The central concept in APS 115 is the business indicator (BI). BI is defined as the sum of three components: ILDC, SC and FC. ILDC itself has three parts. The interest component is the three year annual average of the absolute value of interest income less interest expenses, including income and expenses from finance and operating leases. The asset component is 2.25 per cent times the three year annual average of total gross outstanding loans, advances, interest bearing securities and lease assets, measured at each year end. The dividend component is the three year annual average of dividend income from investments in stocks and funds not consolidated in the ADI’s financial statements. The ILDC equals the lesser of the interest component and the asset component, plus the dividend component. This means if an ADI’s net interest margin is low, the asset component substitutes as a floor, ensuring that BI does not fall solely because of compressed margins.

The services component is calculated as the sum of the other operating component and the fee and commission component. Each of these is the maximum of the three year annual average of income and expenses for that item. For other operating income and expenses, the maximum picks the larger of average income or average expenses. This means an ADI that incurs large operational losses (which are included in expenses) will increase its SC, and therefore its BI and capital charge. The fee and commission component similarly picks the larger of fee income and fee expenses, so heavy outsourcing of financial services that generates fee expenses can inflate BI.

The financial component is the sum of the trading book component and the banking book component. Each is the three year annual average of the absolute value of net profit or loss on the respective book. Absolute values mean that losses on the trading book increase BI just as much as profits do, which penalises volatile earnings.

The capital charge formula applies a base rate of 12 per cent to the entire BI, then adds 3 per cent for the portion between $1.5 billion and $45 billion, and another 3 per cent for the portion above $45 billion. These thresholds are fixed in dollar terms and are not indexed to inflation or the size of the financial system. Over time, as nominal incomes grow, more ADIs will be pushed into higher marginal rates absent regulatory adjustment.

The standard explicitly excludes certain income and expense items from the BI calculation. These include insurance and reinsurance income and expenses, administrative expenses, staff expenses, outsourcing fees for nonfinancial services, depreciation and amortisation (except for lease assets), impairment provisions, goodwill changes, and corporate income tax. The intention is to strip out non operational items and focus on the income streams that most directly correlate with operational risk.

The standard applies on both a Level 1 basis (the ADI alone) and a Level 2 basis (the consolidated group). Where the ADI is a subsidiary of an authorised non operating holding company (NOHC), the NOHC must ensure compliance on a Level 2 basis. This means that the capital charge must be calculated and held at the group level, potentially double counting if not managed carefully.

The primary entities subject to APS 115 are ADIs that APRA treats as significant financial institutions. The standard does not itself define “significant financial institution” but refers to the classification used by APRA under other prudential frameworks. In practice this covers the major Australian banks (Commonwealth, Westpac, NAB, ANZ), regional banks such as Bendigo and Adelaide Bank, and large building societies and credit unions that exceed APRA’s size or complexity thresholds. Foreign ADIs, purchased payment facility providers (such as those operating stored value cards or digital wallets), and non SFIs are exempt. However, APRA may determine that the standard applies to a particular non SFI, so smaller institutions cannot assume permanent exclusion.

Authorised NOHCs of ADI groups are also affected. Where an ADI is a subsidiary of an authorised NOHC, the NOHC must ensure the requirements are met on a Level 2 basis. This imposes direct compliance obligations on the holding company, even though it may not itself conduct banking operations. The NOHC must ensure that the consolidated group holds sufficient regulatory capital against operational risk as calculated under this standard.

The revocations affect all ADIs that previously used the advanced measurement approach to operational risk. Those ADIs must now adopt the SMA. The AMA allowed capital to be calculated using internal models, which could produce a lower charge than the standardised approach for institutions with strong risk controls. The removal of that option increases the capital floor for those institutions. The 2020 version of APS 115 was already an SMA, so ADIs that adopted that version will find the new standard substantially similar, though they must still confirm reliance on any previous APRA discretions.

Practitioners most directly affected are chief risk officers, heads of capital management, financial reporting teams and external auditors. The calculation of BI relies on audited financial statements and detailed categorisation of income and expense line items. Compliance requires mapping accounting data to the standard’s definitions and exclusions. Operational risk managers who previously focused on loss data collection and scenario analysis for the AMA must now focus on understanding the BI drivers and the impact of business decisions on the capital charge.

Shareholders and borrowers bear the ultimate economic incidence. Higher capital requirements reduce return on equity and may increase lending margins. The progressive nature of the capital charge means that larger institutions face a higher marginal rate, which could affect their relative competitiveness against smaller ADIs or non bank lenders not subject to the standard.

The central duty is that an ADI must calculate its operational risk capital charge in accordance with paragraph 13 of the standard, using the BI methodology set out in paragraphs 15 to 22. This is a mandatory, formulaic calculation with no room for internal model adjustments. The ADI must use the most recent three years of audited year end financial statements as the basis for all averages. If it does not have three years of audited statements (for example, a newly established ADI), it must obtain APRA’s approval to use an alternative calculation methodology.

In the event of a merger or acquisition, the ADI must use aggregated values when calculating the BI, unless APRA approves otherwise. This means that the BI of the combined entity is calculated on a pro forma basis using the financial data of both predecessors, which can produce a sudden jump in the capital charge. Conversely, if an ADI divests a business, it may exclude the divested activities from the BI calculation, but only with APRA’s approval. The standard does not provide a safe harbour for de minimis disposals or a standard transition period.

Paragraph 12 imposes a specific procedural duty: an ADI that wishes to rely on a previous exemption or other exercise of discretion by APRA under an earlier version of APS 115 must contact APRA to confirm its continued application. Old discretions do not automatically carry over. This places the onus on the ADI to initiate the confirmation process and document the response.

APRA has several rights and powers under the standard. It may adjust or exclude a specific prudential requirement in relation to one or more specified ADIs, authorised NOHCs or subsidiaries. This power is broad and could be used to reduce compliance burden, impose transitional arrangements, or tailor requirements for unusual circumstances. APRA may also require an ADI to reduce its level of operational risk or increase its capital if it considers that the regulatory capital held is not commensurate with the ADI’s operational risk profile. This is a subjective power that allows APRA to override the formulaic charge if it believes the institution faces higher risk than the BI proxy captures.

Paragraph 11 creates an implicit obligation on the ADI to maintain a risk profile that is consistent with the capital generated by the formula. If APRA exercises its power to require additional capital, the ADI must comply. The standard does not specify a process for challenging such decisions, but the Banking Act’s general provisions on review would apply.

The prudential standard itself does not specify monetary penalties for non compliance. Enforcement occurs through the broader framework of the Banking Act 1959. Failure to comply with a prudential standard made under section 11AF is a breach of the Act. APRA can issue a direction under section 11CA or 11CB requiring the ADI to take specified action, such as increasing capital, restricting business activities, or appointing an external expert. Non compliance with a direction can attract civil penalties of up to 10,000 penalty units for a body corporate (currently approximately $2.2 million per contravention under the Crimes Act scale), plus ongoing daily penalties.

APRA also has administrative powers. Under paragraph 11 of the standard, APRA can directly require the ADI to reduce its operational risk exposure or increase its capital. This can be used as a targeted enforcement tool without invoking formal penalties. An ADI that consistently miscalculates its BI could face a direction to recalculate and hold additional capital pending correction. The requirement to use audited financial statements provides a layer of verification; errors in the BI calculation could be treated as a breach of the standard even if they were unintentional.

The standard does not contain a provision for remission of penalties or a grace period. Compliance was required from 1 January 2023 without transitional relief. ADIs that failed to have systems in place by that date were technically in breach from day one. APRA may have issued informal guidance or allowed time for implementation, but the standard on its face admits no delay.

False or misleading statements in the calculation of the BI could attract sanctions under section 1307 of the Corporations Act 2001 (if the ADI is a corporation) or under general criminal law provisions for providing false information to a Commonwealth body. The reliance on financial statements audited under Australian Auditing Standards adds a further layer; auditors are required to report material misstatements to APRA under section 13 of the Banking Act.

APS 115 is made under section 11AF of the Banking Act 1959. It therefore sits within the hierarchy of prudential standards that apply to ADIs. It must be read together with Prudential Standard APS 001 Definitions, which provides the meaning of key terms such as “ADI”, “authorised NOHC”, “Level 1”, “Level 2” and “regulatory capital”. APS 001 also defines how capital adequacy is measured overall, and APS 115 contributes to the total capital requirement alongside standards for credit risk and market risk.

The standard cross references two other standards for the definition of trading book and banking book. Paragraph 21 defines the trading book component by reference to the meaning given in Prudential Standard APS 116 Capital Adequacy: Market Risk. Paragraph 22 defines the banking book component by reference to the meaning given in Prudential Standard APS 117 Capital Adequacy: Interest Rate Risk in the Banking Book (Advanced ADIs). An ADI must therefore apply the definitions from those standards consistently when calculating the FC sub component. If an ADI later changes its classification of instruments between the trading book and banking book under APS 116 and APS 117, it will affect the BI calculation.

The calculation of BI relies on Australian Accounting Standards. Several footnotes refer specifically to accounting standards for held for sale assets, discontinued operations, finance and operating leases, and impairment. The standard does not override accounting treatment; it adopts accounting data as the raw input, subject to the specific exclusions in paragraph 23. Any change in Australian Accounting Standards that alters how interest income, fees or fair value gains are recognised will flow through to the BI unless APRA amends the standard.

The instrument revokes three earlier determinations: No. 7 of 2012 (APS 114), No. 8 of 2012 (APS 115 AMA), and No. 6 of 2020 (the previous APS 115 SMA). This means the legal effect of those standards ceases from 1 January 2023. ADIs that had approvals under the old AMA for internal models or lower capital charges lose those approvals. Any previous APRA discretions that were not explicitly incorporated into the new standard lapse unless the ADI contacts APRA under paragraph 12.

The Banking Act’s general enforcement provisions, including APRA’s powers to investigate, issue directions, and seek civil penalties, apply to breaches of APS 115. The standard itself does not create individual rights or private causes of action. It is a regulatory instrument enforceable only by APRA.

This instrument is Banking (prudential standard) determination No. 8 of 2022. It was made on 1 December 2022 by Renée Roberts, Executive Director of APRA’s Policy and Advice Division, and commenced on 1 January 2023. It is the third version of a prudential standard dealing with operational risk capital for ADIs. The first version, introduced in 2012, split operational risk into two standards: APS 114 for a standardised approach and APS 115 for advanced measurement approaches. In 2020, APRA replaced those with a single SMA under APS 115 via determination No. 6 of 2020, aligning with the Basel Committee’s revised framework. The current instrument revokes all three earlier determinations and replaces the 2020 SMA with an updated version.

The 2022 version makes no structural changes to the SMA methodology compared to the 2020 version, but it is a standalone instrument that consolidates the framework and removes references to the old AMA and standardised approach. The revocation of the 2012 determinations means that the previous APS 114 and APS 115 (AMA) are no longer in force and cannot be relied upon even for historical comparisons. ADIs must have been using the SMA since 1 January 2023 at the latest.

The standard does not include any transitional provisions or phase in arrangements. ADIs that were SFIs on the commencement date were required to hold capital under the new formula immediately. No grandfathering of previous capital calculations or internal models is provided. The only “previous exercise of discretion” that survives is one that the ADI brings to APRA’s attention and APRA confirms in writing.

The instrument includes a schedule containing the full text of the prudential standard. That schedule is the authoritative text. The standard itself includes a table of contents and an objectives summary but those are not legally operative. The operative provisions are paragraphs 1 to 26.

As at the date of the instrument, no subsequent amendments are recorded. It remains the current version unless APRA issues a later determination. The standard is not subject to periodic sunsetting under the Legislation Act 2003 because it is a disallowable instrument made by APRA, but APRA may revise it as part of its regular review cycle.

The source document records no litigation relating to APS 115. This is unsurprising for a prudential standard that has only been in force since 1 January 2023. The previous SMA (2020 version) may have been the subject of administrative decisions by APRA, but no cases are cited. Under the Banking Act, APRA’s decisions under prudential standards, such as a direction to increase capital or a refusal to adjust a requirement, are reviewable by the Administrative Appeals Tribunal. No such decisions have been reported in public databases as at the date of this analysis.

The AMA that was revoked had been in place for a decade and there is some public commentary about its complexity and potential for inconsistency, but there is no recorded judicial review of APRA’s decisions under that framework. The transition to the SMA was widely consulted on and APRA released a response to submissions in 2020. The current standard is the product of that process and appears to have been implemented without legal challenge.

Potential future litigation could arise if APRA uses its power under paragraph 11 to require an ADI to hold capital significantly above the formulaic minimum, and the ADI disputes that its risk profile is not commensurate. Another possible source is disputes over the calculation of BI components, particularly where an ADI uses a methodology that APRA later deems incorrect. However, the standard gives APRA wide discretion and the accounting data is audited, which limits the scope for factual disputes.

Given that the standard is a disallowable instrument under section 11AF of the Banking Act, it could be disallowed by either House of Parliament within 15 sitting days of tabling. No disallowance motion was passed. The instrument is therefore valid and binding.

The business indicator calculation contains several traps. The ILDC uses the lesser of the interest component and the asset component. For an ADI with a very low net interest margin (for example, a lender that relies heavily on wholesale funding and writes low margin loans), the asset component (2.25 per cent of gross loans) may be the binding constraint. This means that even if net interest income falls toward zero, the ILDC will not fall below 2.25 per cent of loan balances. The asset component is not capped and grows with the loan book, so a large but low margin bank faces a high BI floor.

The services component uses the maximum of income and expenses for both other operating items and fee and commission items. If an ADI’s fee expenses exceed its fee income in a given year (for example, if it outsources significant financial services), the higher expense number will be used. Similarly, if other operating expenses (including operational losses) exceed other operating income, the expense figure applies. This means that an ADI that suffers operational losses will have its BI and capital charge increased, even if those losses are recovered in later periods. The three year averaging smooths the impact but does not eliminate it.

The financial component uses absolute values of net profit or loss on trading and banking books. An ADI that runs a balanced, hedged trading book that produces small profits and losses each year will find that the absolute values sum to something much larger than the net profit over three years. Volatility, not earnings, drives this component. An ADI that hedges its banking book fair value exposures similarly generates absolute values from both gains and losses on hedging instruments and hedged items.

Merger and acquisition treatment requires APRA approval to use aggregated values (paragraph 25). The standard does not allow a simple arithmetic combination of two BIs without approval. If an ADI acquires another entity, it must seek APRA’s approval or use a methodology that APRA prescribes. This creates implementation risk and timeline uncertainty. Similarly, divestitures may be excluded only with APRA approval, so an ADI cannot automatically reduce its BI after selling a business.

Reliance on previous APRA discretions requires the ADI to contact APRA under paragraph 12. There is no automatic grandfathering. An ADI that had a concession under the 2020 SMA (for example, a different treatment of a particular product line) must initiate contact and obtain a written confirmation. Failure to do so means the concession lapses.

Non SFIs are exempt but APRA can bring them within scope in a particular case. This means a smaller ADI cannot safely ignore the standard; it must be prepared to comply if APRA issues a notice. That could happen if the ADI has a high risk profile or is involved in an incident.

The standard does not provide a methodology for calculating the BI when financial statements are not prepared under Australian Accounting Standards. The standard assumes AAS compliance. ADIs with foreign subsidiaries reporting under other standards may need to reconcile to AAS for Level 2 consolidation.

An ADI subject to APS 115 should first confirm its classification as a significant financial institution. If it is a non SFI, it should monitor for any APRA determination bringing it within scope. The compliance process begins with data extraction from the most recent three years of audited financial statements. The ADI must calculate each sub component of the BI using the formulas in paragraphs 15 to 22, applying the exclusions in paragraph 23 strictly.

Practical steps include mapping chart of accounts to the BI components. Interest income and expense allocations need to be identified from the profit and loss statement. The asset component requires gross loans and securities data from the balance sheet. The services component requires detailed breakdowns of fee income, fee expenses, other operating income and other operating expenses, including operational loss events. The financial component requires data on trading book and banking book net profits or losses, including hedge accounting and exchange differences. Each item must be checked against the excluded categories to ensure that administrative expenses, staff costs, depreciation, impairment and tax are stripped out.

The calculations should be performed for each of the three most recent financial years, then averaged. For years where income and expenses are not separately disclosed in the audited statements, the ADI may need to use management accounts and have them audited or reviewed. In the first year of operation, the ADI must apply to APRA for an alternative methodology. For mergers or acquisitions, APRA approval must be sought in advance. The ADI should prepare a written proposal explaining how aggregate BI will be calculated and why it is appropriate.

Once the BI is calculated, the capital charge is determined by applying the tiered rates. The ADI must ensure that regulatory capital held is at least equal to that charge. If APRA has issued a direction to hold additional capital under paragraph 11, the ADI must incorporate that amount.

The ADI should document all assumptions, accounting classifications and calculations in a procedure manual. This documentation will be critical if APRA reviews the calculation during a supervisory visit. The manual should also cover steps to be taken in the event of a future acquisition or divestiture, including the requirement to seek APRA approval.

For authorised NOHCs, the Level 2 calculation must be performed on the consolidated group data. The NOHC must ensure that all subsidiaries within the Level 2 group report consistent data in accordance with Australian Accounting Standards and the standard’s definitions.

Finally, the ADI should contact APRA under paragraph 12 if it has previously relied on any exemption or discretion under the 2020 version of APS 115. This should be done before the calculation is finalised, so that any confirmed concession can be reflected in the current capital requirement.