1. INTRODUCTION Basel II aims at creating a global standard for banking regulators around the world to control how much capital is needed to be left aside to guard against the types of financial and operational risks. Pillar 3 develops a set of disclosure requirements to allow market discipline to operate by requiring institutions to disclose details on the scope of application, capital, risk exposures, risk assessment processes and the capital adequacy of the institution (APRA, 2007). In this report, the disclosures made by the Big Four Australian banks (CBA, NAB, WBC and ANZ) and the Standard Chartered regarding the capital risk and securitization are examined. The first section of the report defines the capital risk and securitization; the second section examined the relevant prudential requirements; the third part compares and contrasts the Australian rules (APS 330) and the UK Rules (BIPRU) regarding capital and securitization. The fourth part evaluates the relative performance of all the banks under a carefully designed system, and the fifth part concludes the previous evaluation and makes pertinent recommendation to the banks that how their performances could be improved. This report has employed an analysis method to capture the true value of the quality of the public disclosures of the Banks. The data are derived from the banks’ public disclosures / financial report and also the analysis made by the analysts are supported by some scientific journal. As for any analysis, the resort to professional judgments based on the available information is unavoidable for certain aspects of the analysis. The judgments might be constrained by the availability of the information and also the lack of confidential information is also a limitation of the report. In addition, the report only focuses on the disclosures of capital and securitisation. Therefore, the depth of analysis has been restricted. 1 2. Key Definitions 2.1 Capital Risk For a financial institution, capital risk refers to the possibility where that financial institution is participating or holding investments that increase the risk of default and it does not have sufficient capital to sustain operating losses and honor withdrawals at the same time (Hirtle, 2003). APRA required ADI to maintain appropriate capital structure. It can be showed by the capital asset (leverage) ratio, πΏ= πΆπππ πππππ‘ππ π΄π π ππ‘π The lower this ratio is, the higher the capital risk is (Lange, Saunders, Anderson, Thomson & Cornett, 2007). For capital adequacy, in order to maintain an appropriate capital risk level, ADI have to maintain an appropriate level of capital for the type of activities they undertake (APRA, 2007). In measuring capital risk, bank’s weight-risk assets method is applied although this method is so complex. In this way the capital can be risk-adjusted. The measurement of capital risk is more reliable under this method. 2.2 Securitization Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation (CMOs), to various investors (APRA, 2007). The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS). The major forms of asset securitization are the pass-through security, the collateralized mortgage obligation (CMO, and the mortgage-backed bond (MBB). Also, although all three 2 forms of securitization originated in the lending market for residential housing, these techniques are also being applied to loans other than mortgages. For example, credit card, car loans, student loans, student loans and commercial and industrial (C&I) loans. Securitizations can be classified into 2 main sections (APRA, 2007): The first one is Traditional securitizations, where legal ownership of the underlying asset pool is transferred into a Special Purpose Vehicle (SPV), which finances the purchase by issuing debt instruments (notes) to investors, with principal and interest paid from realization of or regular cash flows from the assets. The SPV assets are insulated from bankruptcy of the seller or servicer. The second one is synthetic securitizations, where credit risk is transferred to a third party but legal ownership of the underlying assets remain with the originator e.g. by using credit derivatives or guarantees. 3 3. Relevant Prudential Standards 3.1 The prudential standards that apply to capital risk APRA determines PCRs (Prudential Capital Ratios) for Tier 1 and Total Capital at both Level 1 and Level 2 under its prudential standards APS 110. Eligible capital is defined by APS 111 Capital Adequacy: Measurement of Capital, and the RWA calculations are predominantly contained in APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk, APS 115 Capital Adequacy: Advanced Measurement Approach to Operational Risk, APS 116 Capital Adequacy: Market Risk and APS 117 Capital Adequacy: Interest Rate Risk in the Banking Book. All Australian banks' regulatory capital calculation is governed by APRA’s prudential standards which adopt a risk based capital assessment framework, based on the Basel II capital measurement standards (APRA, 2007). This risk-based approach requires eligible capital to be divided by total RWA, with the resultant ratio being used as a measure of an ADI’s capital adequacy. APRA determines Prudential Capital Ratios (PCRs) for Tier 1 and Total Capital, with capital as the numerator and RWAs as the denominator. The capital that the banks are required to hold by the APRA is determined by the banks’ balance sheet, offbalance sheet, counterparty and other risk exposures (APRA, 2007). It is required to inform APRA immediately of any potential breach or even breach of the minimum prudential capital adequacy requirement, which includes details of remedial action taken or planned to be taken. 3.2 The prudential standards that apply to securitization APS 120 is the key prudential standard that aims to ensure that authorized deposit-taking institutions (ADI) adopt prudential practices in managing the risks. And these risks are associated with securitization and that sufficient regulatory capital is held against the credit risk. The key requirements of APS 120 are that an authorized deposit-taking institution must (APRA, 2007): 1) To calculate regulatory capital by applying a standardized or internal ratings-based approach, depending on the approach it takes to general credit risk; 2) Do not provide implicit support to a securitization; 4 3) To stand clearly separate from a securitization, with the extent of the institution's obligations to the securitization set out in legal documentation; and 4) To make sure that there is clear disclosure that its involvement in a securitization does not extend beyond any specific undertakings to which it has formally committed itself. APRA requires the management of capital and risks associated with securitization activities and exposures to be set out in APRA prudential standard APS120 "Securitization" and prudential practice guide APS 120 "Securitization". APRA has policies and procedures to be compliant with the standard. The approaches employed are included with the ratings-based approach (RBA), which is a regulator that provides risk-weights that are matched to external credit ratings, and the internal assessment approach (IAA), which is almost the same as the RBA. The key requirement of APS120 is achieved through ensuring that the group (APRA, 2007): 1) Have to deal with the Special Purpose Vehicles (SPVs) and its investors in closest basis and on market terms and conditions 2) Have to discloses the nature and limitations of its involvement in a securitizations clearly 3) Have to aware the necessary precautions to make sure that the group does not give the precaution that it will support a securitization that is in excess of its explicit contractual obligations. An SPV has to be separated from and ADI clearly involved in the securitization under APS 120. The limitations governing the extent of an ADI’s involvement have to be showed clearly (APRA, 2007). Also, SPV must satisfy the following terms: 1) The SPV is a corporation, trust or other entity organized for a specific purpose 2) The aim of the SPV has to be defined clearly. The activities of the SPV must be limited to those necessary to achieve that target 3) The SPV has to be financially and operationally independent of the originating ADI. Securitizations can be consisted in many different ways. An ADI’s regulatory capital treatment of a securitization exposure has to be calculated on the basis of the exposure’s economic substance rather that its legal form. 5 3.3 Regulatory change In June 2011, APRA published a discussion paper regarding the implementation of Basel III capital reforms in Australia. The major propositions of the paper are increased capital deductions from Common Equity Tier 1 capital and higher capital targets with prescribed minimum capital buffers. It also holds that requirements regarding hybrid Tier 1 and Tier 2 securities should be further tightened. The expected effective date of these reforms should be around January 2013 (McNulty, 2011). The Basel Committee has made it clear that final proposals for contingent capital and measures to address systematic and inter-connected risks would be available by the end of 2012. 6 4. Disclosures of capital and securitization in Australia and UK Basel II Pillar 3 has a purpose to create an international standard for the development of regulation about how much capital banks need to put aside to guard its financial and operational risk. Basel II Pillar 3 recognises that market discipline has the potential to reinforce capital regulation and other supervisory efforts to encourage safety and soundness in banks and financial systems. Furthermore, market discipline enforces strong incentives on banks to run their business in a safe, sound and efficient manner. Basel II Pillar 3 doing that by requiring banks to disclose comprehensive information on their risk profile, capital adequacy, and risk assessment processes which will allow the market participants or investors to be able to evaluate its financial information (Vauhkonen, J., 2009). Market Participant or investors can reward banks that manage their risks prudently and penalise those banks that do not if they have a sufficient understanding of a bank’s activities and the controls it has in place to manage its exposures. In addition, the goal of Basel II Pillar 3 is to help protect the international financial system from the types of problems that might arise should a major or a series of banks collapse. Basel II Pillar 3 requires the banks to disclose their quantitative disclosures at least twice a year (or semi-annual basis). However, in regards to the qualitative disclosures, Banks are only required to disclose their qualitative disclosures once a year (or annual basis). The qualitative disclosures provide a summary of the general risk management objectives whereas the quantitative disclosures provide the risk exposure (in absolute terms and/or as a percentage of economic value) of the banks’ portfolio. Australian Prudential Regulation Authority (APRA) responsible for prudential regulation of Banks, ADIs, insurance companies and superannuation entities in Australia. In order to create a stable, efficient and competitive financial system, APRA established and enforced prudential standards and practices. APS 330 is one of the prudential standards that apply to all Australian Banks and any other authorised deposit-taking institutions (ADIs). All Banks and ADIs in Australia are required to make a disclosure report regarding their risk management practices and capital adequacy to enhance transparency in Australian financial markets. On the other hand, Financial Services Authority (FSA) is the regulator of the financial services industry in the United Kingdom (UK). It purports to maintain market confidence in the financial system, contribute to the protection and enhancement of stability 7 of the UK financial system, and secure the appropriate protection for consumers. Hence, FSA has the same purpose as APRA. GENPRU and BIPRU are 2 types of prudential standards applied in UK, but in this assignment, our main focus is only on BIPRU 11 as it talks about the minimum requirements for the public disclosure of the risk management practices and capital adequacy for UK banks (BIPRU is relevant for ADIs, more specific for the banks). Basically, most of the minimum requirements for the risk and securitisation exposures given by APS 330 and BIPRU 11 are the same. However, there are some major differences that make it does not apply to banks in UK. The table provided below will explain the differences of risk and securitisation exposure for banks in Australia compare to banks in UK. 4.1 Capital Structure Differences between APS 330 and BIPRU 11 APS 330 Applies to all locally incorporated ADIs. If ADIs is subsidiary of non-operating holding company (NOHC) requirement are met on level 2 basis where an ADIs have no authorised NOHC or extended licenced entity (ELE) must comply level 1 basis BIPRU 11 Firm which is neither a parent undertaking nor a subsidiary undertaking, excluded from UK consolidation group or non-EEA subs-group , group which has been granted investment firm consolidation waiver Qualitative disclosures Summary information on the terms and conditions of the main features of all capital instruments. The same as APS 330 plus BIPRU requires ADIs to provide the summary information of hybrid capital, and also redeemable capital instruments. Quantitative disclosures APS 330 only requires ADIs to separate disclosure of any positive items and deductions Application Does not require a Tier 1 deduction for certain capitalised expenses and net deferred tax assets BIPRU has a more favourable treatment for investments in associates and insurance and funds management subsidiaries 8 APS 330 does not mention about tier three capital resources in calculating the total capital In terms of RWA, APRA has set 20% floor on the downturn LGD for mortgages The total amount (capital) must be stated gross of deductions of tier two capital resources plus any innovative tier one capital resources AND tier three capital resources as compared with the 10% minimum set by the FSA FSA does not require IRRBB to be a Pillar I requirement so it is excluded from prudential capital adequacy ratios. Differences in the treatment of specialised property lending, equity and margin lending products 4.2 Capital Adequacy Differences between APS 330 and BIPRU 11 Application Qualitative disclosures Quantitative disclosures APS 330 Applies to all locally incorporated ADIs. If ADIs is subsidiary of non-operating holding company (NOHC) requirement are met on level 2 basis where an ADIs have no authorised NOHC or extended licenced entity (ELE) must comply level 1 basis BIPRU 11 Firm which is neither a parent undertaking nor a subsidiary undertaking, excluded from UK consolidation group or non-EEA subs-group , group which has been granted investment firm consolidation waiver Both APS 330 and BIPRU 11 have same qualitative disclosures APS 330 does not mention about the 8% of the risk weighted exposure amounts for each of the standardised credit risk exposure classes BIPRU 11 requires that firm when calculating their risk weighted exposure amounts in accordance with the standardised approach to credit risk, 8% of the risk weighted exposure amounts for each of the standardised credit risk exposure classes APS 330 only requires the firm capital requirements (in terms of risk-weighted assets) for credit risk in respect to standardised and IRB approach BIPRU 11 requires the firm's minimum capital requirements in respect of its trading-book business and all of its activities 9 APS 330 only mention requirements (in terms of risk-weighted assets) for equity exposures in the IRB approach (simple risk-weight method) For Equity Exposure, the requirements under BIPRU also applies to exchange traded exposures, private equity exposures in sufficiently diversified portfolio, exposures subject to supervisory transition regarding capital requirements, and exposures subject to grandfathering provisions regarding capital requirements 4.3 For securitisation Securitisation for both trading and banking book Application Qualitative disclosures Quantitative disclosures Differences between APS 330 and BIPRU 11 APS 330 BIPRU 11 Applies to all locally incorporated ADIs. If ADIs is Firm which is neither a parent subsidiary of non-operating holding company undertaking nor a subsidiary (NOHC) requirement are met on level 2 basis where undertaking, excluded from UK an ADIs have no authorised NOHC or extended consolidation group or non-EEA licenced entity (ELE) must comply level 1 basis subs-group , group which has been granted investment firm consolidation waiver APS 330 obliges the bank to discuss the regulatory capital approaches that are applicable to the ADI's securitisation activities BIPRU 11 does not mention the regulatory capital approaches stuffs. APS 330 does not discuss anything about the approaches to calculating risk weighted exposure amounts that the firm follows for its securitisation activities, including the types of securitisation exposures to which each approach applies BIPRU 11 requires the firms to discuss the approaches to calculating risk weighted exposure amounts that the firm follows for its securitisation activities, including the types of securitisation exposures to which each approach applies APS 330 does not require the ADI to discuss the amount of securitisation positions that have been risk weighted at 1250% or deducted BIPRU 11 also requires the firms to discuss the amount of securitisation positions that have been risk weighted at 1250% or deducted 10 For securitisation subject to the early amortisation treatment, the aggregate IRB capital charges incurred by the ADI against its retained (seller) shares of the drawn balances and undrawn lines While in BIPRU, the aggregate IRB capital charges incurred by the ADIs (firms) against its originator's interest 11 5. Evaluation of Disclosure Quality 5.1 Choices of disclosures and standards In order to obtain comprehensive information in the disclosures of the banks, only full disclosure reports are used in this report. Due to the discrepancies in the reporting dates, the report as of Dec 11 2011 will be used for Standard Chartered; the report as of 30 June 2011 will be used for CBA; and the reports as of 30 September 2011 will be used for ANZ, WBC and NAB. As the reports of all the Australian banks were released before 2012, it would not be proper to use the APS 330 of 2007. Hence the APS 330 of 2007 will be taken as the standards. As for the BIPRU, it would be appropriate to use the 2010 version. 5.2 Capital In order to enable meaningful comparisons among banks in terms of the disclosure quality regarding capital risk, a systematic grading system has to be in place. Notably, there are some minor inconsistencies between the Australian and UK standards. However, the Australian rules are more stringent (as argued above) and hence the standards of marking are largely derived from the requirements specified in APS 330. The banks have nonetheless developed some other user-friendly disclosure practices, and it is of crucial importance to include those practices in the standards of marking so as to improve the usefulness of the comparison. For every criterion, the performance of each bank would be marked out of 10. 5.2.1 Capital Structure Criteria NAB ANZ Marks without adjustment WBC CBA Standard Chartered Qualitative Disclosures of Capital Structure Other Related Prudential Standard 9 10 0 0 0 5 7 4 6 7 Features of all Capital Instruments Tier 1 Capital 12 Tier 2 Capital Subtotal Explanation of capital movement 3 3 2 2 2 8 10 6 8 9 0 0 0 10 0 Quantitative Disclosures of Capital Structure Separate Disclosures of Tier 1 Capital 10 10 10 10 10 Separate Disclosures of Tier 2 Capital 10 10 10 10 10 Total Capital Base 10 10 10 10 10 5.2.1.1 Qualitative Disclosure ο· According to (a) of Table 2, all the main features of the Tier 1 capital and Tier 2 capital shall be described in a concise but in-depth manner. As Tier 1 capital is much more important than Tier 2 capital in terms of capital adequacy requirements, the disclosure of Tier 1 and Tier 2 capital would be worth 7 marks and 3 marks, respectively ο Discussion of Tier 1 capital should include the explanation of the terms and conditions of fundamental capital, residual capital and Tier 1 deductions. Standard Chartered has impressively provided both verbal and tabular explanations regarding each component of Tier 1 capital, and hence full marks shall be granted. The performances of the Australian banks vary. CBA’s practices are highly similar to those of Standard Charter’s. However, most of the information is provided in the appendix, which might compromise some user-friendliness, and therefore 6 marks are granted to CBA. ANZ has provided more useful information than CBA and Standard Chartered. For example, ANZ has not only explained the adjustment items which APRA does not allow as regulatory capital but also provided details regarding each individual component in the Appendix. With regard to residual capital, disclosures provided by ANZ have informed the investors about all the terms and conditions of hybrid Tier 1 capital items. With respect to Tier 1 deduction, ANZ is the only Australian bank that enumerates the relation between its reported figures and relevant prudential requirements. ANZ’s disclosure deserves full marks. 13 With respect to NAB, despite the fact that its disclosures regarding residual capital are largely satisfactory (it achieves this by adopting a similar approach to that of ANZ), the usefulness and completeness of the information supplied by NAB is far from sufficient, which gives NAB 5 out of 7. Westpac only offers a table in the appendix where all the features of Tier 1 capital instruments are listed. The absence of necessary explanations makes Westpac the worst performer, 4 out of 7. ο Discussion of Tier 2 capital should include the explanation of the terms and conditions of Upper Tier 2 and Lower Tier 2 capital. ANZ and NAB have supplied detailed information regarding both the Upper and Lower Tier 2 capital. Specifically, both banks have mentioned the history of the instruments, the status quo and future prospects. The comprehensiveness of the information makes them eligible for full marks in this aspect. Comparatively speaking, the disclosure of CBA, Westpac and Standard Charter appear to be unduly general as only the present features are illustrated in tables. Therefore, their performances are rated as 2 out of 3 marks. ο· Users of the disclosures, especially the unsophisticated investors, would obtain clearer understanding of the concepts regarding capital adequacy if the relevant prudential standards were quoted (Bushman, Gigler & Indjejikian, 1996). ANZ and NAB have done so, but ANZ’s disclosure in this respect is in a more comprehensive manner. WBC, CBA and Standard Chartered did not consider quotation of relevant prudential standards. Therefore ANZ achieves full marks in this case and NAB seconds to it (9 out of 10), while the rest of the banks obtain 0. ο· It would be beneficial if report users are provided with the information regarding the capital movement throughout the financial year. Diaz and Harchaoui (1997) argues that both stock and flow measures are of crucial importance in determining whether a financial institution is duly capitalized or not. The knowledge of the capital movements enables investors to gage the present and future performance of banks. CBA is the only bank that attempted to explain significant initiative to manage its 14 capital. None of the other banks have treaded CBA’s path and hence they are not entitled to any marks. It would be reasonable to reward CBA with full marks. 5.2.1.2 Quantitative disclosure ο· The quantitative disclosures of the five banks, (b), (c), (d) of Table 2, are in line with the requirements specified by APS 330. Notably, with regard to (c), all the banks have not only disclosed the total amount of Tier 2 capital but also each component of Tier 2 capital. In light of these facts, all the banks should be granted full marks for the quantitative disclosures in regards to capital structure. 5.2.2 Capital Adequacy Marks without adjustment NAB ANZ WBC CBA Standard Chartered Criteria Qualitative Disclosures of Capital Adequacy Discussion of the Approach Key Objectives of the approach 5 5 3 0 5 Description of assessment processes 5 5 5 0 5 Explanation of the changes in RWA and Capital Position 0 10 0 10 0 Subtotal 10 20 8 10 10 Quantitative Disclosures of Capital Adequacy RWA for Credit Risk 10 10 10 10 10 RWA for Equity Exposures 10 10 10 10 10 RWA for Market Risk 7 7 7 7 7 RWA for Operational Risk 7 7 7 7 7 RWA for Interest Rate Risk Total and Tier 1 Capital Ratio 10 10 10 10 10 Consolidated Group 5 5 5 5 5 Significant Subsidiaries 5 5 5 5 0 Other Disclosures 0 10 0 0 10 0 10 0 0 10 International Comparison Impacts of Basel III 15 5.2.2.1Qualitative Disclosure ο· The ADI’s approach to assessing the adequacy of its capital to support current and future activities shall be specified. The objectives and processes of the approach are two important aspects to assess the ADI’s approach to the maintenance of capital. Hence each aspect should have 5 marks. ο Report users ought to be informed about the objectives of capital management. Wu and Bowe (2010) that regulatory compliance is only one of the objectives, and that there are usually other objectives that are crucial for the prosperity of the bank and the maximization of shareholders’ value. ANZ, NAB and Standard Chartered have identified several other salient objectives, especially the maintenance of credit ratings. Westpac’s objective statement is less specific and more general. Therefore ANZ, NAB and Standard Chartered gain full marks; WBC gets 3 out of 5. Whereas CBA does not even bother to make its investors aware of its other objectives of capital retention, depriving itself of all the marks related to this aspect. ο Delineation of the internal capital adequacy processes could provide investors with strong assurance that proper corporate governance practices are in place to ensure that banks are well capitalized. All the banks, with the exception of CBA, have elaborated the relevant processes, with a strong emphasis on stress testing. NAB is exemplary in this aspect as in addition to the comprehensive discussions of the ICAAP processes, it also illustrates the interaction between the processes and other vital functions of the company (eg the Group Treasury). ο· Explanations of changes in the RWA and capital position of the banks assist report users in understanding the bank’s performance in terms of capital preservation. CBA and ANZ are the only two banks that provide detailed explanations of this ilk. 16 5.2.2.2 Quantitative disclosure ο· All the banks have fully complied with (b), (c), and (f) of Table 3. ο· With respect to (g) of Table 3, the four Australian banks have disclosed total and Tier 1 capital ratio for the consolidated group and their subsidiaries. That Standard Chartered did not include the computation of total and Tier 1 capital ratio for each overseas bank subsidiary arises from the fact that the practice is simply not ignored under the BIPRU. However, the practicality of the disclosures would decline in absence of this information. ο· (d) & (f) of capital adequacy require the calculations of RWA to be broken down into two components: RWA under the standard method and IMA (AMA for operational risk). Despite the banks have provided the total RWA for market risk and operational risk, no break-downs of the RWAs have been provided. All the banks get 7 out of 10. 5.2.2.3 Other disclosures ο· In the highly integrated financial markets, it provides great insight to the report user if a bank compares its capital-adequacy position of the bank against financial institutions elsewhere. Both CBA and ANZ have evaluated themselves under the UK rules set by FSA. The other two Australian banks, along with the Standard Charter, have yet appreciated the necessity of this comparison. Henceforth, CBA and ANZ shall be granted full marks and all the rest banks should be punished for ignoring doing so. ο· The impacts of the Basel III (which is expected to be adopted in 2012) upon the capital-adequacy positions of the banks shall be estimated as precisely as possible. Under Basel III, several reforms are expected to take place: capital deductions from Common Equity Tier 1 capital would increase; capital targets with prescribed minimum capital buffers would go up; and requirements around hybrid Tier 1 and Tier 2 securities would tighten. Despite the fact that all the five banks are aware of the strong impacts of Basel III, only ANZ have determined to carry out a detailed quantitative assessment while Standard Chartered has conducted a less comprehensive analysis (largely due to the uncertainties relating to how Basel III will be 17 implemented in UK). The forward-looking approach adopted ANZ offers great privilege to the report users as they are in a better position to make future decisions. The reluctance of other four banks to implement similar analysis might negatively affect the practicality of the disclosures. 18 5.2.3 Assignment of weightage to each standard The above marking standards make little pragmatic sense if the importance of each standard is regarded as equal. Apparently, the more important standards in regards to capital requirements are the quantitative standards specified in Table 2 and 3 in APS 330 as they straightaway leads to the capital adequacy ratios. Therefore more weight shall be allocated to the prescribed quantitative requirements. Along with the quantitative standards, several other factors must also be taken into account to determine the exact weight of each element in the marking system. The following is dedicated to the discussion of the weightage assigned to each standard and the rationale behind the allocation method. Weight Adjusted Marks Criteria Weight NAB ANZ WBC CBA Standard Chartered Qualitative Disclosures of Capital Structure Other Related Prudential Standard Features of all Capital Instruments Tier 1 Capital Tier 2 Capital Explanation of capital movement 2% 0.18 0.2 0 0 0 4% 0.2 0.28 0.16 0.24 0.28 2% 0.06 0.06 0.04 0.04 0.04 2% 0 0 0 0.2 0 Quantitative Disclosures of Capital Structure Separate Disclosures of Tier 1 Capital Separate Disclosures of Tier 2 Capital 20% 2 2 2 2 2 10% 1 1 1 1 1 Qualitative Disclosures of Capital Adequacy Discussion of the Approach Key Objectives of 2% 0.1 0.1 0.06 0 the approach Description of assessment 6% 0.3 0.3 0.3 0 processes Explanation of the changes in RWA and 2% 0 0 0 0.2 Capital Position Quantitative Disclosures of Capital Adequacy RWA for Credit Risk 15% 1.5 1.5 1.5 1.5 0.1 0.3 0 1.5 19 RWA for Equity Exposures 3.75% 0.375 0.375 0.375 0.375 0.38 RWA for Market Risk 3.75% 0.2625 0.2625 0.2625 0.2625 0.26 RWA for Operational Risk RWA for Interest Rate Risk Total and Tier 1 Capital Ratio Consolidated Group Significant Subsidiaries 3.75% 0.2625 0.2625 0.2625 0.2625 0.26 3.75% 0.375 0.375 0.375 0.375 0.38 5% 0.25 0.25 0.25 0.25 0.25 5% 0.25 0.25 0.25 0.25 0 Other Disclosures International Comparison 5% 0 0.5 0 0.5 0 Impacts of Basel III 5% 0 0.5 0 0 0.5 7.115 8.215 6.835 7.455 7.245 Total Mark First of all, interpretations of the main features of each component of capital instrument are prerequisite for the quantitative data to be meaningful. Therefore it would be reasonable to attach 2% to the citation of relevant prudential standards as it would assist the report users in their understanding of the concept of capital in general. 6% should be allocated to (a) of Table 2 since the disclosure of the terms and conditions of all capital instruments of a bank would raise the awareness of report users about the bank’s capital position. Explanations of changes in the Tier 1 and Tier 2 capital can help the report users to appreciate the trend of the capital position of the bank and hence a weightage of 2% shall be allocated. Secondly, a concise discussion of the ADI’s internal adequacy assessment could provide insightful information whether the current capital position of a bank is sustainable or not. The discussion could usually be categorized into two parts: the objectives of the assessment and the processes to achieve the objectives. A weightage of 2% is assigned to the former and 6% goes to the latter. Explanations of changes in capital-adequacy position are also relevant as it allows report users to be informed about the rationale behind the ups and downs of the ratios. Thus a weightage of 2% is assigned to this standard. 20 Thirdly, as international comparisons become increasingly relevant under the current globalized context, it would be grounded to assign a weightage of 5% to the related standard. The fact that Basel III would soon replace the current Basel II requirements should propel banks to reconsider its capital position and hence another 5% of weightage is granted to the standard concerning the qualitative and quantitative assessment of the impact of the adoption of Basel III on the banks’ capital positions. In addition, a reliable capital adequacy ratio would entail precise calculations of Tier 1 and 2 capital and the risk weighted assets. The numerator (capital) and the denominator (RWA) should be of equal significance to report users. With regard to the numerator, more focus shall be directed towards Tier 1 capital rather than Tier 2 capital (Elghanayan, 2010). Thus a weightage of 20% shall be assigned to the quantitative standard regarding Tier 1 Capital and the rest 10% goes to the standard concerning Tier 2 capital. With regard to the denominator, the fact that there are several risks affecting RWA adds complication to the matter. According to Williams (2004), the ability to manage credit risk is most essential to the survival of a bank. Therefore it would be logical if a weightage of 15% goes to the standard relating to RWA for credit risk. In regards to the other four standards concerning the RWA for other risks, each of them is assigned a weightage of 3.75%. Least but not last, the disclosure of total and Tier 1 capital ratio for the consolidated group and each significant subsidiary is of particular use. The fact that the group as a whole satisfies capital adequacy requirement is no guarantee that its subsidiaries are in the same healthy state. Hence, a weightage of 5% shall be assigned to the standard relating to the subsidiary and the rest will go to the standard in relation to the consolidated group. 5.2.4 Interpretation of the results Based on the marking standards and the weightage allocation criteria, the results regarding the quality of the disclosure of capital-adequacy positions are as follows. ANZ’s disclosure enjoys the highest quality whereas the disclosure provided by WBC is of the lowest quality. CBA has the second highest disclosure quality, followed by the Standard Chartered. NAB’s disclosure regarding its capital position is slightly better than the worst performer, Westpac. 21 Given the fact that the prescribed quantitative disclosures made by most banks are satisfactory, the ranking of the disclosure quality is largely ascribed to three exceptional reporting practices: ο BIPRU does not require banks to compute and disclose the Tier 1 and Total capital ratios for its significant subsidiaries; ο ANZ and CBA have supplied information to establish their capital-adequacy position under the BIPRU regulations; ο ANZ and the Standard Chartered have conducted qualitative and quantitative assessment of the impacts of the adoption of Basel III upon its capital position. With regard to the first practice, it is not conducive to the improvement of disclosure quality. Bryan (1991) argue that some disastrous banking crisis occur when the capital adequacy positions of its subsidiaries are deteriorated. Therefore it is important to closely monitor the performance of both the consolidated group and each significant subsidiary under the same rules. Standard Chartered has shown some efforts in the monitoring activities as it has disclosed the separate components of Tier 1 and Tier2 capital under the current UK rules. However, the work is not completed as the RWA for various risks are not calculated, which makes the computation of the ratios impossible. One interesting point is that APRA has explicitly required ADIs to disclose the capital ratios of their subsidiaries. The more stringent Australian standards have, in this case, led to higher disclosure quality. The second practice has facilitated comparisons of the performances of banks in different jurisdictions. At present, despite the wide acceptance of Basel II, the regulatory requirements are not harmonized. The relative capital strength of banks cannot be determined by directly comparing the capital adequacy ratios since different jurisdictions might have different definitions and requirements for capital and RWA. For example, it would be short of legitimacy if the capital adequacy ratios between ANZ and the Standard Chartered are directly contrasted, in that a number of features of APRA’s implementation of Basel II have the effect of making key capital adequacy ratios appear lower than would be the case if they were calculated under UK rules. Considering the inconsistencies between standards, ANZ and CBA have computed 22 capital ratios as if UK rules applied. The failure of other banks to follow the practice undermines the comparability of their disclosures. The third practice, adopted by the Standard Chartered, is exemplary. Only ANZ has taken a similar approach and the rest Australian banks do not even touch the issue. The practice contains both qualitative and quantitative elements. The Standard Chartered has quantified the likely impacts of the adoption of Basel III on the Core Tier 1 capital ratio. It does not extend the quantitative analysis further on the account of some pending uncertainties in relation to the actual implementation of Basel III. In contrast, ANZ’s analysis is much more detailed given the availability of the discussion paper concerning the new practices under Basel III published by APRA. The other Australian banks made the choice to ignore the future yet certain changes and this myopia has led to heavy discount of its disclosure quality. 5.2.5 Recommendations Under the marking system discussed above, there are some short-cuts to increase the marks of each bank so as to improve the disclosure quality. ο As for the Standard Chartered, by disclosing the Tier 1 and total capital ratios of its significant subsidiaries, it would be able to gain 0.25 marks. By enumerating its position as if other international rules applied (for example, the APS 330 by APRA), it would gain another 0.5 marks. ο With regard to WBC and NAB, they could have gained one extra mark if the last two exceptional practices were adopted. ο Had the impacts of Basel III been evaluated, CBA would have obtained another 0.5 marks. Besides the short-cuts discussed above, there are some other details which, though minor, would contribute to the making of more informative disclosures: ο WBC, CBA and Standard Chartered could mention the relevant prudential standards regarding capital adequacy; ο More detailed explications could be made in regards to Tier 1 and 2 capital by NAB, WBC and CBA; ο NAB, WBC, ANZ and the Standard Chartered shall explain the events that caused changes to the Tier 1 and 2 Capital, the RWA and the capital ratios. 23 5.3. Securitisation exposures As we are analysing the 2011 disclosure reports, the document regarding Basel II pillar 3 is APS330 of 2007 since the current APS 330 was not effective at that time. Criteria NAB Marks without adjustment Standard ANZ WBC CBA Chartered Qualitative Disclosures of Securitisation General Qualitative Disclosure Requirements Objectives Transfer of Credit Risk The roles Regulatory Approach Accounting Policies Treatment of transaction Recognition of gain on sale Method and key assumption The ECAI's name 8 0 10 0 8 0 10 0 10 10 10 0 10 0 10 10 10 10 10 0 5 7.5 2.5 2.5 5 10 10 0 0 10 10 10 0 10 10 0 5 0 0 5 5 5 5 5 5 Quantitative Disclosures of Securitisation Total Outstanding Exposures 10 10 10 10 5 Underlying Exposures Originated by ADI 10 10 10 10 0 Exposure Type 8 8 10 8 0 Risk Weight Bands 8 8 10 8 5 Securitisations subject to the early amortisation treatment 10 10 10 10 10 Summary of the current year's securitisation activity 10 10 10 10 10 Aggregate Amount of Securitisation Exposure 24 5.3.1 Qualitative disclosures ο· Based on (a) of Table 9, ADIs should discuss their objectives in relation to securitization activities, which aids report users to conduct a meaningful analysis of the bank’s business model with regard to securitization. Specifically, banks should disclose the objectives of the activities undertaken during the current year. This should enable a better understanding of the quantitative disclosures provided for the current activities. Investors could then evaluate whether the objectives have been achieved or not. For this disclosure, NAB and Standard Chartered have briefly demonstrated their objectives while WBC lists the objectives and explains them in great detail. Hence WBC would be granted 10 marks whereas NAB and Standard Chartered only get 8 out of 10. CBA and ANZ have not expressed any objectives in relation to securitization and hence they should get nil. ο· The extent to which securitization activities transfer credit risk of the underlying securitised exposures away from the ADI to other entities should be explicitly made clear. This disclosure aims at provision of meaningful and relevant data related to the bank’s business strategies and plans for the securitisation activities. This disclosure would permit investors to better appreciate the risk profile of the banks. ANZ, CBA and Standard Chartered have explicitly addressed this issue while NAB and WBC failed to do so. Therefore the former three banks are rewarded with full marks and the latter two get zero. ο· ADI should disclose the nature of roles they have played in the securitization process. NAB and WBC listed those roles and explained in detail. Although Standard Chartered lists a few roles, the lack of further explanation makes its disclosure insufficient. CBA and ANZ have largely ignored the descriptions of the major roles in their securitization processes and hence they should obtain zero. ο· The regulatory approaches that are applicable to the ADI’s securitisation activities are required to be disclosed. All Australian banks have made it clear that they have adopted the IRB approach to determine the regulatory capital charge. In this sense, they shall be assigned full marks. Notably, Standard Chartered has not made any 25 regarding this aspect. This is largely due to the absence of this requirement in the UK standards, and thus Standard Chartered shall not get any marks. ο· (b) of Table 9 aims to provide a more detailed explanation for the accounting policies used in respect of securitisation. The terms and conditions of products of securitizations are always complicated in nature and there are a number of different ways to treat them. Therefore by making the relevant accounting policies clear, bank could increase the comparability of their disclosures in regards to securitization products. Three standards are of particular importance in ensuring the quality of this disclosure. ο Banks have to state the guidelines to classify transactions in securitizations activities. When the balance sheet of the SPV has to be consolidated with that of the banks, any transfer of the assets would be treated as financing. And the other circumstances the transfer of the assets would be largely treated as sales. Therefore, the consolidation guidelines are relevant in this case. ANZ has adopted AASB 112 as the basis to determine when consolidation is required. Standard Chartered has also used the control principle to guide the consolidation activities. The rest of the banks did not inform the report uses of this issue. Only NAB has provided substantial guidelines on what transactions should be treated as sales and what transactions should be treated as financing. The rest of the banks remain silent on this issue. Therefore, NAB, ANZ and Standard Chartered should have full marks while the rest get zero. ο For the recognition of gain on sales, it is also related to the consolidation principles and hence NAB, ANZ, CBA and Standard Chartered have provided rough principles but not in a comprehensive manner. Westpac has largely skipped this issue. ο The key assumptions for valuing securitizations, including significant changes have to be disclosed. This serves as an important resource to investors as it enables them to carry out fundamental analysis of the banks. ANZ and Standard Chartered have mentioned about the principal assumptions but they have not provided any information regarding the changes. It is probable that 26 no such changes have occurred. However, they should have made this clear even if this were the case. This lack of responsibility in report will make them lose half of the marks (5 out of 10). The fact that the rest of the banks totally ignored this point deprives them of all the marks. ο· Based on (c) of Table 9, the name of the External Credit Assessment Institutions (ECAIs) used for securitisations and the types of exposure for which each agency is used ought to be disclosed. This provides report-users, especially stakeholders, assurance about the credit-worthiness of the securitization products. All the banks have made it clear that S&P, Moody and Fitch are employed to rate the securitization products but no further details are supplied to enable the specific duties that have been carried out by each rating agency. Hence, all of the banks are only entitled to half of the marks. 5.3.2 Quantitative disclosureο Basically, all the major banks in Australia have complied with the requirements given by APS 330. On the other hand, Standard Chartered did not mention some of the requirements given by APS 330 because the rules they have followed are different (BIPRU 11). According to the APS 330, there are seven major requirements that ADIs must disclose. Each bullet point below would constitute a standard, which is worth 10 marks. The full compliance with a standard would gain 10 marks for the bank. ο· All the banks should have disclosed the total outstanding exposures of securitisations that are subject to the securitisation framework and they have to break it down into two parts; traditional and synthetic securitisation. In addition, they should also disclose it separately for securitisation of third-party exposures for which the ADI acts only as originator. All the major banks in Australia have disclosed their total outstanding exposures and they separate this with the other securitisation where they only act as originator. Therefore, all the major banks in Australian gain full marks. However, Standard Chartered has broken down the total amount of exposure securitised into 27 traditional and synthetic securitisations, but they did not do the same thing for the total amount outstanding. Therefore, Standard Chartered gets 5 out of 10. ο· For the exposures securitised by the ADI, the amount of impaired/past due assets and losses recognised by the ADI during the current period must be broken down by exposure type. Standard Chartered is the only bank that did not mention anything about this part, which gives Standard Chartered 0 whereas the rest of the banks have satisfied this requirement and hence all of them obtain full mark. ο· APS 330 requires the banks to provide the aggregate amount of securitisation exposure. For example, liquidity facilities, derivatives transactions, holding of securities, and etc. Westpac has provided more information than the other banks, for example, they mentioned the total amount of the liquidity facilities in regards of the originated assets, credit portfolio management, provision of services, and total exposure at default. The comprehensive information given by Westpac makes them entitled to full marks. Despite the fact that ANZ, NAB, and CBA have also provided the aggregate amount of securitisation exposure, their information is not as complete as Westpac. Therefore, these three banks receive 8 out of 10 for each. In addition, Standard Chartered did not even bother to provide the aggregate amount of securitisation exposure. ο· Banks are also obliged by APS 330 to provide the aggregate amount of securitisation exposures and the associated IRB capital charges for these exposures, and then further broken down into number of risk weight bands. If the banks comply with this requirement, they will be given 5 marks. Furthermore, banks must disclose the securitisation exposures deducted from tier 1 capital and other exposures deducted from total capital, by mentioning this part, each bank is entitled to 5 marks. Westpac has been successful to provide more information regarding the IRB and the deduction than the other banks have given; therefore Westpac is able to able to get full marks. For the rest three major banks in Australia, even though they have already mentioned this part, they still did not provide complete information like Westpac did. 28 Therefore, NAB, ANZ, and CBA only manage to get 8 out of 10. With regard to the aggregate amount of securitisation exposures and the associated IRB capital charges for these exposures, Standard Chartered has obeyed this APS 330 requirement. However, Standard Chartered missed out to disclose the deduction from tier 1 capital. As a result of ignoring that requirement, 5 marks will be taken out of them. ο· Regarding the securitisation subject to early amortisation, all of the major banks in Australia have mentioned this part even though none of these securitisations undertaken by them. They should be granted full marks by doing so. On the other hand, this part has been ignored by Standard Chartered, hence they receive nil. ο· Summary of current period’s securitisation activity must be provided by all of the banks, because it would be easier for sophisticated and unsophisticated investor to assess the quality of quantitative disclosure of a bank, if the banks lump all the securitisation activities together (for example, the total amount exposures securitised, and recognised gain or loss on sale by exposure type) in one table. Since all the banks have provided the summary, 10 out of 10 should be awarded to them. 29 5.3.3 Assignment of weightage to each standard Criteria Weight NAB Marks without adjustment ANZ WBA CBA Standard Chartered Qualitative Disclosures of Securitisation General Qualitative Objectives Transfer of Credit Risk The roles Regulatory Approach Accounting Policies Treatment of transaction Recognition of gain Method and key assumption The ECAI's name 5% 0.4 0 0.5 0 0.4 10% 0 1 0 1 1 4% 0.4 0 0.4 0 0.4 5% 0.5 0.5 0 0 0.5 10% 1 1 0 0 1 10% 1 1 0 1 1 8% 0 0.4 0 0 0.4 8% 0.4 0.4 0.4 0.4 0.4 Quantitative Disclosures of Securitisation Total Outstanding Exposures Underlying Exposures Originated by ADI Aggregate Amount of Securitisation Exposure Exposure Type Risk Weight Bands Securitisations subject to the early amortisation treatment Summary of the current year's securitisation activity Total Mark 7% 0.7 0.7 0.7 0.7 0.35 4% 0.4 0.4 0.4 0.4 0 7% 7% 0.56 0.56 0.56 0.56 0.7 0.7 0.56 0.56 0 0.35 5% 0.5 0.5 0.5 0.5 0.5 10% 1 1 1 1 1 7.42 8.02 5.3 6.12 7.3 The reason why weightage is assigned to each standard above is provided in the discussion of the capital risk. First of all, a concise discussion about the ADI’s objectives in relation to securitisation activity could provide insightful information and help investors to evaluate whether the ADIs have achieved the objectives or not. Therefore, it would be reasonable to attach 5% if the ADIs provide their objectives. In addition, the extent to which the securitisation activities transfer credit risk of the underlying exposures away from the ADI to other entities would be another important thing that must be disclosed by ADI and hence 10% should be allocated to this part. The roles played by 30 ADI and the regulatory capital approaches that are applicable to the ADI’s securitisation activities could be allocated 4% and 5%, respectively. Secondly, summary of the ADI’s accounting policies for securitisation activities are also shall be discussed in a comprehensive manner. Both treatment of the transactions and recognition of gain on sale are heavily related to the consolidation. Therefore, 10% weightage shall be allocated for each of this part. Furthermore, method and key assumption for the accounting standards must be disclosed because by disclosing the method they have been using, investors can have a better understanding about the quality of the disclosures. Thus a weightage of 8% is assigned to this standard. Thirdly, ADIs must disclose their total amount of outstanding exposures securitised and it must be broken down into traditional and synthetic securitisation. In addition, ADIs should separate the securitisations of third party exposure if they act only as a sponsor or originator. ADI’s shall do this in a comprehensive manner so that investor would not get confused. ADI’s would be granted 7% in regard to this part. Fourthly, ADIs also need to mention all the underlying exposures originated by them with regard to the total amount of impaired/past due assets, and also the total amount of losses recognised by ADI. The fact that ADIs might be experiencing none of these does not mean that they should not disclose this. Therefore, it would be reasonable to attach 7% regarding this part. Fifthly, exposure types reveal important information regarding the risk profile of the banks. For example, if a bank has unduly huge exposures to a certain type of product. It might not carry an efficient portfolio and diversification benefits are not fully exploited. Therefore, it is crucial for the investor to know the banks’ exposure types so that they have a better understanding about the bank’s risk profile. Sixthly, there are two strands for (g) of table 9, the first strand concerns about the breaking down of securitisation exposures into meaningful number of risk weight bands. This is consistent with the regulatory capital approach as different securitisation exposures should have different risk attributes. The second strand also fits into the regulatory system in a sense that the exposures that reduce tier 1 capital 31 should be of particular concern to report users given the predominant role that tier 1 capital plays in Basel II. Therefore, the weight of this standard is higher than the rest of the standards. In addition, the summary is effectively equivalent to profit and loss statement of the securitisation activities undertaken by the bank. It informs report users about the profitability of the securitisation and therefore this has the largest weight among the other standards (10%). The rest of the weightage will go to the discussion for the securitisation subject to early amortisation treatment, as practically none of the banks undertake this kind of securities. 5.3.4. Interpretation of the resultο Based on the marking standards and the weightage allocation criteria, the results regarding the quality of the disclosure are as follows; from highest to lowest: ANZ 8.02, NAB 7.42, Standard Chartered 7.3, CBA 6.12 and WBC 5.3. According to our marking method, ANZ has the highest quality disclosure. NAB and Standard Chartered got similar marks and show that the have similar quality of disclosure. By the way, the mark of CBA is much lower than the top three. The lowest is WBC, which is also much lower than the top three even CBA. One notable exceptional reporting with the Standard Chartered is that as BIPRU does not require banks to disclose exposures that have been deducted from Tier 1 Capital, it omits this information in its disclosures. This practice is not consistent with the underlying rationale of the Basel II. Any event that would materially affect Tier 1 capital shall be disclosed. APRA, on the other hand, has appreciated the significance of this requirement. As a result, all the Australian banks have superior disclosure quality to the Standard Chartered in this aspect. Another key area of exceptional reporting is that three out of five banks (namely NAB, WBC and CBA) declined to provide principal assumptions regarding the key assumptions in the valuation of positions in securitization disclosure. Despite the fact that most of the details could be found in the accounting policies of the derivatives in 32 the financial statement, the reluctance to present key assumptions seriously undermine the usefulness of the disclosures in the sense that the securitization activities of banks would not be directly comparable with the absence of valuation technique. That the extent to which securitization transfers credit risk away from the ADI to other entities is illustrated in a blurred manner raises doubts about the fundamentals of the securitization activities. Credit risk should be the predominant concern for report users in assessing the risks associated with securitization. Different activities would affect the transfer of credit risk in a different manner. All the banks examined (including those which have obtained high marks) refused to analyse the credit risk in relation to each major securitization exposures. 5.3.5. Recommendationο To improve the disclosure quality, there are some short-cuts that could be used. ο With regard to NAB and WBC, if they can include the extent to the securitisation activities, they are able to gain 1 more mark. ο For the treatment of transaction, if WBC and CBA can show that the transaction is sales or financing, they are able to gain 1 more mark too. ο For WBC, it is better that WBC states the recognition of gain on sale in the report. Then it would be able to get 1 more mark. Besides the short-cuts discussed above, there are some other details which, though minor, would contribute to the making of more informative disclosures: ο With regard to Standard Chartered, by disclosing underlying exposures that have been deducted from Tier 1 Capital, It would be able to gain 0.7 marks. Furthermore, by disclosing the aggregate amount of securitisation exposure broken down by exposure type, 0.4 marks could be added for Standard Chartered. ο With regard to WBC and CBA, if they can disclose the regulatory capital approaches, they could get 0.5 more marks. For accounting policies, if NAB, WBC and CBA can show the method they used and show the key assumption, 33 they would be able to get 0.8 marks. Therefore, in this way, WBC and CBA can get 1.3 more marks in total. ο For ANZ and CBA, they should state the objectives and explain them in detail. It is better that they also describe how to achieve those objectives. 6. Conclusion With respect to the marking system for the quality of disclosures regarding capital, the marking standards are derived both from APS 330, BIPRU, and other appropriate practices adopted by banks. The assignment of weightage to each standard is based on its relative significance. ANZ’s disclosure enjoys the highest quality whereas the disclosure provided by WBC is of the lowest quality. CBA has the second highest disclosure quality, followed by the Standard Chartered. NAB’s disclosure regarding its capital position is slightly better than the worst performer, Westpac. The design for the marking system for the quality of disclosures regarding securitization follows the same logic. The major difference would be that most marking standards are based on the requirements specified under Table 9 of APS 330 (APRA, 2007). The UK rules (BIPRU) are highly similar to the Australian ones with a few exceptions noted in the previous discussion. 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