2
Must constitute at least 50 per cent of the capital requirement.
2 Must constitute at least 50 per cent of the capital requirement.
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Commonwealth legislation
This Act has been repealed and is no longer in force. It is retained for historical reference.
This instrument froze existing state prudential rules as temporary federal standards when APRA took over on 1 July 1999, creating the first national prudential regime for building societies, credit unions and their service providers.
It requires institutions to hold minimum capital and liquid buffers, maintain robust risk-management and securitisation safeguards, and file regular reports — preserving depositor protection and preventing a regulatory gap during the transition to permanent national standards.
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Direct links to the current provisions in APRA transitional prudential standards.
2 Must constitute at least 50 per cent of the capital requirement.
3 May include measured current year earnings net of expected dividends and tax expense.
4 Must be subordinated to depositors and unsecured creditors; must not provide for a return of capital or compensation for unpaid dividends; and dividends (the only form of compensation to investors that should be provided) should not be influenced by the credit standing of the society. The non-declaration of a dividend should not trigger any restrictions on the society other than the need to seek approval of holders of the shares before paying dividends on or retiring other shares.
5 For the purposes of calculating capital adequacy, cannot exceed the value of Tier 1 capital.
6 General provisions, less any associated future income tax benefit, up to a value of 1.25 per cent of total risk weighted assets. The provisions must be additional to the statutory provisions (Prudential Standard 3.3.2.a) and must be created against future, presently unidentified losses. General provision must be available to meet any losses that may subsequently materialise.
7 Where the regular periodic revaluation of property is reflected in the balance sheet and is subject to audit review, revaluation reserves are to be included in Upper Tier 2 capital after allowance for capital gains and any other taxes or costs that would be incurred should the asset be sold for the revalued amount. Regular periodic valuations must be at intervals of no more than 3 years. For revaluations of other assets (including securities) not passed through the profit and loss account and irregular revaluations of property, only 45 per cent of the gain may be included in Upper Tier 2 capital. However, the full value of any decline in value must be reflected in Upper Tier 2 capital. This applies whether revaluations or devaluations are recorded in the balance sheet or in the notes to the accounts.
8 Must meet the criteria for "hybrid debt/equity capital instruments" set out in Prudential Standard 3.2.3.
9 The eligible amount of lower Tier 2 capital for the purposes of calculating capital adequacy is limited to 50 per cent of Tier 1 capital. Minimum original maturity must be at least five years. Lower Tier 2 capital must be amortised at a rate of 5% per quarter of the original amount during the last five years to maturity.
10 To qualify for a particular risk weight, a security arrangement must permit direct, explicit, irrevocable and unequivocal recourse to the collateral. Claims secured or collateralised in other ways eg insurance contracts, put options, forward sale contracts are not considered to be eligible collateral.
11 For the purposes of the capital adequacy standard a guarantee must be issued formally. It must permit direct, explicit, irrevocable and unequivocal recourse to the guarantor. Indirect guarantees (such as guarantees of guarantees eg where the Commonwealth guarantees the entity which provides the guarantee) and letters of comfort are not recognised.
12 see footnote to Prudential Standard 3.2.4.e.
13 Throughout this standard, outstanding balance includes the balance of all loans and other facilities, plus the gross value of any undrawn limits available eg redraw amount available on the loan or undrawn limit on a revolving credit facility, that are secured against the mortgage security. An "all moneys" mortgage includes all loans or facilities to the customer that are effectively secured against the mortgage. To assign capital to undrawn limits, the credit conversion factor should be taken from prudential standard 3.2.5.a. This credit equivalent may then be assigned a 50 per cent risk weight if secured by a qualifying mortgage.
14 In calculating the outstanding balance of a loan, allowance may be made for higher ranking security. A society may deduct from the outstanding balance any eligible cash or Commonwealth or state government security held as collateral. Similarly, it may also deduct any part of the exposure guaranteed by a Commonwealth, State (including central borrowing authority) or local Government, a public sector entity eligible for a 20 per cent risk weight, a bank or other building society or credit union. These portions of the exposure are to be weighted according to the security or guarantee. A mortgage offset or similar account may only be netted off the loan balance where the arrangement would meet the requirements of the cash collateral guidelines.
15 Where there is more than one property offered as security, the LVR will be assessed on the basis of the outstanding balance (after allowance for any higher ranking security to the aggregate value of the secured properties.
16 To qualify as mortgage insured the policy must be taken out with an authorised Lenders Mortgage Insurer with an insurance rating the equivalent of "A" or higher. A captive LMI, though unrated, may demonstrate a claim paying ability rated "A" or higher through third party guarantees. AFIC will consider non-rated LMI arrangements on a case-by-case basis.
17 Where a specific provision for doubtful debt has been made against a loan, the risk weight applies to the outstanding balance (including accrued interest) after deducting the specific provision.
18 The amount to be subject to the credit conversion factor is the maximum unused portion of the facility at the time of calculation (any drawn portion will form part of balance sheet assets). For example, if a rental guarantee is provided on behalf of a customer, then all remaining lease payments (up to any limit specified in the guarantee) are included in the calculation.
19 These items are to be risk weighted according to the type of assets or the issuer of securities and not according to the counterparty with whom the transaction is made.
20 Reverse repos (ie. purchase and resale agreements) are to be treated as collateralised loans. The risk is to be measured as an exposure to the counterparty or according to the asset if it is a recognised collateral security within the risk ratio framework.
21 Redraw facilities that allow redraw only of advance payments, should be assigned a credit conversion factor of 0%.
22 This includes any commitment, that can only be unconditionally revoked with notice, where there is not a clear expiry date within one year.
23 Provided the commitment can only be rolled over or extended after a full credit review is done and there is no presumption or impression conveyed to the client that an approval of a roll over or extension will be a formality. Where this test is not met the commitment will receive a 50 per cent risk weight.
Sourced from the Federal Register of Legislation (legislation.gov.au), CC BY 4.0.
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APRA transitional prudential standards
as at 1 July 1999
APRA transitional prudential standards
Regulation 12 and Schedule 1 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
This instrument is a collection of the provisions that, on 1 July 1999, became APRA transitional prudential standards by operation of regulation 12 of the Financial Sector (Amendments and Transitional Provisions) Regulations 1999.
Prepared by the Australian Prudential Regulation Authority
Table of Contents
Book 3 of the Prudential Notes and Prudential Standards issued by AFIC
Prudential Standards 3.1.1 to 3.1.6
Prudential Standards 3.2.1 to 3.2.7
Prudential Notes 3.3B and 3.3C
Paragraphs 3.3.2a and 3.3.2b of Prudential Standard 3.3.2
Prudential Standard 3.3.5, other than subparagraph 3.3.5a(ii)
Provisions of Book 3 of the Prudential Notes and Prudential Standards issued by AFIC under Part 4 of an AFIC Code, as in force immediately before the transfer date
Note: see paragraph 1 of Schedule 1 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Prudential Note 3.1
Note: see subparagraph 1(a) of Schedule 1 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Prudential Note 3.1 – Building Societies
Risk Management
Objective
To protect and promote the financial integrity and efficiency of the State-based financial institutions system and to ensure that depositors are adequately protected from the risks that building societies incur in the process of financial intermediation. Towards this end, to ensure that societies are aware of the risks to which they are exposed, and that these risks are adequately measured, monitored and managed.
General Background
Pooling and managing risks for both borrowers and lenders is an important element of financial intermediation. Careful management of these risks is fundamental to the successful operation of any financial institution. As noted earlier, the primary responsibility for risk management rests firmly with the management of each society; the role of the supervisory authorities is limited to protecting the interests of depositors. Depositor protection, in turn, is enhanced by ensuring that societies approach risk management in a consistent manner and that they maintain a sufficient cushion of capital to afford depositors maximum confidence in the security of their deposits.
In assessing the appropriate level of capital, SSAs will require detailed information about the risk management procedures and practices of building societies. Inadequate management practices in this area will meet with additional requirements in terms of capital or, in certain cases, with additional requirements with respect to the holding of liquid assets.
While there will be no set formula relating the need for additional capital to particular deficiencies in risk management, SSAs will look for adequate procedures for identifying and measuring risk, adequate procedures for monitoring risks, and appropriate techniques for managing risks.
Additional capital will also be required of societies in direct proportion to their overall risk rating when these ratings imply risk in excess of industry norms. SSAs will advise building societies as to their risk ratings and capital requirements.
In a number of cases, the Prudential Standards require a society to consult with its SSA before particular transactions or activities can be undertaken. Consultation in this context will focus on the society's ability and systems to manage their risks prudently; the emphasis will be on processes rather than on the quality or otherwise of the decisions involved. Such consultation should not be taken to imply that the SSA in any sense sanctions or approves the particular activity. Decisions about the appropriate balance sheet structure for a particular society are its own responsibility. The SSA's role is to ensure that risk analyses are adequate and that each society's capital base is consistent with the risks that it undertakes.
Notwithstanding this responsibility, each building society must, prior to the assumption of any major new risks (for example, borrowing in foreign currency or moving into a new area of lending) first satisfy its SSA that it has:
(a) met all current prudential standards;
(b) the expertise and systems in place to manage the new risks involved; and
(c) sufficient capital in place to meet any additional requirements imposed by the authorities - this may include additional capital requirements if the proposed lending activities alter the assessed risk rating of the society as a whole.
Limited exemptions from this requirement may be granted under the transitional arrangements outlined earlier.
Specific Risks
Building societies face a number of different types of risk in conducting their businesses.
(i) Liquidity Risk - Prime Liquid Assets (PLA) Requirement
Liquidity risk arises from the tendency for a society's deposit base to be more readily liquidated than its assets. This is partly a consequence of the longer maturity of loans relative to deposits. It is also a consequence of the fact that loans which are not in arrears are not normally callable, whereas term deposits are often callable, albeit at a penalty. Despite this asymmetry in balance sheet liquidity, the capacity to meet promptly all obligations as they fall due is fundamental to financial intermediation.
The prudential standards require societies to hold a minimum level of 7 per cent of their total liabilities (excluding capital) in the form of highly-liquid, high-quality assets. This PLA ratio is to be met at all times. In day-to-day operations, however, these assets are not available to meet the ebb and flow of funds. They are intended only to provide a cushion of liquefiable funds, available in times of extreme pressure on liquidity, and then, only with the explicit approval of the SSAs.
(ii) Operational Liquidity Risk
While PLA provides a stock of high quality assets, each society must manage its cash flows without reliance on PLA. It is the responsibility of the board to assess its society's liquidity needs and determine the amount and composition of additional liquid assets required to cover day-to-day fluctuations in its operating liquidity arising from:
· withdrawals of deposits;
· increases in demands for loans, including increased drawdown of overdraft facilities;
· drawdown of credit card facilities;
· maturity mismatch of assets and liabilities; and
· unexpected operating expenses.
Each society is expected to have in place an appropriate management information system to allow monitoring and management of liquidity risk. Each society is also required to demonstrate an understanding of its deposit base (including strengths, limitations and historic volatility), the maturity mismatch between assets and liabilities and any risks arising from off-balance sheet activities. While cash flow projections, incorporating all significant cash flows and management of forward loan commitments, should form part of any liquidity management system, the sophistication of these systems will depend on the society's activities.
A society can pursue a range of strategies to manage liquidity risk including:
· holding adequate cash and readily liquefiable assets in addition to PLA;
· maintaining stand-by and overdraft facilities with banks, SSPs or other counterparties acceptable to AFIC;
· developing and maintaining a stable core of deposits;
· matching maturity structures of assets and liabilities, securitising assets and sourcing long-term funding; and
· developing sophisticated cash flow projections including improving asset and liability management.
In relation to the first point, each society is expected to hold 2 per cent of total liabilities (excluding capital) in one or more of the following: excess PLA, cash, funds securing settlement accounts and liquidity deposits with SSPs.
In determining liquidity needs, a society's board should aim at maintaining access to funds for the purpose of meeting operational demands at 6 per cent of total liabilities (less capital). Access to funds may be through off-balance sheet facilities and generally, each society is expected to look beyond its immediate deposit base to alternative sources of liquidity. These alternative sources include stand-by lines of credit or overdraft facilities with other financial institutions, including SSPs. Evidence that these arrangements have been firmly established and are available for immediate use will be required by SSAs.
To ensure that each SSA is aware of any weakening of a society's liquidity position, each society must advise its SSA if on-balance sheet liquid assets held to meet operating requirements falls below 2 per cent of total liabilities (excluding capital). Deviations below this liquidity trigger may occur from time to time and are not necessarily a source of concern.
Liquidity risk is also associated with large exposures to a single source of funds. Each society must include in its approach to liquidity management, a policy in respect of large liquidity exposures. Further, each society must report exposures in excess of 5 per cent of the society's total liabilities and, before a society accepts an exposure in excess of 10 per cent of total liabilities, it must consult with its SSA.
In reviewing a society's approach to liquidity management, the SSA may consider that the large liability exposure, or exposures in aggregate, create the potential risk for a society's liquidity to be strained or may consider that systems are otherwise inadequate. Under these circumstances, the SSA may require the society to hold higher levels of PLA or operational liquidity, report more frequently, or impose other requirements.
(iii) Market Risk
Market risk arises from the fluctuations that occur in the market values of assets and liabilities in the normal course of business. The primary source of such fluctuations is movements in interest rates. When interest rates change, the market values of loans, securities and deposits change to different extents. Whenever the interest rates paid on a financial institution’s liabilities do not adjust in line with the rates earned on assets, the institution is exposed to market risk. The net effect of these valuation changes alters the institution’s earnings and its net worth.
Financial innovations have provided building societies with a range of techniques for managing this risk. To the extent that deposits and loans are matched, either as variable interest instruments or, in the case of fixed-interest loans and deposits, by duration, the risk may be relatively small. Where a society’s book is not naturally matched in the above sense or not readily adjustable, the market provides instruments for managing the mismatch, while still meeting customer preferences on the terms of loans and deposits. Interest rate futures, options and swaps are now widely used in the finance industry to manage market risk. Sections 120 and 121 of the FI Code outline the scope for societies to trade in these instruments for the purpose of managing market risk.
SSAs will seek detailed information about each society's methods for measuring and monitoring market exposures. In particular, where assets do not satisfy either the primary objects or the liquid asset tests, SSAs will look for evidence that societies are employing appropriate risk management techniques, including regular market value assessments and appropriate provisioning for risks (see Prudential Note 3.3 on Accounting and Disclosure).
Where a society proposes to engage in the raising of funds denominated in foreign currency, its SSA will require, in advance, details of the proposed methodology for hedging the exposure.
(iv) Credit Risk
A primary source of risk for any financial institution is the risk of default. Undue concentration of loans can expose a society to excessive credit risk. Sensible diversification of a society's loan book by geographical area, type of borrower and to some extent by type of loan can reduce the risk of the overall loan portfolio.
SSAs will seek detailed information about each society's practices with respect to credit scoring, loan monitoring and the overall assessment of credit risk. Societies should be able to demonstrate an understanding of the inter-relationships between the various credit risks they are carrying. SSAs will pay special attention to credit risk policies relating to assets which lie outside the definitions of primary objects and liquid assets.
In particular, societies inevitably carry a substantial fixed asset exposure to property through their branch network systems. In the normal course of business this exposure should not exceed the size of the society's capital base. Exposure beyond this level will require prior consultation with its SSA.
A particular source of credit risk is large credit exposures to single borrowers. Large exposures can accumulate indirectly through lending to associated borrowers even though the exposure to any one member of the group may appear reasonable. While "associate" has been defined under Part 4 of the FI Code, the existence of these relationships may not represent any aggregation of risk (for example, where loan
This is an opening excerpt, not the complete document.