Finalising the new pathway to internal ratings-based accreditation

Across both minimum risk-based capital adequacy requirements and prudential capital buffers, ADIs which have been approved by APRA to use the IRB approach (IRB ADIs) are required to hold in aggregate an additional 25 basis points of Common Equity Tier 1 (CET1) capital from January 2027 with the phase out of AT1 capital instruments.

Submissions suggested that the additional 25 basis points of CET1 should only apply to large, internationally active banks and medium-sized ADIs should be permitted to fully replace AT1 with Tier 2 capital on successful IRB accreditation.

Adjustments to Pillar 2 capital requirements or the capital conservation buffer for IRB ADIs were also suggested as ways to limit the impact of AT1 reforms on a standardised ADI attaining IRB accreditation.

One submission suggested that the incentives to pursue IRB should be expressed in terms of a reduction in overall capital requirements, rather than lower IRB risk weights. Another submission noted that relatively small changes to capital requirements could materially affect the competitive position of smaller ADIs.

APRA considers it important that the regulatory capital requirements for IRB ADIs align with international minimums. This alignment supports foreign investor confidence and maintains strong credit ratings for advanced ADIs.

However, APRA recognises that the minimum CET1 for IRB ADIs will be super-equivalent to Basel following the removal of AT1 from the prudential framework. This may be an additional consideration for medium-sized ADIs in determining whether to pursue IRB accreditation.

To address these concerns, APRA will take into account the 25 basis points increase in minimum CET1 when calibrating the Pillar 2 adjustment of medium-sized ADIs that are accredited after 1 January 2027.

APRA will discuss the targeted Pillar 2 reduction with individual IRB applicants as part of its commitment to better communicate the basis for its Pillar 2 decisions. Apart from the targeted reduction, IRB accreditation does not automatically result in changes to an ADI’s overall Pillar 2 outcome. APRA retains full discretion to add-on Pillar 2 capital requirements where new or other risks emerge.

Submissions suggested phasing in the additional capital charge for interest rate risk in the banking book (IRRBB), instead of applying it in full on initial IRB accreditation.

One submission also suggested amending APG 113 to be more definitive that the additional CET1 capital requirement would be phased in.

Consistent with the additional flexibility introduced under the new pathway of phasing in IRB costs and benefits progressively, APRA has amended APG 113 to recognise that the IRRBB capital charge would be phased in on a proportional basis.

For ADIs that are approved to adopt a phased roll-out of an IRB approach, APRA has also amended APG 113 to clarify when the additional CET1 capital requirement applies.

APRA considers that the existing proposal provides adequate guidance and principles regarding the allowable scope of permanent partial use. APRA reiterates that permanent partial use should remain limited given the expectation that IRB ADIs generally model all material credit portfolios.

Noting the distinct nature of an individual ADI’s portfolios and issues that determine suitability for IRB modelling, APRA considers it would be appropriate to discuss and provide clarity regarding the scope of IRB bilaterally with the IRB applicant, as part of early engagements.

Minor amendments have been made to APG 113 to provide examples of data challenges that might impede the development of credible models.

Submissions requested guidance on the criteria for quantitative estimates of operational risk to support APRA’s advanced risk and capital management expectations of an IRB ADI.

One submission sought early feedback from APRA on its quantitative approach to manage risks to avoid a negative accreditation outcome late in the process.

APRA has amended APG 113 to provide guidance for IRB applicants on the expectations for operational risk management. Consistent with the requirements under Prudential Standard CPS 230 Operational Risk Management, APRA expects an IRB applicant to apply approaches (that are appropriately sophisticated based on its size, business mix and complexity) in assessing its operational risk profile.

In the planning stage of the accreditation process, APRA will review the ADI’s self-assessment against APRA’s expectations for seeking IRB approval (as outlined in Table 10 of APG 113) and aim to provide timely feedback on the ADI’s proposed pathway to accreditation.

Submissions suggested that APRA provides more definitive feedback in the early stages of IRB accreditation engagement, including feedback on major model components.

Submissions also sought clarification on the one cycle of annual validation and governance processes that needs to be applied to the final IRB models during the application stage of the accreditation process.

In line with the stages of the IRB accreditation process outlined in APG 113, APRA endeavours to provide feedback (as well as further clarification of APRA’s expectations) as promptly as possible.

In the development stage, APRA is open to providing feedback on key model development decisions, such as high-level methodology, definitions and data treatments. APRA would commence detailed model reviews in the pre-application review stage as provided in APG 113.

APRA has amended APG 113 to clarify its expectation that at least one iteration of validation and governance (which need not cover a 12-month period) is applied to final IRB models prior to IRB approval. This should include an independent assessment of early life model performance and/or ratings outcomes.

Submissions suggested describing how a phased roll-out of an IRB approach can be managed, including parallel or overlapping model developments.

Submissions suggested that APRA provide guidance on how it will apply proportionality in supervising medium-sized ADIs that achieve IRB accreditation.

Submissions suggested allowing new IRB ADIs to build capability over time and only consider capital overlays where data gaps or model calibration issues are not justified by the ADI’s risk profile.

Submissions suggested providing the same allowance provided to incumbent IRB ADIs in relation to the concessional treatment for retail exposures to borrowers that have five or more mortgaged properties.

Consistent with APRA’s risk-based approach to supervision, the IRB risk profile of an ADI determines supervision intensity. Where a phased IRB roll-out is pursued, APRA would adopt a pragmatic approach during the transition period to full IRB implementation.

The new pathway provides ADIs with additional time to build capabilities and demonstrate maturity in modelling portfolios in subsequent phases, while realising the capital benefits at each phase of the accreditation process. APRA clarifies that a simpler modelling approach would not necessarily result in capital overlays.

APRA has amended APG 113 to clarify that the concessional treatment may apply to new IRB ADIs as suggested.