The Australian Prudential Regulation Authority (APRA) today released details on its proposed implementation of two aspects of the Basel II Framework: margin lending, and recognition of external credit assessment institutions (ECAIs), more commonly known as credit rating agencies.
Margin lending
APRA has been considering the appropriate risk‑weight for calculating capital requirements for margin lending activities of authorised deposit‑taking institutions (ADIs), under the standardised and advanced approaches of the Basel II Framework.
Under the Framework, both the standardised and advanced approaches to credit risk would typically result in a zero capital requirement for margin lending exposures, compared with eight per cent (a 100 per cent risk-weight) under current requirements.
However, APRA has previously stated that it did not regard this as acceptable and announced, in April 2005, that the issue required further analysis. APRA subsequently engaged an independent consultant to review the level of capital that may need to be set aside for margin lending exposures. The consultant recommended that a capital charge of three per cent (equivalent to a 37.5 per cent risk‑weight) be applied to margin lending exposures, with an acceptable range between one per cent (12.5 per cent risk-weight) and four per cent (50 per cent risk-weight).
Based on its assessment of the relatively conservative policies and practices of ADIs currently involved in margin lending activities, APRA has decided that, as an interim measure, it will apply a risk-weight of 20 per cent to outstanding loans that are backed by listed equity investments; otherwise, exposures are to be treated as secured loans. This treatment will apply under both the standardised and advanced approaches to credit risk.
APRA will be further reviewing the detail of individual ADI approaches to margin lending; on the basis of those reviews, APRA may consider the application of variable risk-weights to margin lending exposures or recognition of internal models.
ECAI recognition
Under the standardised approach to credit risk, ADIs may use credit assessments provided by recognised ECAIs, where available, to determine the risk‑weights on their rated credit exposures.
APRA has now released draft guidelines setting out the eligibility criteria by which it will recognise ECAIs. The guidelines also provide an outline of APRA’s proposed process for mapping a recognised ECAI’s credit assessments to the risk-weights under the standardised approach.
As part of these proposals, APRA will give automatic recognition to an ECAI if it is regulated by the US Securities and Exchange Commission as a ‘nationally recognised statistical rating organisation’. In addition, if an ADI has an exposure domiciled in any one of 19 specified countries, it will be able to use the credit assessments of an ECAI recognised by the national supervisor in that country.
APRA’s proposed recognition process is not a form of prudential regulation and does not constitute licensing of ECAIs. APRA’s focus is on ensuring that an ECAI’s processes and policies are rigorous and systematic, and produce credit assessments of sufficiently high quality to be used by ADIs. It will be the responsibility of each ADI to determine whether it uses the ratings of a particular ECAI.
The draft ECAI guidelines are available on APRA's web site at www.apra.gov.au/ADI/Basel-II-implementation-in-Australia.cfm.
Comments on these proposals are invited by 21 September 2007 and can be emailed to basel2@apra.gov.au.
The Basel II capital adequacy regime for ADIs comes into force on 1 January 2008. The full suite of Basel II prudential standards is to be finalised in late 2007.
The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry. APRA is funded largely by the industries that it supervises. It was established on 1 July 1998. APRA currently supervises institutions holding approximately $2.5 trillion in assets for 20 million Australian depositors, policyholders and superannuation fund members.
Media and industry inquiries only:
Andrew McCutcheon, Public Affairs Manager
Australian Prudential Regulation Authority
Telephone: 02 9210 3143
Mobile: 0417 528 660
All other inquiries:
APRA Contact Centre 1300 131 060
