Banking Act 1959 Making of Prudential Standards: APS 110 Capital Adequacy; APS 111 Capital Adequacy: Measurement of Capital; APS 221 Large Exposures; APS 222 Associations with Related Entities (25/11/2002) (Cth)
Prudential Standard
APS 110 - Capital Adequacy
Objective
This standard aims to ensure that ADIs maintain adequate capital to support the risks associated with their activities on both a stand-alone and group basis.
This standard outlines the overall framework adopted by APRA for assessing an ADI’s capital adequacy. It should be read in conjunction with: APS 111 – Capital Adequacy: Measurement of Capital; APS 112 – Capital Adequacy: Credit Risk; and APS 113 – Capital Adequacy: Market Risk.
Note: Foreign ADIs (which have the same interpretation as in Division 1B of the Banking Act 1959) operating through branches in Australia are not subject to this Standard (and other related Capital Adequacy Standards as mentioned above). They must, however, be subject to comparable capital adequacy standards in their home country.
Index
Principles
Responsibility for Capital Management
Capital is the cornerstone of an ADI’s financial strength. It supports an ADI’s operations by providing a buffer to absorb unanticipated losses from its activities and, in the event of problems, enabling the ADI to continue to operate in a sound and viable manner while the problems are addressed or resolved. The Board of an ADI has the duty to ensure that the ADI maintains an appropriate level of capital commensurate with the level and extent of risks to which the ADI is exposed from its activities. To this end, the ADI should:
(a)have adequate systems and procedures in place to identify, measure, monitor and manage the risks arising from its activities on a continuous basis to ensure that capital is held at a level consistent with the ADI’s risk profile; and
(b)maintain and implement a capital management plan, consistent with the overall business plan, for managing its capital levels on an ongoing basis. Essentially, the plan should set out:
(i) the ADI’s strategy for maintaining capital resources over time, for example, by outlining its capital needs for supporting the degree of risks involved in the ADI’s activities, how the required level of capital is to be met, as well as the means available for sourcing additional capital where required; and
(ii) actions and procedures for monitoring the ADI’s compliance with minimum regulatory capital adequacy requirements, including the setting of trigger ratios to alert management of, and avert, potential breaches to the minimum capital ratios required by APRA.
Where an ADI is a member of a conglomerate group (see AGN 110.1), associations with other members in the group may expose the ADI to the potential of contagion risk – the possibility that difficulties encountered by individual entities in the group might be transmitted to the ADI (refer APS 222 – Associations with Related Entities). In determining stand-alone capital adequacy, the Board of the ADI should have regard to:
(a)group risks posed by other members in the group to the ADI;
(b)obligations (direct or indirect) arising from associations with group entities which might give rise to a call on the capital of the ADI; and
(c)the ability to readily extract capital from other members in the group should the need to recapitalise the ADI arise (this would include consideration of the integration of business within the group, the importance of subsidiaries to the group, the impact of taxation, regulatory requirements and other factors on the ability to realise investments in, or transfer surplus capital from, subsidiaries).
Aside from maintaining adequate capital on a stand-alone basis, ADIs that head a conglomerate group (see AGN 110.1) must also satisfy APRA that the group as a whole has sufficient capital consistent with the group’s risk profile[1]. To this end, the Board of an ADI that heads a conglomerate group should:
[1] Where an ADI forms part of a conglomerate group headed by an authorised non-operating holding company, paragraph 3 applies to the ADI and its subsidiaries.
(a)establish policies on group capital adequacy (which should have regard to the type and distribution of capital resources held by the group) and implement a group capital management plan (with coverage similar to those outlined in paragraph 1(b) above) to ensure that the group overall is adequately capitalised to cover the risks faced by the group and to meet regulatory, market and strategic needs;
(b)ensure that appropriate systems and adequate procedures are in place to identify, assess, measure and monitor group risks on a continuous basis; and
(c)ensure that the group has sufficient capital freely available to meet unexpected losses and adverse shocks impacting on the group.
Index
Measurement of Capital Adequacy
To ensure that ADIs are adequately capitalised on both a stand-alone and group basis, APRA adopts a tiered approach to the measurement of an ADI’s capital adequacy by assessing the ADI’s financial strength at three levels (see illustrative diagram in the Attachment):
(a)Level 1 – the ADI on a stand-alone basis;
(b)Level 2 – the consolidated banking group i.e. the ADI and all its subsidiaries other than non-consolidated subsidiaries (see AGN 110.2); and
(c)Level 3 – the conglomerate group at the widest level.
Level 1 and Level 2 assessments are applicable to all ADIs. Level 3 assessment applies only to ADIs prescribed by APRA (see AGN 110.3).
Measurement of an ADI’s capital adequacy at each of the above three levels is based on:
(a)Level 1 & Level 2 – a risk-based capital adequacy framework based on the Basel Capital Accord (see AGN 110.4); and
(b)Level 3 – the methodology agreed with APRA (see AGN 110.3).
Index
Minimum Capital Adequacy Requirements
An ADI must, at a minimum, maintain a risk-based capital ratio (see AGN 110.4) of 8 per cent at all times under Level 1 and Level 2. At least half of the ratio must take the form of Tier 1 capital (see APS 111 – Capital Adequacy: Measurement of Capital) i.e. a minimum Tier 1 capital ratio of 4 per cent must be maintained. Where considered appropriate, APRA may require an ADI to maintain a minimum capital ratio above 8 per cent (at least half of the ratio must take the form of Tier 1 capital) at Level 1 and Level 2 (see AGN 110.5). APRA expects all ADIs, as part of their capital management plans (see paragraphs 1(b) and 3(a) above), to target and maintain Level 1 and Level 2 capital ratios (both Tier 1 and total) above regulatory minimums.
ADIs subject to Level 3 capital adequacy assessment must meet the minimum group-wide capital adequacy benchmarks agreed with APRA on a continuous basis. APRA may impose additional or higher Level 1 and/or Level 2 capital requirements on an ADI in a conglomerate group where it is not satisfied with the methodology for measuring the group’s capital adequacy at Level 3 (see AGN 110.3).
Index
Notification Requirements
An ADI must inform APRA immediately of:
(a)any breach of the minimum capital adequacy requirements under paragraphs 7 and 8 above and any potential breach of these requirements (e.g. breaches of trigger ratios set under paragraphs 1(b)(ii) and 3(a) above), including remedial actions taken / planned to deal with the problem; and
(b)any concerns it has about its capital adequacy (whether at Level 1, 2 or 3), along with proposed measures to address these concerns.
Index
Reductions in Capital
Where an ADI proposes any reduction in its capital (whether at Level 1, 2 or 3), it must obtain APRA’s prior written consent (see AGN 110.6).
Index
Reporting
An ADI must provide APRA each quarter (or more frequently if required by APRA) with information on its Level 1 and Level 2 capital adequacy in a form to be determined by APRA from time to time.
ADIs subject to Level 3 capital adequacy assessment must provide APRA each quarter (or more frequently if required by APRA) with the group’s capital adequacy reports in a form agreed with APRA.
Index
ATTACHMENT
Application of Framework to A Simple Corporate Structure
Level 1 – An ADI assessed on a stand-alone basis
Level 2 – An ADI and all its subsidiary entities (other than non-consolidated subsidiaries) assessed on a consolidated banking group basis
Level 3 – Entire group assessed
Index
Guidance Note
AGN 110.1 - Conglomerate Group
For the purposes of this Standard, a conglomerate group is defined as a group of companies containing one or more locally incorporated ADIs. Any reference to an ADI in this Standard applies to each ADI member of a conglomerate group on an individual basis.
A conglomerate group must be headed by an ADI or an authorised non‑operating holding company (NOHC)[2] and may include non-financial (commercial) as well as financial entities (regulated and unregulated). A “regulated entity” in a conglomerate group refers to any entity directly regulated by APRA or by an equivalent banking, insurance or similar prudential regulator overseas.
[2] APRA may not require a locally incorporated NOHC that directly owns only an ADI and no other entities to be authorised under the Banking Act 1959.
A foreign-owned locally incorporated ADI and its subsidiaries constitute a conglomerate group for the purposes of this Standard. Alternatively, where the foreign-owned ADI has a locally incorporated NOHC parent, the conglomerate group will comprise the locally incorporated NOHC and all its subsidiaries. The ADI’s foreign parent(s), the foreign parent’s overseas based subsidiaries and their directly owned non-ADI entities operating in Australia do not form part of the conglomerate group. APRA, however, expects the foreign parent to be subject to regulatory oversight broadly consistent with that applied by APRA and, should the need arise, provide APRA with information concerning activities of their subsidiaries outside the Australian conglomerate group.
Index
Guidance Note
AGN 110.2 - Non-consolidated Subsidiaries
For the purposes of determining an ADI’s capital adequacy at the consolidated banking group level (i.e. Level 2), all banking and other financial activities (both regulated and unregulated) conducted within the banking group must be consolidated.
Consolidation at Level 2 should be conducted in accordance with Australian accounting standards. This should cover the global operations of an ADI and its subsidiary entities, as well as any other controlled banking entities, securities entities and other financial entities (e.g. finance companies, money market corporations, stockbrokers and leasing companies), except for entities involved in the following business activities:
(a)insurance businesses (including friendly societies and health funds);
(b)acting as manager, responsible entity, approved trustee, trustee or similar role in relation to funds management or the securitisation of assets; and
(c)non-financial (commercial) operations.
Group entities excluded from Level 2 consolidation are to be deducted from an ADI’s Level 2 capital in accordance with paragraph 9 of APS 111 – Capital Adequacy: Measurement of Capital and AGN 111.4 – Capital Deductions.
Index
Guidance Note
AGN 110.3 - Level 3 Assessment
Only ADIs prescribed by APRA will be subject to Level 3 capital adequacy assessment[3]. APRA will identify conglomerate groups for which Level 2 assessment is deemed not sufficient for measuring an ADI’s capital adequacy on a group-wide basis. These could be financial conglomerates containing substantial banking and insurance activity, or mixed conglomerates containing significant banking and non-financial activity.
[3] The relevant Level 3 capital adequacy requirements will be set out in a separate Prudential Standard on a bilateral basis.
ADIs subject to Level 3 assessment will need to have an APRA-approved, group-wide capital calculation that corresponds to their corporate structure. Essentially, the capital calculation should have regard to all group members (whether ADIs, insurers or unregulated entities) and the capacity of any surplus capital to be moved around the group according to need. The capital calculation may be based on the methodologies of the Joint Forum, or the ADI’s own internal capital estimation and allocation models. The ADI will need to satisfy APRA that the conglomerate group of which it is a part has sufficient capital (as defined in APS 111 – Capital Adequacy: Measurement of Capital) for the risk profile of the group as a whole.
Prescribed ADIs should provide to APRA a description of their current policies with regard to group capital adequacy at Level 3, including the methodology used to measure capital adequacy of the entire group.
In determining capital levels for the conglomerate group, the Board of an ADI that heads the group should have regard to:
(a)the potential for risk to compound across the group (as well as any proven benefits of risk diversification);
(b)concentration of capital and risk within individual entities in the group;
(c)the capital needs of individual entities in the group;
(d)the nature of capital held by the group, including its maturity, servicing costs and any double counting or upgrading of capital within the group;
(e)the ability to readily transfer surplus or free capital within the group and the type of capital which would be available to individual entities from other group members if required (this would involve consideration of the impact of taxation, regulatory requirements and other factors impinging on the ability to transfer surplus capital among individual entities); and
(f)the integration of business within the group and the ability of the group to readily realise capital through the sale of business lines and/or individual member entities without adversely impacting the group’s on-going operations.
Unlike Level 1 and Level 2 capital adequacy assessments, there would be no prescribed minimum capital adequacy requirements (such as the 8 per cent benchmark) for Level 3 assessment. Instead, ADIs prescribed under Level 3 would need to provide details of their own benchmarks (which might be regulatory minima or, for internal models, probability of default / time horizon parameters) and on an on-going basis, details of the extent to which these are exceeded by the conglomerate group. In instances where APRA is not satisfied with the group-wide assessment – for example, because the group’s internal benchmarks are deemed insufficiently prudent, or because APRA is not satisfied with the assumptions made (e.g. for diversification, or in relation to capital mobility) – APRA may impose additional or higher capital requirements on the ADI at Level 1 and/or Level 2.
Index
Guidance Note
AGN 110.4 - Risk-based Capital Adequacy
Framework
APRA’s approach to the assessment of an ADI’s capital adequacy at Level 1 (i.e. the stand-alone level) and Level 2 (i.e. the consolidated banking group level) is based on the risk-based capital adequacy framework set down in the Basel Capital Accord.
Consistent with the Basel framework, the approach provides for a quantitative measure of an ADI’s capital adequacy and focuses on three main elements:
(a)the credit risk associated with an ADI’s on- and off-balance sheet exposures;
(b)the market risk arising from an ADI’s trading activities; and
(c)the form and quality of capital held by the ADI to support these exposures.
APRA may adjust its risk-based capital adequacy framework in future to take account of developments to the Basel framework. Further elements or other types of risk may be added to this quantitative framework over time, such as the inclusion of a requirement to provide capital to cover operational risk.
Under the risk-based capital adequacy framework, an ADI’s Level 1 and Level 2 capital adequacy is measured by means of a risk-based capital ratio calculated by dividing its eligible capital base by its total risk-weighted exposures i.e.,
risk-based capital ratio = eligible capital base
------------------------------------
total risk-weighted exposures
The definition of eligible “capital base” (the numerator of the risk-based capital ratio), including qualifying criteria for individual capital elements to be included in an ADI’s Level 1 and Level 2 capital base, is set out in APS 111 – Capital Adequacy: Measurement of Capital.
An ADI’s “total risk-weighted exposures” (the denominator of the risk-based capital ratio) at Level 1 and Level 2 is calculated as the sum of the total risk-weighted on- and off-balance sheet credit exposures and the “adjusted” market risk exposures (see paragraph 6 below), determined in accordance with the requirements and procedures set out in APS 112 – Capital Adequacy: Credit Risk and APS 113 – Capital Adequacy: Market Risk respectively.
To ensure consistency in the calculation of capital requirements for credit and market risks, the amount of market risk capital charge (for both specific and general market risk) determined in accordance with APS 113 – Capital Adequacy: Market Risk must be adjusted by multiplying it by a constant factor of 12.5 (i.e. the reciprocal of the minimum capital ratio of 8 per cent)[4] to obtain an equivalent risk-weighted exposure. The resulting figure is then added to the risk-weighted credit exposures, calculated in accordance with APS 112 – Capital Adequacy: Credit Risk, to derive the total risk-weighted exposures.
[4] ADIs required by APRA to maintain a minimum capital ratio above 8 per cent should still use a multiplication factor of 12.5.
Index
Guidance Note
AGN 110.5 - Higher Minimum Ratios
In assessing an ADI’s overall capital adequacy at Level 1 and Level 2, APRA will take account of other risk factors that have not been incorporated or accounted for quantitatively in the risk-based capital adequacy framework to ensure that the minimum capital adequacy requirements for the ADI are broadly proportional to its overall risk profiles at Level 1 and Level 2. These factors include, for example, credit risk concentrations, profitability, liquidity[5], off-balance sheet exposures, concentration of particular types of assets or liabilities, operational risk and the effectiveness of the ADI’s management systems for monitoring and controlling risks.
[5] An ADI’s participation in an APRA-certified industry support arrangements will be considered as a risk mitigant.
APRA will consider the above factors in deciding how much capital an ADI needs to hold above the minimum 8 per cent requirement at Level 1 and/or Level 2. All newly established ADIs are generally subject to a higher minimum risk-based capital ratio, both at Level 1 and Level 2, in their formative years.
Index
Guidance Note
AGN 110.6 - Reductions in Capital
For the purpose of paragraph 10 of the Standard, a reduction in an ADI’s capital (whether at Level 1, 2 or 3) includes share buyback; redemption, repurchase or repayment of any qualifying Tier 1 and Tier 2 capital instruments issued by the ADI or by other entities included in the calculation of the ADI’s Level 2 or 3 capital adequacy; trading in the ADI’s own shares or capital instruments (refer paragraph 4 of AGN 111.4 – Capital Deductions); or where the ADI’s total servicing obligations on Tier 1 capital instruments exceed its after-tax earnings in the financial year to which they relate (refer paragraph 5 of APS 111 – Capital Adequacy: Measurement of Capital).
An ADI proposing a capital reduction (whether at Level 1, 2 or 3) should provide APRA with a relevant capital plan covering the respective level(s). The plan should extend for at least 2 years.
To obtain APRA’s approval for any proposed reduction in its capital (whether at Level 1, 2 or 3), an ADI will need to satisfy APRA that the ADI’s capital (at Level 1, 2 or 3 as appropriate) after the proposed reduction will remain adequate for its future needs.
Index
Prudential Standard
APS 111 – Capital Adequacy: Measurement of Capital
Index
Objective
Principles
·Capital Base
·Tier 1 Capital
·Tier 2 Capital
·Deductions
·Limitations
Related Guidance Notes
AGN 111.1 – Tier 1 Capital
·Eligibility
AGN 111.2 – Tier 2 Capital
·Upper Tier 2 Capital
· Asset Revaluation Reserves
· General Provisions for Doubtful Debts
· Hybrid Capital Instruments
·Lower Tier 2 Capital
AGN 111.3 – Criteria for Capital Issues Involving Use of Special Purpose Vehicles (SPVs)
AGN 111.4 – Capital Deductions
Prudential Standard
APS 111 - Capital Adequacy: Measurement
of Capital
Objective
This standard sets out the essential characteristics that an instrument must have to qualify as Tier 1 or Tier 2 (upper or lower) capital for inclusion in an ADI’s capital base for assessing Level 1 (i.e. stand-alone) and Level 2 (i.e. the consolidated banking group) capital adequacy.
This standard forms part of a comprehensive set of prudential standards that deal with the measurement of an ADI’s capital adequacy at Level 1 and Level 2. It should be read in conjunction with: APS 110 – Capital Adequacy; APS 112 – Capital Adequacy: Credit Risk; APS 113 – Capital Adequacy: Market Risk; and APS 120 – Funds Management & Securitisation.
Index
Principles
Capital Base
APRA’s approach to the measurement of an ADI’s capital adequacy at Level 1 and Level 2 (as defined in APS 110 – Capital Adequacy) is based on the risk-based capital adequacy framework developed by the Basel Committee on Banking Supervision (see AGN 110.4 – Risk-based Capital Adequacy Framework). Under this framework, an ADI’s total qualifying capital at Level 1 (i.e. the stand-alone level) and Level 2 (i.e. the consolidated banking group level) is assessed in two tiers:
(a)Tier 1 capital
Tier 1 or core capital comprises the highest quality capital elements which fully satisfy all of the following essential characteristics:
(i) provide a permanent and unrestricted commitment of funds;
(ii) be freely available to absorb losses;
(iii) not impose any unavoidable servicing charge against earnings; and
(iv) rank behind the claims of depositors and other creditors in the event of winding-up.
(b)Tier 2 capital
Tier 2 or supplementary capital includes other elements which, to varying degrees, fall short of the quality of Tier 1 capital stated in paragraph 1(a) above but nonetheless contribute to the overall strength of an entity as a going concern, and is divided into:
(i) Upper Tier 2 capital – comprising elements that are essentially permanent in nature, including some forms of hybrid capital instruments which have the characteristics of both equity and debt; and
(ii) Lower Tier 2 capital – comprising instruments which are not permanent i.e. dated or limited life instruments.
For capital adequacy purposes, an ADI’s Level 1 and Level 2 capital base (i.e. the numerator of the risk-based capital ratio) is defined as the sum of Tier 1 and Tier 2 (upper and lower) capital, net of all specified deductions (see paragraphs 8 and 9 below) and amortisation (see AGN 111.2) where appropriate, at the respective level and subject to the various limits (see paragraph 11 below) that apply to the different tiers of capital.
In assessing whether an instrument is eligible as Tier 1 or Tier 2 (upper or lower) capital, APRA will have regard to both the form and substance of the instrument. An ADI should consult APRA in advance of issuance of any capital instrument other than ordinary shares (whether to be issued directly by the ADI or by any entity at Level 2, or indirectly through a special purpose vehicle) to ensure its eligibility for inclusion in the ADI’s Level 1 or Level 2 capital base.
Index
Tier 1 Capital
For the purposes of calculating an ADI’s capital base at Level 1 and Level 2 (see paragraph 2 above), Tier 1 capital consists of:
(a)paid-up ordinary shares;
(b)general reserves;
(c)retained earnings;
(d)current year’s earnings net of expected dividends and tax expenses;
(e)minority interests arising from consolidation of Tier 1 capital of subsidiaries (only for Level 2 calculations);
(f)non-cumulative irredeemable preference shares approved by APRA (see AGN 111.1); and
(g)other innovative capital instruments (issued through special purpose vehicles) approved by APRA (see AGN 111.1 and AGN 111.3).
Unless otherwise approved by APRA (see paragraph 3 of AGN 111.1), an ADI’s total servicing obligations on Tier 1 capital instruments must not exceed the ADI’s after-tax earnings in the financial year to which they relate. That is, there should be no dividend or interest payments out of retained earnings without APRA’s prior approval.
Index
Tier 2 Capital
For the purposes of calculating an ADI’s capital base at Level 1 and Level 2 (see paragraph 2 above), Upper Tier 2 capital (see AGN 111.2) consists of:
(a)revaluation reserves of premises and securities;
(b)general provisions for doubtful debts (limited to a maximum of 1.25 per cent of total risk-weighted exposures);
(c)cumulative irredeemable preference shares approved by APRA;
(d)mandatory convertible notes and similar capital instruments approved by APRA;
(e)perpetual subordinated debt approved by APRA; and
(f)any other hybrid (debt/equity) capital instruments of a permanent nature approved by APRA, including any capital amounts that are ineligible for inclusion as Tier 1 capital as a result of the limit referred to in paragraph 11(a)(i) below.
For the purposes of calculating an ADI’s capital base at Level 1 and Level 2 (see paragraph 2 above), Lower Tier 2 capital (see AGN 111.2) consists of:
(a)term subordinated debt approved by APRA;
(b)limited life redeemable preference shares approved by APRA; and
(c)any other similar limited life capital instruments approved by APRA.
Index
Deductions
In calculating an ADI’s Level 1 (stand-alone) capital base (see paragraph 2 above), the following items are deducted (see AGN 111.4):
from Tier 1 capital
(a)intangible assets, including the intangible component of investments (e.g. purchased goodwill) in subsidiaries and other entities;
(b)future income tax benefits (other than those associated with general provisions for doubtful debts);
(c)all holdings of own Tier 1 capital instruments and any unused trading limit agreed with APRA;
(d)equity and other capital investments in associated (e.g. captive) lenders mortgage insurers;
(e)equity investments in non-subsidiary entities that are not operating in the field of finance in excess of:
(i) 0.25 per cent of the ADI’s Level 2 Tier 1 capital for an individual investment; or
(ii) 5 per cent of the ADI’s Level 2 Tier 1 capital in aggregate;
from Upper or Lower Tier 2 capital as appropriate
(f)all holdings of own Upper and Lower Tier 2 capital instruments and any unused trading limit agreed with APRA;
from Total Capital (i.e. the sum of Tier 1 and Tier 2 capital after deductions and amortisation)
(g)equity and other capital investments in other ADIs or equivalent overseas deposit-taking institutions (and their subsidiaries), except where:
(i) that other ADI or equivalent overseas deposit-taking institution is wholly owned or effectively controlled (whether directly or indirectly) by the ADI, and has been consolidated with the ADI at Level 2 for capital adequacy purposes; or
(ii) that other ADI’s or equivalent overseas deposit-taking institution’s capital instruments are held for trading purposes which, in this case, must be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;
(h)equity and other capital investments in authorised non-operating holding companies of ADIs unless these are held for trading purposes in which case they will be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;
(i)any credit support of a capital nature provided to other entities, such as provision of a first loss guarantee, including any undertakings by the ADI to absorb designated first level of losses on claims supported by it (first loss facilities associated with funds management and the securitisation of assets should be deducted in accordance with the requirements set out in APS 120 – Funds Management & Securitisation); and
(j)any non-repayable loans advanced by the ADI under APRA’s certified industry support arrangements.
In calculating an ADI’s Level 2 (consolidated group) capital base (see paragraph 2 above), the following items are deducted (see AGN 111.4):
from Tier 1 capital
(a)goodwill and other intangible assets, including the intangible component of investments (e.g. purchased goodwill) in non-consolidated subsidiaries (see AGN 110.2 – Non-consolidated Subsidiaries) and other entities that do not form part of the consolidated banking group at Level 2;
(b)future income tax benefits (other than those associated with general provisions for doubtful debts);
(c)all holdings of own Tier 1 capital instruments and any unused trading limit agreed with APRA;
(d)equity and other capital investments in non-consolidated captive lenders mortgage insurers (see AGN 110.2 – Non-consolidated Subsidiaries);
(e)equity investments in non-subsidiary entities that are not operating in the field of finance in excess of:
(i) 0.25 per cent of the ADI’s Level 2 Tier 1 capital for an individual investment; or
(ii) 5 per cent of the ADI’s Level 2 Tier 1 capital in aggregate;
from Upper or Lower Tier 2 capital as appropriate
(f)all holdings of own Upper and Lower Tier 2 capital instruments and any unused trading limit agreed with APRA;
from Total Capital (i.e. the sum of Tier 1 and Tier 2 capital after deductions and amortisation)
(g)equity and other capital investments in other ADIs or equivalent overseas deposit-taking institutions (and their subsidiaries) unless these are held for trading purposes in which case they will be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;
(h)equity and other capital investments in authorised non-operating holding companies of ADIs unless these are held for trading purposes in which case they will be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;
(i)equity and other capital investments in non-consolidated subsidiaries or controlled entities (other than captive lenders mortgage insurers) after any intangible component of the investment is deducted from Tier 1 capital as per item (a) above (see AGN 110.2 – Non-consolidated Subsidiaries);
(j)any credit support of a capital nature provided to other entities that do not form part of the consolidated banking group at Level 2, such as provision of a first loss guarantee, including any undertakings by the ADI or by any entity consolidated at Level 2 to absorb designated first level of losses on claims supported by them (first loss facilities associated with funds management and the securitisation of assets should be deducted in accordance with the requirements set out in APS 120 – Funds Management & Securitisation); and
(k)any non-repayable loans advanced by the ADI under APRA’s certified industry support arrangements.
All deductions made at Level 1 or Level 2 (see paragraphs 8 and 9 above) are excluded from total assets when calculating an ADI’s total risk-weighted assets at the respective level (see paragraph 2 of AGN 112.1 Risk-Weighted On-Balance Sheet Credit Exposures).
Index
Limitations
The amount of Tier 1 and Tier 2 (upper and lower) capital included in an ADI’s Level 1 and Level 2 capital base are subject to the following limits:
(a)Tier 1 capital
(i) A capital instrument is not eligible for inclusion in an ADI’s Tier 1 capital (before deductions), whether at Level 1 or Level 2, to the extent that its inclusion will result in the aggregate amount of items (f) and (g) described in paragraph 4 above exceeding 25 per cent of the sum of all the other Tier 1 capital components listed in paragraph 4 (i.e. items (a) to (e)). Any excess amount ineligible for inclusion as Tier 1 capital as a result of this limit will be eligible for inclusion as Upper Tier 2 capital.
(ii) Total Tier 1 capital (net of all specified deductions) must constitute at least 50 per cent of an ADI’s capital base, both at Level 1 and Level 2 (except in the formative years of mutually owned ADIs as approved by APRA).
(b)Tier 2 (upper and lower) capital
(i) Total Tier 2 capital (net of all specified deductions and amortisation) at Level 1 and Level 2 is limited to a maximum of 100 per cent of an ADI’s total Tier 1 capital (net of all specified deductions) at the respective level (except in the formative years of mutually owned ADIs as approved by APRA).
(ii) Total Lower Tier 2 capital (net of all specified deductions and amortisation) at Level 1 and Level 2 is limited to a maximum of 50 per cent of an ADI’s total Tier 1 capital (net of all specified deductions) at the respective level (except in the formative years of mutually owned ADIs as approved by APRA).
Index
Guidance Note
AGN 111.1 - Tier 1 Capital
Eligibility
To be included as Tier 1 capital at Level 1 or Level 2, capital instruments mentioned in items (f) and (g) of paragraph 4 of APS 111 must satisfy the following criteria[6]:
[6] The criteria will apply to instruments issued by an ADI and by any entity at Level 2.
(a)The instrument should normally take the form of shares unless otherwise agreed with APRA. It must be treated as equity under Australian Accounting Standards and be reported as such in the ADI’s published financial statements, except where an alternative treatment has been agreed with APRA.
(b)The instrument must be unsecured and fully paid up. Any partly paid issue is eligible only to the extent that it has been paid up. The proceeds of the issue (whether fully or partially paid up) must be immediately available to the issuer. Only the proceeds actually received from the issue are to be included.
(c)The instrument must be subordinated in right of repayment of principal and interest to all depositors and other creditors of the issuer. Issue documentation must clearly indicate this to prospective holders, and must preclude the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument. Issue documentation must also clearly indicate that the instrument does not represent a deposit liability of an ADI.
(d)The instrument must have no maturity. It must not be redeemable at the initiative of the holder nor must it carry any other provision which requires future redemption by the issuer. The instrument may, however, be redeemable at the option of the issuer. Where the instrument offers a redemption option to the issuer, issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to redeem or purchase the instrument is subject to APRA’s prior approval.
(e)The instrument (including any unpaid dividends or interest) must be available to absorb losses incurred by the issuer in the ordinary course of business.
(f)The instrument must not provide for payment of any form of compensation to investors other than by way of a distribution of profits. Dividend (or interest) payments to the instrument must be non-cumulative. The issuer must be able to waive any dividend (or interest) payments on the instrument and alter the timing of payments. The instrument must not provide for the payment of a higher dividend (or interest) rate if dividend (or interest) payments are not made on time (nor a reduced interest rate if interest payments are made on time).
(g)The non-payment of a dividend (or interest) on the instrument must not trigger any restrictions on the issuer, other than the need to seek the holders’ approval before paying dividends on other shares, or purchasing shares (outside normal trading operations), or retiring shares.
(h)Adjustments to dividend (or interest) obligations on the instrument must not be linked to the credit standing of the issuer. This does not, however, preclude linking dividends (or interest) to movements in general market indices. The rate of dividends (or interest), or the formulae for calculating dividend (or interest) payments, must be fixed at the time of issuing the instrument and set out in the issue documentation.
(i)Where the instrument carries a “step-up” provision, the terms of the step-up must be limited, fixed at the time of issue and subject to APRA’s prior approval. “Step-ups” include the following events:
(i) a change in margin on a floating rate instrument;
(ii) a change in rate on a fixed rate instrument;
(iii) a conversion from fixed to floating rate or vice versa;
(iv) a switch in the basis index (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW).
(j)The size of any proposed step-up should be modest and in line with market terms and conditions. Any increase should come within one of the following measures:
(i) 100 basis points, less the swap spread between the initial basis index and the stepped-up basis index; or
(ii) 50 per cent of the initial credit spread, less the swap spread between the initial basis index and the stepped-up basis index.
The issue documentation should specify one of the above two measures to apply to the instrument; switching between measures is not allowed.
Where the step-up involves a conversion from fixed to floating rate (or vice versa) or a switch in basis index, the swap spread should be fixed at pricing date, reflecting the differential in pricing between the indices at the time.
(k)Any step-up provision must not be operative within the first 10 years from drawdown. The rule is for one step-up over the life of the instrument. Exceptions to allow step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA at the time of issuing the instrument.
(l)Where the instrument provides for a mandatory conversion or an option to the holders or the issuer to convert into another form of eligible Tier 1 capital instrument, it must not contain any conversion feature that effectively provides for a return of capital or compensation for unpaid dividends (or interest). The rate of conversion must be fixed (e.g. by way of a formulae) at the time of subscription to the instrument.
(m)Where an instrument provides for dividend (or interest) payments to be reset, and coincides with an option conferred on the issuer to redeem the instrument, this should not have the effect of signalling to investors an expectation that the instrument is likely to be redeemed. Should this occur, APRA will consider the instrument to be a dated instrument and ineligible for inclusion as Tier 1 capital.
(n)The instrument should not include any “repackaging” arrangements with the effect of compromising the permanency of capital raised.
(o)The instrument must not contain any terms or restrictions that could adversely inhibit the issuer’s ability to be managed in a sound and prudent manner (particularly in times of financial difficulty), or restrict APRA’s ability to resolve any problems encountered by the issuer (e.g. clauses preventing further senior debt issues)[7].
[7] There must be no cross-default clauses, in the documentation of any debt instruments of the issuer, linking the issuer’s obligations under the instrument to default by another party (related or otherwise).
(p)Where the instrument is subject to the laws of a jurisdiction other than Australia or its territories, an ADI must ensure that the instrument satisfy the above criteria under the laws of that jurisdiction. This is particularly relevant, for example, in the case of corporate insolvency law, which may vary across jurisdictions. APRA may, where necessary, require an ADI to provide confirmation from its legal advisers to this effect.
(q)Any subsequent modification of the terms or conditions of the instrument, which impact on its eligibility to continue qualifying as Tier 1 capital, must be subject to APRA’s prior consent.
(r)An ADI is required to provide APRA with copies of documentation associated with the issue of the instrument. Where the terms of an issue depart from established precedent, ADIs should consult APRA prior to issue.
Capital instruments issued through special purpose vehicles must also meet the criteria set out in AGN 111.3.
Although APRA limits an ADI’s total servicing obligations on Tier 1 capital instruments to a maximum of its after-tax earnings in the financial year to which they relate (refer paragraph 5 of the Standard), it is prepared to modify this requirement on a case-by-case basis depending on circumstances at the time of payment. APRA will assess whether the proposed level of dividend or interest payments is justified by reference to other considerations, such as an ADI’s on-going capital position, commitments to raise capital and core profitability.
Index
Guidance Note
AGN 111.2 - Tier 2 Capital
Upper Tier 2 Capital
Asset Revaluation Reserves
Reserves arising from the revaluation of premises are to be included in Upper Tier 2 capital subject to the following conditions:
(a)the premises must be owned by an ADI or one of the entities at Level 2;
(b)the reserves must be shown as a component of equity in the statement of financial position;
(c)the revaluations are conducted regularly and subject to audit review consistent with the Australian Accounting Standards (AASB 1010 and AASB 1041) and auditing practice; and
(d)the amount of reserves to be included in Upper Tier 2 capital must incorporate the full effect of any diminution in the values of premises (i.e. net of any devaluations), and should be after allowance for expected realisation costs and associated taxes.
To be eligible for inclusion in Upper Tier 2 capital, revaluation reserves of quoted, readily marketable securities must satisfy the following conditions:
(a)the securities must be directly held by an ADI or one of the entities at Level 2;
(b)the reserves must be shown as a component of equity in the statement of financial position;
(c)the reserves must incorporate the amount of any diminution in the values of the securities (i.e. net of devaluations); and
(d)only 45 per cent of the net revaluation surplus (net of devaluations) can be included in Upper Tier 2 capital.
Index
General Provisions for Doubtful Debts
The amount of general provisions for doubtful debts to be included in Upper Tier 2 capital should be net of any associated future income tax benefits on a gross basis, and is limited to a maximum of 1.25 per cent of total risk-weighted exposures (see AGN 110.4 – Risk-based Capital Adequacy Framework).
The amount of provisions included must be created against future, presently unidentified losses and must be freely available to meet any losses that may subsequently materialise. Any general provisions created against specific or identified losses and against identified deterioration in the value of particular assets, whether individual or grouped, foreign or domestic, are not eligible for inclusion in Upper Tier 2 capital.
Index
Hybrid Capital Instruments
Hybrid debt/equity instruments must satisfy the following criteria[8] to be eligible as Upper Tier 2 capital:
[8] The criteria will apply to instruments issued by an ADI and by any entity at Level 2.
(a)The instrument must be unsecured and fully paid up. Any partly paid issue is eligible only to the extent that it has been paid up. The proceeds of the issue (whether fully or partially paid up) must be immediately available to the issuer. Only the proceeds actually received from the issue are to be included.
(b)The instrument must be subordinated in right of repayment of principal and interest to all depositors and other creditors of the issuer, except those creditors (not depositors) expressed to rank equally with or behind the holders of the instrument. Issue documentation must clearly indicate this to prospective holders, and must preclude the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument. Issue documentation must also clearly indicate that the instrument does not represent a deposit liability of an ADI.
(c)The instrument must have no maturity. It must not be redeemable at the initiative of the holder nor must it carry any other provision which requires future redemption by the issuer. The instrument may, however, be redeemable at the option of the issuer. Where the instrument offers a redemption option to the issuer, issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to repay, purchase or otherwise redeem the instrument is subject to APRA’s prior approval.
(d)The instrument (including any unpaid dividends or interest) must be available to participate in losses without the issuer being obliged to cease trading. This can be achieved either by conversion into ordinary shares or by treating the instrument as a class of share capital in the event that the issuer’s retained earnings become negative. Where the instrument provides for an automatic conversion into ordinary shares (including any unpaid interest), the rate of conversion must be fixed (e.g. by way of a formulae) at the time of subscription to the instrument. Alternatively, the instrument can provide for principal and unpaid interest to be treated as if it constituted a specific class of share capital of the issuer. Issue documentation must disclose to prospective investors the manner by which the instrument is to be treated in a loss situation.
(e)The instrument must not provide for payment of any form of compensation to investors other than by way of a distribution of profits. The instrument must allow the issuer an option to defer servicing obligations where profitability does not justify a dividend or interest payment. Although any unpaid dividends or interest can be accumulated, they must not be compounded. The instrument must not provide for the payment of a higher dividend (or interest) rate if dividend (or interest) payments are not made on time (nor a reduced interest rate if interest payments are made on time).
(f)Where cumulative irredeemable preference shares do not provide the issuer with the option to defer or reduce dividends when profitability does not justify payment, such shares are to be treated as a Lower Tier 2 capital instrument.
(g)Adjustments to dividend (or interest) obligations on the instrument must not be linked to the credit standing of the issuer. This does not, however, preclude linking dividends (or interest) to movements in general market indices. The rate of dividends (or interest), or the formulae for calculating dividend (or interest) payments, must be fixed at the time of issuing the instrument and set out in the issue documentation.
(h)Where the instrument carries a “step-up” provision, the terms of the step-up must be limited, fixed at the time of issue and subject to APRA’s prior approval. “Step-ups” include the following events:
(i) a change in margin on a floating rate instrument;
(ii) a change in rate on a fixed rate instrument;
(iii) a conversion from fixed to floating rate or vice versa;
(iv) a switch in the basis index (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW).
(i)The size of any proposed step-up should be modest and in line with market terms and conditions. Any increase should come within one of the following measures:
(i) 100 basis points, less the swap spread between the initial basis index and the stepped-up basis index; or
(ii) 50 per cent of the initial credit spread, less the swap spread between the initial basis index and the stepped-up basis index.
The issue documentation should specify one of the above two measures to apply to the instrument; switching between measures is not allowed.
Where the step-up involves a conversion from fixed to floating rate (or vice versa) or a switch in basis index, the swap spread should be fixed at pricing date, reflecting the differential in pricing between the indices at the time.
(j)Any step-up provision must not be operative within the first 10 years from drawdown. The rule is for one step-up over the life of the instrument. Exceptions to allow step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA at the time of issuing the instrument.
(k)In the event that the issuer defaults under the terms of the instrument, remedies available to the holders should be limited to actions for specific performance, recovery of dividend or interest amounts currently outstanding, or the winding-up of the issuer.
(l)The instrument must not provide for any accelerated repayment of principal, except in the event of liquidation or winding-up of the issuer. The winding-up must be irrevocable i.e. either by way of a court order or an effective resolution by shareholders or members. The making of an application to wind-up, or the appointment of a receiver, administrator, or official with similar powers (including the exercise of APRA’s powers under section 13A(1) of the Banking Act) are not sufficient to accelerate repayment of the instrument.
(m)Where the instrument carries a right or obligation to convert into share capital of the issuer, the conversion provisions must not be structured to provide a redemption or return of the original investment or any compensation for unpaid dividends or interest to the holders. The rate of conversion must be fixed (e.g. by way of a formulae) at the time of subscription to the instrument.
(n)Where an instrument provides for dividend (or interest) payments to be reset, and coincides with an option conferred on the issuer to redeem the instrument, this should not have the effect of signalling to investors an expectation that the instrument is likely to be redeemed. Should this occur, APRA will consider the instrument to be a dated instrument and ineligible for inclusion as Upper Tier 2 capital.
(o)The instrument should not include any “repackaging” arrangements with the effect of compromising the permanency of capital raised.
(p)The instrument must not contain any terms, covenants or restrictions that could adversely inhibit the issuer’s ability to be managed in a sound and prudent manner (particularly in times of financial difficulty), or restrict APRA’s ability to resolve any problems encountered by the issuer (e.g. clauses preventing further senior debt issues)[9].
[9] There must be no cross-default clauses, in the documentation of any debt instruments of the issuer, linking the issuer’s obligations under the instrument to default by another party (related or otherwise).
(q)Where the instrument is subject to the laws of a jurisdiction other than Australia or its territories, an ADI must ensure that the instrument satisfy the above criteria under the laws of that jurisdiction. This is particularly relevant, for example, in the case of corporate insolvency law, which may vary across jurisdictions.APRA may, where necessary, require an ADI to provide confirmation from its legal advisers to this effect.
(r)Any subsequent modification of the terms or conditions of the instrument, which impact on its eligibility to continue qualifying as Upper Tier 2 capital, must be subject to APRA’s prior consent.
(s)An ADI is required to provide APRA with copies of documentation associated with the issue of the instrument. Where the terms of an issue depart from established precedent, ADIs should consult APRA prior to issue.
Instruments issued through special purpose vehicles must also satisfy the qualifying criteria set out in AGN 111.3.
Index
Lower Tier 2 Capital
Lower Tier 2 capital instruments must satisfy the following criteria[10]:
[10] The criteria will apply to instruments issued by an ADI and by any entity at Level 2.
(a)The instrument must be unsecured and fully paid up. Any partly paid issue is eligible only to the extent that it has been paid up. The proceeds of the issue (whether fully or partially paid up) must be immediately available to the issuer. Only the proceeds actually received from the issue are to be included.
(b)The instrument must be subordinated in right of repayment of principal and interest to all depositors and other creditors of the issuer, except those creditors (not depositors) expressed to rank equally with or behind the holders of the instrument. Issue documentation must clearly indicate this to prospective holders, and must preclude the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument. Issue documentation must also clearly indicate that the instrument does not represent a deposit liability of an ADI.
(c)The instrument must have a minimum term of 5 years. Where the instrument is drawn down in a series of tranches, the minimum original maturity of each tranche must be 5 years from the date of drawdown.
(d)The amount of the instrument eligible for inclusion in Lower Tier 2 capital is to be amortised on a straight line basis at a rate of 20 per cent per annum over the last 4 years to maturity as follows:
Years to Maturity Amount Eligible for Inclusion in Lower Tier 2 Capital More than 4
100 per cent
Less than and including 4 but more than 3
80 per cent
Less than and including 3 but more than 2
60 per cent
Less than and including 2 but more than 1
40 per cent
Less than and including 1
20 per cent
(e)Where the instrument provides holders with the right or option to demand repayment prior to maturity, the first possible repayment date should be regarded as the effective maturity date of the instrument.
(f)Where the instrument offers the issuer a redemption option prior to maturity, issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to repay, purchase, or otherwise redeem the instrument is subject to APRA’s prior approval.
(g)The instrument must not provide for the payment of a higher dividend or interest rate if dividend or interest payments are not made on time (nor a reduced rate of interest if interest payments are made on time).
(h)Adjustments to dividend (or interest) obligations on the instrument must not be linked to the credit standing of the issuer. This does not, however, preclude linking dividends (or interest) to movements in general market indices. The rate of dividends (or interest), or the formulae for calculating dividend (or interest) payments, must be fixed at the time of issuing the instrument and set out in the issue documentation.
(i)Where the instrument carries a “step-up” provision, the terms of the step-up must be limited, fixed at the time of issue and subject to APRA’s prior approval. “Step-ups” include the following events:
(i) a change in margin on a floating rate instrument;
(ii) a change in rate on a fixed rate instrument;
(iii) a conversion from fixed to floating rate or vice versa;
(iv) a switch in the basis index (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW).
(j)The size of any proposed step-up should be modest and in line with market terms and conditions. Any increase should come within one of the following measures:
(i) 50 basis points, less the swap spread between the initial basis index and the stepped-up basis index, for an issue with a maturity up to 10 years;
(ii) 100 basis points, less the swap spread between the initial basis index and the stepped-up basis index, for an issue with a maturity of more than 10 years; or
(iii) 50 per cent of the initial credit spread, less the swap spread between the initial basis index and the stepped-up basis index.
The issue documentation should specify one of the above three measures to apply to the instrument; switching between measures is not allowed.
Where the step-up involves a conversion from fixed to floating rate (or vice versa) or a switch in basis index, the swap spread should be fixed at pricing date, reflecting the differential in pricing between the indices at the time.
(k)Any step-up provision must not be operative within the first 5 years from drawdown. The rule is for one step-up over the life of the instrument. Exceptions to allow step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA at the time of issuing the instrument.
(l)In the event that the issuer defaults under the terms of the instrument, remedies available to the holders should be limited to actions for specific performance, recovery of amounts currently outstanding (i.e. overdue interest and principal on maturity provided the issuer can make such payments and remain solvent) or the winding-up of the issuer.
(m)The instrument must not provide for any accelerated repayment of principal, except in the event of liquidation or winding-up of the issuer. The winding-up must be irrevocable i.e. either by way of a court order or an effective resolution by shareholders or members. The making of an application to wind-up, or the appointment of a receiver, administrator, or official with similar powers (including the exercise of APRA’s powers under section 13A(1) of the Banking Act) are not sufficient to accelerate repayment of the instrument.
(n)Where an instrument provides for dividend (or interest) payments to be reset with a significant step-up, and coincides with an option conferred on the issuer to redeem the instrument, the instrument will be deemed to mature on the date at which the step-up provisions take effect. Where that date is less than 5 years from the date of drawdown, the instrument is not eligible for inclusion in Lower Tier 2 capital.
(o)The instrument must not contain any terms, covenants or restrictions that could adversely inhibit the issuer’s ability to be managed in a sound and prudent manner (particularly in times of financial difficulty), or restrict APRA’s ability to resolve any problems encountered by the issuer (e.g. clauses preventing further senior debt issues)[11].
[11] There must be no cross-default clauses, in the documentation of any debt instruments of the issuer, linking the issuer’s obligations under the instrument to default by another party (related or otherwise).
(p)Where the instrument is subject to the laws of a jurisdiction other than Australia or its territories, an ADI must ensure that the instrument satisfy the above criteria under the laws of that jurisdiction. This is particularly relevant, for example, in the case of corporate insolvency law, which may vary across jurisdictions. APRA may, where necessary, require an ADI to provide confirmation from its legal advisers to this effect.
(a)includes (but is not limited to):
(i) outstanding balances of all loans and advances;
(ii) all unused advised off-balance sheet commitments (refer Attachment A to AGN 112.2 for examples of these commitments), whether revocable or irrevocable;
(iii) the credit equivalent amounts of all market-related contracts (calculated in accordance with AGN 112.2 or AGN 112.3 where netting applies[32]); and
[32] In determining an ADI’s (or Extended Licensed Entity’s) exposure to a related entity, netting by novation and close-out netting are permissible for market-related contracts provided all the requirements set out in AGN 112.3 for bilateral netting are met.
(iv) any equity investment in the related entity not deducted from the ADI’s Level 1 (stand-alone) capital for capital adequacy purposes (see APS 111 – Capital Adequacy: Measurement of Capital);
(b)excludes:
(i) exposures of the ADI to, including equity investments in, subsidiaries that form part of the Extended Licensed Entity (see AGN 222.1)[33];
[33] However, an ADI is required to report these exposures to APRA as part of the normal prudential reporting framework (see paragraph 33 below).
(ii) exposures (including equity investment) deducted from the ADI’s Level 1 (stand-alone) capital for capital adequacy purposes (see APS 111 – Capital Adequacy: Measurement of Capital);
(iii) exposures to the extent that they are secured by cash deposits (subject to satisfying the criteria set out in Attachment B to AGN 112.1 for the purpose of this Standard);
(iv) exposures to the extent that they are guaranteed by governments, or secured by government securities (subject to satisfying the conditions set out in paragraphs 9, 12, 13, 14 and 15 of AGN 112.1 for the purpose of this Standard);
(v) exposures arising in the course of settlement of market-related contracts; and
(vi) exposures to the extent that they have been written off or specifically provided for.
Index
Approval Requirements
An ADI must obtain APRA’s prior approval for any proposed exposures in excess of the prescribed limits set out in paragraph 27 above. Such approval will only be granted on an exceptional basis. The ADI concerned must be able to satisfy APRA why the proposed exposure(s) might reasonably be expected not to expose the ADI (or Extended Licensed Entity) to excessive risk. APRA may impose a higher minimum capital ratio on the ADI at the stand-alone level (see APS 110 – Capital Adequacy) to compensate for the additional risk that may be associated with the proposed exposure(s).
Index
Prior Consultation Requirements
An ADI should consult with APRA before:
(a)establishing or acquiring a subsidiary (other than an entity which is to be used purely as a special purpose financing vehicle for the ADI);
(b)committing to any proposal to acquire (whether directly or indirectly) more than 10% of equity interest in an entity which operates in the field of finance; and
(c)taking up equity interest in an entity arising from the work-out of a problem exposure where:
(i) this exceeds 0.25% of the ADI’s Level 2 Tier 1 capital (calculated in accordance with APS 111 – Capital Adequacy: Measurement of Capital); or
(ii) this will result in the ADI acquiring (whether directly or indirectly) more than 10% of equity interest in the entity; or
(iii) this will result in the ADI’s aggregate investment in non-subsidiary entities which are not operating in the field of finance exceeding 5% of the ADI’s Level 2 Tier 1 capital (calculated in accordance with APS 111 – Capital Adequacy: Measurement of Capital).
Index
Notification Requirements
An ADI must notify APRA immediately of any breach of the prudential limits on exposures to related entities prescribed in paragraph 27 above, including remedial actions taken or planned to deal with the breach.
An ADI should report any equity investments that are not subject to the prior consultation requirements set out in paragraph 30 above to APRA retrospectively.
Index
Reporting
An ADI must provide APRA each quarter (or more frequently if required by APRA) with information on its (or the Extended Licensed Entity’s) exposures to related entities (including the ADI’s exposures to subsidiaries that form part of the Extended Licensed Entity) in a form to be determined by APRA from time to time. Where necessary, APRA may impose additional reporting requirements on the ADI.
A foreign ADI must provide APRA each quarter (or more frequently if required by APRA) with information on its exposures to its subsidiaries operating in Australia in a form to be determined by APRA from time to time. Where necessary, APRA may impose additional reporting requirements on the foreign ADI.
Index
Guidance Note
AGN 222.1 - Extended Licensed Entity
APRA recognises that most ADIs regularly conduct some of their activities using subsidiaries and special purpose vehicles which are often established to satisfy tax requirements. While they involve separate legal entities, they are to all intents and purposes operated as a division of an ADI.
Subject to the specific requirements set out in paragraph 4 below, APRA may deem a subsidiary of an ADI (other than an entity regulated directly by APRA or by a foreign equivalent) to be part of the ADI itself for the purposes of measuring the ADI’s exposures to related entities. Essentially, this requires APRA to adopt a “substance over form” approach and to “look through” the legal structure involved. Under this approach, an ADI and all its eligible subsidiary entities would be “consolidated” to form an “Extended Licensed Entity” (ELE) for measuring the ADI’s exposures to all other related entities. Accordingly, the ADI’s exposures to these subsidiaries (including equity investments) are exempted from the ADI’s intra-group exposure limits prescribed by APRA.
An ADI may apply to APRA to have one or more subsidiaries approved as part of its ELE. In practice, APRA will agree with the ADI on a list of entities that are eligible to form part of the ELE. An ADI is required to inform APRA as soon as it becomes aware that a member of the ELE no longer meets the criteria set out in this Guidance Note.
In deciding whether to approve a subsidiary of an ADI as eligible for inclusion within the ELE, APRA will have regard to the ADI’s extent of control over, and integration with, the subsidiary as well as the existence of any third-party liabilities of the subsidiary. Potential complications under a scenario where underlying asset holdings must be liquidated during financial stress will also be considered. Essentially, the following criteria should be met in respect of the relationship between the ADI and the subsidiary:
(a)the subsidiary should be wholly owned by the ADI, with a board of directors that is composed entirely of members of the ADI’s Board or senior management;
(b)the ADI has complete information on the individual assets, liabilities and off-balance sheet positions of the subsidiary. The ADI should be able to furnish stand-alone accounting records for the subsidiary, and provide APRA with full and unfettered access to this and any other information at any time (including during on-site visits);
(c)the ADI is unrestricted in its ability to control the composition of the subsidiary’s assets and liabilities as it sees fit. The ADI should demonstrate to APRA that there are no legal or regulatory barriers (including cross-border issues where the subsidiary is not incorporated or established in Australia) to the transfer of the assets/funds back to the ADI. There should be no legal obstacle to the ADI instituting a wind-up of the subsidiary at any time and placing the remaining assets on the balance sheet of the ADI;
(d)the ADI manages the assets and liabilities of the subsidiary as part of its internal management practices. This includes reporting structures, accounting processes, audit arrangements, and risk management and measurement systems. Essentially, the ADI’s risk management processes, MIS systems and internal controls should be fully extended to the operations of the subsidiary. The senior management of the ADI should monitor the operations of the subsidiary to the same extent as the operations of the ADI itself. Systems for monitoring and control over the subsidiary should be included within the internal and external audit programs of the ADI;
(e)the subsidiary should not conduct any business that the ADI would otherwise be prevented from doing under its banking authority (such as insurance). It is important that the ADI is not using the ELE concept to circumvent APRA’s prudential requirements;
(f)where the subsidiary holds or invests in assets (other than claims on the ADI), the subsidiary should have no material liabilities (both on- and off-balance sheet) to entities other than those that are part of the ELE (APRA will exempt tax liabilities and employee entitlements from this requirement); and
(g)where the subsidiary borrows on behalf of the ADI, all funds should be on-lent directly to the ADI.
The criteria in paragraph 4 provide for a simple arrangement involving an ADI and one or more directly owned subsidiary entities. This is not intended to preclude, for example, an arrangement in which an ADI invests in a single entity as a holding company and that entity in turn invests in multiple entities. In these circumstances, APRA is prepared to “look through” the holding company to determine whether these individual entities meet all of the above criteria (this would be for the ADI seeking APRA’s approval to demonstrate) to be included as part of an ELE. Entities that fail to meet the above criteria would be excluded from the ELE.
Index
0
0
0