Banking (prudential standard) determination No. 7 of 2007 Prudential Standard APS 114 Capital Adequacy: Standardised Approach to Operational Risk (Cth)
Banking (prudential standard) determination No. 7 of 2007
Prudential standard APS 114 Capital Adequacy: Standardised Approach to Operational Risk
Banking Act 1959
I, John Francis Laker, Chair of APRA, under subsection 11AF(1) of the Banking Act 1959 (the Act), DETERMINE Prudential Standard APS 114 Capital Adequacy: Standardised Approach to Operational Risk (APS 114) in the form set out in the Schedule, which applies to:
(a)all authorised deposit-taking institutions (ADIs), with the exception of foreign ADIs and ADIs that have approval from APRA to use an advanced measurement approach to operational risk under Prudential Standard APS 115 Capital Adequacy: Advanced Measurement Approaches to Operational Risk; and
(b)where an ADI to which APS 114 applies is a subsidiary of an authorised non-operating holding company (authorised NOHC), the authorised NOHC.
This instrument takes effect on 1 January 2008.
Dated 30 November 2007
[Signed]
…………………...
John Francis Laker
Chair
Interpretation
In this Determination
ADI has the meaning given in section 5 of the Act.
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 5 of the Act.
foreign ADI has the meaning given in section 5 of the Act
Note 1 An ADI or authorised NOHC that does not comply with a standard may be issued with directions by APRA under paragraph 11CA(1)(a) of the Act. Non-compliance with a direction is an offence attracting a penalty of up to 250 penalty units for a body corporate (currently $27,500) for each day that the offence continues. Officers of the ADI or authorised NOHC may also be criminally liable (see section 11CG).
Schedule
Prudential Standard APS 114 Capital Adequacy: Standardised Approach to Operational Risk comprises the 7 pages commencing on the following page.
Prudential Standard APS 114
Capital Adequacy: Standardised Approach to Operational Risk
Objectives and key requirements of this Prudential Standard
This Prudential Standard aims to ensure that an authorised deposit-taking institution holds sufficient regulatory capital against operational risk exposures.
The key requirements of this Prudential Standard are:
an authorised deposit-taking institution must divide its activities into three areas of business: retail banking, commercial banking and all other activity;
different operational risk capital requirements apply to each of the three areas of business; and
the total capital requirement for operational risk is the sum of the capital requirements calculated for each of the three areas of business.
Table of contents
Prudential Standard
Authority
Application
Scope
Definitions
Key principles
Retail and commercial banking areas
All other activity area
Calculation of operational risk regulatory capital
Authority
This Prudential Standard is made under section 11AF of the Banking Act 1959 (Banking Act).
Application
This Prudential Standard applies to all authorised deposit-taking institutions (ADIs) with the exception of :
(a)foreign ADIs within the meaning of subsection 5(1) of the Banking Act; and
(b)ADIs that have approval from APRA to use an advanced measurement approach to operational risk under Prudential Standard APS 115 Capital Adequacy: Advanced Measurement Approaches to Operational Risk.
A reference to an ADI in this Prudential Standard shall be taken as a reference to:
(a)an ADI on a Level 1 basis; and
(b)a group of which an ADI is a member on a Level 2 basis.
Level 1 and Level 2 have the meaning in Prudential Standard APS 110 Capital Adequacy (APS 110).
Where an ADI to which this Prudential Standard applies is a subsidiary of an authorised non-operating holding company (authorised NOHC), the authorised NOHC must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable.
Scope
This Prudential Standard applies to all operations and activities of an ADI.
Definitions
The following definitions are used in this Prudential Standard:
(a)adjusted gross income - adjusted gross income is equal to total operating income from continuing operations excluding certain income items and excluding items for which operational risk regulatory capital is separately calculated by this Prudential Standard;
(b)corporate finance activities - including underwriting and any holdings of equity or debt arising from underwriting, arranging, facilitation, and management activities such as those associated with securitisation, mergers and acquisitions or privatisations and syndication activities that are undertaken, predominantly, with the intention of earning a fee. Also included in corporate finance are longer term positions in equities that are held for strategic reasons and holdings in equity instruments, or in instruments that exhibit characteristics that are more like equity than debt, that arise as a consequence of loan restructurings;
(c)gross income - total operating income from continuing operations;
(d)operational risk - the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk[1] but excludes strategic and reputational risks; and
(e)operational risk regulatory capital (ORRC) - the regulatory capital that an ADI is required to hold against its exposure to operational risk in accordance with this Prudential Standard.
[1] Legal risk includes, but is not limited to, exposure to fines, penalties or punitive damages resulting from supervisory actions as well as ordinary damages in civil litigation, related legal costs and private settlements.
Key principles
For regulatory capital purposes, an ADI must divide its business activities into three areas of business:
(a)retail banking;
(b)commercial banking; and
(c)all other activity.
An ADI’s ORRC for the retail and commercial banking areas of business must be determined using a proportion of the ADI’s total gross outstanding loans and advances as an indicator of each area’s operational risk exposure. The ORRC for the all other activity area is determined by using gross income, adjusted to exclude income primarily relating to retail banking and commercial banking (adjusted gross income).
Retail and commercial banking areas
For the purposes of paragraph 7, an ADI’s total gross outstanding loans and advances is defined as the total on-balance sheet exposure to the following items, as reported in the ADI’s regulatory reporting returns provided to APRA under section 13 of the Financial Sector (Collection of Data) Act 2001:
Retail banking
(a)cash holdings of notes and coins; and
(b)loans to households.
Commercial banking
(a)all deposits and amounts due from financial institutions;
(b)subject to paragraph 10, securities held in the banking book; and
(c)commercial lending.
An ADI that has funded positions with respect to corporate finance activities, must exclude those positions for the purpose of measuring total gross outstanding loans and advances for the commercial banking area of business. In addition, the balances of loans and advances that are excluded from risk-weighted assets under Prudential Standard APS 120 Securitisation must also be excluded from total gross outstanding loans and advances for the retail banking and commercial banking areas of business.
An ADI must, in calculating its total gross outstanding loans and advances within the commercial banking area of business, include the gross book value of securities[2] held in the banking book, excluding those arising from the ADI’s involvement in corporate finance related activities and those that are deducted from capital (refer to Prudential Standard APS 111 Capital Adequacy: Measurement of Capital).
[2] A security for the purposes of this Prudential Standard includes all debt securities held in the banking book.
All other activity area
An ADI must, as an indicator of the operational risk exposure arising from all other activity, determine the capital requirement for that activity using adjusted gross income. Adjusted gross income may exclude irregular items but the amount must include income (including net interest income and servicing activities) from the ADI’s involvement in securitisation, trading[3] and corporate finance activities. In the absence of any adjustments, adjusted gross income will equate to total operating income from continuing operations.
[3] For trading activities, net income includes profits and losses on instruments held for trading purposes, net of funding costs, plus fees from wholesale broking.
The ADI must be able to demonstrate to APRA that the ORRC for the retail or commercial banking areas of business adequately captures the operational risks associated with the activities to which these items relate.
Calculation of operational risk regulatory capital
An ADI’s total ORRC must equal the sum of the average results for the areas of retail banking, commercial banking and all other activity as set out in paragraph 14 of this Prudential Standard. The component formulae are detailed in paragraphs 16 to 19.
The total ORRC is calculated as follows:
where:
KSA = the total operational risk regulatory capital under the standardised approach to operational risk
m = a fixed scaling factor of 0.035
LARt = total gross outstanding loans and advances (as defined in paragraphs 8 and 9) for the retail banking area of business measured at the end of each financial year and half-year of the ADI
LACt = total gross outstanding loans and advances (as defined in paragraphs 8, 9 and 10) for the commercial banking area of business measured at the end of each financial year and half-year of the ADI
AGIt = adjusted gross income earned over a six month period at the end of each financial year and half-year of the ADI
t = half-yearly observation period (at the end of each financial year and half-year of the ADI)
An ADI must multiply KSA by 12.5 in order to convert the operational risk capital requirement to a risk-weighted asset equivalent (refer to paragraph 5 of Attachment D to APS 110).
Retail banking area
An ADI must calculate its ORRC for the retail banking area of business by:
(a)taking the last six consecutive half-yearly balances of total gross outstanding loans and advances for the retail banking area of business;
(b)multiplying 3.5 per cent of total gross outstanding loans and advances at each observation point, by a factor of 12 per cent, to produce a result in respect of each observation; and
(c)determining an average half-yearly result.
Commercial banking area
For the commercial banking area of business, an ADI must calculate its ORRC by:
(a)taking the last six consecutive half-yearly balances of total gross outstanding loans and advances for the commercial banking area of business;
(b)multiplying 3.5 per cent of total gross outstanding loans and advances at each observation point, by a factor of 15 per cent, to produce a result in respect of each observation; and
(c)determining an average half-yearly result.
All other activity area
The ORRC for an ADI’s all other activity area of business must be calculated by:
(a)taking the last six consecutive half-yearly amounts of adjusted gross income earned over a six month period;
(b)multiplying adjusted gross income at each observation point by a factor of 18 per cent to produce a result in respect of each observation; and
(c)determining an average full-year result.
An ADI must, when calculating the three-year average for the all other activity area of business, set an observation to zero and include that zero observation in the numerator of the formula detailed in paragraph 14 if, for any given observation, the ADI’s adjusted gross income is negative.
Financial statements
An ADI must reconcile, on a timely basis, the calculations set out in paragraphs 16 to 19 with its audited year-end financial statements and, where available, its half-yearly financial statements. The ADI may, with APRA’s prior written approval, use business estimates or forecasts when actual balances are not available (e.g. in the case of an ADI in its early years of operation). In the event of a merger, aggregated balances must be used unless otherwise agreed to by APRA.
0
0
0