Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital
DeductionsDeductions
Start here
Get a plain-English read of Deductions
Turn the raw legal text into a practical explanation grounded in Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital.
For the purposes of calculating its Level 1 capital base, an ADI must deduct the following items from Tier 1 capital (also refer to Attachment D):
Asset impairment
(a) any identified impairment of an asset where the impairment has not already been taken into account in profit or loss or the impairment has been incorporated in the fair value changes captured in an asset revaluation reserve included in Upper Tier 2 capital (refer to Attachment B). This will include the value of any deficit in asset revaluation reserves included in Upper Tier 2 capital after taking account of all adjustments;
Deferred tax
(b) deferred tax assets net of deferred tax liabilities (refer to Attachment D);
Fair value gains and losses
(c) cumulative unrealised fair value gains and losses on effective cash flow hedges reflected in retained earnings or reserves included in Tier 1 capital that do not offset gains or losses on revaluations in reserves included in Tier 1 capital;[9]
(d) any fair value gains and losses relating to illiquid financial instruments. Illiquid financial instruments are financial instruments, including instruments covered by effective economic hedges, that do not have a reliable fair value and are to be reported on an amortised cost basis. If fair values can be credibly inferred, the instrument need not be considered “illiquid”;
(e) any fair value gains and losses relating to loans and receivables not eligible to be reported using fair values.[10] Such loans and receivables are to be recognised at amortised cost for capital adequacy purposes;
(f) unrealised fair value gains (or where applicable, adding back unrealised fair value losses), arising from changes in an ADI’s own creditworthiness;
General Reserve for Credit Losses
(g) any amounts included in the General Reserve for Credit Losses that have not already been deducted from retained earnings or current year earnings;
Goodwill and intangibles
(h) goodwill, and any other intangible assets arising on an acquisition, net of adjustments to profit or loss reflecting any changes arising from “impairment” of goodwill;[11]
(i) other intangible assets net of adjustments to profit or loss reflecting amortisation and impairment.[12] This includes capitalised expenses (refer to Attachment D) and the intangible component of investments in subsidiaries[13] that could arise after or outside of acquisitions. Intangible assets are as defined in the Australian accounting standards plus any other assets designated in this Prudential Standard to be intangible;
Part Deductions - Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital - Deductions | Zoe
Own capital holdings
(j) all holdings of own Tier 1 capital instruments, unless exempted by APRA, and any unused trading limit on these instruments agreed with APRA;
Profits from associates
(k) any portion of current year earnings or retained earnings that represents any amount deriving from the ADI’s share of undistributed profit or loss in an associate under equity accounting. This amount should be included in Upper Tier 2 capital;
Revaluation reserves
(l) revaluations of assets not held for trading purposes that are passed through profit or loss, unless the revaluations are specifically permitted to be included in Tier 1 capital for the purposes of this Prudential Standard;
(m) any amounts included in revaluation reserves in Upper Tier 2 capital that otherwise would have been included in Tier 1 capital;
(n) any deficit after taking into account adjustments in the amount available in the respective revaluation reserves for the following items, to the extent not already accounted for in current year earnings or retained earnings:
(i) property (owner-occupied and investment property readily available to be sold);
(ii) readily marketable securities designated as available for sale;
(iii) investments in subsidiaries; or
(iv) investments in associates, including any excess of the share of losses in associates under equity accounting;
(p) the difference between the book value and the value realised for transfers of exposures to an SPV where the realised value is less than the book value, unless the difference has been written off to the ADI’s profit or loss (refer to APS 120);
(pp) where the ADI is an originating ADI for a securitisation vehicle which complies with all the requirements of APS 120 Securitisation (APS 120) other than subparagraph 2(d) of Attachment B of APS 120 because the ADI is holding the subordinated tranche(s) of the securitisation vehicle, and the ADI has received APRA’s written approval to deduct the subordinated tranche(s) in respect of the specific securitisation vehicle, the subordinated tranche(s);
Specific provisions
(q) specific provisions (refer to APS 220), including that portion of collective provisions deemed to be a specific provision for regulatory purposes and any prescribed provisions, are ineligible to be included in Tier 1 and Tier 2 capital. To the extent that they have not already resulted in a charge to profit and loss, by way of establishment of a provision in audited published financial accounts, such provisions must be matched by a corresponding reduction in an ADI’s Tier 1 capital;
Superannuation funds
(r) any surplus, net of deferred tax liabilities, in any defined benefit superannuation fund of which an ADI is an employer-sponsor, unless otherwise approved in writing by APRA. Any excluded surplus must reverse any associated deferred tax liability from Tier 1 capital; and
(s) any deficit in a defined benefit superannuation fund of which an ADI is an employer-sponsor and that is not already reflected in Tier 1 capital.
From Upper or Lower Tier 2 capital (as appropriate)
Own capital holdings
An ADI must, unless exempted by APRA in writing, deduct all holdings of own Upper and Lower Tier 2 capital instruments and any unused trading limit in such instruments as determined by APRA in writing (refer to Attachment D).
From both Tier 1 capital and Tier 2 capital
The following items are to be deducted 50 per cent from Tier 1 capital and 50 per cent from Tier 2 capital:
Equity and capital investments
(a) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in other ADIs or equivalent overseas deposit-taking institutions, and their subsidiaries, except where:
(i) the 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. Equity exposures and capital instruments held in such subsidiaries should be risk-weighted at 400 per cent; or
(ii) equity exposures and other capital investments of the other ADI or equivalent overseas deposit-taking institution are held for trading purposes which, in this case, must be included in the ADI’s total risk-weighted exposures in accordance with Prudential Standard APS 116 Market Risk (APS 116);
(b) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in holding companies of ADIs and equivalent entities overseas unless held for trading purposes, in which case they must be included in the ADI’s total risk-weighted assets in accordance with APS 116;
(c) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in an insurer, including a holding company of an insurer, or other financial institution (other than an ADI, authorised NOHC of an ADI or equivalent overseas entity), where the ADI holds greater than or equal to 20 per cent and less than or equal to 50 per cent of the voting shares;
(d) the portion of equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in non-subsidiary entities in excess of:
(i) 0.15 per cent of the ADI’s Level 1 capital base before deductions (at both Tier 1 and Tier 2), for an individual investment; and
(ii) five per cent of the ADI’s Level 1 capital base before deductions (at both Tier 1 and Tier 2), in aggregate;
(e) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in subsidiaries after deduction of any intangible component, except for equity exposures and other capital investments in subsidiaries that are regulated by APRA or an equivalent regulator overseas. Such equity exposures and other capital investments must be risk-weighted at 400 per cent;
Guarantees
(f) any guarantee, or credit derivative covering a credit exposure of the ADI, that provides for a materiality threshold below which no payment will be made in the event of a loss (refer to APS 112 and APS 113 for limits on amounts an ADI is required to deduct);
Industry support schemes
(g) any non-repayable loans advanced by an ADI under APRA’s certified industry support arrangements;
Securitisation exposures
(h) securitisation exposures required to be deducted 50 per cent from Tier 1 capital and 50 per cent from Tier 2 capital under APS 120;[15]
Shortfalls in provisions for credit losses
(i) the amount of any expected losses (before any tax effects) in excess of eligible provisions (net of deferred tax assets) calculated in accordance with APS 113; and
Unsettled non-DvP transactions
(j) the amount of value transferred for trades made through a non-delivery-versus-payments (non-DvP) system, including any replacement costs, where contractual payment or delivery of the second leg of the transaction does not occur within five business days of the first leg of the transaction (refer to APS 112 and APS 113).
Other matters pertaining to deductions from Level 1 capital
An ADI is not required to deduct an equity exposure (as defined in paragraphs 47 to 50 of APS 113) or other capital investment from Level 1 capital if:
(a) the equity exposure or other capital investment forms part of the ADI’s trading book;
(b) the equity exposure is acquired through underwriting of a new equity instrument and the equity instrument is disposed of within 90 days of the date of issue. If the equity instrument is not disposed of within 90 days of issuance, it must be deducted in accordance with the relevant limits for equity exposures and other capital investments unless the position forms part of the ADI’s trading book; or
(c) the equity exposure or other capital investment is held under a legal agreement on behalf of an external third party, even if held in the name of the ADI.
An ADI may, for the purposes of deducting securitisation exposures from capital, net any specific provisions raised against the relevant securitisation exposure. For an ADI using the IRB approach, the amount of any non-refundable purchase price discount on a defaulting asset, and any related specific provisions, may be applied to reduce the amount of the deduction from capital associated with such a securitisation exposure.
Level 2 deductions
From Tier 1 capital
For the purposes of calculating its Level 2 capital base, an ADI must deduct the following items from Tier 1 capital (also refer to Attachment D):
Asset impairment
(a) any identified impairment of an asset where the impairment has not already been taken into account in profit or loss or the impairment has been incorporated in the fair value changes captured in an asset revaluation reserve included in Upper Tier 2 capital (refer to Attachment B). This will include the value of any deficit in asset revaluation reserves included in Upper Tier 2 capital after taking account of all adjustments;
Deferred tax
(b) deferred tax assets net of deferred tax liabilities (refer to Attachment D);
Fair value gains and losses
(c) cumulative unrealised fair value gains and losses on effective cash flow hedges reflected in retained earnings or reserves included in Tier 1 capital that do not offset gains or losses on revaluations in reserves included in Tier 1 capital;
(d) any fair value gains and losses relating to illiquid financial instruments;
(e) any fair value gains and losses relating to loans and receivables not eligible to be reported utilising fair values.[16] Such loans and receivables are to be recognised at amortised cost for capital adequacy purposes;
(f) unrealised fair value gains (or where applicable, adding back unrealised fair value losses) arising from changes in an ADI’s own creditworthiness;
General Reserve for Credit Losses
(g) any amounts included in the General Reserve for Credit Losses that have not already been deducted from retained earnings or current year earnings;
Goodwill and intangibles
(h) goodwill, and any other intangible assets arising on an acquisition, net of adjustments to profit or loss reflecting any changes arising from “impairment” of goodwill;[17]
(i) other intangible assets net of adjustments to profit or loss reflecting amortisation and impairment. [18] These include capitalised expenses (refer to Attachment D) and the intangible component of investments[19] in non-consolidated subsidiaries (refer to Attachment B) that do not form part of the consolidated banking group at Level 2. Intangible assets are as defined in the Australian accounting standards plus any other assets designated in this Prudential Standard to be intangible;
Own capital holdings
(j) all holdings of own Tier 1 capital instruments, unless exempted, and any unused trading limit agreed with APRA (refer to Attachment D);
Profits from associates
(k) any portion of current year earnings or retained earnings that represents any amount deriving from the ADI’s share of undistributed profit or loss in an associate under equity accounting. Such an amount should be included in Upper Tier 2 capital;
Revaluation reserves
(l) revaluations of assets not held for trading purposes passed through profit or loss, unless the revaluations are specifically permitted to be included in Tier 1 capital for the purposes of this Prudential Standard;
(m) any amounts included in revaluation reserves in Upper Tier 2 capital that otherwise would have been included in Tier 1 capital;
(n) any deficit after taking into account adjustments in the amount available in the respective revaluation reserves for the following items, to the extent not already accounted for in current year earnings or retained earnings:
(i) property (owner-occupied and investment property readily available to be sold);
(ii) readily marketable securities designated as available for sale;
(iii) investments in unconsolidated subsidiaries; or
(iv) investments in associates, including any excess of the share of losses in associates under equity accounting;
(p) the difference between the book value and the value realised for transfers of exposures to an SPV where the realised value is less than the book value, unless the difference has been written off profit or loss;
(pp) where the ADI is an originating ADI for a securitisation vehicle which complies with all the requirements of APS 120 other than subparagraph 2(d) of Attachment B of APS 120 because the ADI is holding the subordinated tranche(s) of the securitisation vehicle, and the ADI has received APRA’s written approval to deduct the subordinated tranche(s) in respect of the specific securitisation vehicle, the subordinated tranche(s);
Specific provisions
(q) specific provisions (refer to APS 220), including that portion of collective provisions deemed to be a specific provision for regulatory purposes and any prescribed provisions, are ineligible to be included in Tier 1 and Tier 2 capital. To the extent that they have not already resulted in a charge to profit or loss, by way of establishment of a provision in audited published financial accounts, such provisions must be matched by a corresponding reduction in an ADI’s Tier 1 capital;
Superannuation funds
(r) any surplus, net of deferred tax liabilities, in any defined benefit superannuation fund of which an ADI or other group member is an employer-sponsor unless otherwise approved in writing by APRA. Any excluded surplus must reverse any associated deferred tax liability from Tier 1 capital; and
(s) any deficit in a defined benefit superannuation fund of which an ADI or other group member is an employer-sponsor and that is not already reflected in Tier 1 capital.
From Upper or Lower Tier 2 capital (as appropriate)
Own capital holdings
An ADI must, unless exempted by APRA in writing, deduct all holdings of own Upper and Lower Tier 2 capital instruments and any unused trading limit in such instruments determined by APRA in writing (refer to Attachment D).
From both Tier 1 capital and Tier 2 capital
The following items are to be deducted 50 per cent from Tier 1 capital and 50 per cent from Tier 2 capital:
Equity and capital investments
(a) equity exposures (as defined in paragraphs 47 to 50 of APS 113) 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 must be included in the ADI’s total risk-weighted exposures in accordance with APS 116;
(b) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in holding companies of ADIs and equivalent overseas entities, unless these are held for trading purposes in which case they must be included in the ADI’s total risk-weighted exposures in accordance with APS 116;
(c) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in an insurer, including a holding company of an insurer, or other financial institution other than an ADI, authorised NOHC or equivalent overseas entity, where the ADI holds greater than or equal to 20 per cent and less than or equal to 50 per cent of the voting shares;
(d) the portion of equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in non-subsidiary entities in excess of:
(i) 0.15 per cent of the ADI’s Level 2 capital base before deductions (at both Tier 1 and Tier 2), for an individual investment; and
(ii) five per cent of the ADI’s Level 2 capital base before deductions (at both Tier 1 and Tier 2), in aggregate;
(e) equity exposures (as defined in paragraphs 47 to 50 of APS 113) and other capital investments in non-consolidated subsidiaries, whether regulated or unregulated. This deduction does not apply to a subsidiary holding company where it acts as a holding company for pass-through of equity exposures and other capital investments in subsidiary ADIs or equivalent overseas deposit-taking institutions. In the event that a subsidiary holding company holds equity exposures and other capital investments in subsidiaries not eligible for consolidation, an ADI must deduct its equity exposures and other capital investments in the holding company net of the value of the holding company’s investment in any consolidated subsidiary ADI or equivalent overseas deposit-taking institutions;
Guarantees
(f) any guarantee, or credit derivative covering credit exposures at Level 2, that provides for a materiality threshold below which no payment will be made in the event of a loss (refer to APS 112 and APS 113 for limits on amounts an ADI is required to deduct);
Industry support schemes
(g) any non-repayable loans advanced by the ADI under APRA’s certified industry support arrangements;
Securitisation exposures
(h) securitisation exposures required to be deducted under APS 120;[21]
Shortfalls in provisions for credit losses
(i) the amount of any expected losses (before any tax effects) in excess of eligible provisions (net of deferred tax assets) calculated in accordance with APS 113; and
Unsettled non-DvP transactions
(j) the amount of value transferred from trades made through a non-DvP system, including any replacement costs, where contractual payment or delivery of the second leg of the transaction does not occur within five business days of the first leg of the transaction (refer to APS 112 and APS 113).
Undercapitalised non-consolidated subsidiaries
APRA may require an ADI to deduct, from Level 2 capital, an amount to cover the undercapitalisation of a non-consolidated subsidiary (or subsidiaries) of the ADI, as determined by APRA. Any such deduction must be made 50 per cent from Tier 1 capital and 50 per cent from Tier 2 capital. The matters APRA may consider in determining the extent of undercapitalisation of a non-consolidated subsidiary of the ADI include, amongst other things, the:
(a) size and scale of the operations of the non-consolidated subsidiary;
(b) materiality of the subsidiary’s operations to group income and strategic outlook;
(c) level of net tangible assets of the subsidiary;
(d) risk profile of the subsidiary;
(e) level of exposure of the Level 2 group to the subsidiary; and
(f) size of any identified capital shortfall and the likelihood of such a shortfall being remedied in the near future.
Other matters pertaining to deductions from Level 2 capital
An ADI is not required to deduct equity exposures and other capital investments from Level 2 capital if:
(a) the equity exposure or capital investment forms part of the ADI’s trading book;
(b) the equity exposure is acquired through underwriting of a new equity instrument and the equity instrument is disposed of within 90 days of the date of issue. If the equity instrument is not disposed of within 90 days of issuance, it must be deducted in accordance with the relevant limits for equity exposures and other capital investments unless the position forms part of the ADI’s trading book; or
(c) the equity exposure or other capital instrument is held under a legal agreement on behalf of a party outside the consolidated group.
An ADI may, for the purposes of deducting securitisation exposures from capital, net any specific provisions raised against the relevant securitisation exposure. For ADIs using the IRB approach, the amount of any non-refundable purchase price discount on a defaulting asset, and any related specific provisions, may be applied to reduce the amount of the deduction from capital associated with such a securitisation exposure.