Australian Prudential Regulation Authority instrument fixing charges No. 2 of 2011

Models-based capital adequacy requirements for ADIs: 2010-11

EXPLANATORY STATEMENT

Issued by the Australian Prudential Regulation Authority (APRA)

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

Instrument to which this explanatory statement relates

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 17 June 2011 (the instrument). 

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:

a)      services and facilities which APRA provides to such persons; or

b)      applications or requests made to APRA under laws of the Commonwealth.

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.

Purpose of the instrument

The instrument, made by the Chief Financial Officer as a delegate of APRA, imposes a charge for certain services provided by APRA relating to the on-going supervision of the capital adequacy of banks which have adopted the models-based approach under the New Basel Capital Framework (Basel II) for ADIs and to the accreditation of other ADIs which have applied to APRA to utilise that approach to determine their capital adequacy requirements.

Factual background

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.

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.

Basis of charging

APRA is principally funded by the annual supervisory levy imposed on regulated entities by the Financial Institutions Supervisory Levies Collection Act 1998 and the related levy imposition Acts.[1]  However, section 51 of the APRA Act empowers APRA to impose charges in respect of services or facilities provided by it and in respect of applications made to it under Acts which it administers.  Underlying section 51 is the principle of ‘user pays’ – that parties who receive special services or benefits from APRA should, where appropriate, have to pay the cost of providing them, rather than leaving them to be funded out of the supervisory levy which is paid by the general body of regulated entities.  This reflects the views of the Wallis inquiry into the regulation of the financial system, which recommended that, in the interests of equity and efficiency, the costs of prudential regulation should be recouped from the financial industry, saying:[2]

“ The arrangements should involve a mix of direct service fees and annual levies and should distinguish, where possible:

 □ services provided at the instigation of individual entities, such as authorisation or registration, for which per-item cost recovery fees are appropriate; and

 □ regulatory activities undertaken at the discretion of the agency and for the general benefit of customers, such as inspections, enforcement and policy development, for which annual industry-wide levies are most appropriate.

 ...

 Recommendation 104:  Regulatory agencies’ charges should reflect their costs

 Regulatory agencies’ charges should reflect their costs.  The regulatory agencies should collect from the financial entities which they regulate enough revenue to fund themselves, but not more.  As far as practicable, the regulatory agencies should charge each financial entity for direct services provided, and levy sectors of industry to meet the general costs of their regulation. ”

In keeping with that philosophy, APRA will charge fees that recover the assessment cost for and ongoing supervision of those entities seeking Basel II accreditation.

How the charges have been calculated

The charges set by the instrument are fixed on a cost recovery basis and in line with the Australian Government Cost Recovery Guidelines July 2005.  A Cost Recovery Impact Statement (CRIS) has been tabled in support of this Explanatory Statement.

The charge is based on the need to recover APRA’s costs of carrying out the on-going monitoring of the capital adequacy 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 2010-11 is $2.1 million.

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

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) contributed directly 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), now part of WBC, 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 (Bank West), now part of CBA, began being charged for similar services in 2006-07.  In 2008-09, assessment work commenced on an accreditation application made by ING Bank (Australia) Limited (ING).

In 2010-11, the focus has been upon the on-going supervision of the capital adequacy of those ADIs approved to use the models-based approach (ANZ, CBA, NAB, WBC and MBL) and the assessment of the accreditation application of ING.

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.

On the basis that there is no discernable difference in the approach to Basel II supervision taken between them, ANZ, CBA, MBL, NAB and WBC will be charged an equal amount of APRA’s Basel II-related costs. 

ING’s application for accreditation continued across 2010-11, consuming similar APRA effort and therefore incurring the same charge recorded for 2009-10.

Description of the charges

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

a)      $385,000 plus GST (which totals $423,500) imposed on ANZ, CBA, MBL, NAB and WBC; and

b)      $175,000 plus GST (which totals $192,500) imposed on ING.

These amounts ($2.1 million plus GST, totalling $2.31 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 of ADIs using the models-based approach.

Charges must be reasonably related to the costs and expenses incurred

As indicated above, the charges set by the instrument are fixed on a cost recovery basis to defray the estimated effort involved in the discharge of APRA’s responsibilities and in line with the Australian Government Cost Recovery Guidelines July 2005. 

Cost Recovery Impact Statement

A Cost Recovery Impact Statement (CRIS) has been tabled in support of this Explanatory Statement.

Charges must not amount to taxation

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

No retrospectivity

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

Consultation

The Legislative Instruments Act 2003 (LIA) requires that consultation be undertaken with those impacted by the instrument and section 17 of the LIA outlines the circumstances and processes underpinning consultation. However, section 18 of the LIA provides for relief from consultation where it may be determined to be unnecessary or inappropriate; for example when appropriate consultation has already been undertaken.

The annual levies consultation process explicitly adopts the Wallis Inquiry recommendations2 wherein direct services are met by specific user charges, resulting in a compensating reduction of the total general levies to be collected from industry participants[3]. 

Before making the instrument, APRA informs the affected ADIs of the proposed charges. 

[1] The Authorised Deposit-taking Institutions Supervisory Levy Imposition Act 1998, the General Insurance Supervisory Levy Imposition Act 1998, the Life Insurance Supervisory Levy Imposition Act 1998 and the Superannuation Supervisory Levy Imposition Act 1998.

[2] Commonwealth of Australia Final Report of the Financial System Inquiry 18 March 1997, section 12.3

[3] See the Consultation Paper Proposed Financial Institutions Supervisory Levies for 2011-12 dated 18 May 2011 at Treasury’s website - content ID: 2033.