Tag: Capital

APRA applies additional capital requirements to ANZ, NAB and Westpac

The Australian Prudential Regulation Authority (APRA) is applying additional capital requirements to three major banks to reflect higher operational risk identified in their risk governance self-assessments.

APRA has written to ANZ, National Australia Bank (NAB) and Westpac advising of an increase in their minimum capital requirements of $500 million each. The capital add-ons will apply until the banks have completed their planned remediation to strengthen risk management, and closed gaps identified in their self-assessments.

The increase in capital requirements follows APRA’s decision in May last year to apply a $1 billion dollar capital add-on to Commonwealth Bank of Australia (CBA) in response to the findings of the APRA-initiated Prudential Inquiry into CBA.

Following the CBA Inquiry’s Final Report, APRA wrote to the boards of 36 of the country’s largest banks, insurers and superannuation licensees asking them to gauge whether the weaknesses uncovered by the Inquiry also existed in their own companies. Although the self-assessments raised no concerns about financial soundness, they confirmed that many of the issues identified in the Inquiry were not unique to CBA. This included the need to strengthen non-financial risk management, ensure accountabilities are clear, cascaded and enforced, address long-standing weaknesses and enhance risk culture.

APRA Chair Wayne Byres said: “Australia’s major banks are well-capitalised and financially sound, but improvements in the management of non-financial risks are needed. This will require a real focus on the root causes of the issues that have been identified, including complexity, unclear accountabilities, weak incentives and cultures that have been too accepting of long-standing gaps.

“The major banks play a vital role in the stability of the entire financial system, and APRA expects them to hold themselves to the highest standards of risk governance. Their self-assessments reveal that they have fallen short in a number of areas, and APRA is therefore raising their regulatory capital requirements until weaknesses have been fully remediated,” Mr Byres said.

APRA supervisors continue to provide tailored feedback to other banks, insurers and superannuation licensees that provided self-assessments to APRA. Where weaknesses have been identified, the level of supervisory scrutiny is being increased as remediation actions are implemented. Where material weaknesses exist, APRA is also considering the need for the application of an additional operational risk capital requirement.

APRA’s 2018 Priorities

APRA released their Policy Agenda 2018 today which sets their priorities and agenda.

Looking at banking, they outlined the following:

  • Capital adequacy tweaking will likely continue for the next 2-3 years, plus  revisions to the prudential standards for operational risk, interest rate risk in the banking book and market risk, and associated changes to reporting and public disclosure requirements. APRA is considering changes to its overall approach to capital requirements in a number of areas where APRA’s methodology is more conservative than minimum international requirements.
  • APRA does not anticipate the need to incorporate BEAR expectations into the prudential standards or prudential practice guides in 2018 but will provide guidance where appropriate, potentially in the form of published Frequently Asked Questions.
  • They will finalise arrangements to licensing some new ADIs through a phased approach.
  • Expect more changes to APG 223 Residential Mortgage Lending, revising underwriting standards and the development of a prudential practice guide for commercial property lending.

 

 

Bank Stress Testing Is Maturing But Diverse

The Basel Committee’s Working Group on Stress Testing has published a 66 page report “Supervisory and bank stress testing: range of practices“. APRA is mentioned several times through the report, most notably about the limited disclosure of results here, compared with some other countries. Also the scope and purpose of these tests vary considerably, and the extensions into macroprudential differs.  So the approach, and outputs of stress testing are very different.

The report sets out a range of observed supervisory and bank stress testing practices with the aim of describing and comparing these practices and highlighting areas of evolution. The level of data reported on supervisory stress tests reflects the differing objectives and areas of focus across supervisors.

It draws on the results of two surveys completed during 2016: (i) a survey completed by Basel Committee member authorities (banking supervisors and central banks), which had participation of 31 authorities from 23 countries; and (ii) a survey completed by 54 respondent banks from across 24 countries, including 20 global systemically important banks (G-SIBs). Case studies, and other supervisory findings.

There are two fundamental types of supervisory stress tests: (1) those in which the supervisors collect data from the firms and then use their own models and scenarios to assess the performance of the firms under stress (referred to in this report as either “supervisor-run” or “top-down” tests), and (2) those in which the supervisors issue scenarios and guidance to the firms, which then run their own models and report the results to the supervisor (the “institution-run” or “bottom-up” tests).

A number of authorities now use stress tests specifically for capital adequacy assessment or to inform macroprudential policies such as the countercyclical capital buffer. In some cases, stress testing frameworks aim to address multiple objectives. For example, in Canada the macroprudential stress test outcomes inform ongoing supervisory work, such as capital adequacy assessments and risk identification, prioritisation, and measurement, as well as financial stability policy initiatives. Stress testing can also be used to facilitate communication with relevant domestic and foreign parties regarding the stability of the financial system.

In the US, supervisory estimates of post-stress capital ratios for each bank under adverse and severely adverse economic and financial conditions are publicly released along with detailed information on losses and revenues. In the EU, for all regular EU-wide stress test exercises hitherto, the EBA Board of Supervisors decided to publish the quantitative results at the bank-level and provide comprehensive granular data for several types of portfolios on a regular basis (eg sovereign portfolios and risk weights from internal models).

In contrast, for a number of countries, only aggregate-level results are published; often this is in the context of an FSAP review. For example, the Australian Prudential Regulation Authority (APRA) has traditionally disclosed only the aggregate results.

APRA do not impose capital requirements directly based on stress test results, but see stress testing as a strong tool to inform supervisors’ judgments of capital adequacy. Stress testing is also expected to be reflected in banks’ capital decisions, helping banks to set target surplus thresholds and fostering greater understanding of the dynamics between capital and risk.

APRA has used stress tests results to evaluate the adequacy of banks’ recovery planning. In particular, a bank’s management actions in a stress test scenario should be consistent with and linked closely to a bank’s recovery plan in order to be credible.

In 2014 and again in 2017, the Australian and New Zealand supervisory authorities completed a coordinated banking industry stress test. Although both countries had worked together for previous banking industry stress tests, the level of engagement increased in 2014 with close coordination and collaboration on scenario design, templates, analysis and outcomes.

There is a strong link between the banking sectors in Australia and New Zealand; the four major Australian banks have significant exposures to New Zealand and their subsidiaries dominate the New Zealand banking system.

APRA was responsible for the overall coordination and execution of the stress test. There was a common scenario and set of reporting templates covering Australia and New Zealand. Timing of all stages was closely coordinated. The Reserve Bank of New Zealand (RBNZ) provided challenge and input into the scenario and determined the specific economic parameters for New Zealand, which focused on additional agricultural risks. The RBNZ was responsible for analysing the results for New Zealand banks. Each authority engaged directly with the banks within their jurisdiction on queries and feedback throughout the process.

Ongoing engagement and communication was critical to the success of the exercise. Particular consideration was given to issues that differed between the two jurisdictions. At the highest level this involved ensuring that the economic parameters between Australia and New Zealand were realistic and consistent in a stressed environment. For example, there was discussion and challenge as to the relationship between interest rates in Australia and a corresponding level for interest rates in New Zealand.

Here is a summary of their overall observations:

  • In recent years, there has been significant advancement and evolution in stress testing methodologies and infrastructure at both banks and authorities.
  • Supervisory authorities and central banks continue to devote more resources to enhance the stress testing of regulated institutions, with most supervisory stress testing exercises being carried out on at least an annual basis. This is resulting in significant progress in how the exercises are performed and how they are incorporated into the banking supervision process.
  • Banks have been making improvements to their governance structures, with banks’ boards, or delegated committees of boards, taking active roles in reviewing and challenging the results of stress tests, in addition to providing oversight of the overall framework.
  • Banks are increasingly looking to leverage the resources dedicated to stress testing frameworks to inform the risk management and strategic planning of the bank. Stress testing frameworks are increasingly integrated into business as usual processes.
  • Key challenges that remain for banks include finding and maintaining sufficient resources to run stress testing frameworks, and improving data quality, data granularity and the systems needed to efficiently aggregate data from across the banking group for use in stress tests. For national authorities, greater coordination of stress testing activities across authorities is needed, eg via the exchange information on stress test plans and results through supervisory colleges.

Microprudential use of supervisory stress tests

  • Supervisory stress test results are primarily used by supervisory authorities for reviewing and validating the Internal Capital Adequacy Assessment Process (ICAAP) of banks and their liquidity adequacy assessments.
  • Since the global financial crisis, an increasing number of countries assess capital ratio levels under adverse scenarios and use the resulting assessment for evaluating capital adequacy or required capital. However, a wide variety of practices exist.
  • Certain supervisor set capital add-ons for banks by using rules-based methods based solely on stress tests (eg by benchmarking against formal hurdle rates). Those authorities which require add-ons based on stress tests mostly employ a combination of formal process and supervisory judgment. A few jurisdictions have a more rules-based treatment.
  • It is less common for supervisors to use outputs from stress tests for other purposes than those related to capital/liquidity assessments. Nevertheless, some supervisors review and challenge banks’ business plans or banks’ recovery plans on the basis of stress test findings.

Macroprudential use of supervisory stress tests

  • Stress tests are increasingly used to calibrate macroprudential measures and supervisory policy changes. Other macroprudential uses are early warning exercises to identify potential weaknesses of the system and enhance crisis management plans.
  • Macroprudential stress tests are increasing in importance as a way of assessing the financial resilience of banking systems, as they can allow for a more direct assessment of feedback loops, amplification mechanisms and spillovers. These important effects are most frequently assessed via top down approaches.

 

APRA welcomes finalisation of Basel III bank capital framework

APRA has welcomed the Basel III announcement and expects to commence consultation on revisions to the ADI capital framework in early 2018.

Despite the 2022 date, APRA also reaffirmed that Australian banks should be following strategies to increase their capital strength to exceed the unquestionably strong benchmarks by 1 January 2020.

The Australian Prudential Regulation Authority (APRA) today welcomed the announcement that the Basel Committee on Banking Supervision had finalised the Basel III bank capital framework.

The announcement confirms the final set of measures designed to address deficiencies in the internationally-agreed capital framework following the global financial crisis and are primarily focused on addressing undue variability in risk-weighted assets, and therefore capital requirements, across banks.

Key elements of the final framework include changes to the standardised approach to credit risk capital for real estate, restrictions on modelled risk estimates by banks using the internal ratings-based (IRB) approach to credit risk capital, and the removal of provisions for banks to use internal models to determine their operational risk capital requirements. The Basel Committee has also agreed to introduce a ‘floor’ to limit the reduction in capital requirements available to banks using capital models relative to those using the standardised approaches.

APRA Chairman Wayne Byres said APRA’s ADI capital framework, including the adjustments made to IRB risk weights in 2016, is well-equipped to accommodate the final Basel III framework. APRA has been involved in the international work to agree the final Basel III reforms.

“We welcome the finalisation of these measures which represent the final stage of a decade’s financial reform work aimed at building resilience in the financial system following the global financial crisis.

“Importantly for Australian ADIs, these final Basel III reforms will be accommodated within the targets APRA set in July this year in our assessment of the quantum and timing of capital increases for Australian ADIs to achieve unquestionably strong capital ratios,” Mr Byres said.

The Basel Committee has agreed to an implementation timetable commencing in 2022 for the final Basel III reforms. APRA will consider the appropriate effective date for revisions to the ADI prudential standards in light of the Basel Committee’s announcement and expects to commence consultation on revisions to the ADI capital framework in early 2018. However, consistent with its July 2017 announcement, APRA reaffirms its expectation that ADIs should be following strategies to increase their capital strength to exceed the unquestionably strong benchmarks by 1 January 2020.

The 2018 consultation will be based on the final Basel III framework but with appropriate adjustments to reflect APRA’s approach and Australian conditions, most notably adjustments to capital requirements for higher risk residential mortgage lending, consistent with the achievement of unquestionably strong capital ratios.

NZ Reserve Bank consults on what should qualify as bank capital

The NZ Reserve Bank has started a public consultation about what type of financial instruments should qualify as bank capital. They offer a range of potential options from simple to more complex and highlight the trans-Tasman context.

Capital regulations address not only the minimum amount of capital that banks must hold, but also the type of financial instruments that qualify as capital. The consultation that starts today is about the nature of financial instruments that are suitable, rather than the amount of capital.

Important considerations for regulations about bank capital include: the Reserve Bank’s regulatory approach; the resolution regime in the event of a bank facing difficulties; international standards issued by the Basel Committee on Banking Supervision; the Reserve Bank’s experience with the current capital regime; and the fact that dominant participants in the New Zealand banking market are subsidiaries of overseas banks. The consultation paper discusses these issues and outlines five options for reforming existing regulations.

The Bank’s proposed reforms to capital regulations aim to reduce the complexity of the regulatory regime; provide greater certainty about the quality of capital that banks hold; and reduce the scope for regulatory arbitrage.

The options consist of “bundles” of reform measures made across 6 dimensions. The measures are combined in such a way that the options provide a gradual shift from the status quo towards:

  • Reduced complexity for the capital regime;
  • Greater certainty as to the loss-absorbing quality of regulatory capital;
  • A more level playing field; and,
  • A reduced risk of regulatory arbitrage.

The consultation closes at 5pm on Friday 8 September.

They also mention the “trans-Tasman context”

An important context for New Zealand’s bank capital regulations is the dominance of four large banks (the “big four”). Each of the big four is a locally incorporated subsidiary of an Australian-incorporated banking parent. Between them the “big four” account for almost 90% of aggregate bank assets in New Zealand.

The big four banks are subject to Australian and New Zealand bank capital regulations – capital issued by the big four potentially qualifies as capital both for the New Zealand bank and for the Australian parent. This is important for a couple of reasons:

  • The Australian regulator’s requirements of the Australian parents can flow down into terms and conditions in the instruments issued by New Zealand banks and these may be problematic in the New Zealand context. An example would be the requirement that, in order to be recognised as capital for the Australian parent, contingent debt issued by the New Zealand subsidiary must, if it offers conversion, convert into listed ordinary shares (the New Zealand subsidiaries do not list their ordinary shares).
  • Banks prefer requirements to be aligned, as this reduces their costs of compliance with both regimes.

Fed Says 2/30 Banks’ Capital Plans Not OK

The Federal Reserve Board has announced it has not objected to the capital plans of 30 bank holding companies participating in the Comprehensive Capital Analysis and Review (CCAR). The Board objected to two firms’ plans. One other firm’s plan was not objected to, but the firm is being required to address certain weaknesses and resubmit its plan by the end of 2016.

CCAR, in its sixth year, evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms’ planned capital actions such as dividend payments and share buybacks and issuances. Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.

When considering a firm’s capital plan, the Federal Reserve considers both quantitative and qualitative factors. Quantitative factors include a firm’s projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm’s capital planning process, which incorporate the risk management, internal controls, and governance practices that support the process. The Federal Reserve may object to a capital plan based on quantitative or qualitative concerns. If the Federal Reserve objects to a capital plan, a firm may not make any capital distribution unless expressly authorized by the Federal Reserve.

“Over the six years in which CCAR has been in place, the participating firms have strengthened their capital positions and improved their risk-management capacities,” Governor Daniel K. Tarullo said. “Continued progress in both areas will further enhance the resiliency of the nation’s largest banks.”

The Federal Reserve did not object to the capital plans of Ally Financial, Inc.; American Express Company; BancWest Corporation; Bank of America Corporation; The Bank of New York Mellon Corporation; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; Capital One Financial Corporation; Citigroup, Inc.; Citizens Financial Group; Comerica Incorporated; Discover Financial Services; Fifth Third Bancorp; Goldman Sachs Group, Inc.; HSBC North America Holdings, Inc.; Huntington Bancshares, Inc.; JP Morgan Chase & Co.; Keycorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; Northern Trust Corp.; The PNC Financial Services Group, Inc.; Regions Financial Corporation; State Street Corporation; SunTrust Banks, Inc.; TD Group US Holdings LLC; U.S. Bancorp; Wells Fargo & Company; and Zions Bancorporation. M&T Bank Corporation met minimum capital requirements on a post-stress basis after submitting an adjusted capital action.

The Federal Reserve did not object to the capital plan of Morgan Stanley, but is requiring the firm to submit a new capital plan by the end of the fourth quarter of 2016 to address certain weaknesses in its capital planning processes. The Federal Reserve objected to the capital plans of Deutsche Bank Trust Corporation and Santander Holdings USA, Inc. based on qualitative concerns. The Federal Reserve did not object to any capital plans based on quantitative grounds.

U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio–which compares high-quality capital to risk-weighted assets–of the 33 bank holding companies in the 2016 CCAR has more than doubled from 5.5 percent in the first quarter of 2009 to 12.2 percent in the first quarter of 2016. This reflects an increase of more than $700 billion in common equity capital to a total of $1.2 trillion during the same period.

Fed-Capital

APRA Conglomerate Supervision Framework (Level 3) Consultation

The Australian Prudential Regulation Authority (APRA) has today released for consultation clarifications to the governance and risk management components of the framework for supervision of conglomerate groups (Level 3 framework).

This includes clarifications to nine prudential standards, intended to become effective on 1 July 2017, and two prudential practice guides. These clarifications are not changes in policy position.

APRA released the Level 3 framework1 in August 2014, but considered it appropriate to wait until the findings of the Financial System Inquiry (FSI) and the Government’s response to FSI recommendations before settling on the final form of the conglomerate framework.

APRA has also announced today that it has deferred the implementation of conglomerate capital requirements until a number of other domestic and international policy initiatives are further progressed. These policy initiatives include:

  • APRA’s implementation of the FSI recommendation on unquestionably strong capital ratios for ADIs (FSI recommendation 1);
  • consideration of proposals in relation to loss absorption and recapitalisation capacity (FSI recommendation 3); and
  • proposed legislative changes to strengthen APRA’s crisis management powers (FSI recommendation 5).

Taken together, these initiatives will influence APRA’s final views on the appropriate requirements with respect to the strength, resilience, recovery and resolution capacity of conglomerate groups.

APRA Chairman Wayne Byres said: ‘The group governance and risk management requirements released today will further strengthen conglomerate groups, by enhancing oversight of group risks and exposures, and limiting potential contagion and systemic risks.’

‘While the timetable for the implementation of the conglomerate capital requirements has been extended, in APRA’s view this is the most appropriate course of action. To finalise the conglomerate capital requirements at this stage would introduce the possibility of needing to amend them within a few years, and this would be unnecessarily disruptive and inefficient for the groups directly affected.’

Given some time has passed since the prudential standards were released in August 2014, APRA is providing a six-week consultation period (until 13 May) for comments on the clarifications to the nine non-capital prudential standards. APRA also invites submissions on the two prudential practice guides by 27 May. As the consultation largely deals with issues of clarification, APRA is not expecting any changes to the underlying policy positions

While the clarifications to the cross-industry standards of Risk Management, Outsourcing, Governance, Business Continuity Management, and Fit and Proper largely relate to their application to conglomerates, these standards also apply to all authorised deposit-taking institutions (ADIs), general insurers and life companies. As such, APRA encourages all entities covered by these standards to review the clarifications.

The Level 3 framework, including prudential standards, prudential reporting forms, and draft prudential practice guides can be found on the APRA website at:

www.apra.gov.au/CrossIndustry/Pages/Supervision-of-conglomerate-groups-L3-March-2016.aspx.

1 www.apra.gov.au/MediaReleases/Pages/14_15.aspx

The Future Shape of Banking Regulation

In a speech entitled “The fence and the pendulum“, by Martin Taylor, External Member of the Financial Policy Committee, Bank of England, he discusses the thorny problems of macroprudential policymaking, which very much include the bank capital and too-big-to-fail agenda. It is worth reading in full.

He concludes:

This is a crucial time for the new international order in bank regulation. We are close to agreement on new standards that the industry, in the UK at least, is not too far off meeting. Four years ago that would have seemed a highly desirable outcome but quite an unlikely one. It’s good for our economies, and it will turn out to be good for the financial industry over the next quarter-century. At the same time the emergence – well, they never went away – the increasingly shrill emergence of voices calling for a regulatory softening is both structurally wrong and conjuncturally wrong. It remains the ungrateful job of the supervisors to save the banks from themselves. The shortness of human memory span and the speed with which we forget the ghastly misjudgements of the recent past: these are the enemies, the unresting enemies, alas, of financial stability.