The Australian Prudential Regulation Authority (APRA) has introduced a strengthened prudential standard aimed at “mitigating contagion risk within banking groups”.
The updated prudential standard – Associations with Related Entities (APS 222) – is designed to further reduce the risk of problems in one part of a corporate group having a “detrimental impact” on an authorised deposit-taking institution (ADI).
Following a consultation process that began in July 2018, APRA has confirmed that APS 222 would be updated to include:
- a broader definition of related entities that includes board directors and substantial shareholders
- revised limits on the extent to which ADIs can be exposed to related entities
- minimum requirements for ADIs to assess contagion risk
- removing the eligibility of ADIs’ overseas subsidiaries to be regulated under APRA’s Extended Licensed Entity framework
In addition, APRA will require ADIs to regularly assess and report on their exposure to “step-in risk” – the likelihood that they may need to “step in” to support an entity to which they are not directly related.
The new APS 222 will come into effect from 1 January 2021.
Deputy chair John Lonsdale said the new rules form part of a strategy to “incorporate some of the lessons learned from the global financial crisis”.
“Concessions in the existing framework led to some ADIs establishing operations in foreign jurisdictions, which are managed and funded within the domestic bank,” he said.
“APRA has only limited visibility of these operations, which also fall outside the purview of foreign regulators. They complicate operating structures, and there is no certainty their assets would be available to an ADI if it were to enter resolution. There are currently around 100 such operations within a small number of ADIs.
“Additionally, if an ADI were to fully utilise some of the limits within the existing framework, they would be exposed to excessive levels of contagion risk.”
Mr Lonsdale claimed that the revised APS 222 guidance would “enhance the prudential safety of ADIs and reinforce financial system stability”.
“As we saw during the global financial crisis, deficiencies in governance or internal controls in one part of a corporate group can quickly spread and cause financial or reputational damage to an ADI,” he said.
“Furthermore, complex group structures could potentially make it difficult for APRA to resolve an ADI quickly and protect depositors’ savings in the unlikely event of a bank failure.
“By updating and strengthening the requirements of APS 222, APRA will ensure ADIs are better able to monitor, manage and control contagion risk within their organisations.”
Mr Lonsdale conceded that aspects of the revised standard would have a “material impact” on some ADIs, but added that APRA has adjusted its original proposals in some areas to make the requirements “less burdensome”.
“We are open to considering appropriate transition arrangements on a case-by-case basis where specific entities request it,” Mr Lonsdale said.
ANZ has acknowledged APRA’s announcement, noting that the only related entity large enough to be impacted by the change is ANZ Bank New Zealand.
The major bank stated that as a result of the new standard, it could have limited capacity to inject capital into ANZ NZ, which may be required to “retain a higher proportion of its earnings to meet any potential increased capital requirements”, adding that any future capital required in New Zealand may also need to be held at a group level.
However, ANZ noted that the final impact on the group remains dependent on a number of factors, which include the outcome of APRA and the Reserve Bank of New Zealand’s (RBNZ) consultations on required capital as well as the size and composition of ANZ’s balance sheet at the time of implementation.
ANZ welcomed APRA’s openness to providing entity-specific transitional arrangements or flexibility on a case-by-case basis, stating that it expects that the flexibility could involve changes to the allotted time frame and the circumstances under which an exemption may be available.