6.2 Credit risk
Credit risk
‘Credit risk’ is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations and arises principally from the Group’s loans and advances to customers and other banks, and investment debt securities. For risk management reporting purposes, the Group considers and consolidates all elements of credit risk exposure – e.g. individual obligor default risk, country and sector risk
Credit risk is the single largest risk from the Group’s business; management therefore carefully manages its exposure to credit risk. The credit risk management and control are centralized in a risk management department which reports regularly to the Risk Management Committee.
The ECL recorded on loans and advances measured at amortized cost and Islamic financing and investing assets measured at amortized cost has been disclosed in note 20 and 21 respectively.
Response to COVID 19
The Group has performed an internal analysis to identify potential accounts that are prima-facie eligible for temporary relief from payments of principal and interest (Deferment or Extension) on outstanding loans of Corporate customers under the TESS program. The Group has received deferment requests from customers (Corporate / SME / Retail) due to Covid-19 pandemic stress in the UAE economy. The Group evaluated each such request on its own merit and consider providing relief to the requesting customer subject to additional terms if any, as deemed fit by the concerned operating entity of the Group.
Significant Increase in Credit Risk
The Group has assessed the SICR factors such as:
1. Rescheduling & Restructuring of the facilities
2. Obligor Risk Rating (ORR) migration due to financial deterioration
3. Increase in past dues
Change in Macro Economic Factors
The assessment of SICR and the calculation of ECL both incorporate forward-looking information. The management has dynamic forward looking ECL computation methodology based on Macro Economic forecast. There is significant increase in volatility (albeit temporary) in Macro Economic factors due to COVID-19 pandemic situation. The Group is carefully assessing the situation and has noticed that volatility levels have reduced in the recent past.
On 11 March 2020, the World Health Organization (“WHO”) officially declared COVID-19 a global pandemic. In light of the rapid spread of COVID-19 across the globe, various economies and sectors have faced significant disruptions and uncertainty and governments and authorities have instigated a host of measures to contain or delay the spread of the virus.
On 27 March 2020, the IASB issued a guidance note, advising that both the assessment of Significant Increase in Credit risk (“SICR”) and the measurement of ECLs are required to be based on reasonable and supportable information that is available to an entity without undue cost or effort. In assessing forecast conditions, consideration should be given both to the effects of COVID-19 and the significant government support measures being undertaken. CBUAE has recently phased out the deferrals under TESS by end of 31 December 2021, however, it has extended the relief granted under TESS for capital, liquidity and stable funding requirements, to all banks and finance companies operating in the UAE, from 31 December 2021 to 30 June 2022.
The Central Bank of the UAE (CBUAE) approved and issued the standards of the UAE’s Targeted Economic Support Scheme (TESS); Circular No.: CBUAE/BSD/N/2020/1479 dated 18/03/2020 (The TESS Regulation) to contain the repercussions of the COVID-19 pandemic in the UAE. The TESS regulation is designed to:
1. facilitate the provision of short and medium term relief from the payments of principal and/or interest/profit on outstanding loans and selective rescheduling/ restructuring of loans for all affected private sector corporates, SMEs and individuals;
2. enhance lending capacity of banks, through partial release of existing capital buffers;
3. outline expectations and the actions to be taken under the TESS by all banks and finance companies operating in the UAE.
Under the TESS program, CBUAE set-up a “Zero Cost Facility” (ZCF) against eligible collateral. ZCF will be priced at zero interest rate and banks and finance companies are expected to pass on the benefits of such a no cost liquidity facility, at the minimum, to their clients who have been identified to be eligible as per these Standards. The “Eligible Collateral” includes the following:
i. Certificate of Deposit, both conventional and Islamic (CDs or ICD’s) issued by CBUAE; and
ii. Interim Marginal Lending Facility (IMLF) and Collateralized Murabaha Facility (CMF).
Finance House has not obtained this facility under TESS program as at 31 December 2021.
The Central Bank of the UAE (CBUAE) approved and issued the Treatment of IFRS 9 Expected Credit Loss in the context of the Covid-19 crisis; Circular No.: CBUAE/BSD/N/2020/2019 dated 22/04/2020 (IFRS 9 ECL Provision Guidelines) to contain the repercussions of the COVID-19 pandemic in the UAE.
Noting the prevailing volatility in the market due to Covid-19 implications and considering that the usage of economic model & forecast can lead to higher volatility in the expected loss for the calculation of IFRS9 accounting provision, CB suggested the following:
I. Bank & Finance Companies have to classify their customer under Group 1 and Group 2 based on impact severity as under:
– Group 1: Temporarily & Mildly impacted i.e. clients are not expected to face substantial changes in their creditworthiness, beyond liquidity issues, caused by the Covid-19 crisis, hence their assigned “stage” under IFRS 9 should remain the same. These clients will remain in their current stage, at least for the duration of the crisis, or their distress, whichever is the shorter.
– Group 2: Significantly impacted i.e. clients are expected to face substantial changes in their creditworthiness, in addition to liquidity issues that will be addressed by payment deferrals, hence their “Stage” migration limited to Stage 1 to Stage 2 only. Due to the possibility of later economic rebound, these clients are not expected to migrate to IFRS 9 stage 3, except for cases involving bankruptcy, fraud, skips etc.
II. No calibration (updation) of IFRS9 models (PD, LGD, EAD etc.) due to the high uncertainty of economic consequences. Only input adjustments and judgmental overlays should be considered, if necessary.
III. Realized additional draw- downs are expected during the crisis, hence input adjustments and judgmental overlays are required to account for weakness in the predictive power of Exposure at Default (EAD) models.
IV. No calibration (updation) of Macroeconomic scenario in ECL estimation models. However, it is recommended to continue assessing the range of possible outcomes on ECL and to be re-introduced in the ECL estimation no later than 30/09/2021. Dedicated governance should be put in place to thoroughly assess and review the overlays before they are added to IFRS 9 ECL estimation models.
Group 1: are the customers who are not expected to face substantial change in their creditworthiness beyond liquidity issue caused by the COVID-19 crisis.
This sub segment includes borrowers for which the credit deterioration is not considered significant enough to trigger a SICR. Such customers are expected to face short term liquidity issues caused by business disruption/salary cuts and are expected to recover rapidly once the economic environment stabilizes. These accounts are not considered to have sufficient deterioration in credit quality to trigger a stage migration and the staging may be retained at the same level.
Group 2: customers that are significantly expected to be impacted by COVID-19.
This sub segment includes borrowers for which the credit deterioration is more significant and prolonged, ranging beyond liquidity issues, with an extended recovery period. Stage migration, i.e. Stage 1 to Stage 2 migration should take place. Due to the possibility of later economic rebound, these clients are not expected to migrate to IFRS 9 stage 3, accepting cases but in exceptional circumstances such as bankruptcy, fraud, skip cases
The Grouping of the client is based on a combination of quantitative analysis and judgmental approach based on subject matter expert views within the Group/Organization.
Clients benefiting from deferrals under Target Economic Support Scheme (TESS) & non-TESS by Segment:
Table 1: Deferrals information as at 31st December 2021
| Segment | Stage | Group | Payment deferrals | Exposure at Default | Impairment allowance |
| AED’000 | AED’000 | AED’000 | |||
| Retail banking | Stage 1 | Group 1 | – | – | – |
| Group 2 | – | – | – | ||
| Stage 2 | Group 1 | – | – | – | |
| Group 2 | |||||
| ——————————- | ——————————- | ——————————- | |||
| Total | – | – | – | ||
| ============== | ============== | ============== |
| Segment | Stage | Group | Payment deferrals | Exposure at Default | Impairment allowance |
| AED’000 | AED’000 | AED’000 | |||
| Wholesale banking | Stage 1 | Group 1 | 61,053 | 35,785 | 246 |
| Group 2 | 39,811 | 60,959 | 1,454 | ||
| Stage 2 | Group 1 | 9,501 | 24,689 | 1,022 | |
| Group 2 | 26,130 | 38,720 | 2,801 | ||
| ——————————- | ——————————- | ——————————- | |||
| Total | 136,495 | 160,153 | 5,523 | ||
| ============== | ============== | ============== |
Table 2: ECL change (flow) since beginning of year to date.
| Non-credit impaired | Credit impaired | |||||
| Stage 1 | Stage 2 | Stage 3 | Total | |||
| AED’000 | AED’000 | AED’000 | AED’000 | |||
| Retail banking | ||||||
| ECL allowance as of start of the year | ||||||
| Credit card | – | – | – | – | ||
| Credit Card Settlement Plan | – | – | – | – | ||
| Personal loans | – | – | – | – | ||
| Payday loans | – | – | – | – | ||
| SME loans | – | – | – | – | ||
| ———————— | ———————— | ———————— | ———————— | |||
| ECL allowance as of end of the year | – | – | – | – | ||
| =========== | =========== | =========== | =========== | |||
| Non-credit impaired | Credit impaired | |||||
| Stage 1 | Stage 2 | Stage 3 | Total | |||
| AED’000 | AED’000 | AED’000 | AED’000 | |||
| Wholesale banking | ||||||
| ECL allowance as of start of the year | 1,420 | 3,372 | – | 4,792 | ||
| Construction | 200 | – | – | 200 | ||
| Service | 107 | 238 | – | 345 | ||
| Real Estate | 92 | (240) | – | (148) | ||
| Manufacturing | 7 | 252 | – | 259 | ||
| Trade | (132) | 201 | – | 69 | ||
| Others | 6 | – | – | 6 | ||
| ———————— | ———————— | ———————— | ———————— | |||
| ECL allowance as of end of the year | 1,700 | 3,823 | – | 5,523 | ||
| =========== | =========== | =========== | =========== | |||
Table 3: Stage migration since beginning of year
| Non-credit impaired | Credit impaired | |||||||
| Stage 1 | Stage 2 | Stage 3 | Total | |||||
| AED’000 | AED’000 | AED’000 | AED’000 | AED’000 | AED’000 | AED’000 | AED’000 | |
| Exposure at Default | Impairment allowance | Exposure at Default | Impairment allowance | Exposure at Default | Impairment allowance | Exposure at Default | Impairment allowance | |
| Retail banking | ||||||||
| As of 1 January 2021 | – | – | – | – | – | – | – | – |
| Transfers from stage 1 to stage 2 | – | – | – | – | – | – | – | – |
| Transfers from stage 2 to stage 1 | – | – | – | – | – | – | – | – |
| Transfers from 1&2 to stage 3 | – | – | – | – | – | – | – | – |
| Transfers from stage 3 to stage 2 & 1 | – | – | – | – | – | – | – | – |
| Other movements | – | – | – | – | – | – | – | – |
| ————————– | ————————– | ————————– | ————————– | ————————– | ————————– | ————————– | ————————– | |
| As of end of at 31 December 2021 | – | – | – | – | – | – | – | – |
| ============ | ============ | ============ | ============ | ============ | ============ | ============ | ============ | |
| Wholesale banking | ||||||||
| As of 1 January 2021 | 106,682 | 1,421 | 55,152 | 3,372 | – | – | 161,834 | 4,793 |
| Transfers from stage 1 to stage 2 | (12,281) | (375) | – | – | – | – | (12,281) | (375) |
| Transfers from stage 2 to stage 1 | – | – | – | – | – | – | – | – |
| Transfers from 1&2 to stage 3 | – | – | – | – | – | – | – | – |
| Transfers from stage 3 to stage 2 & 1 | – | – | – | – | – | – | – | – |
| Other movements | 2,343 | 654 | 8,258 | 451 | – | – | 10,601 | 1,105 |
| ————————– | ————————– | ————————– | ————————– | ————————– | ————————– | ————————– | ————————– | |
| As of end of at 31 December 2021 | 96,744 | 1,700 | 63,410 | 3,823 | – | – | 160,154 | 5,523 |
| ============ | ============ | ============ | ============ | ============ | ============ | ============ | ============ | |
Table 4: Macro overlay added to ECL
| Non-Covid Related Overlay Amount | Covid Related Overlay Amount | Total Macro Overlay | |
| AED’000 | AED’000 | AED’000 | |
| Retail banking | |||
| Credit card | – | – | – |
| Payday loans | – | – | – |
| ———————— | ———————— | ———————— | |
| Total | – | – | – |
| =========== | =========== | =========== | |
| Wholesale banking | |||
| =========== | =========== | =========== |
The below table shows deferment under TESS Group 1 and Group 2 by segment:
| % of Deferred | Amount Deferred | Total Loans and Advances | % of Loans and Advances | ||||
| Group 1 | AED’000 | AED’000 | |||||
| Commercial Loans | 51.7% | 70,553 | 2,018,416 | 2.8% | |||
| Retail Loans | 0% | – | – | 475,400 | 0% | ||
| ———————— | ———————— | ———————— | ———————— | ||||
| 51.7% | 70,553 | 2,493,816 | 2.8% | ||||
| ============= | ============= | ============= | ============= | ||||
| Group 2 | AED’000 | AED’000 | AED’000 | AED’000 | |||
| Commercial Loans | 48.3% | 65,941 | 2,018,416 | 2.6% | |||
| Retail Loans | 0% | – | 475,400 | 0% | |||
| ———————— | ———————— | ———————— | ———————— | ||||
| 48.3% | 65,941 | 2,493,816 | 2.6% | ||||
| ============= | ============= | ============= | ============= |
| Movement of Exposure at Default (EAD) | AED’000 | |
| Exposure at Default (EAD) as at 1 January 2021 | 1,748,976 | |
| Exposure increased/ (decreased) for Commercial loans | 37,248 | |
| Exposure increased/ (decreased) for Retail loans | (14,183) | |
| ———————— | ||
| Exposure at Default (EAD) as at 31 December 2021 | 1,772,041 | |
| ============ |
