Control of Large Exposures and Risk Concentrations
- ADIs[12] are exposed to various forms of risk concentration with the potential to incur significant losses that could materially threaten the ADIs’ financial strength. Risk concentrations may arise from excessive exposures to individual counterparties, groups of related counterparties, groups of counterparties with similar characteristics (e.g. counterparties in specific geographical regions or industry sectors) or to particular asset classes (e.g. property holdings or other investments). Safeguarding against risk concentrations to particular counterparties[13], industries, countries and asset classes should form an essential component of ADIs’ risk management strategies[14].
- The Board of an ADI is responsible for establishing, and monitoring compliance with, policies governing large exposures and risk concentrations of the ADI. The Board should ensure that these policies are reviewed regularly (at least annually) and that they remain adequate and appropriate for the ADI[15]. Any material changes to established policies must be approved by the Board.
- An ADI’s large exposures policy[16] should, as a minimum, cover the following:
(a) exposure limits for:
(i) various types of counterparties (e.g. governments, ADIs and foreign equivalents, corporate and individual borrowers);
(ii) a group of related counterparties;
(iii) individual industry sectors (where applicable);
(iv) individual countries (where applicable); and
(v) various asset classes (e.g. property holdings and other investments, etc.)
that are commensurate with the ADI’s capital base and balance sheet size;
(b) the circumstances in which the above exposure limits may be exceeded and the authority required for approving such excesses (e.g. by the ADI’s Board or a board committee); and
(c) the procedures for identifying, reviewing, controlling and reporting large exposures of the ADI.
- The Board and senior management of an ADI should ensure that:
(a) adequate systems and controls are in place to identify, measure, monitor and report large exposures and risk concentrations of the ADI in a timely manner; and
(b) large exposures and risk concentrations of the ADI are kept under regular review.
- An ADI should, where appropriate, conduct stress testing and scenario analysis of its large exposures and risk concentrations to assess the impact of changes in market conditions or key risk factors (e.g. economic cycles, interest rate, liquidity conditions or other market movements) on its risk profile and earnings.
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Definitions
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A large exposure is an exposure to a counterparty or a group of related counterparties which is greater than or equal to 10% of an ADI’s capital base[17].
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An exposure to a counterparty or a group of related counterparties is the aggregate of all claims, commitments and contingent liabilities arising from on- and off-balance sheet transactions (in both the banking and trading books) with the counterparty or group of related counterparties, and
(a) includes (but is not limited to):
(i) outstanding balances of all loans and advances;
(ii) holdings of debt and/or equity securities;
(iii) all unused advised off-balance sheet commitments (refer Attachment A to AGN 112.2 for examples of these commitments), whether revocable or irrevocable; and
(iv) the credit equivalent amounts of all market-related contracts (calculated in accordance with AGN 112.2 or AGN 112.3 where netting applies[18]);
(b) excludes:
(i) exposures (e.g. claims or equity investments) deducted from an ADI’s capital (see APS 111 – Capital Adequacy: Measurement of Capital);
(ii) exposures to the extent that they are secured by cash deposits (subject to satisfying the criteria set out in Attachment B to AGN 112.1 for the purpose of this Standard);
(iii) exposures to the extent that they are guaranteed by, or secured against securities issued by, governments or central banks (subject to satisfying the conditions set out in paragraphs 9, 12, 13, 14 and 15 of AGN 112.1 for the purpose of this Standard);
(iv) exposures arising in the course of settlement of market-related contracts;
(v) exposures to an ADI required as part of a liquidity support arrangement that has been certified by APRA under section 11CB of the Banking Act; and
(vi) exposures to the extent that they have been written off or specifically provided for.
- A group of related counterparties should be deemed to exist where two or more individual counterparties are linked by:
(a) cross guarantees;
(b) common ownership or management;
(c) the ability to exercise control (defined in accordance with Australian accounting standards) over the other(s), whether direct or indirect;
(d) financial interdependency such that the financial soundness of any of them may affect the financial soundness of the other(s); or
(e) other connections or relationships which, according to an ADI’s assessment, identify the counterparties as constituting a single risk.
As a general rule, family members are not to be treated as connected where they have independent retail relationships with an ADI (although an ADI can choose to treat such exposures as connected should it consider appropriate to do so).
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Prudential Limits
- The aggregate exposure of an ADI to a counterparty or a group of related counterparties is subject to the following limits[19]:
(a) external parties (other than governments, central banks and ADIs or equivalent overseas deposit-taking institutions) unrelated to the ADI – 25% of capital base;
(b) unrelated ADI (or equivalent overseas deposit-taking institution) and its subsidiaries – 50% of capital base, with aggregate exposure to non-deposit-taking subsidiaries capped at 25% of capital base; and
(c) foreign parents and their subsidiaries[20] – 50% of capital base, with aggregate exposure to non-deposit-taking subsidiaries capped at 25% of capital base.
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Although certain types of exposure (e.g. settlement risk, exposure secured by eligible collateral) and counterparties (governments and central banks) are excluded from the above prescribed limits, these exposures are not risk free. ADIs should have adequate procedures and controls in place (e.g. by way of internal limits) to monitor these exposures.
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ADIs should treat the 25% limit as the upper limit for an exposure to a non-government, non-ADI counterparty. APRA expects ADIs to establish lower internal limits to any non-government, non-ADI counterparty commensurate with their risk appetite.
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Notwithstanding paragraph 9 above, APRA may (in writing) set specific limits on an ADI’s exposures to particular counterparties, groups of counterparties, industry sectors, countries or asset classes (including property holdings and any other investments) on a case-by-case basis, having regard to the ADI’s individual circumstances.
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Approval Requirements
- An ADI must obtain APRA’s prior approval for any proposed exposures in excess of the prescribed limits set out in paragraph 9 or alternative limit determined under paragraph 12 above. Such approval will only be granted on an exceptional basis. The ADI concerned must be able to satisfy APRA why the proposed exposure(s) might reasonably be expected not to expose the ADI to excessive risk. APRA may impose a higher minimum capital ratio on the ADI at Level 1 and/or Level 2 (see APS 110 – Capital Adequacy) to compensate for the additional risk that may be associated with the proposed exposure(s).
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Notification Requirements
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An ADI must notify APRA immediately of any breach of the prescribed limits under paragraph 9 or other specific limits imposed by APRA under paragraph 12 above, including remedial actions taken or planned to deal with the breach.
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An ADI must inform APRA immediately where it has concerns that its large exposures or risk concentrations have the potential to impact materially upon its capital adequacy, along with proposed measures to address these concerns.
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Prior Consultation Requirements
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An ADI must consult with APRA prior to committing to any proposed exposures to non-government, non-ADI counterparties in excess of 10% of its capital base[21].
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APRA may (in writing) set a higher consultation threshold or waive the prior consultation requirements for individual ADIs where APRA is satisfied with the robustness of the ADI’s credit risk management systems and controls.
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Concentration of Risk
- Where an ADI has a number of large exposures (excluding exposures set out in paragraph 7(b) above and any exposure to governments and central banks) or where in APRA’s opinion, the ADI is exposed to a significant level of risk concentration, APRA may require the ADI to maintain a higher capital ratio at Level 1 and/or Level 2 (see APS 110 – Capital Adequacy). In considering whether that ADI’s capital ratio should be increased, APRA will take account of the following factors:
(a) consistency with the ADI’s policy on large exposures and risk concentrations;
(b) the number of exposures, their individual size and nature; and
(c) the characteristics of the ADI, including the nature of its business and the experience of its management.
- APRA may also direct an ADI to take measures to reduce its level of risk concentration.
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Reporting
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An ADI must provide APRA each quarter (or more frequently if required by APRA) with information on its large exposures (including exposures to foreign parents and their subsidiaries where applicable) in a form to be determined by APRA from time to time.
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Where necessary, APRA may impose additional reporting requirements on an ADI in relation to its large exposures and risk concentrations.
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Application to Foreign ADIs
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This Standard does not apply to foreign ADIs in Australia which are subject to the consolidated supervision by their home country supervisors in respect of credit concentrations and large exposure limits. However, foreign ADIs should detail their large exposure and risk concentration policies as well as the relevant high level controls in the risk management systems descriptions required under APS 310 – Audit & Related Arrangements for Prudential Reporting. As part of its prudential oversight of the Australian operations of a foreign ADI, APRA may discuss with the foreign ADI’s parent and home supervisor any undue credit risk concentrations associated with the branch’s Australian activities.
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Foreign ADIs are required to report quarterly to APRA (or more frequently if required by APRA) on the large exposures of their Australian operations in a form to be determined by APRA from time to time.
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