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Credit risk provisioning practices for locally incorporated authorised deposit-taking institutions

This image shows APRA's contact details: AUSTRALIAN PRUDENTIAL REGULATION AUTHORITY - 1 Martin Place (Level 12), Sydney, NSW 2000 - GPO Box 9836, Sydney, NSW 2001. Telephone: 02 9210 3000, Website: Australian coat of arms - APRA

To: Locally incorporated authorised deposit-taking institutions (ADIs)


Supervisors internationally remain mindful of challenges in provisioning in the current macro-economic environment, and in particular ensuring that provisioning estimates adequately capture credit risk in portfolios given model and data limitations.

APRA is writing to all locally incorporated ADIs that do not apply prescribed provisioning under Prudential Standard APS 220 Credit Risk Management (APS 220) to outline observations on provisioning practices. This is consistent with APRA’s strategic initiative to Modernise the prudential architecture, providing timely updates on expectations to respond to risks as they emerge.

Observations on provisioning practices

APRA has set out below observations on the application of expected credit loss (ECL) provisioning. Similar observations have been highlighted and reinforced in the Basel Committee on Banking Supervision (BCBS) newsletter on credit risk issues published in July 2023.1 APRA encourages the subject ADIs to reflect on their provisioning practices in light of this letter and the BCBS publication.2 

APRA has recently engaged with a range of ADIs and auditors on ECL practices.  APRA has observed that some of ADIs have made progress in reflecting a forward view in their provisioning estimates, having regard to the current and anticipated risk environment. However, APRA continues to observe a range of provisioning practices and sees opportunities to further embed consistently robust practice across the industry.

APRA’s key observations cover the following three key areas:

1. Controls around model risk management

  • Many ADIs continue to apply sizeable judgment-based adjustments to compensate for model and data limitations, to ensure provisions reflect credit risk expectations. The focus of these ADIs has shifted towards adjustments to capture the impact on borrowers of rising interest rates, high inflation, and commodity market volatility. 
  • APRA acknowledges that judgement-based adjustments have a role to play, and models alone may not be calibrated to adequately capture and reflect all drivers of credit risk. Such adjustments include the addition or removal of overlays, based on expert judgement, where appropriate, to ensure that provisions reflect actual credit risk expectations. Where judgmental adjustments are made, APRA expects that they be supported by appropriately documented analysis and robust controls and governance. This includes sound processes for the application of adjustments, controls to ensure the efficacy of the output, and senior management oversight and accountabilities. 
  • While APRA recognises the need for judgmental adjustments, it is important that ADIs monitor and continuously improve model performance for credit quality assessments and provisioning.

2. Capturing economic uncertainty

  • Sensitivity analysis is used by ADIs to capture the impact of macro-economic headwinds on borrowers. ADIs often use sensitivity analysis to understand how provisions respond to changes in the key underlying drivers of credit risk. 
  • In the current environment, it is important that ADIs can perform comprehensive sensitivity analysis on a regular and timely basis across credit portfolios (by appropriate industry, geographical and other segmentations). This can support management and Boards in understanding the sensitivity of the credit portfolio to key credit risk drivers and help to inform appropriate provisioning levels. Such sensitivity analysis could form part of an ADI’s overall stress testing capability, as part of the ICAAP and risk appetite review processes.3 
  • As with judgmental adjustments, APRA expects that appropriate governance to be in place for sensitivity analysis, including clear accountabilities, robust controls and oversight. This underpins both the process of, and decisions made, in the sensitivity analysis exercise.

3. Identifying credit deterioration in vulnerable sectors and borrowers

  • Many ADIs continue to apply manually intensive, and judgement driven processes to understand and capture the impact of emerging risks on vulnerable borrowers and sectors.  However, it is important for ADIs to invest in systematic processes to identify vulnerable sectors and factor sectoral risks into loss estimates. These processes would include the use of collective assessments, the level of segmentation of models and data, and the indicators used to transfer loans in vulnerable sectors into impairment Stage 2 under Accounting Standard AASB 9 Financial Instruments.

APRA will continue to monitor credit risk assessment methodologies and provisioning levels and engage with ADIs as part of its supervision programme. Please contact your responsible supervisor if you have any questions in relation to this letter.

Yours sincerely, 


Therese McCarthy Hockey 


1  The newsletter is available via the link

2  Under APS 220, an ADI must maintain appropriate credit risk practices, including an effective system of internal control, to consistently determine adequate provisions in accordance with the ADIs stated policies and processes and Australian Accounting Standards. Also, under Prudential Practice Guide APG 220 Credit Risk Management (APG 220, paragraph 106), APRA expects ADIs to have regard to the Basel Committee’s December 2015 “Guidance on credit risk and accounting for expected credit losses”.

3  In addition to meeting the requirements for stress testing in APS 220 (paragraphs 70 – 76), APRA expects that ADIs follow the guidance in Prudential Practice Guide CPG 110 Internal Capital Adequacy Assessment Process and Supervisory Review.