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Australian Prudential Standard 110 – Capital Adequacy Requirements for Deposit Taking Institutions

  • By: Staff Editor
  • Date: December 16, 2011

 

The Australian Prudential Standard 110 – Capital Adequacy outlines the overall framework adopted by APRA for the purpose of assessing the capital adequacy of an authorized deposit-taking institution.
 
This capital adequacy standard aims at ensuring that “authorized deposit-taking institutions maintain adequate capital, on both an individual and group basis, to act as a buffer against the risks associated with their activities.”
 
Applicability
 
The APS 110 - Capital Adequacy standard applies to all authorized deposit-taking institutions or ADIs under the Banking Act.
 
Why is capital adequacy important?
 
According to the standard, capital is the cornerstone of an ADI’s financial strength. Adequate capital fulfills the following functions:
 
  • It supports an ADI’s operations by providing a buffer to absorb unanticipated losses from its activities
  • In the event of problems, it enables the ADI to continue to operate in a sound and viable manner while the problems are addressed or resolved
 
Internal Capital Adequacy Assessment Process (ICAAP)
 
According to the standard, an ADI must have an Internal Capital Adequacy Assessment Process (ICAAP) that includes as a minimum:
 
  • Adequate systems and procedures to identify, measure, monitor and manage the risks arising from the ADI’s activities on a continuous basis to ensure that capital is held at a level consistent with the ADI’s risk profile
  • A capital management plan, consistent with the ADI’s overall business plan, for managing the ADI’s capital levels on an ongoing basis.
 
This capital management plan should include:
 
  • The ADI’s strategy for maintaining adequate capital over time, including:
    • Outlining its capital target for providing a buffer against the risks involved in the ADI’s activities
    • How the target level of capital is to be met
    • The means available for sourcing additional capital where required
  • Actions and procedures for monitoring the ADI’s compliance with minimum regulatory capital adequacy requirements, including:
    • The setting of trigger ratios to alert management to, and avert, potential breaches of these requirements.
The ADI should ensure that its ICAAP is subject to effective and comprehensive review.
 
If the APRA requests information on an ADI’s ICAAP, the institution should provide this and any subsequent changes to the process as well should be communicated to the agency.
 
Conglomerate Groups – Capital Adequacy Requirements
 
If an ADI heads a conglomerate group, then it must ensure that it not only has adequate capital for its requirements but that the group as a whole has enough capital consistent with the group’s risk profile.
 
An ADI board that heads a conglomerate group must ensure the following:
 
  • Establish policies on group capital adequacy
  • Implement appropriate systems and adequate procedures to identify, assess, measure and monitor capital and group risks on a continuous basis
  • Ensure that the group has sufficient capital freely available to meet unexpected losses and adverse shocks impacting on the group.
 
Measurement of Capital Adequacy
 
When it comes to measuring an ADI’s capital adequacy, the APRA adopts a tiered approach – i.e. three levels. These levels are:
 
  • Level 1: Either
    • The ADI itself or
    • Extended Licensed Entity (An ELE comprising the ADI and each subsidiary of the ADI specified in the approval on a consolidated basis)
  • Level 2: Either
    • If the ADI is not a subsidiary of an authorized Non-Operating Holding Company (NOHC) and the ADI has subsidiaries in addition to those included in any ELE
    • if the ADI is a subsidiary of an authorized NOHC
  • Level 3 – The conglomerate group at the widest level
 
For levels 1 and 2, the measurement of ADI’s capital adequacy is based on a risk-based capital adequacy framework aligned with the Basel II Framework.
 
For level 3, a methodology that is approved by the APRA.
 
Prudential Capital Ratio (PCR) requirements
 
An ADI is subject to a prudential capital ratio (PCR) as determined by APRA:
 
  • An ADI’s PCR is 8% of its total risk-weighted assets, half of which must be held in the form of Tier 1 capital.
  • An ADI must, at all times, maintain a risk-based capital ratio in excess of its PCR.
  • The APRA may, in writing, increase an ADI’s PCR to a specified level above 8% if it believes there are sufficient reasons to do so
  • The APRA may, also in writing, require an ADI to hold more than 50% of its required PCR as Tier 1 capital
 
Reductions in Capital
 
If an ADI wants to make planned reductions in capital, it must only do so after getting the APRA’s prior consent.
 
Additional Resources
 
Read the full Australian Prudential Standard 110 – Capital Adequacy  in full.

 

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