A. Introduction

1. Capital adequacy is critical to the safety and soundness of a Bank. This is reflected in the predominance of global regulatory standards addressing capital adequacy for banks, as established by the Basel Committee for Banking Supervision.

2. Capital supports a Bank’s operation by providing a buffer to absorb losses from its activities and, in the event of problems, it enables the Bank to continue to operate in a sound and viable manner while the problems are resolved. Capital management must be an integral part of a Bank’s Credit Risk management process and must align the Bank’s risk tolerance and risk profile with its capacity to absorb losses.

3. This chapter of the BPG sets out the standards, guidance, parameters and norms required to comply with the rules in respect of the Capital Adequacy as well as capital management framework and governance, as specified in Chapter 4 of BBR. These elements convey the supervisory expectations of the AFSA on Capital Adequacy and on capital management framework and its governance. Compliance with the standards, methods, norms, parameters and guidance detailed in this chapter of BPG, both in letter and in spirit, is required to demonstrate fulfillment of the regulatory obligations specified in Chapter 4 of BBR. The AFSA will use these standards, norms and key elements specified here to assess compliance with BBR Rules on Capital Adequacy and capital management.

B. Capital Management

4. In respect of BBR Rule 4.3 (2), the risk tolerance of a Bank is usually defined as part of the Bank’s risk management strategy. The terms ‘risk tolerance’ and ‘risk appetite’ embrace all relevant definitions used by different institutions and supervisory authorities. These two terms are used interchangeably to describe both the absolute risks a Bank is open to take (which some call risk appetite) and the actual limits within its risk appetite that a Bank pursues (which some call risk tolerance).

5. If a Bank is a member of a Financial Group, the AFSA expects the capital of the Financial Group to be apportioned among its members, based on the risk profile of the Group.

6. In relation to BBR Rule 4.4 (3), a Bank’s Internal Capital Adequacy Assessment Process (ICAAP) is the process by which the Bank continuously demonstrates that it has implemented methods and procedures to ensure that it has adequate capital resources to support the nature and level of its risks. ICAAP is a critical component of the Pillar 2 process forming part of the Basel III framework for prudential regulation of banks.

7. For BBR Rule 4.14, retained earnings and other comprehensive income include appropriated profit or loss. Share premium is also known as stock surplus and constitutes additional paid-in capital. An example of disclosed reserve is the foreign currency translation reserve referred in chapter 6 of the BBR.

8. In relation to BBR Rule 4.20, Conversion or write-off under this Rule would be limited to the extent necessary to enable the AFSA to conclude that the Bank is viable without further conversion or write-off.

9. While addressing permitted adjustments to regulatory capital as defined in BBR Rule 4.28, any deferred tax liability that may be netted must be allocated pro rata between deferred tax assets under this Rule and those under the threshold deduction Rule. For the treatment of deferred tax assets that relate to temporary differences (for example, allowance for credit losses), BBR Rule

4.30 defines deductions from CET1 Capital.

C. Capital Conservation Buffers

10. This section provides additional guidance and examples for the purpose of complying with BBR Rule 4.31, in respect of Capital Conservation Buffer. In this respect, a payment made by a Bank that does not reduce its CET 1 capital is not a distribution for the purposes of this Part. Distributions include, for example, dividends, share buybacks and discretionary bonus payments.

Examples of application of table 4A

1.Assume that a Bank’s minimum CET 1 Capital ratio is 4.5% and an additional 2.5% Capital Conservation Buffer (which must be made up of CET 1 capital) is required for a total of 7% CET 1 Capital ratio. Based on Table 4A of BBR:

(a)If a Bank’s CET 1 Capital ratio is 4.5% or more but less than or equal to 5.125%, the Bank needs to conserve 100% of its earnings.

(b)If a Bank’s CET 1 Capital ratio is more than 5.125% but less than 5.75%, the Bank needs to conserve 80% of its earnings and must not distribute more than 20% of those earnings by way of dividends, share buybacks and discretionary bonus payments.

(c)A Bank with a CET 1 Capital ratio of more than 7% can distribute 100% of its earnings.

2.Earnings in respect of BBR Rule 4.32 means distributable profits calculated before deducting elements subject to the restrictions on distributions. Earnings must be calculated after notionally deducting the tax that wouldhave been payablehad none of the distributable items been paid. The effect of calculating earnings after tax is that the tax consequence of the distribution is reversed out.

3.For the purpose of BBR Rule 4.34, the following are examples of ways to reduce capitalby a bank:

(a)a share buyback or the redemption, repurchase or repayment of capital instruments issued by the Bank

(b)trading in the Bank’s own shares or capital instruments outside an arrangement agreed with the AFSA

(c)a special dividend.

D. Leverage Ratio

14. This section provides the guidance, method and parameters required for calculation of the Leverage Ratio of a Bank in compliance with the formula provided in BBR Rule 4.37.

15. The Exposure Measure under Rule 4.37 should be calculated as the sum of:

(a) on-balance sheet items; and

(b) off-balance sheet items.

16. In relation to on-balance sheet items:

(a) for securities financing transactions, the exposure value should be calculated in accordance with IFRS and the netting requirements referred in Rules on Credit Risk Mitigation in Chapter 5 of BBR;

(b) for Derivatives, including credit protection sold, the exposure value should be calculated as the sum of the on-balance sheet value in accordance with IFRS and an add-on for potential future exposure calculated in accordance with Rules on Credit Risk Mitigation in Chapter 5 of BBR; and

(c) for other on-balance sheet items, the exposure value should be calculated based on their balance sheet values in accordance with Rules in Chapter 5 of BBR.

17. In relation to off-balance sheet items:

(a) for commitments that are unconditionally cancellable at any time by the Bank without prior notice, the exposure value should be the notional amount for the item multiplied by a Credit Conversion Factor of 10%; and

(b) for other off-balance sheet items, including:

(i) direct credit substitutes;

(ii) certain transaction-related contingent items;

(iii) short-term self-liquidating trade-related contingent items and commitments to underwrite debt and equity securities;

(iv) note issuance facilities and revolving underwriting facilities;

(v) transactions, other than SFTs, involving the posting of securities held by the Bank as collateral;

(vi) asset sales with recourse, where the credit risk remains with the Bank;

(vii) other commitments with certain drawdown;

(viii) any other commitments; and

(ix) unsettled transactions,

the exposure value should be the notional amount for each of the items multiplied by a CCF of 100%.