APRA Publishes FAQ on Treatment of Rural Exposures in IRB Approach
APRA recently approved the acquisition of 86 400 by the National Australia Bank Limited, allowing the bank to hold a 100% stake in 86 400 Holdings Ltd and 86 400 Ltd, subject to the relevant scheme of arrangement between 86 400 Limited and its members receiving court approval under the Corporations Act. In another update, APRA answered a frequently asked question (FAQ) to clarify the treatment of rural exposures as commercial property and income-producing real estate by the internal ratings-based (IRB) authorized deposit-taking institutions. The regulatory requirements for the clarified treatment are part of the reporting standard on commercial property (ARS 230.0) and the prudential standard and guide (APS 113 and APG 113, respectively) on IRB approach to credit risk.
The instruction guide for the ARS 230.0 clarifies that rural exposures will generally not meet the definition of commercial property, unless the property has been acquired specifically for lease or resale and the servicing of the debt is dependent on such lease or resale (and/or the lease or resale of other properties). However, APRA considers that it would be appropriate to treat rural exposures as commercial property exposures where both of these conditions are met:
- the property has been acquired specifically for lease or resale,
- the servicing of the debt is dependent on such lease or resale
Where an internal ratings-based institution satisfies itself that the exposure can be appropriately serviced on a principal and interest basis over a commercial term, by looking through any lease arrangement to the underlying productive capacity of the rural land based on normal seasonal conditions, then it may consider that the second condition is not met and the exposure does not require classification as commercial property exposure for reporting purposes under ARS 230.0.
APG 113 paragraph 3(d) provides guidance on what constitutes income-producing real estate (as covered by APS 113 paragraph 43) and notes the primary dependence on cashflows generated by the property (generally through lease income or resale) for repayment of the obligation; it further considers that the distinguishing characteristic of income-producing real estate is that there is a strong correlation between the prospects of repayment and prospects for recovery in the event of default. Where an authorized institution considers a rural exposure in terms of the underlying productive capacity of the rural property, in many cases neither the primary dependence test nor the strong correlation test would be met. In these cases, the exposure need not be considered as income-producing real estate and could be risk-weighted under the advanced or foundation IRB approach rather than according to the slotting approach for specialized lending exposures. Given this distinction, APRA expects that these exposures and their respective valuations would be considered by an agricultural lending specialist team, rather than a commercial property specialist team, should any such teams be in place at the particular IRB authorized deposit-taking institution.
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Keywords: Asia Pacific, Australia, Banking, IRB Approach, Credit Risk, Reporting, National Australia Bank, 86400 Ltd, FAQ, CRE, Basel, Regulatory Capital, APRA
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