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APRA strengthens rules to combat contagion risk within banking groups

Wednesday 28 August 2019

20 August 2019

The Australian Prudential Regulation Authority (APRA) has released a strengthened prudential standard aimed at mitigating contagion risk within banking groups.

The updated Prudential Standard APS 222 Associations with Related Entities (APS 222) will further reduce the risk of problems in one part of a corporate group having a detrimental impact on an authorised deposit-taking institution (ADI).

Deputy Chair John Lonsdale said APRA began consulting last July on proposed changes to APS 222 to incorporate some of the lessons learned from the global financial crisis.

“Concessions in the existing framework led to some ADIs establishing operations in foreign jurisdictions, which are managed and funded within the domestic bank. 

“APRA has only limited visibility of these operations, which also fall outside the purview of foreign regulators. They complicate operating structures and there is no certainty their assets would be available to an ADI if it were to enter resolution. There are currently around 100 such operations within a small number of ADIs.

“Additionally, if an ADI were to fully utilise some of the limits within the existing framework, they would be exposed to excessive levels of contagion risk," Mr Lonsdale said.

APRA received submissions from 10 stakeholders to its consultation; most supported updating the requirements, however some raised concerns about the complexity of implementing certain proposed changes.

Responding to the consultation, APRA confirmed that APS 222 will be updated to include:

  • a broader definition of related entities that includes board directors and substantial shareholders; 
  • revised limits on the extent to which ADIs can be exposed to related entities;
  • minimum requirements for ADIs to assess contagion risk; and
  • removing the eligibility of ADIs’ overseas subsidiaries to be regulated under APRA’s Extended Licensed Entity framework.

Additionally, APRA will require ADIs to regularly assess and report on their exposure to step-in risk – the likelihood that they may need to “step in” to support an entity to which they are not directly related.

Mr Lonsdale said the stronger APS 222 will enhance the prudential safety of ADIs and reinforce financial system stability.

“As we saw during the global financial crisis, deficiencies in governance or internal controls in one part of a corporate group can quickly spread and cause financial or reputational damage to an ADI. Furthermore, complex group structures could potentially make it difficult for APRA to resolve an ADI quickly and protect depositors’ savings in the unlikely event of a bank failure. 

“By updating and strengthening the requirements of APS 222, APRA will ensure ADIs are better able to monitor, manage and control contagion risk within their organisations.

“While aspects of the revised standard will have a material impact on some ADIs, we have adjusted our original proposals in some areas to make the requirements less burdensome. We are open to considering appropriate transition arrangements on a case-by-case basis where specific entities request it,” Mr Lonsdale said.

The new APS 222 will come into effect from 1 January 2021.

Copies of APRA’s Response Paper, the updated prudential standard and reporting standards are available at Revisions to the related parties framework for authorised deposit-taking institutions.

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, private health insurers, friendly societies, and most members of the superannuation industry. APRA currently supervises institutions holding $6 trillion in assets for Australian depositors, policyholders and superannuation fund members.