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Commonwealth legislation
This Act has been repealed and is no longer in force. It is retained for historical reference.
This instrument sets how authorised deposit-taking institutions (ADIs) and authorised non-operating holding companies must calculate regulatory capital for credit risk. It prescribes standard risk-weights for on‑ and off‑balance-sheet exposures, conversion rules for contingent exposures, and when collateral, guarantees, credit derivatives or netting can reduce capital. It applies to most Australian ADIs (with stated exclusions) and matters because those capital calculations determine how much loss-absorbing capital banks must hold and therefore influence lending, pricing and risk-taking.
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Direct links to the current provisions in Banking (prudential standard) determination No. 5 of 2012 - Prudential Standard APS 112 - Capital Adequacy: Standardised Approach to Credit Risk.
Sourced from the Federal Register of Legislation (legislation.gov.au), CC BY 4.0.
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Banking (prudential standard) determination No. 5 of 2012
Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk
Banking Act 1959
I, John Francis Laker, delegate of APRA:
(a) under subsection 11AF(3) of the Banking Act 1959 (the Act) REVOKE Banking (prudential standard) determination No. 1 of 2010 including Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk made under that Determination; and
(b) under subsection 11AF(1) of the Act DETERMINE Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk in the form set out in the attached Schedule, which applies to ADIs and authorised NOHCs to the extent provided in paragraphs 2 to 4 of the prudential standard.
This instrument takes effect on 1 January 2013.
Dated 29 November 2012
[Signed]
John Francis Laker
Chair
Interpretation
In this instrument:
ADI is short for authorised deposit-taking institution which has the meaning given in section 5 of the Act.
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 5 of the Act.
Schedule
Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk comprises the 70 pages commencing on the following page.
Prudential Standard APS 112
Capital Adequacy: Standardised Approach to Credit Risk
Objective and key requirements of this Prudential Standard
This Prudential Standard requires an authorised deposit-taking institution to hold sufficient regulatory capital against credit risk exposures.
The key requirements of this Prudential Standard are that an authorised deposit-taking institution:
must apply risk-weights to on-balance sheet assets and off-balance sheet exposures for capital adequacy purposes. Risk-weights are based on credit rating grades or fixed weights broadly aligned with the likelihood of counterparty default; and
may reduce the credit risk capital requirement for on-balance sheet assets and off-balance sheet exposures where the asset or exposure is secured against eligible collateral, where the authorised deposit-taking institution has obtained direct, irrevocable and unconditional credit protection in the form of a guarantee from an eligible guarantor, mortgage insurance from an acceptable lenders mortgage insurer, a credit derivative from a protection provider or where there are eligible netting arrangements in place.
Table of contents
Attachments
This Prudential Standard, subject to paragraphs 7 and 8, applies to all on-balance sheet assets held by an ADI and all its off-balance sheet exposures.
The following items are excluded from the scope of this Prudential Standard:
assets or investments that are required to be deducted from Common Equity Tier 1 Capital, Additional Tier 1 Capital and/or Tier 2 Capital under Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111);
securitisation exposures which are subject to the requirements of Prudential Standard APS 120 Securitisation (APS 120); and
liabilities of a covered bond special purpose vehicle to an issuing ADI as specified in Prudential Standard APS 121 Covered Bonds (APS 121).
Items subject to capital requirements under Prudential Standard APS 116 Capital Adequacy: Market Risk (APS 116) are excluded for the purpose of calculating risk-weighted assets for credit risk under this Prudential Standard, but not for the purpose of calculating counterparty credit risk capital requirements (refer to Attachment C).
The following definitions are used in this Prudential Standard:
central counterparty (CCP) - a clearing house that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer. A CCP becomes counterparty to trades with market participants through novation, an open offer system, or another legally binding arrangement. For the purposes of the capital framework, a CCP is a financial institution;
clearing member - a member of, or a direct participant in, a CCP that is entitled to enter into a transaction with the CCP;
client of a clearing member - a party to a transaction with a CCP through either a clearing member acting as a financial intermediary, or a clearing member guaranteeing the performance of the client to the CCP;
close-out netting - the process of combining all outstanding transactions and reducing them to a single net payment in the event of default by a counterparty to a netting agreement;
counterparty credit risk (CCR) - the risk that the counterparty to a transaction could default before the final settlement of the transaction’s cash flows. An economic loss would occur if the transactions or portfolio of transactions with the counterparty has a positive economic value at the time of default;
credit-event payment - the amount that is payable by the credit protection provider to the credit protection buyer under the terms of a credit derivative contract following the occurrence of a credit event. The payment can be in the form of ‘physical settlement’ (payment of par in exchange for physical delivery of a deliverable obligation of the reference entity) or ‘cash settlement’ (either a payment determined on a par-less-recovery basis, i.e. determined using the par value of the reference obligation less that obligation’s recovery value, or a fixed amount, or a fixed percentage of the par amount);
credit events - events affecting the reference entity that trigger a credit‑event payment under the terms of a credit derivative contract;
credit protection - the extent of credit risk transference from the party buying credit protection to the party selling credit protection under the terms of a credit derivative contract;
credit rating grades - grades of credit ratings to which external credit assessment institution (ECAI) ratings are mapped, and that correspond to relevant risk-weights;
default funds - clearing members’ funded or unfunded contributions towards, or underwriting of, a CCP’s mutualised loss-sharing arrangements;
deliverable obligation - any obligation of the reference entity that can be delivered, under the terms of a credit derivative contract, if a credit event occurs. A deliverable obligation is relevant for credit derivatives that are to be physically settled;
eligible bilateral netting agreement - has the meaning in paragraph 7 of Attachment J;
initial margin - the funded collateral posted by a clearing member or a client of a clearing member to a CCP to mitigate the potential future exposure of the CCP to the clearing member arising from the possible future change in value of their transactions. Initial margin does not include contributions to a CCP for mutualised loss-sharing arrangements;
netting - the process under a netting agreement of combining all relevant outstanding transactions between two counterparties and reducing them to a single net sum for a party to either pay or receive;
netting by novation - a netting agreement between two counterparties under which any obligation between the parties to deliver a given currency (or equity, debt instrument or commodity) on a given date is automatically amalgamated with all other obligations under the netting agreement for the same currency (or other instrument or commodity) and value date. The result is to legally substitute a single net amount for the previous gross obligations;
normal settlement period - a contractual settlement period that is equal to or less than the market standard for the instrument underlying the transaction and, in any case, less than five business days;
off-balance sheet exposures - exposures that must be converted to a credit equivalent amount (CEA) in order to be risk-weighted;
offsetting transaction - the transaction leg between the clearing member and the CCP when the clearing member acts on behalf of a client (e.g. when a clearing member clears or novates a client’s trade);
on-balance sheet netting - a netting agreement covering loans and deposits under which obligations between the parties are determined on a net basis. Loans are to be treated as an exposure and deposits with a lending ADI that are subject to on-balance sheet netting are to be treated as cash collateral as defined in Attachment H;
overseas bank - for the purposes of this Prudential Standard, a reference to an overseas bank includes a financial institution which:
has the power to accept deposits in the ordinary course of business;
is supervised by the supervisor of banks in its home country; and
is subject to substantially the same prudential requirements as ADIs (including capital adequacy);
over-the-counter (OTC) derivative transaction - a customised, privately negotiated, risk-shifting agreement, the value of which is derived from the value of an underlying asset;
payments netting - a process designed to reduce operational costs and risks associated with daily settlement of transactions. Payments netting is not recognised for credit risk mitigation (CRM) purposes under this Prudential Standard;
positive current exposure amount - the difference between the agreed settlement price of a transaction and the current market price of the transaction where this would result in a loss to an ADI;
qualifying CCP (QCCP) - an entity that is licensed to operate as a CCP (including a licence granted by way of confirming an exemption), and is permitted by the CCP’s regulator/supervisor to operate as such with respect to the products offered. This is subject to the provision that the CCP is based and prudentially supervised in a jurisdiction where the relevant regulator/overseer has established, and publicly indicated that it applies to the CCP on an ongoing basis, domestic rules and regulations that are consistent with the CPSS-IOSCO Principles for Financial Market Infrastructures;
reference entity - the entity or entities whose obligations are used to determine whether a credit event has occurred under the terms of a credit derivative contract;
reference obligation - the obligation used to calculate the amount payable when a credit event occurs under the terms of a credit derivative contract. A reference obligation is relevant for obligations that are to be cash settled (on a par-less-recovery basis)[1];
roll-off risk - the risk of a sudden material increase in an exposure(s) when short-term obligations that have been netted against longer term claims either mature, are rescinded or are generally no longer available to offset the obligation;
securities financing transactions (SFTs) - transactions such as repurchase agreements, reverse repurchase agreements, and security lending and borrowing transactions where the value of the transactions depends on the market valuation of securities and the transactions are typically subject to margin agreements;
trade exposures - the current exposure (replacement cost) plus the potential future exposure of a clearing member or a client of a clearing member to a CCP arising from OTC derivatives, exchange traded derivatives or SFTs, plus the initial margin posted by the ADI, plus the variation margin due to the ADI from the CCP but is not yet received;
underlying exposure - the banking book exposure that is being protected by a credit derivative;
variation margin - the funded collateral posted on a da
This is an opening excerpt, not the complete document.