APRA releases discussion paper on Basel II supervisory review process

The Australian Prudential Regulation Authority (APRA) has released a discussion paper on its proposed approach to the supervisory review process under the new Basel II capital adequacy regime, known as the Basel II Framework.

The supervisory review process, or Pillar 2, is one of three mutually reinforcing pillars on which the Framework is based. The process is intended to ensure that locally incorporated authorised deposit-taking institutions (ADIs) have adequate capital to support all the risks in their business and to encourage ADIs to develop and use better risk management techniques in monitoring and managing their risks.

As APRA's existing supervision framework is already largely consistent with Pillar 2, no separate Pillar 2 prudential standard will be issued and APRA will apply draft Prudential Standard APS 110 Capital Adequacy (APS 110).

Consistent with its existing processes for determining capital adequacy, APRA is proposing to set a prudential capital requirement (PCR) for each ADI, which must be met at all times.

Subject to the minimum capital requirement of eight per cent established in the Framework, PCRs will be set at a level proportional to each ADIs overall risk profile.

A key requirement of Pillar 2 is that an ADI should develop, document and maintain a comprehensive internal capital adequacy assessment process (ICAAP), proportional to its operations and consistent with prudential requirements. The information provided by an ADI in its ICAAP is essential input into APRA's supervisory review and determination of the PCR.

In line with the Framework, APRA intends to apply a limit on reductions in regulatory capital for ADIs accredited to use the advanced Basel II approaches, relative to what would have applied had the current Basel Capital Accord continued in force. The limit will be 10 per cent in 2008 and this limit will be retained in 2009 pending a review of experience with the advanced Basel II approaches.

The Basel II Framework will come into force in Australia on 1 January 2008.

Comments on the discussion paper are invited by 26 October 2007.