APRA updated a frequently asked question (FAQ), for authorized deposit-taking institutions, on the measurement of credit risk weighted assets. The answer specifies the appropriate credit conversion factor to be used in determining the regulatory capital for insurance standby letters of credit. An insurance standby letter of credit is issued by an authorized deposit-taking institution to an insurer whereby the authorized deposit-taking institution "guarantees" payment to the insurer in the event that the reinsurer defaults.
Paragraph 1 of Attachment B to the prudential Standard APS 112 (Capital Adequacy: Standardized Approach to Credit Risk) sets out the credit conversion factors to be applied to different categories of non-market-related off-balance sheet transactions under the standardized approach to credit risk. Paragraph 9 of the prudential practice guide APG 112 provides further guidance on the categorization of non-market-related off-balance sheet transactions. Insurance standby letters of credit fall into the category of "direct credit substitutes" (and, therefore, a 100% credit conversion factor is to be applied under the standardized approach). This is because the primary purpose of the letter of credit is to support the claims paying ability of the reinsurer, which is a monetary or financial obligation.
Under paragraph 27 of Attachment B to the prudential standard APS 113 (Capital Adequacy: Internal Ratings-based Approach to Credit Risk), authorized deposit-taking institutions using the Foundation IRB approach must generally apply the credit conversion factors in Attachment B to APS 112. Furthermore, under paragraph 31 of Attachment B to APS 113, products that are assigned a 100% credit conversion factor under the standardized approach are not eligible to be modeled by authorized deposit-taking institutions using the advanced IRB approach. As a result, APRA expects that all insurance standby letters of credit are to be assigned a credit conversion factor of 100%, irrespective of the approach taken by the issuing authorized deposit-taking institution, to determining regulatory capital requirements.
Keywords: Asia Pacific, Australia, Banking, Regulatory Capital, FAQ, Basel, Credit Risk, APS 112, APS 113, Credit Conversion Factor, APRA
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