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Banking (prudential standard) determination No. 5 of 2006 - Prudential Standard APS 112 - Capital Adequacy: Credit Risk
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Turn the raw legal text into a practical explanation grounded in Banking (prudential standard) determination No. 5 of 2006 - Prudential Standard APS 112 - Capital Adequacy: Credit Risk.
To ensure that all locally incorporated ADIs maintain a minimum level of capital that broadly reflects their credit risk profiles, they must risk-weight their on-balance sheet assets and off-balance sheet business (including both market-related and non-market-related transactions) according to certain risk categories.
Each on-balance sheet asset and off-balance sheet transaction is assigned to one of four categories of risk weight – 0, 20, 50 and 100 per cent, based on the riskiness of counterparty default (refer AGN 112.1). All off-balance sheet transactions which give rise to credit risk are converted into on-balance sheet equivalents according to specified credit conversion factors prior to allocating the assigned risk weight (refer AGN 112.2).
The risk weights assigned reflect broad judgements of regulators about credit risk on a portfolio basis, and should not be taken as a substitute for individual assessments of credit risks associated with particular exposures. The board of directors and management of an ADI have primary responsibility to ensure that adequate systems are in place to individually assess the credit risk in an ADI’s operations, to allocate the appropriate amount of capital to cover that risk and to suitably price the transactions to reflect the risk undertaken.