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About this guide
Prudential practice guides (PPGs) provide guidance on APRA’s view of sound practice in particular areas. PPGs frequently discuss legal requirements from legislation, regulations, or APRA’s prudential standards, but do not themselves create enforceable requirements.
Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112) sets out APRA’s requirements for an authorised deposit-taking institution (ADI) in relation to the measurement of credit risk for regulatory capital purposes.
This PPG, Prudential Practice Guide APG 112 Capital Adequacy: Standardised Approach to Credit Risk (APG 112), aims to assist ADIs in complying with those requirements and, more generally, to outline prudent practices in relation to the management and measurement of credit risk. APG 112 should be read in conjunction with other relevant prudential standards and PPGs.
For capital, the relevant standards and guides include:
For risk management, the relevant standards and guides include:
Subject to the requirements of APS 112, an ADI has the flexibility to structure its business operations in the way most suited to achieving its strategic objectives. Not all practices outlined in this PPG will be relevant for every ADI and some aspects may vary depending upon the size, business mix and complexity of the entity’s operations.
Disclaimer and copyright
While APRA endeavours to ensure the quality of this publication, it does not accept any responsibility for the accuracy, completeness or currency of the material included in this publication and will not be liable for any loss or damage arising out of any use of, or reliance on, this publication.
© Australian Prudential Regulation Authority (APRA)
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Glossary
ADC | Land acquisition, development and construction |
ADI | Authorised deposit-taking institution, as defined in the Banking Act 1959. |
Basel Committee | Basel Committee on Banking Supervision |
Board | Board of directors |
Credit conversion factor (CCF) | A factor that converts an off-balance sheet exposure into an on-balance sheet equivalent. |
Credit risk mitigation (CRM) | A credit risk mitigation technique that meets the relevant requirements of APS 112. |
Default | Non-performing as defined in APS 220. |
Loan-to-valuation ratio (LVR) | The ratio of the amount of the loan outstanding to the value of the property securing the loan. |
Risk-weighted assets (RWA) | Determined in accordance with the relevant requirements of APS 112. |
SFI | Significant financial institution, as defined in APS 001. |
SME | Small- and medium-sized enterprise |
Introduction
APS 112 sets out the capital requirements for credit risk under the standardised approach. It sets out the requirements for classifying different types of credit exposure and prescribes specific risk weights to apply to these exposures in calculating capital requirements.
An ADI must determine capital requirements by calculating its total risk-weighted assets (RWA). As shown in Figure 1, total RWA includes on-balance sheet and offbalance sheet credit risk exposures, as well as RWA for other risks. For credit risk, under the standardised approach, RWA are the product of an exposure amount multiplied by an APRA-prescribed risk weight.
Figure 1. Standardised RWA calculation under APS 110
Under APS 110, the minimum CET1 capital requirement is calculated as 4.5 per cent multiplied by RWA, where RWA is determined as per Figure 1.
Under APS 112, an ADI must establish and implement effective internal policies, processes, systems and controls to ensure that the risk weights assigned to its credit exposures align with the classifications in the prudential standard.
This PPG sets out good practice for an ADI in measuring capital required to be held for credit risk exposures. It provides guidance on applying the requirements of APS 112 to property and non-property asset classes, off-balance sheet commitments, external credit ratings and credit risk mitigation (CRM). It also includes worked examples on how to classify exposures into the appropriate asset class.
Chapter 1 - Property exposures
Risk weights for property exposures are determined based on the type of loan - residential property, commercial property or land acquisition, development and construction (ADC) – and whether the exposure is classified as either a standard or non-standard loan. These are summarised in Table 1 below.