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Asset Classification and Provisioning Directive No. 1013/2024

Aug 5, 2024National Bank Of Ethiopia1013/2024

Summary

This directive establishes new guidelines for the classification and provisioning of banking assets in Ethiopia. It aims to ensure that banks accurately reflect the value of their loans and advances by setting standards for classifying non-performing exposures, determining provisioning requirements, and outlining procedures for loan review and write-offs. The directive aligns with international accounting and regulatory standards, including IFRS, to enhance financial stability and transparency.

Who's affected

Banks operating in Ethiopia, including both private and state-owned entities licensed by the National Bank.

Action required

Banks must review and update their internal policies and procedures to comply with the new asset classification and provisioning requirements outlined in this directive. They should also ensure their staff are trained on these updated standards and implement the required reporting mechanisms.

Key points

Establishes a five-category classification system for banking exposures: Pass, Special Mention, Sub-standard, Doubtful, and Loss.
Defines specific criteria and timeframes for classifying loans and advances as non-performing.
Mandates minimum prudential provisioning percentages for each classification category.

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Requires banks to maintain a Provision for Loan Losses Account and to calculate Expected Credit Losses (ECL) in accordance with IFRS.
Outlines requirements for the valuation and eligibility of collateral.
Sets provisioning requirements for off-balance sheet exposures.
Introduces detailed guidelines for loan review systems and the responsibilities of bank boards of directors.
Specifies procedures for loan restructuring, including limitations and criteria for exiting restructured status.
Requires banks to report on loan classification, provisioning, restructured loans, and loans moved from non-accrual to accrual status.
Repeals Asset Classification and Provisioning Directive No. SBB/69/2018 (5th Replacement).
Banks not in full compliance have a transition period of two years to comply, requiring an action plan within 90 days.
Aligns with international accounting and regulatory standards.

Requirements

Banks must establish policies for grading, classifying, and monitoring all credit exposures.
A loan review system must be in place to identify and manage deteriorating loans.
Adequate provisions for expected credit losses and write-offs must be maintained.

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Borrowers must use loan facilities for their intended purposes; deviations require timely corrective measures.
Loan portfolios must be reviewed at least quarterly.
Non-performing loans must be placed on non-accrual status, and accrued interest reversed.
Provisions for expected credit losses must reflect realistic repayment and recovery expectations.
Adequate records supporting loss evaluations must be maintained and made available to examiners.
Lending activities must comply with prudent written lending standards.
Problem loans must be properly and timely identified, classified, and placed on non-accrual status.
Banks with a non-performing exposure to total exposure ratio of 5% or higher must submit an action plan to the National Bank.
Non-performing loans must be placed on non-accrual status.
Accrued but uncollected interest on non-performing loans must be eliminated by the end of the calendar quarter.
Re-categorization of non-performing loans to performing status requires meeting specific criteria (no past-due exposure, continuous repayment period, improved counterparty situation, not defaulted/impaired, all accrued interest paid).
Banks must report restructured loans and loans moved from non-accrual to accrual status quarterly.
If one loan to a borrower meets non-performing criteria and is at least 20% of their total loans, all other loans to that borrower are automatically non-performing.
Exposures must be classified into 'Pass', 'Special Mention', 'Sub-standard', 'Doubtful', and 'Loss' categories.
Specific criteria (days past due, account status) are defined for each classification category.
Forbearance-restructure policies and procedures must be in place, with limitations on iterations.
Restructured non-performing exposures of more than two iterations must be classified at least as sub-standard.
Restructured exposures must meet specific exit criteria (timely payments for one year, resolution of financial difficulty) to be re-classified.
Forbearance-restructure must not be used to circumvent classification and provisioning standards.
Policies on classification and provisioning are subject to National Bank examiner scrutiny.
Examiners can require revisions to policies, adjustments to classifications, and increased provisioning.
Banks must maintain a Provision for Loan Losses Account at an adequate level.
Minimum prudential provision percentages are set for each classification category ('Pass': 1%, 'Special Mention': 3%, 'Sub-standard': 20%, 'Doubtful': 50%, 'Loss': 100%).
Provisions are applied against the total outstanding principal balance.
Accrued interest in a suspended interest account and net recoverable value of collateral can be deducted before applying provisioning, but the minimum provision cannot be less than 3% for non-performing loans.
Provision for loan losses account must always have a credit balance.
Provisioning for off-balance sheet exposures is required, with specific percentages for guarantees, commitments, and letters of credit.
Additional provisions are required for non-performing or litigated off-balance sheet exposures.
Collateral must be legally documented, appropriately charged, insured, valued, free of prior liens, and readily disposable.
Valuation of physical collateral must be impartial, transparent, and objective, with detailed reports.
Valuers must be professionally competent, skilled, knowledgeable, and independent.
Valuer fees should not create a conflict of interest.
Banks must assess valuer performance and take steps to mitigate conflicts of interest.
Expected credit losses must be calculated in accordance with IFRS.
If IFRS-determined ECLs are lower than directive provisions, the difference is a non-distributable reserve.
If IFRS-determined ECLs are higher than directive provisions, they are considered adequate.
Banks must review audited financial statements for borrowers seeking loans of Birr 10 million or above.
Examiners can assess the adequacy of the Provisions for Loan Losses Account.
If provisions are found inadequate by more than 10%, banks must increase them within 30 days.
Banks must have sound policies and processes for timely write-offs of identified losses.
Depreciation of fixed assets must be expensed annually.
Operating and accumulated losses must be provided for from net profit.
Assets lodged or pledged as security must be fully provided for.
Preliminary expenses must be amortized within five years.
Uncollectible claims must be classified and provided for or written off.
All exposures must be accounted for and categorized according to the directive; interpretations require written confirmation from the National Bank.
Banks shall submit quarterly reports on loan classification, provisioning, and off-balance sheet provisioning.
Banks shall submit quarterly reports on restructured loans and loans moved from non-accrual to accrual status.
Banks engaging in interest-free banking shall consider margin/profit in place of interest.
Non-compliant banks must submit an action plan within 90 days to achieve full compliance within two years.

Rights and permissions

Banks have the discretion to transfer cash collateral from customer accounts to specific or general cash collateral accounts or block them.
Banks have the right to liquidate or take legal possession of collateral in the event of default, insolvency, or bankruptcy.
Examiners of the National Bank have the right to request and review bank records supporting evaluations of expected credit losses.

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Examiners have the discretion to conduct file reviews and take appropriate action if policies, processes, or classifications are inadequate.
Examiners have the power to require banks to revise policies, adjust classifications, increase provisioning, or implement other remedial measures.
The board of directors of a bank may appeal to the National Bank in case of material disagreements regarding additional provisions.
Banks can deduct accrued but uncollected interest and net recoverable value of collateral from non-performing loans before applying minimum provision percentages.
Banks can initiate procedures to realize collateral once a credit facility becomes non-performing.

Restrictions

Accrued but uncollected interest on non-performing loans must be reversed out of the bank's income.
Cash-substitutes must meet specific criteria (Federal Government security, unconditional obligation/guarantee from Federal Government or rated foreign bank/insurance company, authorized export credit guarantee, other liquid/marketable securities approved by NBE).
The Net Recoverable Value (NRV) used for provisioning cannot be more than 100% of the outstanding non-performing loan principal.

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Average Recovery Rate (ARR) used for NRV calculation cannot be 15 percentage points greater than the industry average recovery rate.
Non-performing exposures are defined by specific criteria including being past due over 90 days, credit-impaired, or exhibiting other indicators of unlikelihood of full repayment.
Overdrafts and loans without pre-established repayment programs become non-performing under specific conditions (e.g., 90 consecutive days past due, exceeding limit for 90 days, interest due and uncollected for 90 days).
The entire principal balance of exposures exhibiting non-performing characteristics is considered non-performing.
A non-performing loan may be re-categorized as performing only when all specified criteria are simultaneously met.
If one loan to a borrower constitutes at least 20% of their total loans with the bank and is non-performing, all other loans to that borrower are automatically classified as non-performing.
Short- or medium-term loans can be restructured no more than three times; long-term loans no more than four times.
Restructured non-performing exposures for more than two iterations are automatically classified at least as sub-standard.
A restructured exposure remains identified as such until it meets exit criteria (timely payments for one year, resolution of financial difficulty).
Forbearance-restructure applied to a non-performing exposure must remain non-performing for at least six months.
When calculating minimum prudential provisions, net recoverable value of collateral cannot exceed the outstanding principal balance of the loan.
Minimum provision percentage for non-performing loans cannot be less than 3% of the outstanding loan.
Collateral values are not deducted when computing provisioning for off-balance sheet exposures.
Valuers and their first-degree relatives must not be involved in loan application, assessment, decision, or administration to avoid conflicts of interest.
Valuer fees or salaries must not be linked to valuation results in a way that creates a conflict of interest.
If IFRS-determined ECLs are lower than directive minimum prudential provisions, the difference must be placed in a non-distributable reserve.
If the Provisions for Loan Losses Account is found inadequate by more than 10%, banks must increase it within 30 days.
Interpretations of the directive require written confirmation from the National Bank.

Penalties

If policies, processes, or methodologies are inadequate, or if exposure classifications are inaccurate or provisions are deemed inadequate, the National Bank examiner has the power to take appropriate action.
Appropriate actions include requiring the bank to revise policies, adjust classifications, increase provisioning, reserves, or capital, or impose other remedial measures.
Failure to comply with the directive's requirements may lead to supervisory actions by the National Bank.

Objectives

To regularly review and classify loans and advances consistent with international accounting and regulatory standards.
To recognize and report non-performing exposures in line with international standards.
To prevent banks from overstating profits by accruing uncollected interest on non-performing loans.

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To ensure timely and accurate provisions and write-offs reflecting realistic repayment and recovery expectations.
To provide consistent direction to banks on exposure classification and provisioning.
To accurately reflect expected credit losses based on reasonable and supportable information.
To enhance transparency and financial stability within the Ethiopian banking sector.

Organizations

National Bank of Ethiopia
Commercial banks
Federal Government of Ethiopia

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Foreign banks
Foreign insurance companies
Rating agencies (Standard and Poor's Corporation, Moody's Investor Services)

Legal references

Banking Business Proclamation No. 592/2008
Proclamation No. 1159/2019 (Amendment to Banking Business Proclamation)
International Financial Reporting Standards (IFRS)

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Large Exposures Directive
National Bank Directive No. CRB/01/2019

Original sourcehttps://justice.gov.et/en/directives/asset-classification-and-provisioning-directive-no-1013-2024/

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