APRA transitional prudential standards (Cth)
APRA transitional prudential standards
as at 1 July 1999
APRA transitional prudential standards
Regulation 12 and Schedule 1 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
This instrument is a collection of the provisions that, on 1 July 1999, became APRA transitional prudential standards by operation of regulation 12 of the Financial Sector (Amendments and Transitional Provisions) Regulations 1999.
Prepared by the Australian Prudential Regulation Authority
Table of Contents
Book 3 of the Prudential Notes and Prudential Standards issued by AFIC
Prudential Note 3.1
Prudential Standards 3.1.1 to 3.1.6
Prudential Note 3.2
Prudential Standards 3.2.1 to 3.2.7
Prudential Notes 3.3B and 3.3C
Paragraphs 3.3.2a and 3.3.2b of Prudential Standard 3.3.2
Prudential Standard 3.3.5, other than subparagraph 3.3.5a(ii)
Prudential Standard 3.3.6
Prudential Notes 3.4A, 3.4C and 3.4E
Prudential Standards 3.4.1, 3.4.3 and 3.4.5
Prudential Note 3.6
Prudential Standards 3.6.1 to 3.6.7
Prudential Note 3.7
Prudential Standards 3.7.1 to 3.7.7
Book 4 of the Prudential Notes and Prudential Standards issued by AFIC
Prudential Note 4.1
Prudential Standards 4.1.1 to 4.1.6
Prudential Note 4.2
Prudential Standards 4.2.1 to 4.2.8
Prudential Notes 4.3B and 4.3C
Paragraphs 4.3.2a and 4.3.2b of Prudential Standard 4.3.2
Prudential Standard 4.3.5, other than subparagraph 4.3.5a(ii)
Prudential Standard 4.3.6
Prudential Notes 4.4A, 4.4B and 4.4D
Prudential Standards 4.4.1, 4.4.2 and 4.4.4
Prudential Note 4.6
Prudential Standards 4.6.1 to 4.6.7
Prudential Note 4.7
Prudential Standards 4.7.1 to 4.7.7
Book 5 of the Prudential Notes and Prudential Standards issued by AFIC
Prudential Note 5.1
Prudential Standards 5.1, 5.1.1, 5.1.2 and 5.1.3
Prudential Standards 5.1.4 and 5.1.5
Prudential Note 5.2
Prudential Standards 5.2.1 to 5.2.9
Prudential Notes 5.3B and 5.3C
Prudential Standard 5.3.5, other than subparagraph 5.3.5a(iii)
Prudential Standard 5.3.6
Prudential Notes 5.4A, 5.4C, 5.4D, 5.4E, 5.4F and 5.4H
Prudential Standards 5.4.1, 5.4.3, 5.4.4, 5.4.5, 5.4.6 and 5.4.8
Prudential Note 5.5
Prudential Standards 5.5.1 to 5.5.8
Attachment B to the Prudential Notes and Prudential Standards issued by AFIC
Subsections 237(2), and 245(1) to (3) (inclusive), of a Financial Institutions Code
Provisions of Book 3 of the Prudential Notes and Prudential Standards issued by AFIC under Part 4 of an AFIC Code, as in force immediately before the transfer date
Note: see paragraph 1 of Schedule 1 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Prudential Note 3.1
Note: see subparagraph 1(a) of Schedule 1 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Prudential Note 3.1 – Building Societies
Risk Management
Objective
To protect and promote the financial integrity and efficiency of the State-based financial institutions system and to ensure that depositors are adequately protected from the risks that building societies incur in the process of financial intermediation. Towards this end, to ensure that societies are aware of the risks to which they are exposed, and that these risks are adequately measured, monitored and managed.
General Background
Pooling and managing risks for both borrowers and lenders is an important element of financial intermediation. Careful management of these risks is fundamental to the successful operation of any financial institution. As noted earlier, the primary responsibility for risk management rests firmly with the management of each society; the role of the supervisory authorities is limited to protecting the interests of depositors. Depositor protection, in turn, is enhanced by ensuring that societies approach risk management in a consistent manner and that they maintain a sufficient cushion of capital to afford depositors maximum confidence in the security of their deposits.
In assessing the appropriate level of capital, SSAs will require detailed information about the risk management procedures and practices of building societies. Inadequate management practices in this area will meet with additional requirements in terms of capital or, in certain cases, with additional requirements with respect to the holding of liquid assets.
While there will be no set formula relating the need for additional capital to particular deficiencies in risk management, SSAs will look for adequate procedures for identifying and measuring risk, adequate procedures for monitoring risks, and appropriate techniques for managing risks.
Additional capital will also be required of societies in direct proportion to their overall risk rating when these ratings imply risk in excess of industry norms. SSAs will advise building societies as to their risk ratings and capital requirements.
In a number of cases, the Prudential Standards require a society to consult with its SSA before particular transactions or activities can be undertaken. Consultation in this context will focus on the society's ability and systems to manage their risks prudently; the emphasis will be on processes rather than on the quality or otherwise of the decisions involved. Such consultation should not be taken to imply that the SSA in any sense sanctions or approves the particular activity. Decisions about the appropriate balance sheet structure for a particular society are its own responsibility. The SSA's role is to ensure that risk analyses are adequate and that each society's capital base is consistent with the risks that it undertakes.
Notwithstanding this responsibility, each building society must, prior to the assumption of any major new risks (for example, borrowing in foreign currency or moving into a new area of lending) first satisfy its SSA that it has:
(a) met all current prudential standards;
(b) the expertise and systems in place to manage the new risks involved; and
(c) sufficient capital in place to meet any additional requirements imposed by the authorities - this may include additional capital requirements if the proposed lending activities alter the assessed risk rating of the society as a whole.
Limited exemptions from this requirement may be granted under the transitional arrangements outlined earlier.
Specific Risks
Building societies face a number of different types of risk in conducting their businesses.
(i) Liquidity Risk - Prime Liquid Assets (PLA) Requirement
Liquidity risk arises from the tendency for a society's deposit base to be more readily liquidated than its assets. This is partly a consequence of the longer maturity of loans relative to deposits. It is also a consequence of the fact that loans which are not in arrears are not normally callable, whereas term deposits are often callable, albeit at a penalty. Despite this asymmetry in balance sheet liquidity, the capacity to meet promptly all obligations as they fall due is fundamental to financial intermediation.
The prudential standards require societies to hold a minimum level of 7 per cent of their total liabilities (excluding capital) in the form of highly-liquid, high-quality assets. This PLA ratio is to be met at all times. In day-to-day operations, however, these assets are not available to meet the ebb and flow of funds. They are intended only to provide a cushion of liquefiable funds, available in times of extreme pressure on liquidity, and then, only with the explicit approval of the SSAs.
(ii) Operational Liquidity Risk
While PLA provides a stock of high quality assets, each society must manage its cash flows without reliance on PLA. It is the responsibility of the board to assess its society's liquidity needs and determine the amount and composition of additional liquid assets required to cover day-to-day fluctuations in its operating liquidity arising from:
· withdrawals of deposits;
· increases in demands for loans, including increased drawdown of overdraft facilities;
· drawdown of credit card facilities;
· maturity mismatch of assets and liabilities; and
· unexpected operating expenses.
Each society is expected to have in place an appropriate management information system to allow monitoring and management of liquidity risk. Each society is also required to demonstrate an understanding of its deposit base (including strengths, limitations and historic volatility), the maturity mismatch between assets and liabilities and any risks arising from off-balance sheet activities. While cash flow projections, incorporating all significant cash flows and management of forward loan commitments, should form part of any liquidity management system, the sophistication of these systems will depend on the society's activities.
A society can pursue a range of strategies to manage liquidity risk including:
· holding adequate cash and readily liquefiable assets in addition to PLA;
· maintaining stand-by and overdraft facilities with banks, SSPs or other counterparties acceptable to AFIC;
· developing and maintaining a stable core of deposits;
· matching maturity structures of assets and liabilities, securitising assets and sourcing long-term funding; and
· developing sophisticated cash flow projections including improving asset and liability management.
In relation to the first point, each society is expected to hold 2 per cent of total liabilities (excluding capital) in one or more of the following: excess PLA, cash, funds securing settlement accounts and liquidity deposits with SSPs.
In determining liquidity needs, a society's board should aim at maintaining access to funds for the purpose of meeting operational demands at 6 per cent of total liabilities (less capital). Access to funds may be through off-balance sheet facilities and generally, each society is expected to look beyond its immediate deposit base to alternative sources of liquidity. These alternative sources include stand-by lines of credit or overdraft facilities with other financial institutions, including SSPs. Evidence that these arrangements have been firmly established and are available for immediate use will be required by SSAs.
To ensure that each SSA is aware of any weakening of a society's liquidity position, each society must advise its SSA if on-balance sheet liquid assets held to meet operating requirements falls below 2 per cent of total liabilities (excluding capital). Deviations below this liquidity trigger may occur from time to time and are not necessarily a source of concern.
Liquidity risk is also associated with large exposures to a single source of funds. Each society must include in its approach to liquidity management, a policy in respect of large liquidity exposures. Further, each society must report exposures in excess of 5 per cent of the society's total liabilities and, before a society accepts an exposure in excess of 10 per cent of total liabilities, it must consult with its SSA.
In reviewing a society's approach to liquidity management, the SSA may consider that the large liability exposure, or exposures in aggregate, create the potential risk for a society's liquidity to be strained or may consider that systems are otherwise inadequate. Under these circumstances, the SSA may require the society to hold higher levels of PLA or operational liquidity, report more frequently, or impose other requirements.
(iii) Market Risk
Market risk arises from the fluctuations that occur in the market values of assets and liabilities in the normal course of business. The primary source of such fluctuations is movements in interest rates. When interest rates change, the market values of loans, securities and deposits change to different extents. Whenever the interest rates paid on a financial institution’s liabilities do not adjust in line with the rates earned on assets, the institution is exposed to market risk. The net effect of these valuation changes alters the institution’s earnings and its net worth.
Financial innovations have provided building societies with a range of techniques for managing this risk. To the extent that deposits and loans are matched, either as variable interest instruments or, in the case of fixed-interest loans and deposits, by duration, the risk may be relatively small. Where a society’s book is not naturally matched in the above sense or not readily adjustable, the market provides instruments for managing the mismatch, while still meeting customer preferences on the terms of loans and deposits. Interest rate futures, options and swaps are now widely used in the finance industry to manage market risk. Sections 120 and 121 of the FI Code outline the scope for societies to trade in these instruments for the purpose of managing market risk.
SSAs will seek detailed information about each society's methods for measuring and monitoring market exposures. In particular, where assets do not satisfy either the primary objects or the liquid asset tests, SSAs will look for evidence that societies are employing appropriate risk management techniques, including regular market value assessments and appropriate provisioning for risks (see Prudential Note 3.3 on Accounting and Disclosure).
Where a society proposes to engage in the raising of funds denominated in foreign currency, its SSA will require, in advance, details of the proposed methodology for hedging the exposure.
(iv) Credit Risk
A primary source of risk for any financial institution is the risk of default. Undue concentration of loans can expose a society to excessive credit risk. Sensible diversification of a society's loan book by geographical area, type of borrower and to some extent by type of loan can reduce the risk of the overall loan portfolio.
SSAs will seek detailed information about each society's practices with respect to credit scoring, loan monitoring and the overall assessment of credit risk. Societies should be able to demonstrate an understanding of the inter-relationships between the various credit risks they are carrying. SSAs will pay special attention to credit risk policies relating to assets which lie outside the definitions of primary objects and liquid assets.
In particular, societies inevitably carry a substantial fixed asset exposure to property through their branch network systems. In the normal course of business this exposure should not exceed the size of the society's capital base. Exposure beyond this level will require prior consultation with its SSA.
A particular source of credit risk is large credit exposures to single borrowers. Large exposures can accumulate indirectly through lending to associated borrowers even though the exposure to any one member of the group may appear reasonable. While "associate" has been defined under Part 4 of the FI Code, the existence of these relationships may not represent any aggregation of risk (for example, where loans to associated family members are separately collateralised). It is recognised that a number of these relationships cannot be identified from data collected in the normal course of opening and operating accounts. Therefore, building societies will not be expected to monitor large exposures to groups of associated family members who have independent retail relationships with the building society. In the case of commercial lending, borrowers will be assumed to be associated where they collectively control the source of credit risk to the society.
Each society will be required to provide its SSA with a copy of its policy in respect of large exposures and to report exposures to individual borrowers or groups of associated borrowers in excess of 5 per cent of the society's capital base. These exposures are to be measured in terms of exposures to the consolidated group where relevant. Exposures beyond 10 per cent of a society's capital base will require prior consultation with its SSA. Certain exemptions may be permitted with respect to lending within primary objects. Further exemptions and general approvals may be granted by SSAs in the light of experience.
(v) Data Risk
A risk to any building society relates to the security and integrity of its data bases, both automated and non-automated. Detailed records of all financial transactions and balance sheet data should be kept in more than one location. Where records are computerised, back-up and storage procedures should be documented by the society and audited, as should procedures for preventing data corruption. Adequate disaster recovery procedures should be in place.
A particular risk to a society’s data exists due to the potential for damage to or misuse of date-related data, caused by the use of computer programs or code that fail to calculate correctly or record dates after a particular date. This is commonly referred to as the "Year 2000 problem" because many computer and other electronic systems cannot deal with dates after 31 December 1999. However, the problem is not confined to the year 2000 and could arise through a range of other critical dates that might be embedded in computer systems. For convenience, AFIC is referring to this matter as the "Year 2000 problem".
To ensure the security and integrity of a society’s data, the Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to using or storing the society’s data, must be corrected. Directors must:
- ensure that appropriate tests are carried out to ascertain that any critical computerised systems using or storing the society’s data are not affected by the Year 2000 problem; and
- obtain sufficient assurance that the society’s systems and dates will not be significantly affected by inaccurate data or failure of services by its suppliers.
It may not be possible for every internal and external system to be corrected in the short time available before the year 2000, or any other critical date, arrives. Therefore, in anticipation of possible failures, each society must have a comprehensive written statement dealing with the risks and events that may arise due to either the society or an external service provider suffering disruptions that may, in turn, disrupt the society’s normal business operations. These policies and procedures should form part of a society’s Disaster Recovery Plan in respect of managing both data risk and operations risk.
(vi) Operations Risk
Building societies carry a range of operations risk in carrying out their day-to-day business. Many of these risks are insurable, others are not. Of particular importance in the latter category are societies' administrative systems and the consequences of breaches of legislation. In smaller societies, overdependance on a small number of key personnel can constitute a substantial risk to their operations. Other risks arise from litigation associated with a wide variety of possible events and actions, including discrimination, negligent advice and invasion of privacy. Whether or not these risks are insured or even insurable, societies must demonstrate an understanding of the risks involved and the capacity to measure, monitor and control them.
A particular risk to a society’s operations exists due to the Year 2000 problem. Societies are faced with the potential for impairment of normal business operations through the failure of systems dependent on computer microchips, such as communications, security, and fire protection systems.
To ensure the society’s operations risk is minimised, the Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to the society’s normal business operations must be corrected. Directors must ensure that appropriate tests are carried out to ascertain that any critical computerised systems and devices required for the society’s day-to-day operations are not affected by the Year 2000 problem.
A society must keep its insurance contracts under review to ascertain whether it is covered for interruptions to business and possible litigation, due to non-performance or disruption to business, as a result of the Year 2000 problem.
The costs and resource requirements to address the Year 2000 problem may be beyond the scope of some societies. Where directors are of the opinion that the society will be unable to address the Year 2000 problems adequately, with regard to its critical systems, the society should immediately notify its SSA. The SSA, together with the society, will then consider the appropriate action to be taken to ensure that the interests of the society’s members are not adversely affected by the society’s inability to manage Year 2000 problems adequately.
An important source of insurable operations risk arises from potential damage to the physical assets of the society through accident or fire. While compulsory worker's compensation covers potential loss through accidents involving staff, there is a similar risk to members of the public that is not automatically insured. Other operational risks arise from the potential for legal action against the society or its directors.
In addition to compulsory worker's compensation, all building societies should carry effective insurance with a reputable insurance company to protect their personnel, operations and physical assets. At a minimum, each society should carry the following insurance policies:
(a) fidelity guarantee;
(b) asset protection, including fire and malicious damage;
(c) directors' and officers' liability;
(d) public liability;
(e) professional indemnity; and
(f) loss of profits associated with specified events.
Insurance should cover the society and all subsidiaries (if any). SSAs will seek details of insurance policies and each society's approach to insurance.
Prudential Standards 3.1.1 to 3.1.6 (inclusive)
Note: see subparagraph 1(b) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
3.1.1 Prime Liquid Assets Requirement
3.1.1.a Each building society is to maintain at all times a minimum proportion of its balance sheet in specified prime liquid assets. The required PLA ratio is to be 7 per cent of total liabilities excluding capital as defined in Prudential Note 3.2 (Capital Adequacy).
3.1.1.b The PLA ratio is to be met at all times. If a society finds itself in danger of breaching the minimum ratio, it must advise its SSA immediately and, in consultation with the SSA, take prompt action to correct the situation.
3.1.1.c To be eligible for inclusion in the PLA ratio, assets must be held in the society's own name, must be unencumbered by any pledge or restriction (other than restrictions arising from the emergency liquidity support facility) and must be readily negotiable.
3.1.1.d Assets deemed acceptable by AFIC for inclusion in the PLA ratio may change from time to time as circumstances and asset quality change. Until notice of alteration, PLA will include the following:
(i) Treasury notes;
(ii) other Commonwealth Government securities;
(iii) bank deposits and bank accepted and endorsed bills;
(iv) loans to authorised money market dealers against the security of Commonwealth Government securities;
(v) State or Territory Government issued or guaranteed securities; and
(vi) PLA deposits with special services providers (see Book 1).
3.1.1.e Given the potential for the liquidation value of some PLA to vary with market conditions, assets will be valued at market value for the purpose of calculating the PLA ratio.
3.1.1.f Societies must hold half of their required PLA assets in a manner that can be immediately accessed under the emergency liquidity support facility outlined in Part 6 of the AFIC Code (see also Prudential Standard 3.4.6).
3.1.2 Operational Liquidity
3.1.2.a Each society is to provide its SSA, on request, with a written description of its systems to measure, monitor and manage liquidity risk. These systems are to be audited annually by the society's external auditors and their operation in practice will be subject to review during on-site inspections by the SSA.
3.1.2.b It is the responsibility of each board to determine the liquidity needs and normal liquidity operating range of its society, and the associated composition and liquidity of assets to be held. Notwithstanding, each society should aim to maintain access to funds to meet operational demands at 6 per cent or more of total liabilities (less capital) with a minimum component of on-balance sheet assets of 2 per cent of total liabilities (less capital). As part of its liquidity management, each society must also satisfy its SSA that it has access to appropriate levels of funding through off-balance sheet facilities, provided by banks, SSPs or other entities advised by AFIC.
3.1.2.c Unless otherwise advised by Standard or Guidance Note, assets that may be included in on-balance sheet operational liquidity are:
(i) cash on hand;
(ii) PLA in excess of the required minimum;
(iii) funds securing settlement accounts; and
(iv) liquidity deposits with Special Services Providers.
3.1.2.d A society must advise its SSA if the level of on-balance sheet operational liquidity falls below 2 per cent of total liabilities (less capital).
3.1.2.e As part of its liquidity management system, each society must include a policy in respect of large liability exposures to individual lenders or a group of associated lenders. Each society must report quarterly liability exposures in excess of 5 per cent and must consult with its SSA prior to acceptance of a liability greater than 10 per cent of the society's total liabilities. The onus will be on the society to establish that the liability exposure does not constitute an excessive risk to the society.
3.1.2.f A society that fails to satisfy its SSA that it adequately manages its cash flows and operational liquidity may be directed to hold higher levels of liquid assets, maintain higher levels of capital, report more frequently or otherwise as determined by the SSA.
3.1.3 Managing Market Risk
3.1.3.a Each society is to provide its SSA, on request, with a written description of its systems to measure, monitor and control market risk. These systems are to be audited annually by the society's external auditors. Their operation in practice is subject to review during on-site inspections by the SSA.
3.1.3.b Failure by a society to satisfy its SSA that its practices are adequate to the risks involved may lead to its being required to maintain a capital adequacy ratio above the 8 per cent minimum.
3.1.3.c It is a requirement of the FI Code (Section 121) that any funds raised in foreign currency must be hedged so as to minimise the risk of loss. Before a society raises liabilities in foreign currency, it must first satisfy its SSA that it has the capacity to hedge the currency exposure.
3.1.4 Managing Credit Risk and Large Exposures
3.1.4.a Each society is to provide its SSA, on request, with a written description of its systems to measure, monitor and control credit risk. These systems are to be audited annually by the society's external auditors. Their operation in practice is subject to review during on-site inspections by its SSA.
3.1.4.b Each society is to include in this description a written statement of its policy with respect to acquiring assets not defined within primary objects or liquid assets.
3.1.4.c In the normal course of business, a society's exposure to its own fixed assets should not exceed the size of the society's capital base. Exposure beyond this level will require prior consultation with its SSA.
3.1.4.d Each society is to provide its SSA, on request, with a written statement of its policy in respect of exposures to individual members or groups of associated members. Associated members are defined on the basis of control.
3.1.4.e Each society must provide quarterly a return of all exposures of the consolidated group to individual borrowers and/or associated borrowers greater than 5 per cent of its capital base (as defined in Prudential Note 3.2). The intention of this Prudential Standard is to identify concentration of risks. SSAs will declare borrowers to be 'associated' if there is any suggestion of intent to disguise concentration.
3.1.4.f Before entering into any such exposure greater than 10 per cent of a society's capital base (or, in the case of a group, 10 per cent of the group's capital base), the society must first consult with its SSA. The onus will be on the society to establish that the exposure does not constitute an excessive risk. Lending within primary objects may be exempted from this process if, after examining the society's residential lending policies, the SSA is satisfied that they do not introduce excessive risk.
3.1.4.g Failure by a society to satisfy its SSA that its practices are adequate to the risks involved may lead to its being required to maintain a capital ratio above the 8 per cent minimum.
3.1.5 Data Risk
3.1.5.a Each society is to provide its SSA, on request, with a written statement of its policy in respect of managing data risk. Detailed records of all financial transactions and balance sheet data should be kept in more than one location. Where records are computerised, back-up and storage procedures should be documented by the society and inspected by the relevant SSA, as should procedures for preventing data corruption.
3.1.5.b The Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to using or storing the society’s data, must be corrected. Directors must:
- ensure that full testing is carried out to ascertain that any critical systems for using or storing the society’s data are not affected by the Year 2000 problem; and
- obtain sufficient assurance that the society’s systems and dates will not be significantly affected by inaccurate data or failure of services by its suppliers.
3.1.5.c Each society must have a comprehensive written statement dealing with the risks and events that may arise due to either the society or an external service provider suffering disruptions that may, in turn, disrupt the society’s normal business operations. These policies and procedures should form part of a society’s Disaster Recovery Plan in respect of managing both data risk and operations risk.
3.1.6 Operations Risks
3.1.6.a Each society is to provide its SSA annually with a written statement of its policy in respect of disaster recovery planning and insurance including details of its individual insurance policies. SSAs will monitor the adequacy and currency of these policies. At a minimum, societies should take out the following insurance cover:
(i) Fidelity/Bond Insurance
(ii) Fire and Specified Perils
Physical loss or damage to tangible property due to fire and specified perils including:
• storm and tempest;
• earthquake;
• explosion;
• impact;
• water damage;
• malicious damage;
• riots; and
• strikes.
(iii) Directors' and Officers' Liability
(iv) Public Liability
To cover the society's legal liability for bodily injury or damage to property anywhere in Australia or on society business overseas.
(v) Professional Indemnity
To cover legal liability to members and third parties through a breach of professional duty in the conduct of the society's business, by reason of any negligence, including:
• libel and slander;
• amendment of dishonesty clause;
• retroactive cover;
• automatic reinstatement; and
• breaches of Trade Practices/Fair Trading Acts.
(vi) Business Interruption
To cover loss of income or increased cost of working due to interrupted business operations as a result of an insured peril.
3.1.6.b Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to the society’s normal business operations must be corrected. Directors must ensure that full testing is carried out to ascertain that any critical computerised systems and devices required for the society’s day-to-day operations are not affected by the Year 2000 problem.
3.1.6.c A society must keep its insurance contracts under review to ascertain whether it is covered for interruptions to business and possible litigation, due to non-performance or disruption to business, as a result of the Year 2000 problem.
3.1.6.d Where directors are of the opinion that the society will be unable to address the Year 2000 problems adequately, with regard to its critical systems, the society should immediately notify its SSA.
Prudential Note 3.2
Note: see subparagraph 1(c) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Prudential Note 3.2 – Building Societies
Capital Adequacy
Objective
To protect and promote the financial integrity and efficiency of the State-based financial institutions scheme and to ensure that depositors are adequately protected from the risks that building societies incur in the process of financial intermediation. Towards this end, to ensure that individual societies maintain a level of capital which broadly reflects the extent of risks undertaken.
General Background
The primary role of capital in a deposit-taking institution is to provide a cushion against loss and to maintain the confidence of its depositors. While effective management systems can reduce the risk to depositors' funds, they are unlikely to eliminate risk entirely, given that risk pooling is a fundamental element of financial intermediation. Societies, therefore, must hold capital against a range of risks, including the loss of capital value of assets as a result of credit risk, a competitive squeeze on margins, mismatching of the characteristics of assets and liabilities, off-balance sheet exposures and concentration of particular types of assets or liabilities.
Framework
AFIC's approach to capital adequacy has three elements - capital adequacy ratio of individual institutions, quality and structure of capital and credit risk of assets.
Risk weightings focus on credit risk of assets. However, the SSA will look beyond the asset portfolio in reviewing a society and setting capital adequacy requirements. The SSA will determine a 'risk ratio' for each society that is consistent with its overall assessed risk rating. Under this approach, the level of capital required to support the risk-weighted assets of any society may increase (from a base of 8 per cent) as the overall riskiness of the society increases.
Capital is considered in two tiers. Tier 1 (or 'core capital') comprises the highest quality capital elements. Tier 2 (or 'supplementary capital') represents additional elements, including some forms of hybrid capital that contribute to the overall strength of the society as a going concern (see Prudential Standards 3.2.1 and 3.2.2). At least 50 per cent of a building society's required capital must be core capital (Tier 1); the remainder may consist of 'supplementary' elements (Tier 2).
Tier 2 capital is further qualified as Upper and Lower Tier 2 capital. Upper Tier 2 capital includes elements that are essentially permanent in nature and have characteristics of both equity and debt. Lower Tier 2 capital consists of elements that are not permanent. The value of Lower Tier 2 capital that may be included in the capital adequacy calculation cannot exceed 50 per cent of Tier 1 capital (net of goodwill, other intangible assets and future income tax benefits).
It is not appropriate that the capital of a building society be used to support the balance sheet of another building society or credit union as this could raise doubts about the adequacy of capital available to support the industries. Therefore, for the purposes of calculating capital adequacy, a society must deduct from its total capital (and assets) the carrying value of any holding of capital instruments of another building society or credit union.
Similarly, consistent with the requirements of Prudential Notes 3.6 and 3.7, a society must deduct any equity investment in a securitisation or funds management vehicle (that includes a subsidiary that acts as an approved trustee under the SIS legislation) and any subsidiary that is active in these areas of business as a manager, custodian, trustee or similar role. The deduction must be for the maximum amount of capital that may be required to be committed to the entity. This includes any guarantee that acts as a substitute for capital that would otherwise need to be provided and any uncalled amount on partly paid shares.
Consistent with the approach adopted by banking supervisors around the world, assets are risk-weighted to reflect the differing capital needs to support different types of lending activity. The focus in risk weighting is on credit risk, namely the potential for default by the borrower or counterparty and the associated potential loss. Credit risk focuses primarily on the financial strength of the borrower. However, where collateral is involved, this may have a major bearing on the extent of potential loss.
Balance sheet assets and off-balance sheet exposures are weighted according to broad categories of relative risk, based largely on the nature of the counterparty. The higher the risk, the greater the capital backing required. The sum of risk-weighted assets (including risk-assessed off-balance sheet business) together with the society's 'risk ratio' defines the amount of capital needed to support its lending activity.
Credit exposures (on and off-balance sheet) are risk weighted according to three broad types of counter party - government, banks and FI Scheme institutions, and all others. There are five specific categories of risk weights - 0, 10, 20, 50, and 100 per cent (see Prudential Standard 3.2.4). Off-balance sheet transactions (including derivative products) are converted to balance sheet equivalents before being allocated a risk weight.
Prudential Standards 3.2.1 to 3.2.7 (inclusive)
Note: see subparagraph 1(d) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
3.2.1 Capital Adequacy
3.2.1.a Each building society and consolidated building society group is required to maintain at all times a minimum ratio of capital to risk-weighted assets of 8 per cent (or more for an individual society as determined from time to time by its SSA).
3.2.1.b Capital will be considered in two tiers:
• Tier 1 (or 'core capital') comprises the highest quality capital elements (defined in Prudential Standard 3.2.2.a).
• Tier 2 (or 'supplementary capital') represents additional elements (defined in Prudential Standard 3.2.2.b) that contribute to the overall strength of the society.
3.2.1.c At least 50 per cent of a building society's required capital must be core capital (Tier 1); the remainder may consist of 'supplementary' elements (Tier 2).
3.2.2 Definition of Capital
3.2.2.a Core Capital (Tier 1)1,2
• Paid up permanent share capital.
• Non-repayable share premium account.
• General reserves.
• Retained earnings.3
• Non-cumulative irredeemable preference shares.4
• Minority interests in subsidiaries that are consistent with the above Tier1 components.
3.2.2.b Supplementary Capital (Tier 2)5
UPPER
• General provisions for doubtful debts.6
• Asset revaluation reserves.7
• Cumulative irredeemable preference shares.8
• Mandatory convertible notes and similar capital instruments.8
• Perpetual subordinated debt. 8
LOWER9
• Term subordinated debt and limited life redeemable preference shares.
Any instrument or issue of subordinated debt or limited life redeemable preference shares by a building society must be approved by the SSA, in consultation with AFIC, before the instrument may qualify for treatment as Tier 2 capital. Relevant documentation will be examined by the supervisors with particular regard to the provisions by which the instrument is subordinated to the claims of other creditors and the events or circumstances which may accelerate payment of interest and/or repayment of principal ("events of default").
As a precondition for qualification of subordinated debt as Tier 2 capital the subordinated debt instrument or other relevant documentation governing the terms of issue must, unless otherwise agreed in writing by AFIC, preclude the subordinated debt holder (and any agent, trustee or other person acting on behalf of the holder) from enforcing rights to accelerate payments or repayments in consequence of events of default except by instituting proceedings (or joining in proceedings) for the winding up of the society pursuant to the Financial Institutions Code.
The review by supervisors of terms and conditions of instruments for inclusion in Tier 2 capital will give close regard to step up rates, conditions for conversions, deferral of interest and other payments, options to repay and early repayment.
3.2.3 Hybrid (Debt/Equity) Capital Instruments
3.2.3.a A range of instruments that combine characteristics of equity capital and of debt may be included in upper Tier 2 capital. To qualify for inclusion in the capital base they must be:
(i) unsecured, subordinated and fully paid-up;
(ii) not redeemable at the initiative of the holder or without the prior consent of the SSA; and
(iii) available to participate in losses without the building society being obliged to cease trading (unlike conventional subordinated debt).
3.2.3.b Although these instruments may carry an obligation to pay interest that cannot permanently be reduced or waived (unlike dividends on ordinary shareholders' equity), they should allow servicing obligations to be deferred (as with cumulative preference shares) where profitability would not justify payment. For example, where payment of interest would result in the society’s non-compliance with capital adequacy requirements.
3.2.3.c As with term subordinated debt an instrument or issue of hybrid capital by a building society must be approved by its SSA in consultation with AFIC before it may qualify for inclusion as Tier 2 capital.
3.2.4 Categories of Risk
3.2.4.a Nil Weight:
• notes and coin;
• overnight settlements, loans and other claims fully secured10 against cash;
• Commonwealth, State or Territory Government securities, including securities issued by State or Territory central borrowing authorities; and
• claims fully secured against Commonwealth, State10 or Territory Government securities.
3.2.4.b 10 per cent Weight:
• all other claims on, or guaranteed 11by, Commonwealth or State or Territory Governments.
3.2.4.c 20 per cent Weight:
• liquidity deposits with special services providers (see Book 5);
• claims on Australian local governments or public sector entities (except those which have corporate status or operate on a commercial basis) or which are guaranteed by these entities;
• claims on, or guaranteed by, Australian or OECD banks;
• claims on, or guaranteed by, building societies, credit unions or SSPs;
• claims on, or guaranteed by, international banking agencies or regional development banks; and
• cash items in the process of collection.
3.2.4.d 50 per cent Weight:
• loans12 for housing or other purposes, fully secured by registered mortgage over a residential building or development (as defined in Section 3 of the FI Code) where, the mortgage falls within one of the following categories:
(i) a first registered mortgage where the ratio of the outstanding balance13 of the loan14 to the valuation of the property is no more than 80 per cent.15 If the loan is 6 months or more in arrears, the valuation must be no older than 12 months;
(ii) a first registered mortgage where the outstanding balance is 100 per cent mortgage insured.16
(iii) a second mortgage where the ratio of the outstanding balances of the loans secured by both mortgages to the valuation of the property does not exceed 80 per cent and the first mortgage cannot be extended without it being subordinated to the second mortgage;
(iv) a second mortgage where the ratio of the outstanding balances of the loans secured by both mortgages to the valuation of the property exceeds 80 per cent, where the first mortgage cannot be extended without it being subordinated to the second mortgage and the outstanding balance is 100 per cent mortgage insured.16
Elsewhere in the standards, mortgages satisfying any one of the conditions i) - iv) above will be referred to as 'qualifying' mortgages.
The 50 per cent risk weight applies to loans for housing, or for other purposes, fully secured by a registered mortgage over residential property (whether or not the property is owned by the borrower) subject to the following criteria being satisfied:
• the building society has at all times a clear and unequivocal access to mortgaged residential properties in the event of default by borrowers;
• the building society has been involved directly in making credit assessments of individual borrowers, including the valuations of the associated residential properties secured by mortgage;
• where security is provided by third parties (ie. parties other than the specific borrower), other than on loans in respect of which the relevant mortgage is unenforceable under the Consumer Credit Code, the building society has ensured that those parties understand fully the consequences of default on the loans and their legal obligations; and
• loans for purposes other than housing are fully secured by mortgages over existing residential property. Loans, for whatever purpose, secured against speculative residential development – eg. multiple dwellings such as blocks of units – do not qualify for a concessional risk weight.
Where a loan fails to satisfy any of the above criteria, the full value of the loan should be assigned a 100 per cent risk weight in the absence of any other eligible collateral or guarantees. A concessional risk weight does not apply to mortgage-backed securities which should be risk weighted as a claim on the issuer of the securities. Other asset backed paper should be risk weighted in a similar fashion.
3.2.4.e 100 per cent Weight
• other loans17
• other assets and claims.
3.2.4.f Other Considerations
Certain asset classes and investments may result in additional capital requirements if, in the opinion of the SSA, they lead to excessive risk for the building society.
3.2.5 Off-Balance Sheet Business
Measurement of off-balance sheet business will involve a two-step process:
- the principal (or face value) amounts of transactions will be converted into on-balance sheet equivalents ('credit equivalent amounts') by application of credit conversion factors; and
- the resulting credit equivalent amount will be assigned the risk weight appropriate to the counterparty or, if relevant, the risk weight assigned to the guarantor or the collateral security.
3.2.5.a Credit conversion factors for selected major off-balance sheet transactions:
| Credit Conversion Factor18 | |
| Direct credit substitutes, including financial guarantees and endorsements (which do not have the prior endorsement of a bank) | 100% |
| Assets sold with recourse19 where credit risk remains with the building society | 100% |
| Sale and repurchase agreements20 where credit risk remains with the building society forward asset purchases20, placement of forward deposits, and other commitments to acquire assets20 | 100% |
| Loans approved by a building society but not yet advanced, where there is certainty of drawdown (i.e. forward loan commitments) | 100% |
| Trade and performance-related contingent items, including warranties, bid bonds, indemnities, performance bonds and standby letters of credit related to particular non-monetary obligations | 0% |
| Other commitments (e.g. formal standby facilities and undrawn amounts under an equity credit or redraw facility21) with a residual maturity exceeding one year22 Other commitments that can be unconditionally revoked without notice but are not subject to review at least annually. | 50% |
| Other commitments (eg undrawn overdraft and credit card facilities) which can be unconditionally revoked at any time without notice where the society provides for any outstanding unused balance to be reviewed at least annually | 0% |
| Other commitments with a residual maturity of one year or less23 | 0% |
3.2.5.b Other Items
For items not included above24, credit conversion factors should be discussed with the relevant SSA.
3.2.6 Derivative Products
3.2.6.a Under Sections 120 and 121 of the FI Code, societies may only enter into contracts involving derivative products for the purpose of reducing market risk. Given the nature of building society business, the general presumption is that societies will only use derivative products related to interest rates or exchange rates. The credit risk associated with derivative products is the cost to the society of replacing the cash flow specified by the contract in the event of counterparty default. This will depend, among other things, on the maturity of the contract and on the price volatility of the underlying physical instrument.
3.2.6.b Credit-equivalent amounts for derivative products may be calculated in either of two ways, using a ‘mark-to-market’ approach or a ‘rule-of-thumb’ approach25
Mark-to-Market approach
Credit equivalent amounts are represented by the sum of current credit exposure and potential credit exposure:
(i) Current Credit Exposure
This is the mark-to-market valuation of all contracts with a positive replacement cost. Replacement costs which are fully collateralised by cash and government securities, or backed by eligible guarantees, may be given the weight of the underlying security or guarantor.
(ii) Potential Credit Exposure
This is calculated as a percentage of the nominal principle amount of a society's portfolio of interest rate and exchange rate related contracts split by residual maturity as follows:
| Remaining term to maturity | Interest contracts | Exchange rate contracts |
| Less than 1 year | nil | 1.0% |
| One year or more | 0.5% | 5.0% |
Rule-of-thumb approach
Credit-equivalent amounts are calculated by applying credit conversion factors to the principal amounts of contracts according to the nature of the instrument and its original maturity.
| Original Maturity of contract | Interest rate of contract | Exchange rate of contract |
| Less than 1 year | 0.5% | 2.0% |
| One year and less than two years | 1.0% | 5.0% |
| For each additional year | 1.0% | 3.0% |
3.2.6.c The following derivative products (interest and foreign exchange contracts) are to be included in the calculation of credit-equivalent amounts:
• forward rate agreements;
• interest rate swap agreements;
• cross currency interest rate swap agreements;
• forward foreign exchange contracts;
• futures contracts;
• interest rate and foreign currency options purchased; and
• any other instruments of similar nature that give rise to credit risks.
3.2.6.d The following derivative products are excluded in the calculation of credit-equivalent amounts:
• instruments traded on futures and options exchanges that are subject to daily mark-to-market and margin payments.
3.2.7 Deductions of Certain Investments from Capital
3.2.7.a For the purpose of calculating capital adequacy, a building society must deduct from its total capital (and assets) the carrying value of any investment (by it or its subsidiary) in the capital instruments (in the form of equity or subordinated debt26) of another building society or credit union.
3.2.7.b Where a building society (or its subsidiary) invests capital in, or provides a guarantee or similar support to, an entity which undertakes the role of manager, responsible entity, approved trustee, trustee, custodian or similar role in relation to funds management or the securitisation of assets then the value of capital27 and guarantees should be deducted from the society’s and the group’s capital base.
3.2.7.c A building society is required to deduct from its capital base (and risk assets) its equity and other capital investments in non-consolidated subsidiaries or associates which it effectively controls. Investments in life general and lenders mortgage insurance companies, as well as friendly societies, will generally be subject to this requirement.
3.2.7.d Where a building society enters into an undertaking which provides for it to absorb the first level of losses28 on claims supported by the society (eg guarantees, up to a limit, of losses on a portfolio of loans held in a securitisation vehicle) the amount of the undertaking (or limit) should be deducted from its capital base (and risk assets) unless it has already been written off.
1 Goodwill and similar intangible assets including future income tax benefits (FITB) (other than those associated with the general provision for doubtful debts) (net of any provision for deferred income tax liability (DITL) that may be offset in accordance with AASB 1020) will be deducted from 'core' capital and hence total capital. If the DITL exceeds FITB, the excess may not be added to capital.
2 Must constitute at least 50 per cent of the capital requirement.
3 May include measured current year earnings net of expected dividends and tax expense.
4 Must be subordinated to depositors and unsecured creditors; must not provide for a return of capital or compensation for unpaid dividends; and dividends (the only form of compensation to investors that should be provided) should not be influenced by the credit standing of the society. The non-declaration of a dividend should not trigger any restrictions on the society other than the need to seek approval of holders of the shares before paying dividends on or retiring other shares.
5 For the purposes of calculating capital adequacy, cannot exceed the value of Tier 1 capital.
6 General provisions, less any associated future income tax benefit, up to a value of 1.25 per cent of total risk weighted assets. The provisions must be additional to the statutory provisions (Prudential Standard 3.3.2.a) and must be created against future, presently unidentified losses. General provision must be available to meet any losses that may subsequently materialise.
7 Where the regular periodic revaluation of property is reflected in the balance sheet and is subject to audit review, revaluation reserves are to be included in Upper Tier 2 capital after allowance for capital gains and any other taxes or costs that would be incurred should the asset be sold for the revalued amount. Regular periodic valuations must be at intervals of no more than 3 years. For revaluations of other assets (including securities) not passed through the profit and loss account and irregular revaluations of property, only 45 per cent of the gain may be included in Upper Tier 2 capital. However, the full value of any decline in value must be reflected in Upper Tier 2 capital. This applies whether revaluations or devaluations are recorded in the balance sheet or in the notes to the accounts.
8 Must meet the criteria for "hybrid debt/equity capital instruments" set out in Prudential Standard 3.2.3.
9 The eligible amount of lower Tier 2 capital for the purposes of calculating capital adequacy is limited to 50 per cent of Tier 1 capital. Minimum original maturity must be at least five years. Lower Tier 2 capital must be amortised at a rate of 5% per quarter of the original amount during the last five years to maturity.
10 To qualify for a particular risk weight, a security arrangement must permit direct, explicit, irrevocable and unequivocal recourse to the collateral. Claims secured or collateralised in other ways eg insurance contracts, put options, forward sale contracts are not considered to be eligible collateral.
11 For the purposes of the capital adequacy standard a guarantee must be issued formally. It must permit direct, explicit, irrevocable and unequivocal recourse to the guarantor. Indirect guarantees (such as guarantees of guarantees eg where the Commonwealth guarantees the entity which provides the guarantee) and letters of comfort are not recognised.
12 see footnote to Prudential Standard 3.2.4.e.
13 Throughout this standard, outstanding balance includes the balance of all loans and other facilities, plus the gross value of any undrawn limits available eg redraw amount available on the loan or undrawn limit on a revolving credit facility, that are secured against the mortgage security. An "all moneys" mortgage includes all loans or facilities to the customer that are effectively secured against the mortgage. To assign capital to undrawn limits, the credit conversion factor should be taken from prudential standard 3.2.5.a. This credit equivalent may then be assigned a 50 per cent risk weight if secured by a qualifying mortgage.
14 In calculating the outstanding balance of a loan, allowance may be made for higher ranking security. A society may deduct from the outstanding balance any eligible cash or Commonwealth or state government security held as collateral. Similarly, it may also deduct any part of the exposure guaranteed by a Commonwealth, State (including central borrowing authority) or local Government, a public sector entity eligible for a 20 per cent risk weight, a bank or other building society or credit union. These portions of the exposure are to be weighted according to the security or guarantee. A mortgage offset or similar account may only be netted off the loan balance where the arrangement would meet the requirements of the cash collateral guidelines.
15 Where there is more than one property offered as security, the LVR will be assessed on the basis of the outstanding balance (after allowance for any higher ranking security to the aggregate value of the secured properties.
16 To qualify as mortgage insured the policy must be taken out with an authorised Lenders Mortgage Insurer with an insurance rating the equivalent of "A" or higher. A captive LMI, though unrated, may demonstrate a claim paying ability rated "A" or higher through third party guarantees. AFIC will consider non-rated LMI arrangements on a case-by-case basis.
17 Where a specific provision for doubtful debt has been made against a loan, the risk weight applies to the outstanding balance (including accrued interest) after deducting the specific provision.
18 The amount to be subject to the credit conversion factor is the maximum unused portion of the facility at the time of calculation (any drawn portion will form part of balance sheet assets). For example, if a rental guarantee is provided on behalf of a customer, then all remaining lease payments (up to any limit specified in the guarantee) are included in the calculation.
19 These items are to be risk weighted according to the type of assets or the issuer of securities and not according to the counterparty with whom the transaction is made.
20 Reverse repos (ie. purchase and resale agreements) are to be treated as collateralised loans. The risk is to be measured as an exposure to the counterparty or according to the asset if it is a recognised collateral security within the risk ratio framework.
21 Redraw facilities that allow redraw only of advance payments, should be assigned a credit conversion factor of 0%.
22 This includes any commitment, that can only be unconditionally revoked with notice, where there is not a clear expiry date within one year.
23 Provided the commitment can only be rolled over or extended after a full credit review is done and there is no presumption or impression conveyed to the client that an approval of a roll over or extension will be a formality. Where this test is not met the commitment will receive a 50 per cent risk weight.
24 This includes any commitment to provide an off-balance sheet facility.
25 Credit conversion factors are based on the Basle Supervisors' Committee's paper "International convergence of capital measurement and capital standards", July 1988.
26 The deduction will apply to the full value of a holding of subordinated debt even if the issue of debt is being amortised in terms of the footnote to prudential standard 3.2.2.b.
27 This includes any amount which is unpaid or callable on any shares or capital securities issued by the subsidiary and held by the society (or within its consolidated group).
Prudential Notes 3.3B and 3.3C
Note: see subparagraph 1(e) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Prudential Note 3.3 - Building Societies
Accounting and disclosure
B. Financial Reports to State Supervisory Authorities
Objective
To protect and promote the financial integrity and efficiency of the State-based financial institutions system and to ensure that depositors are adequately protected from the risks that building societies incur in the process of financial intermediation. Towards this end, to ensure that financial information provided to SSAs is complete, timely and consistent with external reporting requirements and is adequate for supervisory purposes.
General Background
Supervision of building societies by SSAs is conducted, in part, through a review of financial data provided by societies. It is appropriate that this information should be more extensive than that provided in the public financial accounts. These data should form an extension of the information contained in the annual accounts and should be consistent with them.
It is the responsibility of directors and management to oversee the internal operating procedures of the society. Each society will, for its own purposes, be expected to have adequate accounting records, registers and supporting documentation. Normal budgets, monthly financial statements and reports on loans, liquidity, capital adequacy and investments should form an integral part of any management and control process.
Much of this information, prepared for internal purposes, will provide the data for reporting to SSAs.
C. Audit
Objective
To protect and promote the financial integrity and efficiency of the State-based financial institutions system and to ensure that depositors are adequately protected from the risks that building societies incur in the process of financial intermediation. Towards this end, to ensure that the auditors appointed by each building society are competent, adequately resourced and given sufficient scope to complete the duties imposed by the FI Code. Further, to ensure that societies are able to provide such reports of audit as are required by SSAs as part of their supervisory role.
General Background
Section 270 of the FI Code requires directors to ensure that the annual accounts and group accounts of building societies are audited. As well as the audit report attached to the published financial statements, auditors must provide to the directors and to the relevant SSA a report of compliance with respect to internal controls. Auditors are also required to provide a number of reports of compliance under the FI Code.
Sub-section 284(7) of the FI Code requires the auditors to report on the adequacy of systems adopted by the society:
• to ensure compliance with its primary objectives; and
• to monitor and manage the risks associated with its financial activities.
The intention of independent audit reviews is to lend credibility to the financial information presented in the annual report by the building society's directors. In carrying out their supervisory responsibilities, AFIC and the SSAs rely largely on information presented by societies. A properly planned and conducted audit should provide reasonable assurance that the financial statements are true and fair. In addition to the supervisory authorities, members and depositors should be able to place greater reliance on financial information where an audit has ascertained that the accounts are free of material misstatement and present a true and fair view of the entity.
It is important that a society’s external auditor receives timely information concerning the prudential standing of the society. Accordingly, an SSA should provide to the society’s external auditor a copy of any report following an inspection of the society and any other information the SSA may from time to time consider relevant to the auditor’s audit responsibilities in respect of the society. If the SSA considers the provision of the whole or part of the report or such other information unnecessary or undesirable in the circumstances, the SSA need not provide it to the external auditor.
Audit Standards
All audit work should be carried out in compliance with Auditing Standards and Auditing Guidance Statements prepared by the Auditing Standards Board of the Australian Accounting Research Foundation issued by the Australian Accounting Research Foundation on behalf of the Australian Society of Certified Practising Accountants and the Institute of Chartered Accountants in Australia. Particular notice should be taken of the requirements within the standard for proper planning and completion of audit techniques which take account of the nature and risks of building societies. Directors of societies should be satisfied that auditors have sufficient understanding of the industry to enable them to adequately plan the audit and assess audit risks.
The operations of societies involve a large number of transactions. The audit approach, therefore, must emphasize the importance of transaction testing. Adequate transaction testing is regarded as critical if audits are to satisfy the requirements of the FI Code.
The audit approach must set out how evidence will be gathered. Since that evidence is the basis of audit opinion, sufficient audit evidence must be obtained to enable an opinion to be properly formed.
The responsibility for appointing an auditor of proper ability is the responsibility of the society. Building societies can expect that SSAs will communicate with their auditors annually or more frequently if it is deemed necessary. The purpose of this contact will be to establish the efficacy of audit techniques. If a SSA is not satisfied with the quality of an audit it has the power, under Section 88(4) of the FI Code to appoint an additional auditor or remove an auditor and appoint another auditor in that auditor's place, as it sees fit.
Audit Committees
An Audit Committee should comprise a majority of non-executive directors to which has been assigned, amongst other functions, the oversight of the financial reporting and auditing process and formulation and periodic review of the disaster recovery plan. The main objectives of an appropriately established and effective independent Audit Committee include enhancing the credibility and objectivity of financial reporting and assisting the Board to discharge its responsibilities. All building societies shall, if they have not already done so, establish an Audit Committee. It is the responsibility of the directors to establish the Audit Committee and to develop clear guidelines for its operation, including its role, terms of reference, responsibilities and method of operation.
Internal Audit
The effectiveness of the internal audit function depends on the scope and objectives of the function, degree of independence and the technical competence of staff. As with any internal control, the cost of an internal audit function must be justified by the benefits. Usually, the size of the society will play a significant part in determining the nature, scope and objectives of the internal audit function. In general, internal audits will be most effective where they are directed towards the review and testing of internal controls and risk management systems. Societies should consider the standards for the professional practice of internal auditing issued by The Institute of Internal Auditors.
Paragraphs 3.3.2a and 3.3.2b of Prudential Standard 3.3.2
Note: see subparagraph 1(f) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Public Reporting
3.3.2 Accounting Standards Specific to Building Societies
Provisions
3.3.2.a Statutory Provisions for Doubtful Debts
Each society shall provide for, and show in the body of its accounts, a provision for doubtful debts covering all loan advances, including revolving credit arrangements. Directors should ensure that all problem loans are reviewed regularly and that provisions are appropriate. The minimum provisions shall be the amounts specified below.
Loan Provisions
The minimum loan provisions required depend on the type of loan. Three categories of loans are distinguished.
(i) • A loan which is secured by a registered first mortgage against residential building and/or development (defined in Prudential Standard 3.2.4.d) and is insured by an authorised(a) insurer for 100 per cent of the outstanding balance;
• A loan which is secured by a registered first mortgage against residential building and/or development, where the ratio of the outstanding balance, less the amount of mortgage insurance, to the valuation of the security is no more than 80 per cent (where the loan is 6 months or more in arrears, the valuation must be no older than 12 months);
• A loan which is secured by a qualifying registered second mortgage. (A qualifying second mortgage is one which satisfies the conditions spelled out in Prudential Standard 3.2.4.d.)
No minimum provision is required for this type of loan.
(ii) A loan which is secured by a registered first mortgage against residential building and/or development, where the ratio of the outstanding balance, less the amount of mortgage insurance, to the valuation of the security is greater than 80 per cent but no more than 100 per cent (where the loan is 6 months or more in arrears, the valuation must be no older than 12 months).
For these loans, the minimum provision required is a percentage of the balance outstanding, where the percentage depends upon the loan arrears period, as shown below.
Loan Arrears Provision (%)
up to 3 months 0
3 months and less than 6 months 5
6 months and less than 9 months 10
9 months and less than 12 months 15
12 months and over 20
Where the provision calculated under this category (ii) is greater than the provision which would have been calculated under category (iii) then the category (iii) is the minimum required.
(iii) All other loans
For all loans which do not fall into categories (i) and (ii) above, including unsecured and commercial loans, and mortgage loans where the ratio of the outstanding balance, less the amount of mortgage insurance, to the valuation of the security is greater than 100 per cent, the minimum required provision is a percentage of the balance outstanding, where the percentage depends upon the loan arrears period, as shown below.
Loan Arrears Provision (%)
up to 3 months 0
3 months and less than 6 months 40
6 months and less than 9 months 60
9 months and less than 12 months 80
12 months and over 100
Where these loans are secured by a mortgage over real property, the provision may be adjusted to reflect a part of the collateral value. In this case, the minimum provision percentage in the table above will be applied to the difference between the outstanding balance (less any loan insurance) and 70 per cent of the security value (where the loan is 6 months or more in arrears, the valuation must be no older than 12 months).
The minimum total provision required under loan provisions is the sum of the provisions made with respect to the different types of loans.
Where a loan is otherwise secured by equivalent or better security arrangements, the society may on application to its SSA, seek to have the provision adjusted to reflect the whole or part of the collateral value. After consideration of all relevant circumstances pertaining to the loan and security the SSA may reject or may, with the consent of AFIC, agree to the application.
Revolving Credit Provisions
Unless a variation is approved by its SSA, a society will be required to provide an amount equal to 1.0 per cent of the total unsecured(a) balances outstanding for line of credit advances, credit cards, overdrafts and any other revolving credit facilities. These provisions will be in addition to any provisions required under (iii) above.
After consideration of a society’s loss experience and the level of non-statutory provisions available to cover potential losses on revolving credit facilities, an SSA may reduce the 1% requirement set out above. The SSA is to notify AFIC of any variation issued.
For overdrawn savings and overdrawn limits on credit cards, overdrafts and line of credit advances, the minimum required provision is a percentage of the balance outstanding, as shown below. Secured loans should be provisioned in accordance with Loan Provisions (i), (ii) and (iii). In calculating the minimum provision for each revolving credit facility, except overdrawn savings, the full amount of the credit drawn is to be included in the balance outstanding.
Period of Irregularity Provision (%)
14 days less than 3 months 40
3 months and less than 6 months 75
6 months and over 100
Where a revolving credit facility is both overdue (in terms of contractual repayments) and has a balance in excess of its authorised limit, the minimum provision required will be that calculated from the table above.
3.3.2.b Restructured Loans
- Restructured loans are loans and other similar facilities where the original contractual terms have been modified to provide for concessions of interest, principal or repayment for reasons related to financial difficulties of the member or group of members. The following concessions are examples that would lead to a loan being classified as restructured:
- a reduction in the principal amount of the loan;
- a rate of interest lower than the society applies to a similar loan;
- reduction of accrued interest;
- a deferral or extension of interest or principal payments including interest capitalisation; or
- Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with a similar risk.
A loan extended or renewed on terms similar to those available for debt with similar risks where the member has met the originally contracted terms, is not considered a restructured loan.
Restructuring required under the provisions of the Consumer Credit Code which satisfy the above definition are not excluded from the definition of restructured loans.
- Each society must develop policies to identify, monitor and manage restructured loans. Any restructuring of a loan or similar facility must be supported by a current, well documented credit assessment of the member’s financial condition and prospects for repayment under the modified terms.
- Renegotiation of a loan must not be used to "hide" the poor quality of loan performance. Before any concession is made to a member, a restructure of the member’s loan should receive prior approval of the board of directors or its delegate. If there has been no prior approval, the restructured loan must be ratified by the society's board or their committee within 30 days of approval.
- A restructured loan may only be returned to performing status, if it was not fully performing when restructured, for both the purposes of accrual and provisioning, when:
- it has been formally restructured ie. at a minimum the customer is provided with a written agreement, signed by the society, which outlines the new terms and is complying with these terms;
- there are no concessional terms applying to the facility, that is, the loan operates under the terms and conditions comparable to those applied by the society to a similar new facility; and
- the member's financial condition and prospects for full repayment have improved such that the facility has been operating in accordance with the new terms and conditions for a period of at least six months.
Provisioning requirements for a loan that has been formally restructured but is yet to be considered as performing should generally be based on the arrears period as at the time of the restructure. A society may, however, take into account additional security provided under the agreement which would result in a reduction of the provisioning requirement.
- A single facility cannot be split into a performing and non performing part to avoid the total facility being classed as restructured.
- For the purposes of reporting under AASB1032 only formally restructured loans may be included in the restructured category. Informally restructured loans are to be reported as non-accrual loans as appropriate. If, following a restructure, the yield on a facility is less than the society’s average cost of funds, it should be reported as non-accrual.
Prudential Standard 3.3.5, other than subparagraph 3.3.5a(ii)
Note: see subparagraph 1(g) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
3.3.5 Required Returns
3.3.5.a Each building society will complete the following returns for the purposes of section 290 of the FI Code as required by notice from its SSA.
(i) Quarterly:
A general return containing the information contained in Attachment B to the Prudential Standards.
In addition to this quarterly general return, other returns on:
• Loans
• Directors' Interests
• Primary Objects
• Assets
3.3.5.b A SSA may, by notice, vary the reporting interval for any or all of the returns included in Prudential Standard 3.3.5.a for any or all societies under its jurisdiction.
3.3.5.c Any society which fails to comply with the notice of lodgement of returns by the due date will be in breach of the Prudential Standards under Section 402 of the FI Code.
Prudential Standard 3.3.6
Note: see subparagraph 1(h) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Audit
3.3.6 Audit Standards
3.3.6.a A building society is to be audited in accordance with Auditing Standards and Auditing Guidance Statements and any additional requirements considered necessary by the auditor in satisfying the various requirements of the FI Code.
3.3.6.b Directors of a building society are to satisfy themselves that the auditor has sufficient relevant expertise to audit the society properly and that the auditor maintains appropriate levels of professional indemnity insurance.
3.3.6.c Directors of a building society are to satisfy themselves that the auditor has adequate computer audit support to be able to access any and every transaction within the society, as the auditor determines.
3.3.6.d A building society is to obtain from its auditor, an engagement letter which confirms acceptance of the appointment, the objectives and scope of the audit, the extent of the auditor’s responsibilities and the form of reports and any other matters identified in AUS204 - Terms of Audit Engagements.
3.3.6.e A building society is to maintain an audit committee whose members comprise at least half non executive directors.
3.3.6.f An internal audit function should be considered by each society’s directors as part of the society’s system of internal control.
3.3.6.g Audit reports are to be forwarded directly to the audit committee in addition to any other recipients required by the society.
3.3.6.h Pursuant to section 284(7) and (8) and section 285(10) of the FI Code, an external auditor is to provide to the SSA, reports on the compliance and adequacy of the following risk management systems and internal controls:
• operational liquidity risk management systems (annually) - Prudential Standard 3.1.2.a;
• market risk management systems (annually) - Prudential Standard 3.1.3.a;
• credit risk management systems (annually) - Prudential Standard 3.1.4.a;
• data risk management systems (annually) - Prudential Standard 3.1.5.a;
• operations risk management systems (annually) - Prudential Standard 3.1.6.a; and
• internal controls within the above risk management systems.
3.3.6.i Pursuant to section 285(10) of the FI Code, an external auditor is to provide to the SSA, reports on the security for Emergency Liquidity Support Scheme (6 monthly) - Prudential Standard 3.4.6.l.
If any aspect of a proposed securitisation or funds management initiative or transaction is inconsistent with, or not covered by, the guidelines set out in the standard, then an SSP should obtain prior approval from AFIC. An SSP (or its subsidiary) will be required to demonstrate that it has adequately identified the risks arising from the proposed transaction and has adequate expertise and systems in place to measure, manage and monitor the risks involved.
Despite its detailed nature, this standard cannot encompass every aspect of an SSP’s securitisation or funds management activities. Where an SSP may have plans for a particular initiative that may raise issues not covered in the standard, it should discuss them with AFIC as early as possible.
The introduction of this standard (by revising and superseding earlier standards) may see an SSP in breach of some of its requirements. Where this is the case the SSP should contact AFIC to discuss its position.
The prime responsibility for the prudent participation of an SSP and its subsidiaries in securitisation, funds management and other marketing activities rests with its board and management. An SSP should have in place clear strategies as well as board approved policies governing its participation in these areas. In addition, it must maintain appropriate systems to identify, measure, monitor and control risks arising from its participation in these areas.
This standard applies to all securitisation and funds management activities even if a trust based vehicle and the issuing of units is not involved. Unless otherwise indicated, reference to an SSP includes any subsidiaries within its consolidated group. Intermediation activities against which an SSP is required to hold capital do not constitute funds management or securitisation activities.
Prudential Standards 5.5.1 to 5.5.8 (inclusive)
Note: see subparagraph 3(l) of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
5.5.1 Disclosure
5.5.1.a To safeguard against investor confusion, an SSP must ensure that, where it is involved in funds management or securitisation activities, the following conditions are satisfied:
(i) Investors are given to understand clearly that the securities in which they invest do not represent deposits or other liabilities of the SSP or any of its subsidiaries.
- investors are made aware that their holdings of securities are subject to investment risk, including possible delays in repayment and loss of income and principal invested.
(iii) Investors are unambiguously informed that the SSP or its subsidiaries do not in any way stand behind the capital value or performance of the securities issued by the special purpose vehicle or of the assets held by the vehicle except to the limited extent allowed under this standard and as specified in the documentation provided to investors.
5.5.1.b The disclosures in 5.5.1.a. must be provided in a conspicuous manner to prospective investors, and appear in any marketing document. A document inviting investment should include the disclosures as a prominent (and preferably stand alone) item on the inside front cover. It is recognised that variations in the location and form of the required disclosures could be appropriate where regulatory or statutory requirements restrict the presentation or content of disclosures. Any proposal to modify the requirements set out above must be agreed with AFIC.
5.5.1.c Investors must also provide a signed acknowledgment indicating that they have read and understood the required disclosures. To ensure this the disclosures in 5.5.1.a should also appear in close proximity to the signature on the application form in any document inviting investment.
5.5.1.d More generally, an SSP must ensure that the marketing or promotion of a special purpose vehicle with which it is associated does not give any impression that could be construed as being contrary to the disclosure requirements.
5.5.1.e It is possible that securities could be traded in a paperless environment. Where this is envisaged an SSP must discuss with AFIC procedures for ensuring that the spirit of the disclosure requirements are met.
5.5.1.f Where an SSP has a limited involvement in a securitisation or funds management scheme, its ability to ensure the required level of disclosure (and signed acknowledgments) may also be limited. In such cases, compliance with the disclosure requirements may be relaxed by AFIC.
This concession will not be available where the SSP or its subsidiary is the sponsor, manager, trustee or responsible entity of the scheme. It will also be unavailable (except in exceptional circumstances) where the SSP or its subsidiary or associate permits the use of its name, badge, logo or any other identifier in the marketing of the securitisation or funds management scheme.
5.5.2 Structuring Funds Management and Securitisation Schemes
5.5.2.a The main basis of the policy on funds management and securitisation is that there is a clear separation between the SSP involved and any special purpose vehicle or scheme. To this end, an SSP must not without prior approval from AFIC:
(i) Have any ownership or beneficial interest in a special purpose vehicle.
(ii) Include the word "building society" or "credit union" in the name of the special purpose vehicle or any subsidiary involved in securitisation or funds management related activities.
(iii) Provide credit support, liquidity support, other lending, treasury or transaction facilities or any other facilities or services (unless expressly provided for in this standard) to a special purpose vehicle, or underwrite the issue of units or securities by a vehicle.
(iv) Have any of its directors, officers or employees on the board of a special purpose vehicle.
(v) "Control" the special purpose vehicle such that it would need to be consolidated in accordance with Australian Accounting Standards.
5.5.2.b Requirements i, iv and v set out above do not apply (where AFIC’s prior approval has been obtained to establish the relevant entity), to:
- A subsidiary involved in a scheme in the capacity of a pure "trustee" or "custodian".
- A life insurance company and its statutory funds regulated by the Insurance and Superannuation Commission.
- An "approved trustee" or "custodian" established under the provisions of the Superannuation Industry (Supervision) Act 1993 (Cth).
- "Common trust funds" established pursuant to legislation and complying with Australian Securities Commission Policy Statement 32.
- A "responsible entity" established under proposed changes to the Corporations Law dealing with collective investments.
5.5.2.c An SSP, itself, must not act in any circumstances as a manager, trustee, custodian, responsible entity or any similar role for the purposes of managing investors’ funds or securitising assets. Any participation must be through stand alone subsidiaries that are adequately capitalised in their own right.
5.5.2.d Where an SSP’s subsidiary or other associate acts in such a role, the SSP should ensure that a clear distinction exists between the SSP and the subsidiary or associate concerned. Any documentation or marketing of a funds management or securitisation scheme with which a subsidiary or associate is involved should not give the impression the entity is in any way backed by the SSP or any of its subsidiaries (unless a formal commitment of support has been approved by AFIC).
5.5.2.e An SSP may not subordinate, defer or waive the receipt of fee or other income associated with funds management or securitisation activities without obtaining approval from AFIC.
5.5.3 Offering Investment Advice and Sale of Securities
5.5.3.a In its operations, an SSP’s subsidiary may (subject to AFIC’s and other appropriate regulatory approvals) offer advice to customers regarding investments (including in securitisation, funds management schemes and other products such as life and general insurance policies), act as a broker in obtaining securities (and other products) on behalf of customers or market such products directly to customers.
In conducting such business, there is a risk that customers may be confused as to the relationship between an SSP and the issuer of a security (or other product), and a possibility of the SSP feeling some moral or commercial obligation to customers as a result of its actions.
To minimise such risks, an SSP should ensure that where it undertakes such activities:
(i) They are conducted with investors on an arm’s length basis and on market terms and conditions.
(ii) Any decision to invest in particular securities (or acquire other products) is clearly taken by the customer alone and that customers are aware they bear the risks associated with their investment decisions. The SSP should be careful to ensure that customers are aware of the level and type of risks they face on the investments.
(iii) Policies and procedures are in place to ensure that staff (and any agents of the SSP) dealing with customers are required to be appropriately trained and to avoid misleading or confusing them concerning the risks involved or the SSP’s relationship with (or support for) investments recommended or offered for sale by the SSP.
5.5.3.b Where an SSP makes investment decisions or purchases securities for customers at its own initiative or discretion (and is not required to hold capital against these assets), then the SSP will be deemed to be acting as a "manager" and the relevant provisions of this standard will apply.
5.5.4 Badging
5.5.4.a Where an SSP allows its name, logo or trade mark to be used in the marketing of products provided by a third party institution it faces risks over and above those covered in 5.5.3. In these circumstances it will also be required to ensure:
(i) The 'name' or 'badge' of the other party providing the product or service also features prominently in all advertising material, marketing documents and any documents inviting investment or participation in a product.
(ii) The respective roles of the parties should be explained clearly and prominently in any document inviting investment or participation in the product - including the extent to which each party is responsible for the safety and performance of the product.
(iii) For investment products, the provisions of section 5.5.1 "Disclosure" are fully satisfied.
5.5.4.b An SSP which fails to comply with these conditions may be required, by AFIC, to discontinue its association with the relevant product.
5.5.4.c In its operations an SSP or its subsidiary may provide administrative, processing and similar facilities or services to its members (eg standard documentation) which have been sourced from an external party. Where this is the case the SSP is required to ensure:
(i) The ultimate provider of the service is identified to its members and any other users.
(ii) The division of responsibility, between an SSP and the facility or service provider, for the safety and performance of the product is clearly established.
(iii) It has adequately identified the risks arising from these contracts and has appropriate policies and procedures in place to measure, monitor and manage the risks involved.
5.5.5 Purchase of Securities
5.5.5.a Unless exempted by AFIC, an SSP will only be permitted to purchase securities issued by a special purpose vehicle provided:
(i) The purchases are at the sole discretion of the SSP, are acquired on an arm's length basis on market terms and conditions (including price), and are subject to the SSP’s normal credit policies.
(ii) Purchases are completed within a short time period (less than one week as a guide) from the time the SSP commits to purchase the securities.
(iii) Any holding is less than 10 per cent of the class of securities issued by the vehicle.
(iv) They do not represent subordinated securities issued by the vehicle.
(v) The securities are fully performing.
5.5.5.b An SSP should have in place adequate systems and controls to ensure that it does not accumulate disproportionate exposure (vis a vis the SSP's asset portfolio and capital) to securities issued by special purpose vehicles, eg large aggregate exposures arising from holdings of securities issued by associated special purpose vehicles or vehicles holding similar or related assets.
5.5.5.c An SSP should not purchase assets held by a special purpose vehicle. Exceptions are the purchase of liquid assets from a special purpose vehicle in the normal course of an SSP’s liquidity management or trading operations and assets purchased pursuant to the exercise of representations and warranties.
5.5.5.d Should AFIC come to the view that the pattern of an SSP’s purchases of securities (and/or assets), or its willingness to do so, suggests that the SSP is supporting investments in a special purpose vehicle, then the SSP may be required to hold capital against all the securities issued by the special purpose vehicle.
5.5.6 Servicing
5.5.6.a A funds management or securitisation scheme may involve the participation of an entity acting as a "servicer" or "servicing agent". An SSP or its subsidiary may undertake the role of servicing a pool of assets held by a special purpose vehicle provided:
(i) There is a formal written servicing agreement in place which specifies the services to be provided and any required standards of performance. Those standards should be reasonable and in accordance with normal market practice. There should be no recourse to the SSP beyond the fixed contractual obligations specified. The servicer should be under no obligation to fund payments, absorb losses on assets, or otherwise recompense investors for losses.
(ii) The services are provided on an arm's length basis, on market terms and conditions (including remuneration), and subject to the SSP’s normal approval and review processes.
(iii) The servicing agreement is limited as to a specified time period (ie the earlier of the date on which all claims connected with the issue of securities are paid out or the SSP’s replacement as servicer). A fixed termination date need not be specified provided the SSP is able, at its absolute discretion, to withdraw from its commitments at any time with a reasonable period of notice.
(iv) Subject to reasonable qualifying conditions, the special purpose vehicle and/or investors have the clear right to select an alternative servicer.
(v) The servicing agreement is documented in a fashion which clearly separates it from any other service provided by the SSP. An SSP’s obligation under each facility must be stand-alone.
(vi) The SSP’s operational systems are adequate to meet its obligations as a servicer.
5.5.6.b Unless approved by AFIC, an SSP acting as servicer should be under no obligation to remit funds to the special purpose vehicle or investors until they are received from the underlying assets.
5.5.6.c An SSP may receive a performance-related payment (or benefit from any surplus income generated) for its role as servicer, in addition to its base fee, provided that the base fee is on market terms and conditions and any performance-related payment does not commit the SSP to any additional obligations. This payment should be recognised for profit and loss (and capital) purposes only if it has been irrevocably received.
5.5.6.d Where a servicing agreement does not meet the conditions above an SSP may be required to hold capital against the assets it is servicing as if they were held on its balance sheet.
5.5.7 Managing Investors Funds
5.5.7.a A subsidiary of an SSP may act as a manager of funds placed in a funds management or securitisation vehicle by investors, provided:
(i) There is a written management agreement in place specifying the functions which the manager is required to perform and any performance standards placed on the manager. Such standards should be reasonable and in accordance with normal market practice. The agreement must not (unless prior approval is received from AFIC) obligate an SSP or any subsidiary to buy back securities or units issued, or assets held, by the vehicle.
(ii) The management agreement is undertaken on an arm's length basis and is subject to the SSP’s normal approval and review processes. The agreement must be undertaken on market terms and conditions (including remuneration to the manager).
(iii) The agreement is limited as to a specified time period (ie. the earlier of the date on which all claims in connection with the issue of securities are paid out or the SSP’s replacement as manager). A fixed termination date need not be specified provided the SSP is able, at its absolute discretion, to withdraw from its commitments at any time with a reasonable period of notice.
(iv) Subject to reasonable qualifying conditions, the special purpose vehicle and/or investors have the clear right to select an alternative party to provide the management services.
(v) The management agreement is documented in a fashion which clearly separates it from any other facilities provided by the SSP. An SSP’s obligations under each facility must be stand-alone.
5.5.7.b The manager may receive a performance-related payment (or benefit from any surplus income generated) for its role as manager, in addition to its base fee, provided that the base fee is on market terms and conditions and any performance-related payment does not commit the SSP to any additional obligations. Such payment should be recognised for profit and loss (and capital) purposes only if it has been irrevocably received.
5.5.8 Representations and Warranties
5.5.8.a Where an SSP undertakes to provide facilities and services, or provide assets to a special purpose vehicle, it is customary to make representations and warranties concerning those functions or assets. Where all of the following conditions are satisfied, an SSP will not be required to hold capital as a result of providing representations and warranties. Otherwise, it will need to hold capital against the full value of securities issued by the special purpose vehicle. The conditions are:
(i) Any representations and warranties are provided only by way of a formal written agreement and are in accordance with market practice.
(ii) The SSP undertakes appropriate due diligence before providing or taking on any representations and warranties.
(iii) The representations and warranties refer to an existing state of facts that the SSP can verify at the time services are contracted or assets sold.
(iv) Representations or warranties are not open-ended and, in particular, do not relate to the future creditworthiness of assets or the performance of the special purpose vehicle or the securities it issues.
(v) The exercise of any representation or warranty requiring the SSP to repurchase or replace assets sold to the special purpose vehicle, or any part of them, must be undertaken within 120 days of their transfer to the vehicle and any transfer should be conducted on the same terms and conditions as the original sale. This time limit does not preclude the subsequent payment of damages by an SSP as a result of breaches of representations and warranties.
5.5.8.b Any agreement by an SSP to pay damages as a result of a notice of claim being made must be conditional on:
(i) There being documentary substantiation of the negotiation of the agreement to pay damages in good faith.
(ii) The onus of proof for a breach of a representation or warranty resting with the other party.
(iii) Damages being limited to the loss incurred as a result of the breach.
(iv) The written notice of claim specifying the basis for the claim.
AFIC should be notified of any instance where an SSP has agreed to pay damages arising out of any representation or warranty.
Attachment B to the Prudential Notes and Prudential Standards issued by AFIC under Part 4 of an AFIC Code, as in force immediately before the transfer date
Note: see paragraph 4 of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Attachment B to the
Prudential Standards
Part 1
This part is applicable to societies with reporting periods ending up to 30 June 1997
A general return containing:
Profit & Loss Statement
Balance Sheet
Cash Flow Statement
Capital Adequacy Return
Liquidity Return
Credit Rick Return
Other Operational Information
Part 2
This part is applicable to societies with reporting periods commencing 1 July 1997
The quarterly return to SSAs will contain the following information:
§In respect of Revenue and Expenses for the society and group details of:
INTEREST REVENUE FROM FINANCIAL INSTITUTIONS
INTEREST REVENUE FROM SECURITIES
INTEREST REVENUE FROM LOANS AND ADVANCES SPLIT BETWEEN:
Personal
Residential
Commercial
INTEREST REVENUE FROM OTHER SOURCES
NON INTEREST REVENUE
Dividends
Securities
- realised gains/losses
- unrealised gains/losses
Fees and Commissions
- Loan fees and other fees
- Commissions
- Facility fees – off-balance sheet
Rent and lease receipts
Bad debts recovered
Gains and losses on sale of investments, property, plant and equipment and other intangibles
Other
INTEREST EXPENSE TO FINANCIAL INSTITUTIONS
Bank borrowings
SSP borrowings
Credit Union & Building Society borrowings
Other borrowings
INTEREST EXPENSE FOR DEPOSITS
Call deposits
Term deposits
Retirement savings accounts deposits
INTERST EXPENSE FOR BONDS, NOTES, DEBENTURES AND SUBORDINATED DEBT
OTHER INTEREST EXPENSE
Marketing and promotion
Salaries and associated costs
Information technology
Office occupancy
AFIC/SSA levy
General administration
Depreciation expense
Amortisation expense
Auditors remuneration for audit
Auditors remuneration for other services
Directors fees
Bad debts written off
Doubtful debts expense
Other
Income tax attributable to operating profit/(loss)
Profit/(loss) on extraordinary items
Income tax attributable to extraordinary items
Outside equity interests in operating profit•
Retained profits at the beginning of the period
Aggregate of amounts transferred from reserves
Dividends provided for or paid
Aggregate of amounts transferred to reserves
Other appropriations
In respect of Assets of the society and group, details of the cost of:
CASH LIQUID ASSETS
Cash on hand
Loans and overnight settlements fully secured against cash
Cash items in process of collection
RECEIVABLES DUE FROM OTHER FINANCIAL INSTITUTIONS
Bank deposits
Building society deposits and credit union deposits
ELSS Loans
PLA deposits — SSPs
Other deposits (operational liquidity accounts/funds securing settlement account SSPs)
SECURITIES
Commonwealth Government Securities (CGS) and loans and securities fully secured by CGS: maturing < 12 months
Other Commonwealth Government Securities and loans and securities secured by guarantee from a commonwealth government authority
State Government Securities and loans and securities secured by guarantee from a state government authority
Local Government Securities
Promissory notes — State and Local Government
Promissory notes — Other
Other
Bank bills
NCSs
Other PLA investment
Other Operational Liquidity Investment
FRNs — Commonwealth Government
FRNs — State and Local Government
FRNs — Other
Other
OTHER RECEIVABLES
Accrued income
Sundry debtors — net
Prepayments
In respect of the above assets, details of the market value is also required.
LOANS AND ADVANCES
Personal — qualifying mortgage secured
Personal — other
Residential qualifying mortgage secured
Residential other
Commercial qualifying mortgage secured
Commercial — Other
§ In respect of the above loans and advances details of the amount, statutory provision and additional specific provision:
Total General Provision for Doubtful Debts
PROPERTY, PLANT AND EQUIPMENT
Land
Buildings
Accumulated Depreciation for Buildings
Leasehold Improvements
Accumulated Depreciation for Leasehold Improvements
Plant and Equipment
Accumulated Depreciation for Plant and Equipment
OTHER INVESTMENTS
Subordinated debt/equity in SSPs
shares in subsidiaries
Credit Union contingency fund
Subordinated debt/equity — building society, credit union
Subordinated debt/equity — risk related investment
Equity accounted investments
Other equity investments
OTHER ASSETS
FITB
Goodwill (at wdv)
Other intangible assets (at wdv)
Other Assets
Investments with a risk weight greater than 100%
• In respect of Liabilities and Members’ Funds of the society and group details of:
PAYABLES DUE TO OTHER FINANCIAL INSTITUTIONS
Bank borrowings
SSP borrowings
Credit union Building society borrowings
Other
DEPOSITS
Call deposits
Term deposits
Retirement Savings Accounts deposits
BORROWINGS
Other borrowings
CREDITORS & OTHER LIABILITIES
Accrued expenses
Provision for employee entitlements
Provision for income tax
Provision for deferred tax liability
Other liabilities
SUBORDINATED DEBT, BONDS, NOTES AND DEBENTURES
Perpetual subordinated debt
Term subordinated debt
Debentures
Unsecured notes
Other supplementary capital instrument
Other
MEMBERS’ FUNDS
Permanent share capital
Share premium A/C
Financial reserves
Statutory reserve — Building Society Fund (Queensland)
Retained profits/(Accumulated losses)
Asset revaluation reserve
Other reserves
Outside equity interests
Term subordinated debt net of required amortisation
In respect of Cash Flows of the society and group details of:
New loans made
— personal
— residential
— commercial
Principal collected on loans
Physical assets purchased
Physical assets sold
Income tax paid
In respect of the Loans in Arrears of the society and group details of:
— the number of accounts
— loan balances
— provisions split between:
LOANS IN ARREARS
Category (i) Loans
≥ 1 < 3 mths
≥ 3 < 6 mths
≥ 6 < 9mths
≥ 9 < l2mths
≥ 12 months
Category (ii) Loans
≥ 1< 3 mths
≥ 3 < 6 mths
≥ 6 < 9 mths
≥ 9 < 12 mths
≥ 12 months
Category (iii) Loans
≥ 1 < 3 mths
≥ 3 < 6 mths
≥ 6 < 9 mths
≥ 9 < l2mths
≥ 12 months
Overdrawn Savings/Overlimits
14 days < 3 mths
≥ 3 < 6mths
≥ 6 months
Total Outstanding Balances Of All Revolving Credit Facilities
§ In respect of the society and group, asset exposures between 5% and 10% of capital and greater than 10% of capital, details of:.
— individual exposure
— account name
— amount of exposure
• In respect of the society and group, liability exposures between 5% and 10% of total liabilities and greater than 10% of total liabilities, details of:
— individual exposure
— counterparty name
— amount of exposure
• In respect of bad debts of the society and group, details of:
— number
— amount of bad debts written off
• In respect of impaired loans of the society and group, details of:
— non-accrual loans
— provision for non-accrual loans
— restructured loans
— provision for restructured loans
— real estate acquired via security
— provisions for real estate acquired via security
• In respect of fiduciary activities of the society and group details of:
—. funds managed
— trusteeship
— securitisation programs
• In respect of off balance sheet facilities of the society and group details of:
— amount
— risk weight of facilities provided to members
Direct credit substitutes
Assets sold with recourse
Sale and repurchase agreements
Forward assets purchases
Placement of forward deposits
LANA — qualifying mortgages
LANA — other loans
Warranties, bids and
Member commitments with maturities > 1 year
— overdrafts — limit
— undrawn balance
— standby facilities — limit
— undrawn balance
Member undrawn credit commitments cancellable at any time or less than 1 year
— overdrafts — limit
— undrawn balance
— standby facilities — limit
— undrawn balance
Other commitments
§ In respect of the society and group, details of facilities obtained:
Standby facilities — limit & undrawn balance
Overdraft facilities — limit & undrawn balance
Other facilities — limit & undrawn balance
§ In respect of the derivatives of the society and group, details of opening positions and transactions during the period:
— type
— counterparty amount
— maturity
— mark to market or rule of thumb credit equivalent amount
— detail underlying exposure being hedged
• In respect of other operational information of the society details of:
Number Of Members At End Of Period
Staff Branches and Agencies
— Full-time staff
— Part-time staff (in full-time staff equivalent)
— Number of Branches
— Number of Agencies
• In respect of unreconciled accounts details of:
— description
— discrepancy amount
— date last specified
• The lowest on balance sheet operational liquidity over period and the date on which that occurred.
• The required on balance sheet operational liquidity as assessed by the SSA.
• The required capital adequacy ratio as assessed by the SSA.
• Has the society complied with the required primary objects ratio throughout the reporting period?
• In respect of investments and loans of the society and group, details of:
— repricing analysis and
— weighted average interest rates in the following time periods:
overnight to 30 days
30-60 days
60-90 days
90-180 days
180-365 days
1-2 years
2-5 years
5 years
Overdrafts
• In respect of deposits and borrowings of the society and group, details of:
— repricing analysis and
— weighted average interest rates in the following time periods:
overnight to 30 days
30-60 days
60-90 days
90-180 days
180-365 days
1-2 years
2-5 years
> 5 years
Subsections 237(2), and 245(1) to (3) (inclusive), of a Financial Institutions Code
Note: see paragraph 5 of Schedule 1 to the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Chairperson
237 (2) An employee of the society is not eligible to be the chairperson.
Management contracts
245 (1) In this section –
"management contract" means a contract or other arrangement under which-
(a)a person who is not an officer of the society agrees to perform the whole, or a substantial part, of the functions of the society; or
(b)a society agrees to perform the whole or a substantial part of its functions-
(i)in a particular way; or
(ii)in accordance with the directions of any person; or
(iii)subject to specified restrictions or conditions.
245 (2) A society must not enter into a management contract without the prior written approval of the SSA.
Maximum penalty - $75 000
245 (3) The SSA may subject its approval under subsection (2) to conditions
0
0
0