Australian Prudential Regulation Authority instrument fixing charges No. 2 of 2009

Australian Prudential Regulation Authority instrument fixing charges No. 2 of 2009

Models-based capital adequacy requirements for ADIs: 2008-09

EXPLANATORY STATEMENT

Issued by the authority of the Australian Prudential Regulation Authority (APRA)

Australian Prudential Regulation Authority Act 1998, paragraphs 51(1) (a) and (b)

This explanatory statement relates to the instrument fixing charges which is made under paragraphs 51(1) (a) and (b) of the Australian Prudential Regulation Act 1998 (the APRA Act) and which is dated 15 June 2009 (the instrument).  The instrument, made by a delegate of APRA, imposes a charge for certain services provided by APRA relating to the on-going supervision of banks which have adopted the models-based approach under the New Basel Capital Framework (Basel II) for authorised deposit-taking institutions (ADIs) and to the accreditation of other ADIs which have applied to APRA to utilise that approach to determine their capital adequacy requirements.

Background

Legislative framework

The APRA Act is administered by APRA.  APRA has statutory responsibility for the prudential supervision of most of the superannuation industry, the life insurance and general insurance industries, and authorised deposit-taking institutions (ADIs). ADIs include banks, building societies and credit unions.

Subsection 51(1) of the APRA Act provides that APRA may, by legislative instrument, fix charges to be paid to it by persons in respect of:

1. services and facilities which APRA provides to such persons; and
2. applications or requests made to APRA under any law of the Commonwealth.

(These paragraphs reflect the contents of paragraphs 51(1) (a) and (b).)

Subsection 51(2) of the APRA Act provides that a charge fixed under subsection 51(1) must be reasonably related to the costs and expenses incurred or to be incurred by APRA in relation to the matters to which the charge relates and must not be such as to amount to taxation.

Basel II

In June 2004, the Basel Committee on Banking Supervision (the Committee) released Basel II, reforming the 1988 Basel Capital Accord (the 1988 Accord). 

The objectives of Basel II are to provide capital adequacy guidelines that are more accurately aligned with the individual risk profile of institutions, lessen regulatory arbitrage opportunities and offer greater flexibility for supervisors to recognise or encourage the use of more sophisticated risk management techniques, where appropriate.  Basel II provides a menu of methods for calculating capital adequacy for each risk class, ranging from standardised (default) methods, which are in essence more-risk sensitive versions of the 1988 Accord, to more sophisticated methods which involve institutions adopting their own individualised internal risk assessment methodologies.

APRA implemented Basel II in Australia for all ADIs on 1 January 2008, through new prudential standards under section 11AF of the Banking Act 1959.

Models-based approach under Basel II

Under Basel II, ADIs are able to determine their capital adequacy requirements using one of two methods: a standardised (default) method (the standardised method) or a models-based approach more closely aligned with an ADI’s individual risk profile (the models-based approach).  ADIs seeking to use the models-based approach must have APRA’s approval to do so.

For a number of years, the four major banks in Australia, viz., Australia and New Zealand Banking Group Limited (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank Limited (NAB) and Westpac Banking Corporation (WBC) have been directly contributing to APRA’s development and accreditation costs for the Basel II models-based approach.  These ADIs have been using internal rating and modeling systems for a considerable period and have also incorporated more quantitative elements into their risk management systems.  For the same reason, Macquarie Bank Limited (MBL) and St. George Bank Limited (SGB) commenced directly contributing to APRA’s development and accreditation costs for the Basel II models-based approach in 2004-05.  Bank of Western Australia Limited (BankWest) began being charged for similar services in 2006-07.  In 2007-08, work has also been undertaken on the assessment of the application made by ING Bank (Australia) Limited (ING).

In 2008-09, work has continued on the on-going supervision of those ADIs approved to use the models-based approach (ANZ, CBA, NAB, WBC and MBL) and the assessment of the applications of the other ADIs.

APRA’s work relating to implementation of models-based approach

APRA’s work relating to the implementation of the standardised method and the models-based approach has three phases, which can be depicted as follows:

Phase I commenced in 2002-03 and finished in 2007-08, with the implementation of Basel II in Australia on 1 January 2008.  It involved developing a policy and technical framework for both the standardised method and the models-based approach.  Phase II commenced in October 2005 and involved a substantial resource effort to examine individual ADIs’ models and provide the necessary approvals.  Phase II work for some of the applicant ADIs was completed in 2007-08, with work continuing for the remaining ADIs over 2008-09.  Finally, Phase III commenced in 2007-08 and involves the on-going monitoring of ADIs’ capital adequacy positions; in the case of ADIs using the models-based approach, this work is more intensive than for ADIs using the standardised method.

Operation of Australian Prudential Regulation Authority instrument fixing charges No. 2 of 2009

The charge imposed by the current instrument is based on a three-tiered structure:

1. $400,000 plus GST (which totals $440,000) imposed on each of the four major banks, and on MBL;
2. $80,000 plus GST (which totals $88,000) imposed on SGB and BankWest; and
3. $40,000 plus GST (which totals $44,000) imposed on ING.

These amounts ($2.20 million plus GST, totaling $2.42 million) have been set as a contribution to APRA’s:

• Phase II work, being assessment of applications made by certain ADIs; and

• Phase III work, being on-going monitoring of the capital adequacy position of ADIs using the models-based approach.

Consistent with the approach taken in 2007-08, and on the basis that there is no discernable difference in the approach to Basel II supervision taken between them, the four major banks (ANZ, CBA, NAB and WBC) and MBL will be charged an equal portion of APRA’s Basel II-related costs. 

However, unlike the previous financial year, SGB will not be charged the same amount as the four major banks. As the amount of APRA’s Basel II-related work for SGB for 2008-09 is broadly equivalent to that for BankWest, it is considered appropriate that these two ADIs be charged the same amount.

ING will be charged a lower amount as the resources devoted to ING have been less compared to the other ADIs.  This is consistent with the approach taken in 2007-08.

How the charge has been calculated

The charge is based on the need to recover APRA’s costs of carrying out the on-going monitoring of the capital adequacy positions of ADIs using the models-based approach and assessing applications for model approval.  Those costs are based on the estimated APRA staff time involved.  In addition, direct overhead costs are added to the salary costs.  On this basis, APRA’s total cost recovery in respect of the models-based approach for 2008-09 is $2.20 million.

The costs incurred in monitoring the capital adequacy positions of ADIs using the standardised method are recovered through the financial sector levies for those ADIs.

The charges are reasonably related to the costs and expenses incurred

As indicated above, the charges set by the instrument are fixed on a cost recovery basis for the work to which they apply.  They are based on estimated effort involved in the discharge of APRA’s responsibilities and incorporate all the direct costs and appropriate overheads.

The charges do not amount to taxation

As the charges are reasonably related to the costs incurred by APRA in providing the services concerned, the charges do not constitute a tax.

The charges are not retrospective

The charges are imposed prospectively.  They are payable 14 days after receipt of APRA’s invoice.

Cost Recovery Impact Statement

A Cost Recovery Impact Statement (CRIS) has been prepared for this instrument.

Consultation

As part of annual consultation, each industry sector is made aware of APRA’s cost recovery process including the reduction of levies as a consequence of direct user charging.

Before making the instrument, APRA informed the eight ADIs of the proposed charges.  The ADIs have raised no objection to the charges.