APRA Kicks Off Capital Framework Discussion

The Australian Prudential Regulation Authority (APRA) has released two discussion papers for consultation with authorised deposit-taking institutions (ADIs) on proposed revisions to the capital framework.

The key proposed changes to the capital framework include:

  • lower risk weights for low LVR mortgage loans, and higher risk weights for interest-only loans and loans for investment purposes, than apply under APRA’s current framework;
  • amendments to the treatment of exposures to small- to medium-sized enterprises (SME), including those secured by residential property under the standardised and internal ratings-based (IRB) approaches;
  • constraints on IRB ADIs’ use of their own parameter estimates for particular exposures, and an overall floor on risk weighted assets relative to the standardised approach; and
  • a single replacement methodology for the current advanced and standardised approaches to operational risk.

The paper also outlines a proposal to simplify the capital framework for small ADIs, which is intended to reduce regulatory burden without compromising prudential soundness.

The papers include proposed revisions to the capital framework resulting from the Basel Committee on Banking Supervision finalising the Basel III reforms in December 2017, as well as other changes to better align the framework to risks, including in relation to housing lending. APRA is also releasing a discussion paper on implementation of a leverage ratio requirement.

In the papers released today, APRA is not seeking to increase capital requirements beyond what was already announced in July 2017 as part of the ‘unquestionably strong’ benchmarks.

During the process of consultation, APRA will undertake further analysis of the impact of these proposed changes on ADIs. This analysis will include a quantitative impact study, which will be used to, where necessary, calibrate and adjust the proposals released today.

APRA Chairman Wayne Byres said that, taken together, the proposed changes are designed to lock in the strengthening of ADI capital positions that has occurred in recent years.

“These changes to the capital framework will ensure the strong capital position of the ADI industry is sustained by better aligning capital requirements with underlying risks. However, given the ADI industry is on track to meet the ‘unquestionably strong’ benchmarks set out by APRA last year, today’s announcement should not require the industry to hold additional capital overall,” Mr Byres said.

APRA has also released today a discussion paper on implementing a leverage ratio requirement for ADIs. The leverage ratio is a non-risk based measure of capital strength that is widely used internationally. A minimum leverage ratio of three per cent was introduced under Basel III, and is intended to operate as a backstop to the risk-weighted capital framework. Although the risk-based capital measures remain the primary metric of capital adequacy, APRA has previously indicated its intention to implement a leverage ratio requirement in Australia. This approach was also recommended by the Financial System Inquiry in 2014.

APRA is proposing to apply a higher minimum requirement of four per cent for IRB ADIs, and to implement the leverage ratio as a minimum requirement from July 2019.

In addition to the two papers released today, APRA will later this year release a paper on potential adjustments to the overall design of the capital framework to improve transparency, international comparability and flexibility.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

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