case of half yearly Repayment (i.e. 12 months),
 
iv.
2 instalments in the case of yearly Repayment (i.e. two years),
 
v.
12 instalments in the case of any other frequency.
 
9.36
The above criteria will apply to every subsequent restructuring.
 
9.37
Particular attention should be paid to Facilities that are “Purchased or Originated Credit Impaired” or “POCI”. This process involves the de-recognition of the original Credit Facility and the recognition of a new Credit Facility, that is now credit-impaired. The new Credit Facility is recognised in the LFI’s financial statements at reduced fair value and routinely monitored for further deterioration in value with appropriate provisions made accordingly.
 
9.38
For any of the cases outlined above, LFIs that extend further Lending/financing to a defaulted restructured Obligor must retain the Stage 3 classification for an additional 12 months to the timeframes outlined above.
 

1 For instance, assume a facility of 100, with a collateral of 60 after haircut, and 35 additional expected cash flows (ECF). For the first year, the secured portion is 60 and the unsecured portion is 100 – 60 = 40. The unsecured sub-portion not covered by ECF is 40 – 35 = 5, attracting a min provision of 5 (100%). Separately, the minimum provision for the entire unsecured portion is 40 x 25% = 10, which will be retained because it is greater than 5, i.e. the min provision on the unsecured sub-portion. Overall, the floor will be 10, for the first year. This estimation must be conducted again the following year with new collateral haircuts according to Article 10.