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Home ›  Best Practices

Australian Prudential Standard 112 – Requirements for Capital Adequacy against Credit Risk Exposures

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

 

The Australian Prudential Standard 112 – Capital Adequacy: Standardized Approach to Credit Risk aims at ensuring that “ensure that an authorized deposit-taking institution holds sufficient regulatory capital against credit risk exposures.”
 
Applicability
 
The APS 112 - Capital Adequacy: Standardized Approach to Credit Risk applies to all authorized deposit-taking institutions or ADIs under the Banking Act.
 
However, ADIs that have approval from APRA to use an internal ratings-based approach to credit risk under Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk are exempt from this standard’s requirements.
 
Key Principles for this Prudential Standard
 
The APS 112 - Capital Adequacy: Standardized Approach to Credit Risk has been conceptualized on the following key principles:
 
  • An ADI must apply risk-weights to its on-balance sheet assets and off-balance sheet exposures in accordance with the risk classes set out in the standard for regulatory capital purposes.
  • An ADI may, subject to meeting the standard’s requirements, use certain credit risk mitigation (CRM) techniques in determining the capital requirement for a transaction or exposure.
 
 
Requirements for Risk-Weighting Approach
 
If the APRA feels that an ADI has not risk-weighted its exposure to credit risk properly, the agency will then determine the risk-weighted amount of a particular on-balance sheet asset or off-balance sheet exposure in writing.
 
The following are the standards requirements for on-balance sheet assets and off-balance sheet exposures:
 
On-Balance Sheet Assets
  • The total risk-weighted on-balance sheet assets must equal sum of the risk-weighted amounts of each on-balance sheet asset.
  • Risk-weighted amount of each on-balance sheet asset is determined by multiplying its current book value by relevant risk-weight as detailed in the standard’s Attachment A
Off-Balance Sheet Exposures
  • Total risk-weighted off-balance sheet credit exposure must be calculated as the sum of the risk-weighted amount of all its market-related and non-market-related transactions.
  • Risk-weighted amount of an off-balance sheet transaction that gives rise to credit exposure must be calculated by the following two-step process:
    • Notional amount of the transaction must be converted into an on-balance sheet equivalent, i.e. credit equivalent amount (CEA), by multiplying the amount by a specified credit conversion factor (CCF)
    • The resulting CEA must be multiplied by the risk-weight applicable to the counterparty or type of exposure.
 
 
When calculating risk-weighted credit exposures, an ADI must include all market-related off-balance sheet transactions (including on-balance sheet unrealized gains on market-related off-balance sheet transactions) held in the banking and trading books.
 
The following are exempted from risk-weighting by an ADI:
 
  • Foreign exchange contracts that have an original maturity of 14 calendar days or less
  • Instruments traded on futures and options exchanges that are subject to daily mark-to-market and margin payments.
 
Using Ratings by External Credit Assessment Institutions (ECAI)
 
  • An ADI may use an ECAI’s solicited ratings only to determine the credit rating grades that correspond to the risk-weights for counterparties and exposures.
  • An ADI cannot use credit ratings for one entity within a corporate group to determine the risk-weight for other (unrated) entities within the same group.
 
Using Credit Risk Mitigation (CRM) Techniques
 
  • An ADI cannot recognize additional credit risk mitigation on claims where the risk-weight is mapped from an ECAI issue-specific rating and that rating already reflects CRM
  • In order for an ADI to obtain capital relief to use a CRM technique, it should ensure that all documentation is legally binding on all parties and legally enforceable in all relevant jurisdictions
  • An ADI should have policies and procedures to manage risks associated with its CRM techniques
  • If multiple CRM techniques cover a single credit risk exposure, then an ADI will have to divide the exposure into portions covered by each CRM technique. The risk-weighted assets of each of these portions will then have to be calculated and the total arrived at.
 
 
Additional Resources
 
Read the full Australian Prudential Standard 112 – Capital Adequacy: Standardized Approach to Credit Risk in full.

 

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