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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This Act has been repealed and is no longer in force. It is retained for historical reference.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 revokes the prior APS 113 and prescribes a new Prudential Standard for authorised deposit‑taking institutions (and authorised NOHCs) that use an internal ratings‑based (IRB) approach to calculate capital for credit risk. It sets which IRB approaches may be used, the maths for converting PD, LGD, EAD and maturity into risk‑weighted assets, and rules on governance, data, validation, collateral recognition and APRA approval. It matters because it determines banks’ capital charges and the modelling, reporting and operational burden they must meet.
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Direct links to the current provisions in Banking (prudential standard) determination No. 7 of 2022.
Sourced from the Federal Register of Legislation (legislation.gov.au), CC BY 4.0.
Banking (prudential standard) determination No. 7 of 2022
Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk
Banking Act 1959
I, John Lonsdale, a delegate of APRA:
(a) under subsection 11AF(3) of the Banking Act 1959 (the Act) REVOKE Banking (prudential standard) determination No. 6 of 2012, including Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk, made under that determination; and
(b) under subsection 11AF(1) of the Act DETERMINE Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk, in the form set out in the schedule, which applies to all ADIs and authorised NOHCs to the extent provided in paragraphs 2 to 4 of the prudential standard.
This instrument commences on 1 January 2023.
Dated: 8 December 2022
[Signed]
John Lonsdale
Chair
APRA
Interpretation
In this instrument:
APRA means the Australian Prudential Regulation Authority.
ADI and authorised NOHC have their respective meanings given in section 5 of the Act.
Schedule
Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk comprises the document commencing on the following page.
Prudential Standard APS 113
Capital Adequacy: Internal Ratings-based Approach to Credit Risk
| Objectives and key requirements of this Prudential Standard<br>This Prudential Standard sets out the requirements that an authorised deposit-taking institution that has, or is seeking, approval to use an internal ratings-based approach to credit risk must meet, both at the time of initial implementation and on an ongoing basis.<br>The key requirements of this Prudential Standard are that an authorised deposit-taking institution must:<br>determine the capital requirement for a given credit exposure, within certain parameters set by APRA;develop and maintain rating and risk estimation systems and processes that provide for a meaningful assessment of borrower and transaction characteristics, meaningful differentiation of risk, and accurate and consistent quantitative estimates of risk; andensure that systems and processes for the internal ratings-based approach to determining capital also play an integral role in the institution’s credit approval, risk management and internal capital allocation functions. |
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Table of Contents
Authority
Application and commencement
2. This Prudential Standard applies to authorised deposit-taking institutions (ADIs) that are seeking, or have been approved, to use an internal ratings-based (IRB) approach to credit risk for the purpose of determining the Regulatory Capital requirement for credit risk.
3. A reference to an ADI in this Prudential Standard, unless otherwise indicated, is a reference to:
(a) an ADI on a Level 1 basis; and
(b) a group of which an ADI is a member on a Level 2 basis.
4. If an ADI to which this Prudential Standard applies is:
(a) the holding company for a group, the ADI must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable; or
(b) a subsidiary of an authorised non-operating holding company (authorised NOHC), the authorised NOHC must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable.
5. This Prudential Standard commences on 1 January 2023.
Interpretation
6. Terms that are defined in Prudential Standard APS 001 Definitions appear in bold the first time they are used in this Prudential Standard.
7. Where this Prudential Standard provides for APRA to exercise a power or discretion, the power or discretion is to be exercised in writing.
8. In this Prudential Standard, unless the contrary intention appears, a reference to an Act, Regulations or Prudential Standard, is a reference to the Act, Regulations or Prudential Standard as in force from time to time.
Adjustments and exclusions
9. APRA may adjust or exclude a specific prudential requirement in this Prudential Standard in relation to one or more specified ADIs or authorised NOHCs.[1]
Previous exercise of discretion
10. An ADI must contact APRA if it seeks to place reliance, for the purposes of complying with this Prudential Standard, on a previous exemption or other exercise of discretion by APRA under a previous version of this Prudential Standard.
Scope
11. The following items are excluded from the scope of this Prudential Standard:
(a) non-standard retail residential mortgage exposures,[2] equity exposures, margin lending exposures, cash items, fixed assets, unsettled and failed transactions, and related-party exposures that are subject to the requirements of Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112);
(b) assets or investments that are required to be deducted from Common Equity Tier 1 Capital, Tier 1 Capital or Total Capital under Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111);
(c) securitisation exposures that are subject to the requirements of Prudential Standard APS 120 Securitisation (APS 120), excluding funding-only or synthetic securitisations for which an ADI must include the underlying exposures in the pool in its calculation of the Regulatory Capital requirement for credit risk under this Prudential Standard;
(d) liabilities of a covered bond special purpose vehicle to an issuing ADI as specified in Prudential Standard APS 121 Covered Bonds (APS 121); and
(e) items that are subject to capital requirements under Prudential Standard APS 116 Capital Adequacy: Market Risk (APS 116) which do not have a counterparty credit risk exposure under Prudential Standard APS 180 Capital Adequacy: Counterparty Credit Risk (APS 180).
12. Subject to paragraph 13 of this Prudential Standard, an ADI must apply the requirements set out in this Prudential Standard to calculate risk-weighted assets (RWA) and expected loss (EL) for any exposures of overseas banking subsidiaries that form part of the Level 2 group.
13. For the purpose of calculating the Level 2 Regulatory Capital requirement for exposures of an overseas banking subsidiary that is prudentially regulated by a prescribed New Zealand authority, an ADI must calculate RWA and EL using the prescribed New Zealand authority’s equivalent prudential rules as in force from time to time except that, in calculating RWA, the ADI must not apply the prescribed New Zealand authority’s:[3]
(a) scaling factor that is equivalent to paragraph 2 of Attachment A to this Prudential Standard, and instead must only apply a scaling factor of 1.1; and
(b) floor value and calculation that is equivalent to paragraph 4 of Attachment A to Prudential Standard APS 110 Capital Adequacy (APS 110), and instead must only apply the floor value and calculation in APS 110.
Definitions
14. The following definitions are used in this Prudential Standard:
(a) capital requirement (K) – means the capital requirement for unexpected loss derived from inputting the risk components to the risk-weight functions;
(b) commitment – has the meaning given in APS 112;
(c) commodities finance – has the meaning given in APS 112;
(d) corporate exposure – has the meaning given in paragraph 30 of this Prudential Standard;
(e) credit conversion factor (CCF) – means the percentage value used to convert an off-balance sheet exposure into an on-balance sheet equivalent;
(f) credit obligation – means a contractual agreement in which a borrower receives something of value now (usually cash) with the agreement to repay the ADI at some stated date;
(g) credit risk mitigation (CRM) – means a credit risk mitigation technique that meets the requirements detailed in Attachment E to this Prudential Standard and APS 112 where applicable;
(h) defaulted exposure – means a non-performing exposure as defined in Prudential Standard APS 220 Credit Risk Management (APS 220);
(i) dilution risk – means the possibility that the total amount of purchased receivables is reduced through cash or non-cash credits to the receivables’ obligors;
(j) effective maturity (M) – means the remaining effective term of a credit obligation;
(k) expected loss (EL) – means the average credit loss that the ADI is reasonably expected to experience;
(l) exposure at default (EAD) – means the gross exposure (including accrued interest) under a facility (i.e. the amount that is legally owed to the ADI) upon the default of a borrower;
(m) financial institution – has the meaning given in paragraph 34 of this Prudential Standard;
(n) group of connected borrowers – means a group of connected counterparties that is connected by control or single-risk relationships under Prudential Standard APS 221 Large Exposures (APS 221). Where an ADI assesses that a borrower may form part of more than one group of connected borrowers, the ADI may primarily assign the borrower based on a control relationship rather than a single-risk relationship for the purpose of this Prudential Standard;
(o) income-producing real estate (IPRE) – has the meaning given in paragraph 31 of this Prudential Standard;
(p) large corporate – means a corporate counterparty with total consolidated annual revenue greater than $750 million as reported in the audited financial statements of the corporate counterparty or, where the counterparty is part of a group, the audited financial statements of the group. The revenue amount must be based on the average amount calculated over the prior three years, or on the latest amount updated at least every three years by the ADI;
(q) lenders’ mortgage insurance (LMI) – has the meaning given in APS 112;
(r) loss given default (LGD) – means the ADI’s economic loss upon the default of a borrower;
(s) object finance – has the meaning given in APS 112;
(t) probability of default (PD) – means the risk of borrower default;
(u) project finance – has the meaning given in APS 112;
(v) purchased receivables – means a pool of receivables that has been purchased by the ADI from another entity;
(w) rating system – means all of the methods, processes, controls, data collection and technology that support the assessment of credit risk, the assignment of internal credit risk ratings and the quantification of associated default, exposure and loss estimates;
(x) regulated financial institution – means a financial institution that is subject to prudential requirements that are broadly equivalent to APRA’s prudential requirement, or is part of a group where any material legal entity within the group is subject to prudential requirements that are broadly equivalent to those set by APRA;
(y) revolving exposure – means an exposure where a borrower’s outstanding balance is permitted to fluctuate based on their decision to borrow and repay, up to a limit established by the ADI. This does not include exposures that allow prepayments and subsequent redraws of those prepayments;
(z) risk component – means the ADI’s internal estimate, or a supervisory estimate provided in this Prudential Standard, of probability of default, loss given default, exposure at default or effective maturity required as inputs to the risk-weight functions;
(aa) risk-weight function – means the calculation method that transforms the risk components into the capital requirement for unexpected loss;
(bb) securities financing transaction (SFT) – has the meaning given in APS 112;
(cc) sovereign – has the meaning given in APS 112;
(dd) specialised lending – has the meaning given in APS 112 but also includes IPRE as defined in this Prudential Standard;
(ee) unexpected loss (UL) – means the credit loss in excess of expected loss; and
(ff) unregulated financial institution – means a financial institution that is not a regulated financial institution.
Key principles
15. An ADI that has received IRB approval from APRA may rely on its internal estimates for some, or all, of the risk components required as inputs to the risk-weight functions used in determining the Regulatory Capital requirement for credit exposures. The risk components include measures of PD, LGD, EAD and M.
16. An ADI must meet the relevant minimum requirements detailed in this Prudential Standard to use an IRB approach for a given asset class.
17. An ADI must apply a foundation IRB (FIRB), advanced IRB (AIRB), retail IRB or supervisory slotting approach to a given asset class in accordance with its IRB approval and subject to the constraints set out in paragraph 18 of this Prudential Standard. Where the ADI uses the:
(a) FIRB approach, it must provide its own estimates of PD and M, and rely on supervisory estimates for LGD and EAD;
(b) AIRB approach, it must provide its own estimates of PD, LGD (excluding senior unsecured and subordinated corporate exposures for which the ADI must use supervisory LGD estimates) and M, and rely on supervisory estimates for EAD;
(c) retail IRB approach, it must provide its own estimates of PD, LGD and EAD (excluding non-revolving retail exposures for which the ADI must use supervisory EAD estimates); and
(d) supervisory slotting approach, it must provide its own mapping of credit exposures to the supervisory slotting categories, and rely on supervisory risk weights for the slotting categories and supervisory estimates for EAD.
Under all approaches, the ADI must use the relevant IRB risk-weight function or schedule, as detailed in Attachment A to this Prudential Standard, to derive RWA for UL and the approach detailed in Attachment C to this Prudential Standard to derive EL.
18. An ADI must apply the:
(a) FIRB approach to all sovereign, financial institution and large corporate exposures, except IPRE exposures that meet the definition of a large corporate exposure where the ADI may apply a FIRB or supervisory slotting approach in accordance with its IRB approval;
(b) retail IRB approach to all retail exposures; and
(c)
This is an opening excerpt, not the complete document.