Section II Minimum Provisioning Requirements
2.1 General Provisions
Experience shows that loan portfolios often contain loans which are in fact impaired at that balance sheet date, but which will not be specifically identified as such until some time in the future. Generally, there will not be sufficient information on hand during the review of loans to be certain that all impaired loans have been identified or of the correctness of the estimated losses and the adequacy of the provision for loan losses.
2.2 Impaired Loans
As a result, a general provision should be made to cover the impaired loans which will only be identified as such in the future. Unless otherwise prescribed by SAMA, this general provision should be a minimum of 1% of the outstanding balances of the Standard and Special Mention categories. All Saudi government loans or claims fully backed by collateral of Saudi government in form of securities or guarantees should be deducted before calculating general provision.
2.3 Historical Data
In general, if a bank has at least 3 years of reliable historical data captured through a system validated and approved by SAMA, it could establish an appropriate general provision using such data adjusted for current observable conditions. Such banks may seek exemption from SAMA in relation to the requirements in paragraph 2.2 above. Saudi banks are also encouraged to develop and implement more sophisticated systems that capture historical data on loan defaults and loss experience that could be used for general provisioning purposes. Although historical loss experience provides a reasonable starting point for a bank analysis, these cannot be accepted without analysis of current conditions and future prospects. Banks must make an adjustment that should reflect management’s best estimate of the level of charge-offs or specific provision that will be recognized. Factors include:
• Change in national and international lending policies and procedures.
• Change in local, national and international economic and business conditions.
• Changes in trends, volumes and severity of past due loans, impaired loans and troubled debt restructuring.
• Changes in experience, depth and ability of lending management and staff.
• Changes in bank’s loan review system and the degree of oversight by the Board.
• Existence and effect of any concentration of credit.
• Effect of external factors, competition, legislation, regulatory requirement, etc.
• Changes in the risk profile of the portfolio as a whole.
Loans that have been individually analyzed and provided for with a provision should also be included in the group for determining a bank’s historical experience for such group. However, to avoid double counting, loans for which specific provision has already been made should be subtracted from the group before a historical loss factor is applied to the group to establish appropriate general provisions.
Saudi banks should use a period of at least 3 years to determine their average historical loss experience. However, banks should weigh recent experience more heavily to accurately estimate bank’s expected losses in the current economic climate.
2.4 Specific Provisions
A specific provision should be made for incurred and expected losses for individually assessed corporate, government, private banking and other large loans to reduce the carrying value of impaired credits to their estimated net realizable amount. Retail loans that fall under the non-performing loan categories should also be covered by specific provisions. Unless otherwise prescribed by SAMA, the following minimum provisions should be made on the aggregate of individual net exposures for each classification category. Loans which have been individually assessed and on which specific provisions, in excess of the prescribed minimum, have been made should be excluded in computing the minimum provisions by each classification category. Minimum provisions are to be computed on the net exposure which represents the balance outstanding less a prudent estimate of the fair value of the perfected collateral.
Category Minimum Provision (% of net exposure) ‘Substandard’ 25% ‘Doubtful’ 50% ‘Loss’ 100% 2.5 Treatment of Differences between Supervisory and Accounting Provisions
Saudi banks are expected to apply the relevant Accounting Standards. For purposes of bank accounting and financial reporting, the computation of general and specific provisions for loan impairment is governed by these accounting standards. Consequently, these are likely to differ from the supervisory general and specific provisions provided in this circular. While the accounting provisions are to be used for all published financial statements of a Saudi bank, the supervisory provisions are to be used solely for the purpose of prudential reporting to SAMA.
The treatment of accumulated specific and general accounting and supervisory provisions will continue to be guided by the relevant accounting standards and relevant SAMA rules respectively. However, the difference in the annual charge between accounting and supervisory provisions must be reflected by an adjustment directly into the accumulated retained earnings of the bank on the supervisory returns. In case a bank has no retained earnings, the adjustment will be made to the general or statutory reserves after discussion with the Central Bank on a case by case basis.