APRA outlines Basel II market risk proposals

Plan to mesh credit and market risk elements

The Australian Prudential Regulation Authority (APRA) has released its proposed approach to the treatment of market risk under Basel II.

APRA has released a discussion paper, draft prudential standard and a prudential practice guide that set out proposed refinements to APRA’s current approach to market risk for authorised deposit-taking institutions (ADI).The proposed approach is designed to better align ADI market risk capital requirements with Basel II, but preserves APRA’s requirement that ADIs have in place a framework to measure, manage, and monitor market risk commensurate with the nature, scale and complexity of their operations.

As is currently the case, under the proposed rule an ADI must use the standard method of market risk measurement or obtain APRA’s approval to use its own risk measurement model. APRA also requires an ADI using the advanced approaches to measuring credit risk and operational risk to hold regulatory capital against its interest rate risk in the banking book.

The refinements were guided by the need to bring existing capital requirements into line with the market risk principles in the Basel framework and to ensure consistency with the revisions for credit risk under Basel II, according to APRA chairman John Laker.

“These amendments recognise the rapid expansion in the range and volume of instruments traded and potential changes in ADIs’ market risk profiles on their trading and non-trading books.”

The suite of Basel II prudential standards for credit, market and operational risk is expected to be finalised in the second half of 2007, with Basel II set to come into force in Australia on January 1 2008.