Banking (prudential standard) determination Nos. 1 and 2 of 2020
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 17 January 2020, APRA made the following determinations (the instruments):
(1) Banking (prudential standard) determination No. 1 of 2020, commencing on 1 January 2022, which revokes Prudential Standard APS 114 Capital Adequacy: Standardised Approach to Operational Risk made under Banking (prudential standard) determination No. 7 of 2012 (APS 114); and
(2) Banking (prudential standard) determination No. 2 of 2020, commencing on 1 January 2021, which revokes Prudential Standard APS 115 Capital Adequacy: Advanced Measurement Approaches to Operational Risk made under Banking (prudential standard ) determination No. 8 of 2012 (APS 115) and determines a new Prudential Standard APS 115 Capital Adequacy: Standardised Measurement Approach to Operational Risk (new APS 115).
- Background
APRA’s mandate is to ensure the safety and soundness of prudentially regulated financial institutions so that they can meet their financial promises to depositors, policyholders and fund members within a stable, efficient and competitive financial system.
APRA carries out this mandate through a multi-layered prudential framework that encompasses licensing and supervision of institutions. In the case of the banking industry, APRA is empowered under the Banking Act to issue legally binding prudential standards that set out specific prudential requirements with which ADIs must comply.
A key component of APRA’s prudential framework is the suite of prudential standards that impose regulatory capital requirements on ADIs (the capital standards). The capital standards ensure ADIs hold sufficient capital to address the risks associated with their operations.
The capital standards have their foundation in international capital standards set by the Basel Committee on Banking Supervision (Basel Committee). These standards are the 1998 Basel Capital Accord (Basel I), the International Convergence of Capital Measurement and Capital Standards (Basel II), released in 2004, and Basel III: A global regulatory framework for more resilient banks and banking systems (Basel III).
The developments in these international capital standards strengthen the capital position of ADIs by addressing deficiencies identified during the global financial crisis.
As part of its Basel III reforms, the Basel Committee concluded that the Advanced Measurement Approach (AMA), which is reflected in APS 115, is complex and makes it challenging to compare the wide range of global modelling practices. Also, for some banks, operational risk capital requirements have been insufficient to cover incurred losses. For these reasons, the Basel III operational risk proposals replaced the AMA with a new Standardised Measurement Approach (SMA). The SMA also replaces the Basel II standardised approaches to operational risk, which are reflected in APS 114.
2. Purpose and operation of the instrument
Banking (prudential standard) determination No. 1 of 2020
The purpose of this instrument is to revoke APS 114 on 1 January 2022.
Banking (prudential standard) determination No. 2 of 2020
The purpose of this instrument is to revoke APS 115 and replace it with a new version of APS 115 to reflect regulatory developments.
The new APS 115 ensures that ADIs hold sufficient regulatory capital against their operational risk exposures.
The new APS 115 updates quantitative requirements for operational risk to ensure they continue to align with international standards. APS 115 will require an ADI to calculate the amount of capital it must hold for operational risk based on a business indicator, which is a financial statement-based proxy for the operational risk exposure of the ADI. The business indicator is calculated using a number of inputs including an interest component, services component and financial component.
The new APS 115 will apply from 1 January 2021 to ADIs which held APRA’s approval to use an AMA to operational risk under the previous APS 115. ADIs that do not have approval from APRA to use an AMA immediately prior to the commencement of the new APS 115 will continue to use the standardised measurement approach under APS 114 until APS 114 is revoked on 1 January 2022, at which time the new APS 115 will apply to them.
Where the new APS 115 refers to an Act, Regulation, prudential standard or Australian Accounting Standard[1], this is a reference to the document as it exists from time to time, and which is available on the Federal Register of Legislation at www.legislation.gov.au.
The new APS 115 provides for APRA to exercise various discretions. Decisions made by APRA exercising those discretions are not subject to merits review. This is because these decisions are preliminary decisions that may facilitate or lead to substantive decisions which are subject to merits review.
A breach of a prudential standard is a breach of the Act, as section 11AG of the Act provides that ADIs must comply with applicable prudential standards. However, there are no penalties prescribed for breach of a prudential standard. Instead, an ADI’s breach of a provision in the Act is grounds for APRA to make further, substantive decisions under the Act in relation to the ADI. Those decisions are:
(a) to revoke an authority to carry on banking business (section 9A of the Act); and
(b) to issue a direction to the ADI, including a direction to comply with the whole or part of a prudential standard (section 11CA of the Act).
It is only at this stage that an ADI is exposed to a penalty: loss of its authority under section 9A or 50 penalty units if it breaches the direction (section 11CG of the Act). The subsequent substantive decisions by APRA to impose a direction or revoke an authority are subject to merits review. In nearly all cases[2] the decision is preceded by a full consultation with the ADI to raise any concerns it may have in relation to the decision.
3. Consultation
APRA consulted extensively on its proposals for the application of the SMA to operational risk between February 2018 and September 2019.
APRA released the following public discussion papers, response papers and drafts of a new APS 115 for consultation:
- February 2018: Consultation on revisions to the capital framework for ADIs;
- June 2019: Response to Submissions – Revisions to the Capital Framework for ADIs;
- June 2019: Prudential Standard APS 115 Capital Adequacy: Standardised Measurement Approach to Operational Risk; and
- December 2019: Response to Submissions – Release of final Prudential Standard APS 115 and draft Reporting Standard ARS 115.0 Capital Adequacy: Standardised Measurement Approach to Operational Risk.
APRA received submissions from several ADIs and an industry body.
Respondents to the consultation commented on two material issues. The first concerned the capital calculation process. Some respondents requested that APRA provide additional guidance and clarity on advanced risk management expectations, the treatment of legal and insurance costs and the treatment of boundary events. In response, APRA noted that it would separately consult on a new cross-industry standard including coverage of advanced risk management expectations. APRA also noted it would not recognise deductions for insurance coverage as part of the operational risk framework.
The second material issue concerned the commencement date of the new APS 115. Some submissions expressed a preference for APRA to align the commencement date of APS 115 with the Basel Committee’s internationally agreed commencement date of 1 January 2022. Others submissions expressed support for the earlier commencement date of 1 January 2021. APRA noted that the earlier implementation date will be advantageous for ADIs using an AMA under the previous APS 115, as the more onerous requirements will be replaced with the simpler SMA. Ultimately, replacing the AMA is expected to provide ADIs with greater clarity in calculating their operational risk capital requirements.
4. Regulation Impact Statement
APRA’s assessment of options and cost benefit analysis was set out in a Discussion Paper and Response Letter, which have been lodged as supporting material. The Office of Best Practice Regulation has acknowledged APRA’s certification that the Discussion Paper and Response Letter are equivalent to a final Regulation Impact Statement.
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) determination Nos. 1 and 2 of 2020
The legislative 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 are:
- to revoke Prudential Standard APS 114 Capital Adequacy: Standardised Approach to Operational Risk determined by APRA in 2012; and
- to revoke Prudential Standard APS 115 Capital Adequacy: Advanced Measurement Approaches to Operational Risk determined by APRA in 2012 and replace it with a new Prudential Standard APS 115 Capital Adequacy: Standardised Measurement Approach to Operational Risk.
The new APS 115 replaces the previous APS 115 and APS 114 to reflect international regulatory developments in measuring the operational risks of banks.
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] Australian Accounting Standards is defined in Prudential Standard APS 001 Definitions as the Australian Accounting Standards issued by the Australian Accounting Standards Board as may be amended from time to time.
[2] Subsection 9A(4) of the Act specifically provides that APRA does not need to consult where APRA is satisfied that doing so could result in a delay in revocation that would be:
(a) contrary to the national interest; or
(b) contrary to the interests of depositors with the ADI.