The Australian Prudential Regulation Authority (APRA) today released revised prudential standards and guidance notes to reflect its prudential approach to the adoption of International Financial Reporting Standards (IFRS) by authorised deposit-taking institutions (ADIs). The changes have been finalised after extensive industry consultation.
The revised standards de-couple the definition of capital instruments eligible for Tier 1 capital from Australian accounting standards and bring APRA's approach to innovative capital instruments into line with international practice. The revised standards also de-couple the assessment of securitised assets for capital adequacy purposes from the accounting treatment of these assets, and address some other adverse prudential outcomes flowing from the adoption of IFRS.
APRA Chairman, Dr John Laker, said that APRA has aligned its prudential and reporting framework with IFRS-based financial reports, except where this would not be consistent with the intent and integrity of the framework.
"Overall, APRA's approach to IFRS is intended to ensure that the financial position of ADIs continues to be underpinned by adequate levels of high quality capital."
The revised prudential standards and guidance notes will apply to all ADIs from 1 July 2006. Institutions expecting their total capital to be reduced by APRA's IFRS-related changes may seek transition relief until 1 January 2008. New Tier 1 capital limits will come into effect on 1 January 2008. Institutions expecting that their Innovative Tier 1 capital will exceed the proposed limit of 15 per cent of net Tier 1 capital as at that date may apply to APRA for a two-year transition period, until 1 January 2010.
Similar changes to the prudential standards for general insurers will be introduced following the completion of consultation on APRA's general insurance 'Stage 2' reforms dealing with capital, assets in Australia and custodian arrangements. These particular reforms are expected to take effect around the end of 2006.
The revised standards and guidance notes for ADIs are located on APRA's website at: http://www.apra.gov.au/ADI/ADI-Prudential-Standards-for-1-July-2006.cfm.
A summary of the main changes is attached.
Summary of main changes to prudential standards:
Tier 1 capital - APRA has de-coupled the definition of capital instruments eligible for Tier 1 capital from Australian accounting standards. This allows certain instruments that could be classified as liabilities under IFRS to be included in capital.
APRA has also introduced new Tier 1 capital categories and limits. The new categories and limits are:
- Fundamental Tier 1 - a minimum of 75 per cent of net Tier 1 capital;
- Residual Tier 1 - a limit of 25 per cent of net Tier 1 capital;
- Innovative Tier 1 - a sub-category of Residual Tier 1 capital, limited to 15 per cent of net Tier 1 capital.
Non-innovative instruments included in Residual Tier 1 capital comprise non-cumulative irredeemable preference shares without innovative capital features. They can include instruments that contain conversion features that are set at the time of issuance.
Other changes to Tier 1 capital involve:
- limits to be calculated net of deductions, rather than on a gross basis as previously;
- enhanced loss absorption criteria for Innovative Tier 1 and Upper Tier 2 capital instruments; and
- direct issuance of Innovative Tier 1 capital instruments to be allowed. Issuers may continue to use special purpose vehicles (SPVs) but all instruments issued through an SPV will continue to be classified as Innovative Tier 1 capital.
Securitised assets - APRA has de-coupled the assessment of securitised assets for capital adequacy purposes from the accounting treatment of these assets.
Fair value measurement - APRA has restricted the use of fair value measurement for illiquid financial instruments in the banking book. For regulatory capital purposes, ADIs will also be required to eliminate any unrealised fair value gains and losses arising from changes in an ADI's own creditworthiness.
Cash flow hedges - APRA has excluded from the definition of Tier 1 and Tier 2 capital cumulative gains and losses on cash flow hedges that are recognised directly in equity.
Property - APRA has introduced a consistent regulatory capital treatment for owner-occupied and investment property. An amount of 45 per cent of pre-tax revaluation reserves on owner-occupied property or fair value gains on investment property will be allowed in Upper Tier 2 capital, subject to meeting certain conditions.
'Available for sale' assets - APRA has introduced a consistent regulatory capital treatment for 'available for sale' securities. An amount of 45 per cent of pre-tax revaluation reserves on securities will be allowed in Upper Tier 2 capital, subject to meeting certain conditions.
Estimated future credit losses - On adoption of IFRS, ADIs cannot raise general provisions for expected but not incurred loan losses. APRA will require ADIs to create a general provision called 'General Reserve for Credit Losses' as a buffer against potential (but not certain) credit losses which are intrinsic to the overall business of the ADI. Such a reserve is to be treated as forming part of Upper Tier 2 capital. APRA has also made a number of IFRS-related changes to the prudential standard and guidance notes on credit quality to deal with impairment of facilities and provisioning.
Employer sponsored defined benefit superannuation fund surplus. APRA will not recognise a fund surplus as an asset for capital purposes unless the employer sponsor is able to demonstrate unrestricted and unfettered access to the surplus in a timely manner.
Intangibles. All items defined as 'intangible' under Australian accounting standards, as well as certain capitalised expenses (and capitalised transactions costs) defined in AGN 111.4 Capital Deductions, are to continue to be deducted from Tier 1 capital.
Prudential standards and guidance notes revised to reflect IFRS
Capital adequacy - APS 110, AGN 110.1, AGN 110.2, AGN 110.3, AGN 110.4, AGN 110.5 and AGN 110.6
Capital adequacy: measurement of capital - APS 111, AGN 111.1, AGN 111.2, AGN 111.3 and AGN 111.4
Capital adequacy: credit risk - APS 112, AGN 112.1, AGN 112.2, AGN 112.3 and AGN 112.4
Funds management and securitisation - APS 120, AGN 120.1, AGN 120.2, AGN 120.3, AGN 120.4 and AGN 120.5
Credit quality - APS 220, AGN 220.1, AGN 220.2 and AGN 220.3
Large exposures - APS 221
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 $2.2 trillion in assets for 20 million Australian depositors, policyholders and superannuation fund members.
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