ADI capital reforms: Minor updates
To: All authorised deposit-taking institutions
As foreshadowed in the Policy priorities update letter (August 2023), APRA is releasing for consultation proposed minor updates to the capital framework for authorised deposit-taking institutions (ADIs).1 The ADI capital framework came into effect on 1 January 2023, following extensive industry consultation.
The aim of these minor updates is to address specific implementation issues raised by industry in applying the new capital framework in practice. These changes are technical in nature; APRA is not adjusting any major policy settings or changing the overall calibration of the framework through this consultation.
Updates are proposed to the following prudential and reporting standards and guidance:
- Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112);
- Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk (APS 113);
- Prudential Practice Guide APG 110 Capital Adequacy (APG 110);
- Prudential Practice Guide APG 112 Capital Adequacy: Standardised Approach to Credit Risk (APG 112);
- Prudential Practice Guide APG 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk (APG 113);
- Reporting Standard ARS 110.0 Capital Adequacy (ARS 110.0);
- Reporting Standard ARS 112.0 Capital Adequacy: Standardised Approach to Credit Risk (ARS 112.0);
- Reporting Standard ARS 113.0 Capital Adequacy: Internal Ratings-based Approach to Credit Risk (ARS 113.0); and
- Reporting Standard ARS 115.0 Capital Adequacy: Standardised Measurement Approach to Operational Risk (ARS 115.0).
Further detail on the specific amendments to these standards and guidance are provided in Annex A.
Next steps
To ensure the ADI capital framework is appropriately calibrated and to understand the impact of the proposed amendments, APRA is conducting a quantitative impact study (QIS) with selected ADIs. APRA will review the calibration should the revisions materially change the capital framework’s overall calibration.
APRA welcomes feedback on the proposed updates. Written submissions should be sent to ADIPolicy@apra.gov.au by 8 March 2024 and addressed to the General Manager, Policy, APRA. Subject to feedback, and following finalisation in 2024, APRA expects that the updated standards and guidance would become effective from 30 June 2024.
Yours sincerely,
Clare Gibney
Executive Director
Policy & Advice
Annex A. Proposed revisions
References are to the proposed paragraphs following the incorporation of the amendments.
- Risk weight for unrated corporate (non-SME) borrowers
(Reference: Paragraph 25 of Attachment B to APS 112, and paragraph 36 and Attachment C to APG 112)
Subsidiaries of well-established parent companies are often not individually rated by credit rating agencies, but have inherently lower credit risk due to their ties with their parent. The existing flat 100 per cent risk weight for unrated corporates may not provide adequate risk differentiation. APRA proposes an update to paragraph 25 of Attachment B to APS 112 to allow the use of a more risk-sensitive approach to better reflect the underlying risk of these borrowers. APRA intends to consider the calibration of risk weights following the QIS.
- LGD for domestic public infrastructure
(Reference: Paragraph 10 of Attachment B to APS 113)
Some ADIs have identified borrowers such as government owned businesses that currently do not meet the conditions set out in paragraph 10 of Attachment B to APS 113 but warrant a treatment that is similar for exposures to private operators of public infrastructure. APRA considers that a 25 per cent loss given default (LGD) for government businesses can be justified provided that the prospect of government support is not already factored into the probability of default (PD). The PD consideration is to prevent double counting as the support from the government could also be factored into the PD assessment of the government owned business.
APRA is also sharpening the requirements for privatised infrastructure and public private partnerships that could qualify for the 25 per cent LGD.
- LGD for carbon credits and allowances
(Reference: Paragraph 11 and Table 4 of Attachment B to APS 113)
APRA proposes an update to paragraph 11 and Table 4 of Attachment B to APS 113 to recognise the recoverable value of carbon credits and allowances.
- Creditworthiness checks prior to drawdowns
(Reference: Paragraphs 62 and 63 of APG 112)
Industry has highlighted the imbalance between the risk mitigation effects and the burden of paragraph 3(d) of Attachment C to APS 112 and the overlap between the existing ongoing monitoring of relationship managed borrowers and the required pre-drawdown credit assessments. APRA proposes an update to APG 112 paragraph 62 to recognise the use of an existing control framework, for the purpose of meeting APS 112 (Attachment C, paragraph 3(d)) subject to meeting some minimum expectations. The proposed update also clarifies what APRA expects to be evidenced to exclude an arrangement from the definition.
- IRB scalar for exposures subject to the RBNZ’s supervisory slotting approach
(Reference: Paragraph 13(a) of APS 113, and paragraph 40 of APG 113)
APRA has reviewed the application of the 1.1 scaling factor for New Zealand exposures subject to the RBNZ’s supervisory slotting approach. The 1.1 scaling factor should be applied to these exposures as the intent of the standard is that RBNZ capital requirements flow through to Level 2 regulatory capital (with the exception of the 1.2 RBNZ IRB scalar being replaced by APRA’s 1.1 IRB scaling factor). The amendment to paragraph 13 of APS 113 reflects this expectation.
- Loss given default (LGD) for multilateral organisations
(Reference: Table 3 of Attachment B to APS 113)
APRA has reviewed the risk weight treatment of multilateral organisations that are risk-weighted at zero per cent under the Standardised approach to credit risk. Of the listed entities, only three are not rated by an external credit assessment institution (ECAI): the Bank for International Settlements (BIS), the International Monetary Fund (IMF) and the Multilateral Investment Guarantee Agency. APRA proposes to allow a five per cent sovereign LGD for exposures to the BIS, IMF and the World Bank Group. For the remaining entities, the LGD will be determined by their external ratings in accordance with the current framework.
- Public sector entities that carry out the functions of a financial institution
(Reference: Paragraphs 30 and 34 of APS 113, and Table 9 in Attachment B to APG 113)
The classification of public sector entities that carry out the functions of a financial institution is ambiguous in APS 113. APRA proposes an update to APS 113 paragraphs 30 and 34 and Table 9 in Attachment B to APG 113 to clarify that such public sector entities should be captured under the financial institution asset class as they share similar risk characteristics as financial institutions.
- LVR for non-arm’s length property transactions
(Reference: Footnote 5 in Attachment A to APS 112)
APRA proposes an update to footnote 5 in Attachment A to APS 112 to address the concern that the purchase price of a property might not accurately reflect the inherent LVR of the exposure in a non-arm’s length property transaction.
- Treatment of trusts in five or more investment properties
(Reference: Paragraph 28(e) of APG 113)
Industry has asked for guidance on how properties should be counted when a trust is involved and the trustee is an individual who also owns other properties. APRA proposes to include an update in APG 113 paragraph 28 that for complex lending relationships, ADIs must assess any interdependency (or interconnectedness) in line with the relevant credit policies and consider if properties should be aggregated.
- Public disclosure of overlays
(Reference: Paragraph 10 of APG 110, and paragraph 85 of APG 113)
APRA proposes a minor update to paragraph 10 of APG 110 and paragraph 85 of APG 113 to promote the visibility of material adjustments to Pillar 1 requirements beyond those imposed by APRA. These may include material RBNZ or bank-determined overlays. This will allow the market to readily identify portfolios where the reported risk estimates might not adequately reflect the underlying risk.
- Validation of supervisory LGD and EAD estimates
(Reference: Paragraphs 145 to 147 of APG 113)
APRA proposes an update to APG 113 to provide guidance on the validation of supervisory estimates, especially for the banks which are now subject to more supervisory estimates. In addition, the update provides clarity about the types of reviews expected for arrangements that are excluded from the definition of a commitment.
- Controls on business function approval of ratings
(Reference: Paragraph 75 of APG 113)
APRA proposes to provide guidance in APG 113 in relation to paragraphs 45 to 47 of Attachment D to APS 113 regarding the appropriate controls to be applied around the business function approval of ratings.
- Changes to Reporting Standards
The amendments to ARS 112.0 and ARS 113.0 seek to incorporate clarifications given to industry during the parallel runs of data when the ADI capital framework was being implemented. The reporting changes to ARS 110.0 and ARS 115.0 facilitate more consistent and timely reporting of overlays.
Footnotes
1 Refer to: APRA policy priorities: Interim update.