In response to a request from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Royal Commission), the Australian Prudential Regulation Authority (APRA) has prepared this paper on the effect on an authorised deposit-taking institution’s (ADI) Tier 1 capital where a loan is classified as impaired, a provision is raised and enforcement action against the loan’s security is taken.
As outlined in the paper APRA previously provided to the Commission, The regulatory capital framework for authorised deposit-taking institutions (ADIs) (Background Paper 9), an ADI must hold regulatory capital against an exposure such as a loan, based on the risk associated with that exposure.
Where an ADI forms a view that it may not recover the full amount of money owed to it in a timely manner, a loan must be classified as impaired for regulatory capital purposes. In making this assessment, an ADI takes into account both the borrower’s likely repayments and the amount that it might recover through the sale of any security for the loan. Not all loans that become distressed or are past due in payments must be classified as impaired for regulatory capital purposes. For example, a borrower may be in arrears but, if the ADI has security sufficient to cover the amount of the loan, the loan will not be classified as impaired (but will be considered a non-performing loan). Conversely, a loan may be classified as impaired regardless of whether it is behind on payments if there are doubts about timely and complete repayment.