Targeted changes to ADI liquidity and capital standards

To: All authorised deposit-taking institutions 

APRA has recently undertaken a targeted review of its liquidity requirements, following bank crisis events in the United States and Europe earlier this year. These events have highlighted new complexities and challenges that could create future risks to financial stability. 

Australian banks’ liquidity positions remain strong, and APRA is not proposing to increase the amount of liquidity that banks must hold. APRA’s review found that most banks have prudent practices for managing risks; however, there are some gaps which need to be addressed. These gaps relate to valuation practices, processes for accessing emergency liquidity assistance and the composition of liquidity portfolios.  

APRA is consulting on targeted changes to strengthen authorised deposit-taking institutions’ (ADIs) liquidity and capital requirements. These will be reflected in: 

• Prudential Standard APS 210 Liquidity (APS 210);
   
• Prudential Practice Guide APG 210 Liquidity (APG 210); and 
   
• Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111). 

Proposed targeted revisions 

The proposals outlined in this letter seek to ensure that ADIs have strong crisis preparedness, prudently value their liquid assets and minimise potential contagion risks. APRA’s objective is that the Australian banking system remains resilient into the future. 

APRA’s proposed changes would primarily impact ADIs on the Minimum Liquidity Holdings (MLH) regime. The proposed targeted revisions would ensure that:

1. ADIs on the MLH regime value liquid assets at their market value; 
    
2. All ADIs have robust processes for accessing exceptional liquidity assistance from the Reserve Bank of Australia (RBA), where needed; and
    
3. Contagion risk is reduced by strengthening the composition of MLH liquid assets.

Rationale for policy changes

Valuing liquid assets at their market value 

Under APRA’s proposals, ADIs on the MLH regime would be required to adjust the value of their liquid assets regularly for movements in market prices, consistent with the existing approach of ADIs subject to the Liquidity Coverage Ratio (LCR). Unrealised losses on liquid assets were a key source of stress for some US banks earlier this year, resulting in less liquidity being available at a time when it was needed most. APRA’s proposal would ensure that ADIs’ liquidity portfolios are based on prudent valuations and able to absorb stress as intended.   

Processes for accessing exceptional liquidity assistance

APRA is proposing to adjust APS 210 to formalise requirements for accessing exceptional liquidity assistance, including providing clarity on the information APRA would request from an ADI in such an event. It is important that ADIs are prepositioned and ready to access emergency liquidity if needed in a crisis, and that systems are in place in advance. 

Reducing contagion risks by strengthening the composition of MLH liquid assets

The final proposal outlined in this letter is that bank bills, certificates of deposits and debt securities issued by other ADIs would no longer be counted as eligible liquid assets for ADIs on the MLH regime.¹ This treatment would align with the LCR approach and reduce the risk that stress could be propagated across the financial system as banks draw down on their liquidity buffers.²

APRA’s proposal would dampen the earnings of ADIs on the MLH regime, without corresponding mitigating actions. Holdings of other bank securities represent a large share of MLH ADIs' existing liquid assets, at around 60 per cent on average. To maintain the same level of liquidity, ADIs may seek to replace these securities with lower yielding government bonds. Alternative funding sources may also need to be found.

To ameliorate potential impacts, APRA is seeking feedback on policy options that would assist ADIs in managing adjustments to their liquidity portfolios. Mitigating options could include, for example: (i) providing MLH ADIs with transition times to support a gradual implementation, as outlined in Attachment A; and (ii) reviewing the calibration of MLH ADIs’ minimum liquidity requirements, taking into account that liquid assets would be higher quality and more prudently valued. 

Further details on APRA’s proposals are outlined in Attachment A. 

Next steps 

In addition to seeking written submissions, APRA will engage with industry through workshops during the consultation period, to gather further information on potential cost and funding impacts, among other things. APRA will use these workshops to discuss options that would balance risk and cost impacts. 

APRA invites feedback on the draft proposals outlined in this letter. Written submissions should be sent to adipolicy@apra.gov.au by 16 February 2024 and addressed to: General Manager, Policy.

All information in submissions will be made available to the public on the APRA website unless a respondent expressly requests that all or part of the submission is to remain in confidence. APRA intends to finalise this consultation in the first half of 2024, ahead of a planned effective date of 1 January 2025.

While this consultation is targeted at lessons learned from recent international events, APRA plans to undertake a more comprehensive review of APS 210 in due course. This will seek to address feedback gathered through the 2022 post-implementation review of the Basel III liquidity reforms.³

Yours sincerely,

Therese McCarthy Hockey
Member, APRA 
 

Attachment A - Detail on proposed revisions 

This attachment provides further detail on APRA’s proposed changes. The table below outlines the specific proposals and the relevant associated references in prudential standards and guidance that would be amended.

1. Accounting for unrealised losses

a. Using the market value of liquid assets for ADIs on the MLH regime 

Under the MLH regime, ADIs can currently measure the value of their liquid assets based on their accounting treatment, which often results in their inclusion at amortised cost rather than market value. This can present risks in stress, since unrealised losses may result in weaker liquidity positions than assumed. 

Under APRA’s proposed changes, liquid assets would be included at market value for ADIs subject to the MLH regime. This would ensure that the value of the liquid assets are regularly updated to reflect changes in market prices. This is already required of ADIs subject to the LCR regime, and would align the valuation of liquid assets across all ADIs. 

b. Deducting unrealised losses from capital

Consistent with the treatment above, APRA also proposes that unrealised losses for liquid assets would be deducted from Common Equity Tier 1 Capital at Level 1 and Level 2, for both ADIs on the MLH and LCR regimes. This would provide a parallel treatment for capital and liquidity. It is important that unrealised losses flow through to capital positions in a timely manner, and that capital and liquidity ratios provide an accurate representation of financial resources available to absorb stress. The proposed treatment would be asymmetric – gains in value would not be recognised for capital purposes.

2. Exceptional liquidity assistance from the RBA

In times of stress, the RBA may provide exceptional short-term liquidity assistance to ADIs experiencing acute liquidity difficulties. When requesting exceptional liquidity assistance, ADIs must provide information to APRA and the RBA regarding their financial position. 

To ensure that information can be provided in a timely manner, APRA is proposing that ADIs must be operationally ready to provide certain key information at the time of their request. APRA has provided additional guidance in draft APG 210 to assist ADIs in meeting this requirement. Accompanying this letter is a draft information request that APRA expects would be completed by an ADI requesting exceptional liquidity assistance and that could be submitted via a spreadsheet through APRA Connect. 

3. Reducing contagion risk

APRA is proposing to remove bank securities from eligible MLH liquid assets. This would seek to ensure that banks can draw down on their liquidity buffers, where needed in stress, without creating contagion risk. 

APRA is seeking feedback on options to mitigate the potential impact of this proposal on MLH ADIs’ funding and income.⁴ APRA could, for example, provide MLH ADIs with an extended implementation timeline, such as that set out below. Under this approach, the proportion of bank securities included in eligible liquid assets would steadily reduce over a five-year period. This would support a more measured and gradual transition, smoothing the potential impact on funding and expenses. 

APRA is also open to considering other options to reduce the potential impact on ADIs. Options could include, for example, reviewing the calibration of the MLH ADI’s minimum liquidity requirement, given this would be made up of a higher quality liquid assets. 

As part of APRA’s future planned comprehensive review of liquidity requirements, APRA will also consider additional changes to ensure that both the MLH and LCR regimes remain appropriate under a range of different scenarios, including a potentially lower stock of government bonds.

Footnotes

¹  APRA’s original approach for MLH ADIs was established at a time when there was low availability of high-quality liquid assets in Australia. However, there have been significant changes in market dynamics since the regime was established, including increased government bond issuance. As a result of these changes in the market, APRA made adjustments to the LCR regime, with the Committed Liquidity Facility (CLF) being reduced to zero by the end of 2022.
 
²  ADIs on the LCR regime do not include bank securities in eligible liquid assets. More than 90 per cent of LCR ADIs’ liquid assets are in the form of central bank reserves and government issued or guaranteed securities. 

³  Refer to: Post-implementation review of Basel III liquidity reforms

⁴  The impact of this proposal might also be affected by subsequent changes in risk-weighted assets and capital impacts.