Prudential Standard

APS 111 - Capital Adequacy: Measurement

of Capital

Objective

This standard sets out the essential characteristics that an instrument must have to qualify as Tier 1 or Tier 2 (upper or lower) capital for inclusion in an ADI’s capital base for assessing Level 1 (i.e. stand-alone) and Level 2 (i.e. the consolidated banking group) capital adequacy.

This standard forms part of a comprehensive set of prudential standards that deal with the measurement of an ADI’s capital adequacy at Level 1 and Level 2. It should be read in conjunction with: APS 110 – Capital Adequacy; APS 112 – Capital Adequacy: Credit Risk; APS 113 – Capital Adequacy: Market Risk; and APS 120 – Funds Management & Securitisation.

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Principles

Capital Base

1. APRA’s approach to the measurement of an ADI’s capital adequacy at Level 1 and Level 2 (as defined in APS 110 – Capital Adequacy) is based on the risk-based capital adequacy framework developed by the Basel Committee on Banking Supervision (see AGN 110.4 – Risk-based Capital Adequacy Framework). Under this framework, an ADI’s total qualifying capital at Level 1 (i.e. the stand-alone level) and Level 2 (i.e. the consolidated banking group level) is assessed in two tiers:

(a) Tier 1 capital

Tier 1 or core capital comprises the highest quality capital elements which fully satisfy all of the following essential characteristics:

(i) provide a permanent and unrestricted commitment of funds;

(ii) be freely available to absorb losses;

(iii) not impose any unavoidable servicing charge against earnings; and

(iv) rank behind the claims of depositors and other creditors in the event of winding-up.

(b) Tier 2 capital

Tier 2 or supplementary capital includes other elements which, to varying degrees, fall short of the quality of Tier 1 capital stated in paragraph 1(a) above but nonetheless contribute to the overall strength of an entity as a going concern, and is divided into:

(i) Upper Tier 2 capital – comprising elements that are essentially permanent in nature, including some forms of hybrid capital instruments which have the characteristics of both equity and debt; and

(ii) Lower Tier 2 capital – comprising instruments which are not permanent i.e. dated or limited life instruments.

2. For capital adequacy purposes, an ADI’s Level 1 and Level 2 capital base (i.e. the numerator of the risk-based capital ratio) is defined as the sum of Tier 1 and Tier 2 (upper and lower) capital, net of all specified deductions (see paragraphs 8 and 9 below) and amortisation (see AGN 111.2) where appropriate, at the respective level and subject to the various limits (see paragraph 11 below) that apply to the different tiers of capital.

3. In assessing whether an instrument is eligible as Tier 1 or Tier 2 (upper or lower) capital, APRA will have regard to both the form and substance of the instrument. An ADI should consult APRA in advance of issuance of any capital instrument other than ordinary shares (whether to be issued directly by the ADI or by any entity at Level 2, or indirectly through a special purpose vehicle) to ensure its eligibility for inclusion in the ADI’s Level 1 or Level 2 capital base.

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Tier 1 Capital

4. For the purposes of calculating an ADI’s capital base at Level 1 and Level 2 (see paragraph 2 above), Tier 1 capital consists of:

(a) paid-up ordinary shares;

(b) general reserves;

(c) retained earnings;

(d) current year’s earnings net of expected dividends and tax expenses;

(e) minority interests arising from consolidation of Tier 1 capital of subsidiaries (only for Level 2 calculations);

(f) non-cumulative irredeemable preference shares approved by APRA (see AGN 111.1); and

(g) other innovative capital instruments (issued through special purpose vehicles) approved by APRA (see AGN 111.1 and AGN 111.3).

5. Unless otherwise approved by APRA (see paragraph 3 of AGN 111.1), an ADI’s total servicing obligations on Tier 1 capital instruments must not exceed the ADI’s after-tax earnings in the financial year to which they relate. That is, there should be no dividend or interest payments out of retained earnings without APRA’s prior approval.

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Tier 2 Capital

6. For the purposes of calculating an ADI’s capital base at Level 1 and Level 2 (see paragraph 2 above), Upper Tier 2 capital (see AGN 111.2) consists of:

(a) revaluation reserves of premises and securities;

(b) general provisions for doubtful debts (limited to a maximum of 1.25 per cent of total risk-weighted exposures);

(c) cumulative irredeemable preference shares approved by APRA;

(d) mandatory convertible notes and similar capital instruments approved by APRA;

(e) perpetual subordinated debt approved by APRA; and

(f) any other hybrid (debt/equity) capital instruments of a permanent nature approved by APRA, including any capital amounts that are ineligible for inclusion as Tier 1 capital as a result of the limit referred to in paragraph 11(a)(i) below.

7. For the purposes of calculating an ADI’s capital base at Level 1 and Level 2 (see paragraph 2 above), Lower Tier 2 capital (see AGN 111.2) consists of:

(a) term subordinated debt approved by APRA;

(b) limited life redeemable preference shares approved by APRA; and

(c) any other similar limited life capital instruments approved by APRA.

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Deductions

8. In calculating an ADI’s Level 1 (stand-alone) capital base (see paragraph 2 above), the following items are deducted (see AGN 111.4):

from Tier 1 capital

(a) intangible assets, including the intangible component of investments (e.g. purchased goodwill) in subsidiaries and other entities;

(b) future income tax benefits (other than those associated with general provisions for doubtful debts);

(c) all holdings of own Tier 1 capital instruments and any unused trading limit agreed with APRA;

(d) equity and other capital investments in associated (e.g. captive) lenders mortgage insurers;

(e) equity investments in non-subsidiary entities that are not operating in the field of finance in excess of:

(i) 0.25 per cent of the ADI’s Level 2 Tier 1 capital for an individual investment; or

(ii) 5 per cent of the ADI’s Level 2 Tier 1 capital in aggregate;

from Upper or Lower Tier 2 capital as appropriate

(f) all holdings of own Upper and Lower Tier 2 capital instruments and any unused trading limit agreed with APRA;

from Total Capital (i.e. the sum of Tier 1 and Tier 2 capital after deductions and amortisation)

(g) equity and other capital investments in other ADIs or equivalent overseas deposit-taking institutions (and their subsidiaries), except where:

(i) that other ADI or equivalent overseas deposit-taking institution is wholly owned or effectively controlled (whether directly or indirectly) by the ADI, and has been consolidated with the ADI at Level 2 for capital adequacy purposes; or

(ii) that other ADI’s or equivalent overseas deposit-taking institution’s capital instruments are held for trading purposes which, in this case, must be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;

(h) equity and other capital investments in authorised non-operating holding companies of ADIs unless these are held for trading purposes in which case they will be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;

(i) any credit support of a capital nature provided to other entities, such as provision of a first loss guarantee, including any undertakings by the ADI to absorb designated first level of losses on claims supported by it (first loss facilities associated with funds management and the securitisation of assets should be deducted in accordance with the requirements set out in APS 120 – Funds Management & Securitisation); and

(j) any non-repayable loans advanced by the ADI under APRA’s certified industry support arrangements.

9. In calculating an ADI’s Level 2 (consolidated group) capital base (see paragraph 2 above), the following items are deducted (see AGN 111.4):

from Tier 1 capital

(a) goodwill and other intangible assets, including the intangible component of investments (e.g. purchased goodwill) in non-consolidated subsidiaries (see AGN 110.2 – Non-consolidated Subsidiaries) and other entities that do not form part of the consolidated banking group at Level 2;

(b) future income tax benefits (other than those associated with general provisions for doubtful debts);

(c) all holdings of own Tier 1 capital instruments and any unused trading limit agreed with APRA;

(d) equity and other capital investments in non-consolidated captive lenders mortgage insurers (see AGN 110.2 – Non-consolidated Subsidiaries);

(e) equity investments in non-subsidiary entities that are not operating in the field of finance in excess of:

(i) 0.25 per cent of the ADI’s Level 2 Tier 1 capital for an individual investment; or

(ii) 5 per cent of the ADI’s Level 2 Tier 1 capital in aggregate;

from Upper or Lower Tier 2 capital as appropriate

(f) all holdings of own Upper and Lower Tier 2 capital instruments and any unused trading limit agreed with APRA;

from Total Capital (i.e. the sum of Tier 1 and Tier 2 capital after deductions and amortisation)

(g) equity and other capital investments in other ADIs or equivalent overseas deposit-taking institutions (and their subsidiaries) unless these are held for trading purposes in which case they will be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;

(h) equity and other capital investments in authorised non-operating holding companies of ADIs unless these are held for trading purposes in which case they will be included in the ADI’s total risk-weighted exposures in accordance with APS 113 – Capital Adequacy: Market Risk;

(i) equity and other capital investments in non-consolidated subsidiaries or controlled entities (other than captive lenders mortgage insurers) after any intangible component of the investment is deducted from Tier 1 capital as per item (a) above (see AGN 110.2 – Non-consolidated Subsidiaries);

(j) any credit support of a capital nature provided to other entities that do not form part of the consolidated banking group at Level 2, such as provision of a first loss guarantee, including any undertakings by the ADI or by any entity consolidated at Level 2 to absorb designated first level of losses on claims supported by them (first loss facilities associated with funds management and the securitisation of assets should be deducted in accordance with the requirements set out in APS 120 – Funds Management & Securitisation); and

(k) any non-repayable loans advanced by the ADI under APRA’s certified industry support arrangements.

10. All deductions made at Level 1 or Level 2 (see paragraphs 8 and 9 above) are excluded from total assets when calculating an ADI’s total risk-weighted assets at the respective level (see paragraph 2 of AGN 112.1 Risk-Weighted On-Balance Sheet Credit Exposures).

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Limitations

11. The amount of Tier 1 and Tier 2 (upper and lower) capital included in an ADI’s Level 1 and Level 2 capital base are subject to the following limits:

(a) Tier 1 capital

(i) A capital instrument is not eligible for inclusion in an ADI’s Tier 1 capital (before deductions), whether at Level 1 or Level 2, to the extent that its inclusion will result in the aggregate amount of items (f) and (g) described in paragraph 4 above exceeding 25 per cent of the sum of all the other Tier 1 capital components listed in paragraph 4 (i.e. items (a) to (e)). Any excess amount ineligible for inclusion as Tier 1 capital as a result of this limit will be eligible for inclusion as Upper Tier 2 capital.

(ii) Total Tier 1 capital (net of all specified deductions) must constitute at least 50 per cent of an ADI’s capital base, both at Level 1 and Level 2 (except in the formative years of mutually owned ADIs as approved by APRA).

(b) Tier 2 (upper and lower) capital

(i) Total Tier 2 capital (net of all specified deductions and amortisation) at Level 1 and Level 2 is limited to a maximum of 100 per cent of an ADI’s total Tier 1 capital (net of all specified deductions) at the respective level (except in the formative years of mutually owned ADIs as approved by APRA).

(ii) Total Lower Tier 2 capital (net of all specified deductions and amortisation) at Level 1 and Level 2 is limited to a maximum of 50 per cent of an ADI’s total Tier 1 capital (net of all specified deductions) at the respective level (except in the formative years of mutually owned ADIs as approved by APRA).

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