Banking (prudential standard) determination No. 1 of 2011
EXPLANATORY STATEMENT
Prepared by the Australian Prudential Regulation Authority
Banking Act 1959 subsection 11AF(3)
Acts Interpretation Act 1901 subsection 33(3)
Under subsection 11AF(3) of the Banking Act 1959 (the Act) APRA may, in writing, vary or revoke a prudential standard. Under subsection 33(3) of the Acts Interpretation Act 1901, where an Act confers a power to make, grant or issue any instrument (including rules, regulations or by‑laws) the power shall, unless the contrary intention appears, be construed as including a power exercisable in the like manner and subject to the like conditions (if any) to repeal, rescind, revoke, amend, or vary any such instrument.
Banking (prudential standard) determination No. 1 of 2011 (the instrument) varies Prudential Standard APS 210 Liquidity (APS 210), Prudential Standard APS 110 Capital Adequacy (APS 110) and Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111) as set out in the Schedule attached to the instrument.
- Background
A number of developments in the securitisation market have posed challenges to the ability of regional and small ADIs (ADIs) to efficiently securitise their residential mortgages, which has adversely affected their ability to compete in the Australian residential mortgage market.
In the above context, the -ADIs have raised as an issue APRA’s prudential requirements where an originating ADI holds the most subordinated tranche(s) of notes (even if rated) with no externally provided credit enhancement other than lenders mortgage insurance. APRA would not consider such a scenario as ‘significant credit risk transfer’ and therefore would expect ADIs to hold regulatory capital for those securitised assets as though they were on the ADI’s balance sheet.
2. Purpose of the instrument
The instrument gives effect to an alternative capital treatment for these tranche(s) (that is, the most subordinated tranche(s) of notes (even if rated) with no externally provided credit enhancement other than lenders mortgage insurance). Instead of holding capital for the subordinated tranche(s) as if they were on the ADI’s balance sheet, the alternative proposal will be to deduct from Tier 1 capital all subordinated tranche(s) held. The amount deducted can be reduced if notes are sold to third parties and credit risk transfer occurs. Furthermore, the amount to be deducted will be capped to the amount that would need to be held if the mortgage pool was on balance sheet (the current treatment). By capping the alternative capital treatment, this will not worsen the capital outcome from that required by the current requirement and will create a strong incentive for the ADIs to sell the subordinated tranche(s) as quickly as possible.
3. Operation of the instrument
This instrument takes effect on 1 March 2011 or the date of registration on Federal Register of Legislative Instruments (FRLI)[1] whichever last occurs.
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4. Consultation
No formal consultation on this amendment was undertaken. APRA believes that the alternative treatment will be beneficial to ADIs and their ability to compete in difficult market conditions. ADIs will be no worse off than under the current requirements, as the alternative treatment will be capped at the amount that ADIs would otherwise need to hold under the current capital treatment. The alternative treatment, however, is designed to enable ADIs to hold subordinated tranches in difficult market conditions with the incentive to sell the subordinated tranches as quickly as possible in order to reduce the amount of securitised assets that are to be deducted from Tier 1 capital.
The OBPR has agreed (OBPR ID: 2011/12286) that the proposed changes are of a minor nature and no further analysis (in the form of a Regulation Impact Statement) is required.
[1] Established under the Legislative Instruments Act 2003
Overview
The Banking (prudential standard) determination No. 1 of 2011, enacted under the authority of the Banking Act 1959, was introduced to address the challenges faced by regional and small Authorised Deposit-taking Institutions (ADIs) in efficiently securitising their residential mortgages, which adversely impacted their competitiveness in the Australian residential mortgage market. This determination was made by the Australian Prudential Regulation Authority (APRA) to provide an alternative capital treatment for the most subordinated tranches of notes, which these ADIs held without externally provided credit enhancement other than lenders mortgage insurance. Instead of requiring ADIs to hold regulatory capital for these securitised assets as though they were on their balance sheet, the determination allows for a deduction from Tier 1 capital, capped at the amount that would need to be held under the current treatment. This approach aims to incentivise ADIs to sell the subordinated tranches as quickly as possible, thereby mitigating the adverse effects on their capital requirements. The instrument took effect on 1 March 2011 or the date of registration on the Federal Register of Legislative Instruments, whichever was later. While no formal consultation was undertaken, APRA believed that the alternative treatment would benefit ADIs and their ability to compete under challenging market conditions.
Scope and Application
The Banking (prudential standard) determination No. 1 of 2011, issued under the Banking Act 1959 and Acts Interpretation Act 1901, applies to Australian Deposit-taking Institutions (ADIs) and modifies the prudential standards APS 210 Liquidity, APS 110 Capital Adequacy, and APS 111 Capital Adequacy: Measurement of Capital. This amendment primarily targets regional and small ADIs that face challenges in securitising their residential mortgages due to recent developments in the securitisation market, which have impacted their competitiveness. The instrument alters the capital treatment for the most subordinated tranches of notes held by ADIs, allowing a deduction from Tier 1 capital instead of requiring the capital to be held as if the assets were on the ADI's balance sheet. This deduction is capped at the amount that would be required under current capital treatment, ensuring ADIs are not worse off, while incentivising them to sell the subordinated tranches to reduce the capital deduction. The amendment took effect on 1 March 2011 or the date of its registration on the Federal Register of Legislative Instruments, whichever is later. While no formal consultation was conducted, the Australian Prudential Regulation Authority (APRA) believes this change will benefit ADIs by aiding their market competitiveness without compromising capital requirements.
Key Provisions
The main provisions of the Banking (Prudential Standard) Determination No. 1 of 2011 (the Determination) are found in its Schedule, where it varies Prudential Standards APS 210, APS 110 and APS 111. These variations pertain to the capital requirements for Australian Deposit-taking Institutions (ADIs) that hold the most subordinated tranches of notes in securitised residential mortgages, particularly when these notes have no externally provided credit enhancement other than lenders mortgage insurance. Specifically, under the new rules, instead of requiring ADIs to hold regulatory capital for these subordinated tranches as if they were on the ADI’s balance sheet, the Determination proposes an alternative treatment. This involves deducting the value of these subordinated tranches from the ADI’s Tier 1 capital, with the deduction amount being reduced if the notes are sold to third parties and credit risk transfer occurs. Importantly, the deduction is capped at the amount that would need to be held if the mortgage pool was on the balance sheet. This ensures that ADIs are not worse off under the new requirements compared to the current capital treatment.
The Determination imposes several obligations on ADIs governed by the Banking Act 1959. Primarily, ADIs must adhere to the new capital treatment for the most subordinated tranches of notes as specified in the Schedule. This means ADIs must deduct the value of these subordinated tranches from their Tier 1 capital, with the deduction subject to the conditions outlined in the Determination. Furthermore, ADIs are encouraged to sell these subordinated tranches to third parties to mitigate the deduction from their capital. In doing so, ADIs must ensure that the credit risk transfer is appropriately documented and recognised. The Determination also requires ADIs to maintain accurate records of the deductions made from their Tier 1 capital and any subsequent adjustments resulting from the sale of the subordinated tranches.
Breaches of the Determination could result in significant regulatory consequences for ADIs. Under the Banking Act 1959, non-compliance with prudential standards set by the Australian Prudential Regulation Authority (APRA) can lead to enforcement actions. These may include the imposition of financial penalties, the requirement to rectify non-compliant practices, and potential sanctions such as public reprimands or restrictions on business activities. The maximum penalties for contravening the Banking Act can include substantial fines and, in severe cases, criminal charges against individuals responsible for the non-compliance. Additionally, ongoing non-compliance could lead to further regulatory scrutiny, reputational damage, and a loss of market confidence, adversely affecting the ADI's operations and financial stability.