3. Credit Risk Classification
Finance companies will be required to classify exposures on an individual or collective basis in one of three stages or regulatory categories based on their original credit risk at origination and the change in credit risk at reporting date since origination. SAMA encourages finance companies to adopt General Approach for measuring expected credit losses (ECL).
SAMA has provided mapping of IFRS 9 stages to regulatory categories (for the naming convention only keeping in view conservatism of IFRS 9) i.e. Regular, Special Monitoring Accounts, Substandard, Doubtful and Loss categories. The definitions given in SAMA previous circular on Provisions Guidelines (Circular No. 381000046342 dated 27/04/1438H) for these regulatory categories should no longer be used while applying the requirements of this new circular.
3.1 Stage 1 or Regular Category
Any exposure for which there is no significant increase in credit risk since origination (SICR) or otherwise are considered high quality or exhibit indicators of low credit risk. Indicators of low credit risk include, but are not limited to:
i. The borrower has a low risk of default;
ii. The payments are not past due by more than 30 days;
iii. The borrower has a strong capacity to meet contractual cash flow obligations in the near term; and
iv. Adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil contractual cash flow obligations.
3.2 Stage 2 or Special Monitoring Accounts/Substandard Category
Any exposure for which there is significant increase in credit risk since origination. Each finance company must clearly define what it considers to be significant increase in credit risk. Such indicators may include, but are not limited to:
i. The borrower has a moderate risk of default;
ii. The payments are past due by more than 30 days; this is rebuttable only for direct exposures to the Government, Government Agencies or Ministries (or equivalent entities including contractors working directly for a governmental entity in cases where the delay is not due to performance issues);
iii. The borrower has a weak or deficient capacity to meet its contractual cash flow obligations in the near term; and
iv. Adverse changes in economic and business conditions in the longer term are more likely than not to reduce the borrower's ability to fulfil its obligations.
Finance companies should continuously monitor stage 2 exposures to identify improvements in credit quality and determine eligibility for re-staging stage 2 exposures to stage 1. Finance companies should document the minimum eligibility requirement for re-staging stage 2 exposures into stage 1 exposures, which should at least include the following conditions:
i. The borrower does not have any exposure more than 30 days past due;
ii. Exposure repayments have been made when due over a continuous repayment period (cure period excluding grace period, if any) of 90 days for those non-retail customers that have moved from stage 1 to stage 2 due to overdue principal and/or interest for more than 30 days (but less than 90 days) or extended due to credit risk reasons;
iii. The borrower's situation has improved so that the full repayment of the exposure is likely (tested over 90 days as part of cure period), according to the original or modified terms and conditions; and
iv. The indicators which has contributed to the significant increase in credit risk no longer existed (tested over 90 days as part of cure period) to threaten the full repayment of the exposure under the original or modified terms and conditions.
v. The cure period requirements as stated above (90 days) do not apply to retail customers. For retail customers that have moved from stage 1 to stage 2B (as detailed below), they should be allowed to be moved back to stage 1 after a cure period of 60 days.
SAMA recognizes the added value of having discrete tiers of credit risk exposures within Stage 2 allocation. As a result, SAMA is establishing, for regulatory reporting purposes only and not for accounting purposes, a bifurcation of Stage 2 totals to be reported in the quarterly prudential returns. It is expected that finance companies will have robust internal risk rating processes and mappings, which can identify and categorize discrete levels of borrower performance characteristics and the resulting credit risk.
Stage 2 exposures segregation into Stage 2A and Stage 2B categories are explained as follows:
Stage 2A or Special monitoring accounts category represents lower levels of credit risk within the stage 2 allocation. It represents borrowers with some or all of the following qualitative and quantitative indicators:
Qualitative indicators include, but are not limited to:
i. Lower but increasing levels of credit risk;
ii. Expected change in credit risk to remain low and currently manageable;
iii. Demonstrates current capacity to repay the financial commitment but this capacity is declining or diminishing from the original approval standards and warrants greater attention;
iv. Demonstrates periodic ability of addressing past due levels within reasonable time frames without significant finance company intervention; and
v. Close monitoring and intervention generally required.
Quantitative indicator:
i. Past due more than 30 days and up to 60 days.
Stage 2B or substandard category represents moderate levels of credit risk within the stage 2 allocation. It represents borrowers with some or all of the following qualitative and quantitative indicators:
Qualitative indicators include, but are not limited to:
i. Obvious cash flow deficiencies;
ii. Higher probability of default;
iii. Higher increase in credit risk is clearly identified;
iv. Financial statements do not demonstrate additional financial resources necessary to reduce credit risk to the finance company or demonstrating additional sources of repayment ability;
v. Monitoring and intervention is done on a continuing basis whether past due or not; and
vi. Finance company is considering or is in the process of providing concessionary terms under a modified exposure arrangement due to financial difficulties of the borrower.
Quantitative indicator:
i. Past due more than 60 days and up to 90 days.
Finance Companies may apply other limited discretionary measures to designate exposures as Stage 2B. Such measures must be well documented as this can be subject to thematic review by SAMA in future, if needed.
3.3 Stage 3 or Doubtful/Loss Category
Any exposure (including purchased originated exposures) which is assessed as impaired or otherwise is in default as determined in Section 8 of these Rules. In addition to Section 8 of these Rules, such indicators may include, but are not limited to:
i. The borrower has a high risk of default or has defaulted;
ii. Past due more than 90 days;
iii. The borrower has an inadequate capacity to meet contractual cash flow obligations due to financial difficulty in the near term;
iv. The collection of principal, commission income highly questionable and improbable; and
v. Adverse changes in economic and business conditions in the near and longer term will only further negatively impact borrower's ability to fulfil obligations.
Finance companies should consistently monitor stage 3 exposures to identify improvements in credit quality and determine eligibility for re-staging stage 3 exposures to stage 2 or stage 1. Finance companies should document the minimum eligibility requirement for re-staging stage 3 exposures, which should include, at minimum, all of the following conditions:
i. The borrower does not have any material exposure (greater than 95% of total exposures) more than 90 days past due;
ii. Exposure repayments have been made when due over a continuous repayment period (cure period excluding grace period, if any) of 12 months (9 months for restaging from Stage 3A to Stage 2B and 3 months for restaging from Stage 2B to Stage 1);
iii. If a forborne exposure becomes non-performing during the 12-month probation/cure period, the probation/cure period starts again.
iv. Restructuring agreements and its conditions should consider the following:
➢ For the first time restructuring agreement with non-retail customers, 100% repayment of overdue interest and satisfactory compliance with the terms and conditions of the restructuring agreement.
v. For the second time restructuring agreement with non-retail customers, at least 7% of the funded outstanding amount should be settled within the 12 months cure period;
vi. The borrower's situation has improved (the borrower has resolved its financial difficulty) so that the full repayment of the exposure is likely, according to the original or modified terms and conditions;
vii. The exposure is not in default as defined in Section 8 of these Rules or impaired according to the accounting framework - IFRS 9; and
viii. The cure period requirements as stated above (12 months) do not apply to retail customers. For retail customers, cure period for moving stage 3 exposures into stage 1 exposures is 6 months (4 months for restaging from Stage 3A to Stage 2B and 2 months for restaging from Stage 2B to Stage 1).
SAMA recognizes the added value of having discrete tiers of credit risk exposures within Stage 3 allocation. As a result, SAMA is establishing, for regulatory reporting purposes only and not for accounting purposes, a bifurcation of Stage 3 totals to be reported in the quarterly prudential returns.
Stage 3A or Doubtful category within the stage 3 allocation. It represents borrowers with some or all of the following qualitative and quantitative indicators:
Qualitative indicators include, but are not limited to:
i. The borrower has a high risk of default or has defaulted;
ii. A restructuring arrangement is in advanced stages of negotiation, expected to finalize before the loan is past due by more than 120 days.
iii. Stage 3 loans which are in cure period.
Quantitative indicator:
i. Past due more than 90 days and up to 120 days.
Stage 3B or Loss category within the stage 3 allocation. It represents borrowers with some or all of the following qualitative and quantitative indicators:
Qualitative indicators include, but are not limited to:
i. The borrower has defaulted;
ii. The loan is uncollectible
Quantitative indicator:
i. Past due more than 90 days.
ii. Stage 3A exposures past due more than 120 days
3.4 Additional Consideration for Stage Allocation
i. A single exposure to a borrower should not be split between stages. The total balance outstanding (including any overdue amount) must be staged in the higher credit risk stage. Thus, staging of such exposures must occur at the counterparty level instead of at the transactional level.
ii. Multiple exposures to the same borrower should be allocated in the same stage if each individual exposure is greater than 5% of total exposures to the customer. The aggregate of the exposures (including any overdue amounts) should be staged in the highest credit risk stage. Thus, staging of such exposures must occur at the counterparty level instead of at the transactional level.