This is an article that first appeared in The Sheet.
Over the last three years, APRA’s primary focus in the regulation of banks, building societies and credit unions has been the transition from the old international regulatory standards on bank capital known as Basel I to the new regime, Basel II.
Basel II is due to come into effect in Australia from January next year, which means that the first APRA returns under the new standards will be for the January month end – or about six months from now.
The problem for all banks is that none of the new standards have yet been issued in final form, leaving APRA a busy few months to get them finalised and an even busier few months after that for banks to get them implemented.
For convenience in discussing what is to come I will use the groupings APRA uses when releasing their responses to submissions.
Advanced approaches to credit, operational and interest rate risks
This section covers the approach that the four major banks, Macquarie, St. George and BankWest are expected to take once they pass APRA’s tests for using the advanced approach.
In essence, the advanced approach allows banks to calculate their own capital based on their internal modelling of those requirements. APRA issued the latest paper on advanced approaches on 13 June this year, and this covers the new APSs 113 (credit risk), 115 (operational risk) and 117 (interest rate risk) and their associated guidelines (APG 113, 115 and 117).
Of the draft APSs the three mentioned above have been the most debated and two of them (115 and 117) are largely complete. Probably all that will happen is that the wording may be updated and the “draft” taken off them. The 13 June paper accepted most of the points made by those who have made submissions on these standards and revised drafts included no real surprises in there.
APS 113 on credit risk has a bit more work to be done. There are three main areas of controversy.
The first draft of the rules on exposure netting are now a bit overdue. APRA is still not happy with the capital outcome on margin lending – with no capital required under the current draft. APRA also does not believe that a bank can correctly model exposures to related entities, so they are looking at this as well.
APRA now does not have much time to deliver the final draft of this standard on credit risk in what is the most complex area of Basel II.
APRA has also decided to defer work on the more recent Basel II changes in counterparty credit risk into 2008 as it judges these topics are less critical.
Final submissions on credit risk are due by 13 September, giving APRA roughly four months to finalise both the APSs and the associated APGs and allow the banks some time to make any needed internal changes.
Standardised approaches to credit and operational risk
The “Standardised” approaches are the ones all other ADIs in Australia will use with respect to credit and operational risk. This includes all smaller banks, credit unions, building societies and also some foreign banks.
Like the prudential standards relevant to the advanced approaches, these documents are fairly complete. The operational risk standard (APS 114) is virtually in a state just to remove the word “Draft” from it. Only minor issues remain with the credit risk standard, APS 112.
For APS 112, the outstanding issues are: margin lending (the same issues that relate to the advanced approach); confirmation of which external ratings firms are acceptable (this is expected to be only Moody’s, Standard and Poor’s and Fitch Ratings); and the sheer size of 112 – which is actually bigger than 113 even though the document details what is meant to be a less complex approach. Less complex, though, appears to mean more prescriptive.
Still missing in action from all this regulatory effort is a new standard that will detail the qualitative requirements for the management of operational risk. Considering how late this is, and the fact that all non-advanced ADIs have no choice but to comply with the final version, we should not expect this to be too onerous – but leaving it this late will always induce some nervousness.
For APS 112 and 114 the comments period expires on 3 September, again leaving just over four months to get the entire process finished.
Of the ones still open for comment the standard on securitisation (APS 120) is the one with the shortest time frame from now (10 August, or this Friday). It was also the one with the most extensive changes from the first draft. Fortunately, APRA seems to have taken both the substance and the spirit of most of the comments received on board and the current draft should not be too far from the final state.
The pipeline here, then, is to make any further detail changes needed and to get the final version of the associated prudential practice guidelines (APG 120) out as soon as possible after the close of the comments period.
This standard (APS 330) was released in first draft form on 6 June this year, and by about 8 June APRA probably realised that there would need to be at least one change to it. APS 330 gives effect to “Pillar 3” of Basel II on the disclosures that need to be made to the market. As “the market” is not actually defined it has been regarded as generalised disclosure to the world at large. APRA’s chosen method for this disclosure (and internationally it is a common one) is for the disclosures to be made on the ADI’s website.
The potentially landmark change?
Buried within the proposed quarterly disclosures is the requirement to post retained earnings figures – which means that the quarterly profit figures have to be published.
This would represent a major change from the current semi-annual disclosures for the listed ADIs and an even bigger change from annual reports for the non-listed sector. The belief amongst the ADIs is that APRA simply did not think this one through.
The rest of APS 330 was fairly non-contentious and, for the advanced ADIs at least, confined itself to implementing Pillar 3 with a few exclusions. Smaller ADIs got away with fairly minimal quantitative and no qualitative disclosures.
The pipeline on disclosure will be for APRA to get a revised draft of 330 out in fairly short order, addressing the concerns about quarterly reporting and then have what should be a fairly abbreviated comments period after that. The first disclosures under this standard are (under the current draft) not due to be made until the last week of May 2008 for the March quarter.
The draft standard on market risk (APS 116, covering exposure to foreign exchange, commodities, interest rate and equity markets) came out only last week with a fairly short comments period. Given this is one of the more complex standards and it runs to 53 pages this reflects the compressed timescales APRA now finds itself left with.
Smaller institutions have a handy “out” clause, though. If they meet the conditions in paragraph 21 they do not have to apply the standard. Many, if not most, smaller ADIs can be expected to meet the