Article 5: Credit Underwriting

C 3/2024-STD

5.1

In order to comprehensively address the Risk Profiles of its portfolios, each LFI must operate with a sound and granular credit underwriting policy based on its Lending strategy in accordance with its Board approved Risk Appetite. The Risk Appetite and the credit underwriting policy must incorporate sufficient risk-return discipline, consistent with the LFI’s business model.

5.2

The underwriting process must ensure a thorough understanding of the Risk Profile and characteristics of the Obligors and the drivers of their credit performance. For that purpose, the LFI must establish well defined criteria within its policies and processes for approving new Facilities, renewing and refinancing existing Facilities. This decision process must be supported by a clearly defined approval authority based on the size and complexity of the Facilities.

5.3

Materiality thresholds must be established to govern decisions surrounding the issuance of each Credit Facility. All financing to existing and new Obligors must be assessed against risk acceptance criteria during the initial credit evaluation process and during the continuous Obligor/portfolio monitoring phase, as per Article 3.12.

5.4

LFIs must ensure that the underwriting framework and respective criteria, policies and procedures are implemented effectively and are subject to regular audit reviews.

Decision-making process

The decision-making process must include the following key elements:

5.5

Credit Committee: Decisions to issue Credit Facilities are expected to be governed by a management credit committee or individual(s) with the appropriate sanctioning authority where appropriate. The credit committee is expected to be a forum to analyse and discuss in detail the risk drivers, the pricing and the structure of Credit Facilities or, pools of Credit Facilities. Robust documented evidence must be retained to demonstrate that underwriting decisions are sufficiently challenged. Underwriting decisions must clearly document an appropriate balance between risk and commercial considerations.

5.6

Depending on their materiality, their rating and other criteria, some Facilities may be delegated for approval at levels of authority that report to the CCO and are below that of the credit committee. However, those delegations must be clearly documented and approved.

5.7

As an alternative to a credit committee, LFIs may structure underwriting approvals through individual delegations, however they must have in place a clearly documented and approved delegation matrix setting out delegations from Board level down to Senior Management (excluding control functions), CCO and individual credit officers.

5.8

LFIs must ensure that the approval of Credit Facilities is achieved through a continuous accountability framework for each step of the underwriting process. LFIs must define the roles of executive committees and senior executives involved in the process of underwriting of Credit Facilities.

The following principles apply:

a.	The Board and/or Senior Management must be directly involved in the approval of Credit Facilities with the following characteristics: (i) materially large Facilities relative to the LFI’s capital and (ii) Facilities with a high Risk Profile as explicitly defined in the policy.
b.	The authority to approve Credit Facilities must flow through a mandate from the Board of directors or a designated body in the Board. The delegation must be vested with the highest executive committee/individual in the LFI that oversees the underwriting of Credit Facilities.
c.	The delegation process must consider, at a minimum, the Obligor risk captured by Obligor rating, Facility amount and structure, the experience and qualifications of staff, the business segment of the Credit Facility to be approved, and the ranking of the financial obligation.
d.	The staff delegated to make credit decisions have the adequate level of experience, qualifications and abilities.
e.	The individuals responsible for underwriting must remain accountable for their decisions and should be subject to performance indicators reflecting the quality of their underwriting decisions.

5.9

LFIs must establish a performance assessment mechanism for all stakeholders involved in the acquisition and the management of Credit Risk which is aligned with the long term sustainability of the LFI. The mechanism must be articulated differently for the business lines and the control functions, based on the following principles:

a.	The mechanism must enforce accountability amongst employees who make decisions that commit the LFI over several years and/or that result in material risk taking activities.
b.	All internal employees involved in the acquisition and the management of Credit Risk including employees from the business lines must be subject to key performance indicators reflecting the quality of their underwriting decisions i.e. demonstrated by the credit worthiness of the Obligors after the underwriting process.
c.	Each LFI should put in place deferred compensation mechanisms that align with the risk outcomes for the employees who benefit from the completion of large transactions that expose LFIs to long term risks.
d.	Staff in the control functions involved in Credit Risk management must be compensated in a way that makes their incentives independent of the performance of the business. Their performance incentives must be based on achievements assessed against the objectives of the control functions, so as not to compromise their independence.

5.10

Independence: All credit decisions must be made free of conflicts of interest and on an arm’s length basis. In particular, Related Party transactions must be governed by internal policies, to prevent potential conflicts of interests. They must be authorised by the Board of the LFI, and regularly monitored. The policies and processes must be articulated so as to prevent persons benefiting from the transaction and/or persons related to such a person from being part of the process of granting and managing the transaction. All Credit Facilities to Related Parties must be formally approved and signed-off by each Board member.

Key components of underwriting

5.11

The underwriting process must be structured to adequately support the decision-making process for the issuance and the acquisition of Credit Facilities, consistent with the LFI’s Risk Appetite and strategic objectives. The underwriting process must enable the LFI to form a view on the suitability of the Risk Profile of each Credit Facility in light of the associated risk-adjusted return objective of the LFI. Consequently, this process must be clear and comprehensive, fully documented, and enforced in accordance with its internal policy.

5.12

In addition, the underwriting process is expected to include the following at a minimum:

Limits: The underwriting process must be controlled adequately with Risk Limits established at a suitable level of granularity. LFIs must establish overall credit limits at the level of individual Obligors and counterparties, and groups of connected counterparties that aggregate different types of Credit Facilities in a comparable and meaningful manner. The limits must be structured around the drivers of Credit Risk, including but not limited to Obligor rating, industry type, product type, geography, Credit Facility tenor and Credit Facility structure. LFIs must define acceptable terms in accordance with the limits, (for example: Credit Facility covenants, legal requirements, leverage, tenor, amortization, pricing and/or minimum security).

Due diligence: LFIs must ensure that they implement a robust and comprehensive credit due diligence process (including legal aspects as appropriate) in order to fully capture all the relevant information necessary to assess the Obligors’ credit worthiness. They must demonstrate a robust documented understanding of the purpose of the Credit Facility and the associated risk measured by key financial parameters such as leverage, debt service coverage ratio, liquidity, net worth and operating cash flows. This process must include quantitative and qualitative information over a period of time suitable to make informed credit decisions. It must also cover the assessment of the ownership structure of the Obligor and related group and the identification of the ultimate beneficial owner. Finally, LFIs must define a set of criteria triggering an enhanced due-diligence process with a larger and deeper scope of investigation.

Risk drivers: The underwriting process must incorporate a comprehensive identification and analysis of the key drivers of Credit Risk, typically separated into systemic risks and specific risk (or ‘idiosyncratic’ risk). Systemic risks should include Country Risk and industry risk. Specific risk should include business risk, financial risk and management risk.

Financial information: LFIs must collect comprehensive financial information and cash flow projections from their Obligors, contingent Obligors and guarantors. They must ensure that the due diligence process captures all financial obligations of their Obligors (including other LFIs and Related Parties). LFIs must refrain from making underwriting decisions mostly based on subjective information.

In addition, for Wholesale Obligors:

i.	Credit analysis must be forward-looking incorporating macro-economic forecasts considering business cycle effects, the sector in which the Obligor operates, the Obligor’s relative position and expertise within that sector and associated downside scenarios.
ii.	Affordability analysis throughout the Credit Facility should include a sensitivity analysis based on stressed market benchmark rates and profitability.
iii.	For Credit Facilities that are not fully amortising, an assessment of the LFI’s exposure to re-finance risk, including possible exit options for the LFI, should be undertaken.
iv.	The LFI should have a formal documented process to ensure that the financial analysis of an Obligor is based on financial statements that have been audited by reputable auditing firms.

5.13

Documentation: The credit files must be well documented and include all information necessary to ascertain the current financial condition of the Obligor, including but not limited to the rationale and computations upon which classification and provisioning has been determined. In addition, files must contain sufficient information to track the decisions made and the history of the credit. For example, the credit files should include current financial statements, financial analyses and internal rating documentation, internal memoranda, reference letters, appraisals and forward-looking financial projections. The credit review function must determine that the credit files are complete and that all Credit Facility approvals and other necessary documents have been obtained. Documents must include the evidence of the perfection of the LFI’s legal interest as well as evidence of the ability to collect / exercise their creditor interest in collateral taken in support of the Credit Facility.

5.14

Collateral: LFIs must ensure that the collateral used as risk mitigant in the underwriting process is appropriately identified and valued. In addition, LFIs must monitor, control and assess the implications of multiple Lending against the same collateral. For that purpose, the following actions must be undertaken, at a minimum:

a.	When appropriate, LFIs must ensure that collateral used as mitigation are registered with the relevant official body: (i) the land department for real estate collateral and (ii) the Emirates Integrated Registries Company LLC for other collateral.
b.	The types of collateral covered in the registers are likely to evolve through time. Therefore LFIs must verify all collateral types.
c.	Prior to the disbursement of any secured Lending, LFIs must verify the registration of collateral and ensure that the priority of their claim is reflected in underwriting and provisioning.

5.15

Facility structure: LFIs must ensure that amortization schedules and Facility tenors are suitably designed to meet the needs of Obligors and their Repayment abilities. The amortization structure should include the following principles:

a.	The depth and breadth of credit analysis should increase with the Facility tenor, i.e. additional justifications and business rationale should be provided to support Facilities with long tenors.
b.	The Repayment schedule should match the business cyclicality.
c.	Tenors and amortization profiles should be within acceptable Risk Appetite and risk-reward relationship.
d.	In the case of project finance, the Repayment schedule should match the expected development schedule of the project.

5.16

Legal due diligence: The LFI must ensure that the legal documentation of the Credit Facility is adequate to support the right of the LFI over the recoverability of the debt, including but not limited to, the liquidation of collateral, enforceability of guarantees, access of overseas assets. In addition, the LFI should review and evaluate the right to use Credit Facilities as collateral to raise liquidity, and ensure the conclusions of such evaluation are reflected in the legal documentation.