Review by the MA

4.7.1 In reviewing and evaluating an AI’s CAAP, the MA will have regard to the supervisory standards set out in this section. Key factors to be considered include:

 the soundness of the overall CAAP given the nature and scale of the AI’s business activities;

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CA-G-5 Supervisory Review Process

 the degree of management involvement in the process, for example, whether the target and actual capital levels are properly monitored and reviewed by the Board (or a designated committee) and senior management;

 the extent to which the internal capital assessment is used routinely within the AI for decision-making purposes;

 the extent to which the AI has provided for unexpected events in setting capital levels; and

 the reasonableness of the outcome of the CAAP in terms of whether:

 the amount of capital required as demonstrated by the CAAP is sufficient to support the risks faced by the AI;

 whether the levels and composition of capital chosen by the AI are comprehensive, relevant to the current operating environment, appropriate for the nature and scale of the AI’s business activities and can withstand stressed scenarios in all the relevant stress tests (e.g.

the supervisor-driven stress tests and other relevant stress tests conducted by the AI, and supervisory top-down solvency stress tests conducted by the MA, as applicable); and

 the appropriateness and comprehensiveness of the potential capital actions identified in the CAAP to address any capital shortfall.

4.7.2 AIs should be able to explain and demonstrate to the satisfaction of the MA:

 how their CAAP meets supervisory requirements;

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 how their material risks are defined, categorised and measured (if their own terminology is adopted), and how their approach relates to their obligations under the Banking (Capital) Rules; and

 how the internal capital targets are determined and how these targets are consistent with their overall risk profile and the current operating environment as well as current and planned business needs.

AIs are also expected to explain the similarities and differences between the level of capital calculated under their CAAP and their regulatory capital requirements.

4.7.3 The MA expects that AIs with complex operations should have a more structured and well-defined risk management framework to monitor the effectiveness of internal control processes and risk exposures in comparison to AIs with simple organisational structures and less complex operations and activities, for which a less sophisticated firm-wide risk management framework may be more appropriate.

4.7.4 In assessing whether AIs have sufficient capital to enable them to continue to operate their business on a going concern basis, the MA will place particular importance on, among other things, the capacity of an AI’s capital structure to absorb losses and how this structure could be adversely affected by changes in performance²³. The MA recognises that Tier 1 capital is an important component of an AI’s capital structure because it allows AIs to absorb losses on an ongoing basis and is permanently available for this purpose. It also allows AIs

23 For example, an AI experiencing a net operating loss (perhaps due to realisation of unexpected losses) will not only face a reduction in its retained earnings but also possible constraints on its access to capital markets. These constraints could be exacerbated if detrimental conversion options are exercised. These adverse effects could be further accentuated if adverse events take place at critical junctures for raising or maintaining capital (e.g. as term capital instruments are approaching maturity or new capital instruments are being issued).

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to conserve resources when they are under stress as AIs have discretion as to the amount and timing of dividends and other distributions ²⁴ . Therefore, AIs should determine the optimal level of Tier 1 (in particular CET1 capital) and Tier 2 capital to be maintained to meet their capital goals. AIs should also note that the capital structure implied by the BCR minimum CAR is only a minimum standard. AIs should attach more weight to CET1 and Tier 1 capital components in their capital structure if it is prudent to do so.

4.7.5 If an AI’s CAAP does not meaningfully link the identification, evaluation and monitoring of the risks that arise from the AI’s business activities to the determination of its capital needs, the MA will require the AI to improve the CAAP for better integration with internal risk measurement and analysis. The MA will monitor the progress made by the AI in implementing the corrective actions.

4.7.6 Where the amount of capital which the MA considers that the AI should hold is not the same as that generated from the AI’s CAAP (particularly where the amount of capital generated is lower than that expected by the MA), the MA will discuss the difference with the AI. The MA will take into consideration the results of the CAAP and any explanations from the AI in relation to the outcome and appropriateness of the CAAP when determining the Pillar 2 capital requirement.

4.7.7 To facilitate his review, the MA will ask for information such as the results of an AI’s CAAP, together with an explanation of the process used. The MA will require the AI to provide information not only on the amount of capital it considers appropriate, but also on the

24 In fact the Basel III capital framework has leveraged on this characteristic and imposed earnings conservation requirements for banks to observe when their capital level falls within the capital buffer range. This is reflected in the Part 1B Division 2 of the Banking (Capital) Rules.

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composition of that capital. In the case of a group CAAP, there should be a breakdown of group capital so as to facilitate evaluation of the extent to which diversification benefits have been incorporated into the underlying assumptions.

4.7.8 The MA may seek other additional information from the AI where necessary.

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Contents Glossary Home Introduction

Supervisory Policy Manual

CA-G-5 Supervisory Review Process

Annex A: List of major supervisory guidelines applicable to