The Australian Prudential Regulation Authority (APRA) has proposed revisions to its prudential standard on credit risk management requirements for authorised deposit-taking institutions (ADIs) due to the “significant evolution in credit risk practices” since the last major update was made in 2006.
The revised standard, to be renamed Prudential Standard APS 220 Credit Risk Management, requires ADIs to “maintain an appropriate credit risk appetite statement and credit risk management strategy”, the latter of which should reflect the ADI’s credit risk appetite and credit risk profile”, according to a discussion paper released on Monday (25 March) for consultation.
The board of an ADI would be responsible for reviewing and approving the credit risk appetite statement and credit risk management strategy at least annually.
The revised standard also requires an ADI’s senior management to implement prudent policies and processes to identify, measure, monitor, report and control or mitigate credit risk over the full credit life cycle, with the board required to “regularly challenge, seek assurance and evidence from senior management” of consistency in these policies and processes.
Further, an ADI must have “appropriate systems” for the ongoing administration of its credit portfolio and for monitoring both individual exposures and the overall composition and quality of its credit portfolio.
When it comes to credit assessment and approval, APRA’s new proposed standards requires ADIs to consider:
- the purpose and structure of the exposure and sources of repayment, including effective verification of income or cash flows;
- the current risk profile of the borrower, including all commitments and total indebtedness;
- the borrower’s repayment history and capacity, assessed under various scenarios; and
- covenants designed to limit the ADI’s exposure to changes in the future risk profile of the borrower.
ADIs that use third parties (such as brokers or introducers) to undertake credit assessments must incorporate “appropriate oversight processes of the third party”, according to APRA’s revised standard.
“APRA is proposing that an ADI monitor and test the integrity of the third-party assessment and approval on a regular basis, either directly or through operationally independent personnel, to ensure it aligns with the ADI’s credit assessment and approval criteria,” the prudential regulator’s discussion paper states.
In regards to collateral valuations, APRA is proposing that ADIs, in cases where agricultural land is taken as security, take into account the likelihood of natural disasters which could impact the valuation of the land, in line with the banking royal commission's final recommendation.
In other cases, ADIs must ensure collateral valuations are appraised independently from its credit origination, credit assessment, and approval processes, and also take into account “prevailing market conditions, such as time taken for the liquidation or realisation of collateral”.
For prudential reporting purposes, APRA’s proposed new standard stipulates that an ADI must classify its exposures as “performing”, “significantly deteriorated”, or “nonperforming”, with exposures that are 90 or more days overdue to be classified as non-performing exposures even if well-secured. Further, restructured or “hardship” exposures are required to meet the updated terms for 12 months before returning to performing status.
Additionally, under the revised standard, ADIs are required to recognise and address risks emerging from different origination channels, and where there are material changes to origination channels, they must assess the impact of the changes on its credit risk profile and address the risks.
APS 220 also includes supervisory discretion to impose limits on lending and require independent reviews of an ADI’s credit risk management practices, including the ability to set the terms of review, at the ADI’s expense.
The proposed reforms are expected to come into effect on 1 July 2020.
The review of RG 209 will consider whether the guidance “remains effective” and will seek to identify changes and additions to the guidance that “may help holders of an Australian credit licence to understand ASIC’s expectations for complying with the responsible lending obligations”.