Banking (prudential standard) determination No. 1 of 2015 - Prudential Standard APS 110 - Capital Adequacy

Banking (prudential standard) determinations Nos. 1 and 2 of 2015

EXPLANATORY STATEMENT

Prepared by the Australian Prudential Regulation Authority (APRA)

Banking Act 1959, section 11AF

Under subsection 11AF(1) of the Banking Act 1959 (the Act), APRA has the power to determine standards (prudential standards), in writing, in relation to prudential matters to be complied with by authorised deposit-taking institutions (ADIs) and authorised non-operating holding companies (authorised NOHCs). Under subsection 11AF(3) of the Act, APRA may, in writing, vary or revoke a prudential standard.

On 4 May 2015, APRA made the following determinations (the instruments):

• Banking (prudential standard) determination No. 1 of 2015, which revokes Prudential Standard APS 110 Capital Adequacy made under Banking (prudential standard) determination No. 3 of 2012 (APS 110), and determines a new Prudential Standard APS 110 Capital Adequacy (new APS 110); and
• Banking (prudential standard) determination No. 2 of 2015, which revokes Prudential Standard APS 330 Public Disclosure made under Banking (prudential standard) determination No. 11 of 2014 (APS 330), and determines a new Prudential Standard APS 330 Public Disclosure (new APS 330).

The instruments commence on 1 July 2015.

1. Background

APRA regulates banking, insurance and superannuation entities with the aim of ensuring that they can meet their financial promises to depositors, policyholders and superannuation fund members within a stable, efficient and competitive financial system. APRA seeks to fulfil this mandate through an authorisation process, and ongoing supervision of ADIs under a prudential framework consisting of guidance and mandatory rules. APRA also supervises and regulates with the aim of promoting financial system stability in Australia.

APRA’s prudential framework for ADIs is based on the framework agreed by the Basel Committee on Banking Supervision (Basel Committee). The Basel Committee’s framework consists of three Pillars:

• Pillar 1 sets out the minimum amount of capital that banks must hold as a safeguard against the credit, market and operational risks they face. Simple ‘standardised’ approaches to calculating capital under Pillar 1 are used by the majority of ADIs. On application, an ADI may be approved by APRA to use the outputs from its own internal models to calculate capital for credit risk (referred to as the internal ratings-based (IRB) approach); market risk (internal model approach) and operational risk (advanced measurement approaches (AMA)). The five largest ADIs in Australia have been approved to use the AMA and IRB approaches;
• Pillar 2 outlines how institutions should undertake their own assessments of their capital adequacy and guidance on the enhanced supervision (supervisory review process) of capital management; and
• Pillar 3 sets out the public disclosures that banks should make in a timely way to allow market participants to have standardised and comparable information about banks’ risk management and financial health. Pillar 3 complements Pillars 1 and 2 by harnessing market discipline to promote and encourage sound banking practices.

The global financial crisis highlighted a number of deficiencies in the Basel framework, including excessive bank leverage, inadequate liquidity management and the risks to global financial stability posed by global systemically important banks (G–SIBs). In accordance with commitments by Group of 20 (G20) Leaders, including Australian Prime Ministers, the Basel Committee developed reforms intended to address these deficiencies, including new Pillar 3 requirements.

The new provisions in the two new prudential standards are based on these Pillar 3 measures[1]. APRA is also taking the opportunity to address minor errors and omissions in the previous APS 110 and APS 330 that were identified during the Basel Committee’s 2013/2014 review of APRA’s implementation of the Basel framework[2].

2.             Purpose and operation of the instruments

Banking (prudential standard) determination No. 1 of 2015

The purpose of the instrument is to revoke APS 110 and replace it with the new APS 110.

The new APS 110 is the same in substance as APS 110 with the addition of Attachment D, which sets out a methodology for calculating a new leverage ratio, which measures the amount of Tier 1 capital an ADI has in relation to its total on- and off-balance sheet exposures. The new APS 110 sets out the methodology for calculating the leverage ratio for the purposes of the leverage ratio disclosure requirements in the new APS 330 but does not impose the ratio as a minimum requirement.

Banking (prudential standard) determination No. 2 of 2015

The purpose of the instrument is to revoke APS 330 and replace it with the new APS 330.

The new APS 330 is the same in substance as APS 330 with additional requirements under which specified ADIs must publicly disclose information about their:

• leverage ratio, calculated in accordance with the methodology in Attachment D to the new APS 110;
• ability to withstand a short-term (30 day) severe liquidity stress event by reference to a Liquidity Coverage Ratio (LCR). The LCR as a minimum requirement forms part of the liquidity framework that APRA finalised in December 2013[3] and which came into effect from 1 January 2015[4]; and
• position vis-à-vis indicators used by the Basel Committee to identify G–SIBs under the framework intended to reduce the likelihood of problems emanating from the failure of such institutions.

The new APS 330 requirements apply as follows:

• ADIs with approval to use the IRB approach, currently the five largest ADIs, will be required to disclose information about the leverage ratio. Disclosure of the ratio itself will be required quarterly with other disclosures to be made semi-annually, concurrent with publication of the ADI’s financial statements;
• ADIs classified as ‘LCR ADIs’ in accordance with APS 210 that are not foreign ADIs will be required to meet the LCR disclosure requirements concurrently with the publication of their financial statements (either annually or semi-annually). There are currently fifteen ADIs classified as LCR ADIs that are not foreign ADIs; and
• if specified by APRA, an ADI must publish information against a set of 12 indicators used by the Basel Committee to identify G–SIBs. It is currently APRA’s intention that the four largest ADIs will be required to make these disclosures because, although not themselves G–SIBs, they are of sufficient size[5] to be included in the pool of international banks used to identify G–SIBs. Disclosure is intended to enhance the transparency of the assessment methodology of the G–SIB framework. Disclosure against the 12 indicators is an annual exercise to be completed by 31 July each year.

3.             Consultation

Before finalising these reforms, the Basel Committee sought public comment and published submissions received from investors, analysts, ratings agencies, other banks and industry associations, including Australian industry associations and/or their parent associations.

Before consulting specifically on the new APS 110 and APS 330, APRA had foreshadowed its intended implementation of some of the measures:

• in its September 2011 discussion paper seeking feedback on the Basel III capital measures, Implementing Basel III capital reforms in Australia[6], APRA indicated that it proposed to apply transitional provisions for the leverage ratio’s introduction, including full disclosure from 2015;
• in its November 2011 discussion paper, Implementing Basel III liquidity reforms in Australia[7], APRA outlined its intention to introduce prudential disclosure requirements in relation to an ADI’s liquidity risk management framework and liquidity position; and
• APRA’s undertaking to rectify the minor omissions and errors identified during the RCAP was included in the published RCAP report[8].

APRA’s formal consultation on the new APS 110 and APS 330 commenced in September 2014 with the release of its discussion paper, Basel III disclosure requirements: leverage ratio; liquidity coverage ratio; the identification of potential global systemically important banks; and other minor amendments and draft amendments to the previous versions of the standards[9]. Written submissions were invited on the proposed measures, including on the compliance impact.

Three submissions were received, all from industry associations, and one request for clarification from an ADI. Submissions were broadly supportive, but raised specific queries about when the leverage ratio and G–SIB indicators disclosures are to be made, the content of the leverage ratio disclosures and whether APRA would provide additional guidance on the G–SIB disclosures. APRA made some amendments to the new APS 330 in response to submissions, including extending the timeframe for publishing the G–SIB indicators after further consultation with the affected banks. APRA’s response to submissions received during the September 2014 consultation is set out in the response paper released as part of the final package that includes the new APS 110 and APS 330.

APRA also sought specific advice from individual ADIs about costs that would be incurred in implementing the new APS 110 and APS 330.

4.             Regulation Impact Statement

APRA has prepared a Regulation Impact Statement, which has been lodged as supporting material.

5.             Statement of compatibility prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

A Statement of Compatibility prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 is provided at Attachment A to this Explanatory Statement.

ATTACHMENT A

Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Banking (prudential standard) determinations Nos. 1 and 2 of 2015

The instruments are compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (HRPS Act).

Overview of the Legislative Instruments

The purpose of the instruments is to:

• revoke Prudential Standard APS 110 Capital Adequacy and replace it with a new Prudential Standard APS 110 Capital Adequacy (new APS 110). The new APS 110 includes the methodology for calculating a new capital measure, the leverage ratio; and
• revoke Prudential Standard APS 330 Public Disclosure and replace it with a new Prudential Standard APS 330 Public Disclosure (new APS 330). The disclosure requirements in the new APS 330 are intended to enhance market discipline by requiring selected ADIs to publicly disclose information regarding their leverage and liquidity, and to promote transparency of the international framework for identifying and supervising global systemically important banks.

The new APS 110 and APS 330 also rectify some minor errors and omissions in APRA’s implementation of the internationally agreed capital framework.

Human rights implications

APRA has assessed the instruments and is of the view that they do not engage any of the applicable rights or freedoms recognised or declared in the international instruments listed in section 3 of the HRPS Act. Accordingly, in APRA’s assessment, the instruments are compatible with human rights.

Conclusion

The instruments are compatible with human rights as they do not raise any human rights issues.

[1] Specifically, Basel III leverage ratio framework and disclosure requirements, January 2014: http://www.bis.org/publ/bcbs270.pdf, Liquidity coverage ratio disclosure standards, January 2014 (revised March 2014): http://www.bis.org/publ/bcbs272.pdf and Global systemically important banks: updated assessment methodology and the higher loss absorbency requirements, July 2013: http://www.bis.org/publ/bcbs255.pdf

[2] Regulatory Consistency Assessment Programme (RCAP): Assessment of Basel III regulations – Australia, March 2014: http://www.bis.org/press/p140317.htm (the RCAP report)

[3] http://www.apra.gov.au/adi/PrudentialFramework/Pages/Implementing-Basel-III-liquidity-reforms-in-Australia-December-2013.aspx

[4] The liquidity framework, including the LCR, is set out in Prudential Standard APS 210 Liquidity (APS 210)

[5] That is, their exposures calculated under the leverage ratio methodology exceed EUR 200 billion.

[6] http://www.apra.gov.au/adi/PrudentialFramework/Pages/Basel-III-Capital-Reforms-September-2011.aspx chapter 5

[7] http://www.apra.gov.au/adi/PrudentialFramework/Pages/Implementing-Basel-III-Liquidity-Reforms-in-Australia-November2011.aspx chapter 8

[8] RCAP report, Appendix 6

[9] http://www.apra.gov.au/adi/Pages/September-2014-Consultation-disclosure-leverage-ratio-LCR-GSIBs.aspx