ADI capital reforms: Minor updates

Some submissions raised concerns with the proposal to categorise borrowers as investment grade if their parent company is listed, suggesting this factor was not reflective of a borrower’s underlying credit risk.

Additionally, while submissions welcomed the more risk sensitive approach of an 85 per cent risk weight for investment grade borrowers and a 110 per cent risk weight for sub-investment grade borrowers, some submissions recommended that risk weights could be even more risk sensitive: for example, implementing a 65 per cent and 135 per cent split.

APRA is removing the requirement that, to be categorised as investment grade, an unrated corporate or its parent company must have securities outstanding on a recognised securities exchange. Instead, unrated corporates must not meet the definition of “Corporate small-medium enterprise” under APS 112 and must have sufficient information to conduct adequate due diligence for the assessment of whether the corporate entity is investment grade. An ADI must have in place an APRA approved methodology that differentiates between ‘investment grade’ and ‘non-investment grade’ to use the more risk sensitive approach.

Given that the revised approach is expected to capture a broader set of unrated corporate borrowers, APRA considers the risk weights to remain appropriate. 

Some submissions suggested removing the condition that an ADI should disregard the prospect of government support from Probability of Default (PD) assessments to qualify for the 25 per cent Loss Given Default (LGD). 

Other suggestions included extending the scope of application to Government owned enterprises (GOEs) that invest in public infrastructure and operators that have a tripartite or similar agreement with a statutory body, rather than directly with the government.

APRA has amended APS 113 to remove the condition that an ADI should remove the prospect of government support from PD assessments to qualify for the lower LGD. Furthermore, APRA has clarified expectations in relation to security agreements and step-in rights.

This revised approach reflects APRA’s policy intent to capture GOEs that operate large domestic public infrastructure in the lower LGD, noting that the essential nature of the underlying infrastructure assets supports recovery values in an event of default. APRA is not adjusting the scope further.

Industry agreed with the proposal to recognise the recoverable value of carbon credits and allowances. 

One submission suggested that APRA should extend the recognition further to capture environmental products purchased through repurchase agreements.

While APRA is amending its requirements to recognise the recoverable value of carbon credits and allowances, APRA is not extending this recognition to assets purchased through repurchase agreements. 

This is in line with APRA’s established approach to repurchase agreements, where assets owned by the ADI cannot be treated as pledged collateral.

Some submissions suggested that APRA should relax the guidance in APG 112 that sets out a specific checklist that ADIs should consider when undertaking a creditworthiness check.

Some submissions also provided some suggestions to tighten the guidance. 

APRA has amended APG 112 so that risk indicators are not restricted to a prescribed list. However, APRA expects ADIs to be able to demonstrate, upon APRA’s request, how existing credit policies and data support the timely monitoring of borrower risk. As noted previously, given the zero-capital requirement for uncommitted facilities, it is reasonable that banks adhere to robust creditworthiness checks.

APRA is not extending the 24-hour grace period as the Basel framework ultimately requires an assessment immediately prior to each drawdown. However, there is more flexibility for cross-time zone processes.

Some submissions suggested that APRA extend the proposal to include arm’s length transactions that are ‘off-market’. 

However, other submissions suggested the footnote should be removed altogether, given the effective purchase price is not the best proxy for value. 

APRA recognises the differences in origination and data collection practices between ADIs and the difficulty to align the calculation of five or more investment properties.

At this time, APRA is retaining its amendments to APG 113 as the additional guidance provides ADIs flexibility to judge when it is appropriate to aggregate loans. 

APRA has amended the reporting instructions for ARS 110.0 to clarify the approach to the reporting of overlays across the capital framework.

APRA has amended the calculation for Item 6.3 in Section B of ARS 110.0. The updated formula is in APRA’s Taxonomy Artefacts, available on its public website.³

APRA is delaying implementation by three months to provide additional time for industry to implement the changes.

The prudential standards and reporting standards will come into effect 30 September 2024. ADI reporting will be under the new reporting standards for the September 2024 quarter.