APRA releases discussion paper on Basel II supervisory review process

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.

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).

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.

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

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.

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