APRA Standard APS with Respect to Capital and Liquidity - Essay Example

APRA Standard APS with Respect to Capital (APS 330) and Liquidity (APS 210) Name Course Tutor Unit Code Date Introduction On April 9, 2013 the Australia Prudential Regulatory Authority (APRA) publicised a session paper containing the outlined new Prudential Standard (APS 330) as relates to the Basel III capital framework: Pillar 3 on public disclosures titled: “Composition of capital and remuneration”. This was to apply to each local authorised depository institution (ADIs) with an exception of Purchased Payment Facility Providers ADIs. On May 9, 2013, the APRA publicised the draft Basel III liquidity modification with the key elements supposed to be put into practise by ADIs. This came along with the draft Prudential Standard (APS 210): “Liquidity” as well as the draft Prudential Practice Guide (APG 210): “Liquidity”. These developments come in line with the authority’s mandate of certifying the ‘safety and soundness’ of prudentially regulated financial institutions. This paper describes the draft APS 330 as relates to capital reforms and the draft APS 210 as relates to liquidity reforms. For each, we analyse their impact on ADIs. Draft Prudential Standard as Relates to Capital (APS 330) Prudential Standard APS 330 was drafted in light of the regulatory insufficiency spotted by the Basel Committee for the duration of the Global Financial Crisis (GFC). Consequently, the Basel Committee on Banking Supervision publicised the Basel III capital reforms in December 2010. Included in these reforms was the requirement for ADIs to disclose more information on their capital adequacy as well as their capital instruments. The regulations are intended to enhance clarity regarding the composition of a ADIs’ regulatory capital. APRA is a member of the Basel Committee on Banking Supervision. Therefore it adopted Basel III capital framework (APRA, 2014a). The framework comprises three ‘pillars’; Table 1: Basel III Capital Framework Source: Author (2014) The main aspects of the draft Prudential Standard APS 330 applying to ADIs only relates to the third pillar of the Basel III capital framework. Specifically, the Prudential Standard introduces three key changes; i. Introduction of the Common Disclosure Template The intention of the common disclosure template is to record the capital standing of ADIs. In this regard, an ADI will have to work out each and every one capital element, as well as any capital adjustment/deduction, applicable in the template so as to satisfy the Basel III description of capital. The filled up common disclosure template will be published as regular as the publication of the financial statements. The template can be included in the financial statements or the financial statement should have a direct link to the template. In addition, the template should disclose regulatory fine-tuning as regards specific national jurisdictions for each one capital class (APRA, 2014a). ii. Detailed Publication of ADI’s Capital Instruments In this regard, the APRA proposes that an ADI must publish each and every one capital element in the balance sheet. PWC (2014) describes this in three steps: (1) the ADI will publish the usual balance sheet as provided for by law in consolidation; then (2) expand the balance sheet to capture the disclosed capital elements; and finally (3) reconcile step (2) components with those of the common disclosure template. iii. Introduction of a Main Features Template The main features template is intended to ensure consistency and comparability in the disclosure of and ADI’s regulated capital instruments. The template embodies a least possible level of summary disclosure that ADIs must report as regards each one regulated capital instrument. In addition, the APRA intends that all terms and conditions of an ADI’s regulated capital instrument be availed on the ADI’s website. Also any change to the regulated capital instruments, such as issue of new capital instrument or any redemption, among others, should be updated in a period of seven days in the main features template not forgetting the new full terms and conditions that should be updated in the website (PWC, 2014). iv. Other Disclosures Additionally, the APRA proposed that terms not used under the Basel III capital framework to explain regulatory capital ratios as well as the formulas used be explained comprehensively. Also the body wished-for all ADIs incorporated locally to have a prescribed policy describing their individual prudential disclosures permitted by their individual Boards of directors. The prudential disclosures are intended to concentrate on the ADIs move towards establishing the substance of an ADI’s prudential disclosures plus the internal controls over the disclosure procedure (APRA, 2014c). Moreover, APRA intended to introduce changes to the market risk capital requirements. The changes are; (1) Disclosing the method adopted in modelling incremental risk and comprehensive risk capital charge internally. This includes the approach employed by the ADI in settling on the scope of liquidity, the methods used to get the capital measurement that conforms to the required security standard and the approach (es) used to corroborate the models; and (2) For portfolios trading under the IMA, the ADI should disclose the high, mean along with the low stressed VaR computations over the period of reporting and the period-end. Also the ADI should disclose the high, mean and low incremental and comprehensive risk capital charges over the period of reporting and the period-end (PWC, 2014). v. Remuneration Disclosures APRA also proposed the inclusion of financial as well as non-financial qualitative and quantitative disclosures as regards an ADI’s remuneration practices. This applies to both listed as well as unlisted ADIs. The disclosures may be included in the remuneration report but they are different and cover more individuals apart from those holding key management positions including employees regarded as ‘material risk takers’ (KPMG, 2014). Impact on Authorised Depository Institutions (ADIs) The proposed Prudential Standard APS 330 would necessitate ADIs incorporated locally to make particular public disclosures regarding the composition of their regulatory capital along with their remuneration practices. This will affect ADIs in two key ways. First, the ADIs will have to keep more capital reserves so as to maintain the required capital ratios and keenly manage their instruments. Their lending ability will be restrained since they will not lend out money recklessly and hence they will reduce risky practices. This is because the current APS 330 requires ADIs to publicise particular information relating to their capital structure, sufficiency of capital, credit risk and securitisation only. However, the proposed APS 330 will require ADIs to compute the amount of regulatory capital they have to hold under Pillar 1 by means of either internal models or methods set in the Prudential Standards (PWC, 2014). They also will be required to divulge more information regarding these issues plus information on operational risk, market risk, equities and interest rate risk in the accounting book. Moreover, the ADIs will be required to make public all terms and conditions of their regulatory capital instruments. Secondly, with the introduction of remuneration practice regulations, the ADIs will continue to operate in a highly regulated environment. Under the present prudential framework ADIs do not have to disclose any information regarding their remuneration practices. However, under the proposed Prudential Standard APS 330, listed big as well as some small proprietary ADIs will have to include a remuneration report in their annual directors’ report (KPMG, 2014). Draft Prudential Standard as Relates to Liquidity (APS 210) On 9 May, 2013, APRA publicised the draft Prudential Standard APS 210: Liquidity made under banking (prudential standard) determination No. 13 of 2007 that was intended to repeal the existing Prudential Standard APS 210: Liquidity. The aim of the proposed APS 210 is to make sure that an ADI follows wise practices in liquidity risk management along with preserving a sufficient level of liquidity to rally its outstanding short-term requirements that enable its daily operations (Basel Committee, 2014a). The proposed Prudential Standard APS 210 introduces key changes; i. Enhanced Qualitative Requirements The APRA introduced improved qualitative requirements for each and every one ADI. This will certify that an ADI’s risk management framework corresponds to the nature, magnitude and involvedness of the financial institution. The requirements comprise: (1) Improved Board supervision of an ADI’s liquidity risk management framework; (2) Enunciation of the Board’s forbearance of liquidity risk; and (3) quantification as well as allotment of costs and benefits; among others (Claynutz.com, 2014). ii. Liquidity Coverage Ratio (LCR) Requirements APRA adjusted the smallest amount of liquid assets holding required for big and multifaceted ADIs. Through the Liquidity Coverage Ratio (LCR), the APRA will oblige an ADI to dash a 30-day stress analysis integrating the market-wide plus eccentric strain apparatus. The LCR is a means of guaranteeing that during a liquidity stress, an ADI is able to endure duration of not less than 30 days with its own wherewithal, exclusive of any call for extraordinary intercession from the public sector. The APRA also adopted several revisions made by the Basel Committee as regards the cash outflow assumptions that touch on the computation of the LCR. All ADIs will be required to get together the previous 100 per cent LCR requirement on January 1, 2015 (APRA, 2014d). iii. High-Quality Liquid Assets (HQLA) Requirements APRA proposes ADIs operating on the global scene to cleave to adequate High-Quality Liquid Assets (HQLA) that will enable them to bear up a harsh liquidity stress. This will cover would-be cash outflows from their business over the 30-day duration assuming market-wide and peculiar strain occurs. However, APRA will pass up enlarging the list of entitled assets to be included as HQLA (APRA, 2014b). iv. Net Stable Funding Ration (NSFR) Requirements Besides the LCR, APRA is implementing the NSFR prescribing the least amount of longer-term financial support that an ADI should source resulting from the quantity of longer-term assets on its statement of financial position (APRA, 2014b). v. Revisions over Minimum Liquidity Holdings approach for ADIs with Smaller, Retail-Based Operations The APRA abolished the prior intended 20 per cent cap on holding assets with a credit rating of grade III or lower (APRA, 2014d). Impact on Authorised Depository Institutions (ADIs) The proposed Prudential Standard APS 210 on liquidity reforms is intended to tighten the liquidity of ADIs. This will affect the ADIs in two main ways; Tightening liquidity means that the banks will have to be conservative. This implies that they will have to hold on to more liquid assets which could have been invested elsewhere to gain more returns. Therefore there will be a higher opportunity cost tied within the liquidity and the overall operating expenses will go up as a result. With the old prudential regime, ADIs were obliged to run an LCR within a five-day name crisis where they would run a stress setting simulating a name explicit strain episode on their banking function and guesstimate likely cash outflows for each one of the five business days of the analysis (Basel Committee, 2014b). Under the new regime, this has to be done for 30 calendar days. This is expected to proof that a financial institution has adequate estimated cash inflows and holdings of liquid assets to endure 30-day duration devoid of relying on public backing. The difference here is that the ADIs will on average hold on to extra HQLA weighed up against what they held under the name crisis. This amounts to a range of about 11 per cent of the usual retail bank statement of financial position. As a consequence, some accumulation of liquid assets to the statement of financial position plus some reclassification of loans as liquid assets will be embraced (Claynutz.com, 2014). On the positive side, ADIs will operate within a safety margin that will lessen the likelihood of liquidation or total closure. The improved liquidity measures will create a bigger buffer zone within which to conduct business. At the individual and systemic level, a financial institution will have a sounder liquidity schedule, and within the global financial market, the financial institution will have a better access to funds (Basel Committee, 2014c). Specifically, the quantitative and qualitative measures will support stronger liquidity that will ensure that the financial institutions will be within a safety margin should any financial crisis, such as the GFC, occur in future. The ADIs will also attract better credit ratings. With improved credit ratings, the institutions will be able to attract more investors. References Australia Prudential Regulatory Authority (APRA), (2014a). Prudential Framework APS 330. Viewed 22 April 2014, . Australia Prudential Regulatory Authority (APRA), (2014b). Liquidity Reforms. Viewed 21 April 2014, . Australia Prudential Regulatory Authority (APRA), (2014c). APRA Discussion Paper Capital Composition Requirements. Viewed 21 April 2014, . Australia Prudential Regulatory Authority (APRA), (2014d). Draft APA 210: Liquidity. Viewed 24 April 2014, . Australia Prudential Regulatory Authority (APRA), (2014e). Implementing Basel III liquidity reforms in Australia. May 2013, Viewed 23 April 2014, . Basel Committee, (2014a). Principles for Sound Liquidity Risk Management and Supervision, September 2008, Viewed 24 April 2014, . Basel Committee, (2014b). Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools. January 2013, Viewed 22 April 2014, . Basel Committee, (2014c). Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring, December 2010, Viewed 22 April 2014, . Claynutz.com, (2014). APRA Sets a High Water Mark for Implementing Basel III Liquidity Reforms. Viewed 21 April 2014, . KPMG, (2014). Mutuals Proposed New Capital Remuneration Disclosure APS 330. Viewed 23 April 2014, . PriceWaterhouseCoopers (PWC), (2014). APRAs Disclosure Requirements. Viewed 23 April 2014, . 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