Risk-based Capital Adequacy Framework

1. APRA’s approach to the assessment of an authorised deposit-taking institution's (ADI’s) capital adequacy at Level 1 (i.e. the stand-alone level) and Level 2 (i.e. the consolidated banking group level) is based on the risk-based capital adequacy framework set down in the Basel Capital Accord.
2. Consistent with the Basel framework, the approach provides for a quantitative measure of an ADI’s capital adequacy and focuses on three main elements:

(a) the credit risk associated with an ADI’s on- and off-balance sheet exposures;

(b) the market risk arising from an ADI’s trading activities; and

(c) the form and quality of capital held by the ADI to support these exposures.

3. APRA may adjust its risk-based capital adequacy framework in future to take account of developments to the Basel framework. Further elements or other types of risk may be added to this quantitative framework over time, such as the inclusion of a requirement to provide capital to cover operational risk.

4. Under the risk-based capital adequacy framework, an ADI’s Level 1 and Level 2 capital adequacy is measured by means of a risk-based capital ratio calculated by dividing its eligible capital base by its total risk-weighted exposures i.e.

risk-based capital ratio = eligible capital base

------------------------------------

total risk-weighted exposures

5. The definition of eligible “capital base” (the numerator of the risk-based capital ratio), including qualifying criteria for individual capital elements to be included in an ADI’s Level 1 and Level 2 capital base, is set out in Prudential Standard APS 111 Capital Adequacy: Measurement of Capital.

6. An ADI’s “total risk-weighted exposures” (the denominator of the risk-based capital ratio) at Level 1 and Level 2 is calculated as the sum of the total risk-weighted on- and off-balance sheet credit exposures and the “adjusted” market risk exposures, determined in accordance with the requirements and procedures set out in Prudential Standard APS 112 Capital Adequacy: Credit Risk (APS 112) and Prudential Standard APS 113 Capital Adequacy: Market Risk (APS 113) respectively.

7. To ensure consistency in the calculation of capital requirements for credit and market risks, the amount of market risk capital charge (for both specific and general market risk) determined in accordance with APS 113 must be adjusted by multiplying it by a constant factor of 12.5 (i.e. the reciprocal of the minimum capital ratio of 8 per cent) to obtain an equivalent risk-weighted exposure. The resulting figure is then added to the risk-weighted credit exposures, calculated in accordance with APS 112, to derive the total risk-weighted exposures.