APRA today (or was it yesterday now) released what is probably very close to their last words on how Basel II Advanced methodologies will look in Australia. The good news is that they seem to have taken on board most of the input from the submissions and other discussions they have been having since the release of the drafts of the new prudential standards. The bad news? I have not found much yet.
In the words of one of the guys I respect most in this process “this looks like one of the best papers out of APRA on the subject of Basel II.”
The only real bad news in here seems to be that the nonsensical 20% LGD floor, imposed a few months ago by letter (and covered here), will remain for the time being – although it is not being added into APS 113.
Fuller coverage is over the fold for those interested.
For the moment, I will mainly confine myself to the changes from the previous draftsnoted in the Response. As I normally do, though, I will divert when I feel it is needed.
Credit Risk – APS 113 Changes
The size thresholds will stay in place for the most part – the 1:1 EUR to AUD conversions stay. This is appropriate. The change here is only a minor one, affecting only foreign subsidiaries. APRA is to allow them to use the foreign retail SME definition for those subs. It will make administration easier.
The second change only affects institutions going FIRB (I wonder who that is?) and it will allow the use of a lower CCF on undrawn lines for borrowers that have access to debt securities markets – essentially rated counterparties. Another small, but good, concession.
The next change is really a clarification – there was always a problem with retail thresholds where total facilities to connected borrowers (say a business person as an individual and the business they own) exceeded $1m. The way it originally read meant that once the combined facility exceeded $1m then it may no longer qualify as retail. This change just clarifies what is common sense anyway – the business’ borrowings need to be above $1m before it becomes an SME borrowing. Another good change.
The next change is probably the best of all – and really one that probably should not even have had to be argued. Big headlines – many leases have collateral. OK – not exciting and definitely not news, but to the banks doing leasing this move to recognise reality is a good one. Don’t get me wrong; this is a good change – just one that should not have had to be made.
A tidy up to the definition of default is next – with that in APS 113 now referencing that in AGN 220.1. Again, a good move. No point having a couple of (slightly different) defintions out there. It would have been confusing at best.
“Re-aging” is a strange way of saying re-starting the clock on a defaulted loan. APRA’s original approach to this had a rather strange approach to the problem. This has been settled by simply deleting the offending paragraph. No great loss there.
The last change picks up and closes a rather interesting little loop-hole in relation to lending to corporates. The old 113 effectively allowed lending to corporates, if secured by a residential property, to get an LGD lower than the retail 10% floor. This change just closes that loop-hole. Pity – I was wondering if I would have been able to get a lower home loan through this. [Sniff].
APS 115 – Operational Risk
The operational risk changes are mostly by way of clarification rather than anything else, covering such things as where conservatism can be included in the models (now it can be in the models, rather than just the parameters), where EL offsets must be included or just considered (just considered – a good outcome IMHO), the split between market and operational risk. Data management and sourcing is also discussed, as is the difference between sensitivity analysis and stress testing.
The only changes of any real substance, though, are around the management of operational risk. The APS has been changed to clarify that other incentive than capital can be used to manage ops risk; that the independent review of the framework needs to also look at whether the models are up to date; and to clarify the role of ops risk people out in the line.
All, good, sensible changes that most people had probably already mentally changed, but will now be in 115.
The other changes – those to APS 117 (Interest Rate Risk in the Banking Book) I will cop out of for the moment. I plan to cover these when I have had a chat with a mate more comfortable in this area. On a brief read, though, these changes look sensible – even if the author (or authors) of this section use a heck of a lot more words to come to a conclusion than did the authors of the other ones.