Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital
Use of fair valuesUse of fair values
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Use of fair values
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Fair value, including the use of the Fair Value Option, must only be applied to financial instruments for which an ADI is able to reliably estimate fair values.
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An ADI must have risk management systems including associated policies, procedures and controls that cover the application of fair value measurement in the banking book. The ADI must be able to demonstrate that the use of fair value measurement and, in particular, the use of the Fair Value Option is managed, monitored and reported in a sound and effective manner, taking into account the scale, complexity and scope of the ADI’s operations. These risk management systems must:
(a) outline the assets and liabilities to be recognised at fair value and the processes for approving use of fair values for new items, products and transactions;
(b) enable the ADI to make choices regarding the alternative treatments for categorising financial instruments using fair value measures under accounting practice in a fully informed and disciplined manner;
(c) specify the relationship between the application of fair value measures and the ADI’s risk management framework;
(d) outline methods used for the selection and validation of valuation processes used in calculating and reporting fair values including, where appropriate, independent review, analysis of model stability and performance over a variety of conditions, use of backtesting and frequency of validation. The ADI must retain data and supporting documentation for these purposes;
(e) detail the processes for ensuring use of fair values is being applied consistently across the ADI for both reporting and risk management purposes. This should include the frequency at which fair values will be calculated and reported for those assets and liabilities recognised at fair value; and
(f) detail how the ADI determines the fair value gains and losses arising from changes in the ADI’s own creditworthiness and that of other group members at Level 2.
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An ADI must supply information, if requested by APRA, to assist APRA in assessing the impact of the application of fair values, in particular the application of the Fair Value Option, on the value of financial instruments for capital adequacy purposes.
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Where APRA considers that an ADI’s policies and procedures for the use of fair values are not reliable or affect adversely its safety and soundness, APRA may, in writing, require an ADI to amend its policies and procedures, to discontinue use of fair value measures for regulatory reporting, or to hold higher levels of capital.