The capital adequacy requirements for all Australian authorised deposit-taking institutions (ADIs) are based on the Basel Committees 1988 Capital Accord. These requirements establish a broad framework for determining the financial health of an institution, based on the ratio of its capital base to its risk-weighted assets. Since it was introduced, the Accord has become the international standard for measuring and supervising the capital adequacy of banks and similar institutions. However, developments in financial markets, products and risk management capabilities have put increasing pressure on the Accords relatively broad-brush approach. In response, the Basel Committee announced in June 1999 a wide-ranging review of the Capital Accord and issued a set of draft reform proposals for discussion and comment.

With much of the detail of the proposed framework still to emerge, APRAs comments are fairly high-level, concentrating on a number of key themes:

• APRA supports the move towards introducing into the capital adequacy framework greater sensitivity to institutions individual risk profiles. This includes measures such as the use of credit ratings (internal and external) for the allocation of credit risk capital, and the application of separate, explicit capital charges for other types of risk.
• That said, APRA believes that, to have a meaningful impact, some of the suggested changes should go further. For example, there should be a more graduated scale of credit risk weights and the capital charge for balance sheet interest rate risk should be applied to all institutions, not just outliers.
• APRA also believes that some aspects of the existing Capital Accord, where changes have not been proposed, need to be revisited. Two important areas are:
• the 50 per cent risk weight applied to housing loans is, based on Australian experience, well in excess of the relative riskiness of the relevant exposures; and
• the desirability of higher capital charges for large exposures to single (or related) borrowers as a means of discouraging portfolio concentrations.
• More detail is required on a number of the proposals before APRA can assess whether the Committees goal of not reducing the overall level of capital in the banking system has been achieved. Meeting this objective, while at the same time introducing a range of new capital charges, will require considerable recalibration of the existing framework if supervisors are to ensure that the overall minimum capital requirements placed on the banking industry are not to be significantly increased.
• APRA supports the attention given to supervisory review (Pillar II) and market discipline (Pillar III) within the new framework. Australian supervisors have long recognised that capital rules are not a panacea, and that the scrutiny of an institutions activities, by both supervisors and other market participants, can provide powerful incentives for prudent behaviour.

The full text of the submission is available on the APRA web site (www.apra.gov.au) in the Policy area.

For further information contact:

Mr Wayne Byres
General Manager, Capital & Risk Analysis
Australian Prudential Regulation Authority
GPO Box 9836
SYDNEY NSW 2001

Tel: 02 9210 3146
Fax: 02 9210 3022
Email: wayne.byres@apra.gov.au