The Australian Prudential Regulation Authority (APRA) today announced an upgraded internal rating system, the Probability And Impact Rating System (PAIRS), which will be used to assess the more than 3000 financial institutions that it regulates.

In developing PAIRS, APRA has drawn upon and refined international rating models to ensure that its practice continues to reflect its reputation as a world-class regulator.

PAIRS assesses both a regulated entitys probability (based on risk) of failure and the potential impact (based on size) of failure. A non-linear measure, the composite PAIRS Index rises at an increasing rate as the probability and impact measures rise.

APRAs Chief Executive Officer, Mr Graeme Thompson, said that the introduction of PAIRS placed the agency in a stronger position to gauge the scale of its overall supervisory task, to identify priority areas within the regulated population and allocate resources according to the degree of risk, and to monitor market trends in risk profiles.

"APRAs ratings are for internal use, but regulated entities will be in no doubt as to how we view them as PAIRS is progressively introduced across industry over the next two years," he said.

Once an entity is assigned a rating, a supervisory strategy is developed that is commensurate with the risks associated with the entity and the necessary APRA resources are allocated to the task.

APRA has identified four broad supervisory stances: Normal, Oversight, Mandated Improvement and Restructure.

"A Normal mode rating means APRA is collecting and analysing data and making routine on-site visits. Oversight means a significant step-up in information collection and inspection intensity, and sending the entitys management and Board strong signals that we are less than comfortable with its position," Mr Thompson said.

"At the next stage, entities tagged Mandated Improvement are operating in an unsustainable way. APRA will direct them to present and execute a business plan that quickly restores financial stability. At this level, APRA is allowing the regulated entity to keep control of its destiny, but is clearly signaling that change must happen."

Restructure entities have failed or are at risk of near-term failure. For these entities APRA will apply its full enforcement powers, including replacing people and issuing directions. Our paramount concern here is to avoid losses for depositors, policyholders and superannuation fund members."

Implementation of PAIRS will be rolled out progressively from October.

APRA will be releasing more detailed information on PAIRS to industry over the coming weeks.

APRA is the prudential regulator of the financial services industry including banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry. It currently regulates and maintains $1.5 trillion in assets for 20 million Australians.