APRA’s new capital framework for ADIs takes effect from 1 January 2023. APRA has just released final Prudential Practice Guides, final reporting standards and an amended APS 113. APRA has also started a short consultation on consequential amendments to NSFR and New Zealand capital requirements. Here is what you need to know.
The purpose of APRA’s new capital framework is to ensure that ADIs are “unquestionably strong” and that Australian prudential standards for banks are aligned with the standards agreed by the Basel Committee on Banking Supervision following the global financial crisis in 2009.
If the words “unquestionably strong” sound familiar, that is because APRA has been on the path towards implementation of the new framework for a few years now, and put new capital requirements in place in 2017 which were intended to make Australian banks “unquestionably strong”. ADIs are already meeting those capital requirements.
What will the new framework look like?
The new framework is intended to further strengthen the banking sector by ensuring that ADIs remain capitalised at the levels set in 2017. This will be effected by:
- enhancing flexibility (through higher capital buffers – over half of Australian banks’ Common Equity Tier 1 Capital will be positioned as buffers which could be used by banks in periods of stress)
- increasing capital requirements for higher risk lending (and decreasing it for less risky lending)
- supporting competition (by limiting differences in capital requirements between smaller and larger banks – safeguards will be built in to ensure that the capital requirements for the larger banks that use internal models do not become excessively low)
- improving the comparability of bank capital ratios (domestically and with global peers)
- reducing the operational burden on smaller banks (by introducing simplified capital requirements for smaller, less complex banks).
The framework was finalised by APRA in November 2021 – see APRA Information Paper – An Unquestionably Strong Framework for Bank Capital November 2021.
Latest from APRA – new Prudential Practice Guides
APRA released the following draft Prudential Practice Guides in November 2021: APG 110, APG 112 and APG 113. Following consultation with the banks, the PPGs were finalised in July, taking into account feedback from industry. APRA has “revised its guidance on capital management targets and regulatory capital buffers, the treatment of residential property-backed guarantees, the definition of income-producing real estate, and loss given default for infrastructure assets”.
The final PPGs replace a number of letters to ADIs and FAQs published by APRA – see Annex A to the July 2022 Response to Submissions on Finalising Bank Capital Guidance: APRA Response to Submissions – Finalising Bank Capital Guidance July 2022.
APRA notes that the revisions to the PPGs are intended to streamline and simplify the guidance that supports the capital standards, “in line with the strategic initiative to modernise the prudential architecture”. This objective was referred to in APRA’s 2021-2025 Corporate Plan, and is tied to APRA’s ultimate goal of “building a modern and adaptable prudential framework that provides a platform to maintain system stability and support innovation, in a changing operating environment”.
APG 110
The capital management targets and regulatory buffers are set out in APG 110. The management target will need to be “above the top of regulatory capital buffers in stable operating conditions to allow for business growth, volatility in risk-weighted assets, profit and capital surplus and dividend policy” and must also be “sufficient to withstand a severe but plausible downturn while remaining above the ADI’s PCR”. In response to industry seeking clarity on the usability of the buffers, APRA confirmed that it will not treat the management target in the same way as a regulatory minimum or buffer – for example there would be no restriction on an ADI making distributions if it falls below its management target range. ADIs are not required to set another buffer on top of the management buffer to avoid falling below it. APRA noted that the usability of buffers continues to be considered by the Basel Committee and that APRA will engage with offshore regulators to ensure the approach to buffers in Australia is consistent with global standards.
APG 112 and APG 113
Through its updated APG 112, APRA has clarified that restrictions on ADIs using credit risk mitigation (CRM) techniques in the calculation of the LVR and risk weight for an exposure do not apply to property-backed guarantees in certain circumstances. This was in response to industry feedback noting that market practice is to include such guarantees in the LVR calculation for loans secured by residential property. However, property-backed guarantees may only be included in the property value if the rights to the property would be the same as a standard mortgage in the event of a default.
Further updates in the finalised APS 112 and APS 113 (and the associated APGs) have been made in response to industry feedback on the definitions of SME and income-producing real estate, as well as to the requirements relating to the prescribed loss given defaults (LGDs) for large public infrastructure assets.
Reporting standards
On 10 August 2022, APRA released final reporting standards to support the updated capital adequacy and credit risk capital requirements for ADIs. The new standards are available here and will be effective for the reporting period commencing from 1 January 2023. The package published by APRA responds to the consultation released in April 2022, and is intended “to better meet data needs, simplify reporting requirements, and reduce the need for future data collections and ad hoc requests”.
Again, these changes reflect a theme evident in APRA’s 2021-2025 Corporate Plan, namely, promoting “greater data-driven decision-making” and enhancing the quality of data that is collected by APRA.
A new (but short) consultation – New Zealand and NSFR
APRA has commenced a short consultation (it closes on 26 August 2022) on consequential amendments which relate to:
- the treatment of exposures to New Zealand (by applying a similar treatment of NZ exposures under APS 180 and APS 120 to the treatment APRA is applying under APS 112 and APS 113 – i.e. NZ overseas banking subsidiaries will be able to apply the RBNZ’s equivalent prudential rules for measuring counterparty credit risk exposures); and
- the net stable funding ratio requirement in APS 210 Liquidity (to reduce an unintended impact which flows from the changes to the risk weights for residential mortgages in APS 112).
These amendments will also apply from 1 January 2023.
Data proxies allowed – but approval required
Finally, APRA will allow ADIs to use temporary proxies to calculate capital requirements where data is unavailable, but expects usage to be temporary – proxies cannot be used for more than 12 months after the framework is implemented on 1 January 2023. ADIs are required to obtain APRA’s approval prior to the use of material proxies, being proxies that apply to more than one per cent of an ADI’s exposures at default or credit RWA. Submissions on material proxies are due as soon as practicable but in any event, by 1 September 2022 (proxies that apply to more than 5% of EAD or credit RWA were due on 1 August 2022). The July 2022 Response to Submissions (link above) sets out the information required for a submission on a material proxy (see page 22).
