Additional tier 1 capital

Components of capital that are not included in common equity tier 1 capital but nonetheless are high‑quality.

Asset‑backed security

See securitisation.

Basel I

International convergence of capital measurement and capital standards (Basel Capital Accord); a 1988 agreement between the central banks of G10 countries that applied common minimum capital standards to participating banking sectors. Replaced by Basel II.

Basel II

The 2004 agreement International convergence of capital measurement and capital standards: a revised framework which replaced Basel I and introduced a more risk‑sensitive framework based on three pillars (see pillar 1, pillar 2 and pillar 3). Basel II came into effect in Australia on 1 January 2008.

Basel 2.5

Amendments to Basel II that were finalised in July 2009 and commenced at the end of 2011. Basel 2.5 was focused on the better management of resecuritisation exposure, introduced higher risk weightings for securitisation exposures and other measures to strengthen pillars 2 and 3.

Basel III

Revised global banking regulatory standards published in 2010 and developed in response to the global financial crisis. It builds on the Basel II framework and is comprised of measures intended to increase the quality and quantity of capital held by banks, as well as introducing a framework for liquidity risk measurement, standards and monitoring.

Basel Committee on Banking Supervision

A committee comprised of the banking regulators of 27 countries based in Basel, Switzerland. The committee aims to improve the quality of banking supervision worldwide and develops guidelines and supervisory standards to achieve this, such as Basel III.

Bullet bond

A debt instrument where the entire face value is paid at once on the maturity date—i.e. it cannot be redeemed prior to maturity.

Capital

Equity and debt instruments held by a bank to provide a buffer against unexpected losses. See regulatory capital.

Capital adequacy ratio

Minimum prudential capital requirements expressed as a percentage of total risk‑weighted assets (RWA). Under Basel III, capital ratios will be in place for common equity tier 1 capital, tier 1 capital and total capital.

Capital conservation buffer

Basel III requires that outside of periods of stress, banks will need to hold a capital conservation buffer of 2.5 per cent (of common equity tier 1) to withstand future periods of stress. If the capital levels of a bank fall into the buffer range, capital distribution constraints will be imposed (such as restrictions on the payment of dividends, share buybacks and discretionary bonus payments to staff) that increase in severity as the buffer reduces.

Common equity tier 1 capital

Comprised of the highest quality components of capital that includes, among other things, paid-up ordinary shares issued by an ADI, retained earnings, undistributed current year earnings and other disclosed reserves.

Competition Inquiry

Senate Economics References Committee's inquiry into competition within the Australian banking sector (2011).

Countercyclical buffer

Under Basel III, regulators will be able to require banks to hold additional common equity tier 1 capital of between zero and 2.5 per cent of total risk‑weighted assets when excess aggregate credit growth is judged to be associated with an unacceptable build-up of system‑wide risk, such as when credit growth is occurring at a rate which, historically, financial system stability has been undermined.

Counterparty credit risk

A type of credit risk which applies to a bank's trading book activities (e.g. interest rate swaps, foreign exchange swaps and credit derivatives). It is the risk that the counterparty does not meet their obligations, usually because of financial distress.

Covered bond

An instrument issued by an ADI where, in the event that the issuing ADI defaults on its payment to the bondholder, the bondholder may recoup their investment either from the issuing ADI or through a preferential claim on a specified pool of high quality assets.

Credit risk

The risk that a counterparty will not settle an obligation for full value, either when due or thereafter.

Derivative

A security whose value is dependent upon or derived from one or more assets or a market index.

Henry Review

Australia's Future Tax System Review (2009), chaired by Dr Ken Henry AC.

Impaired asset

In accounting, an asset is described as impaired (and the company recognises an impairment loss) if its carrying amount exceeds the amount to be recovered through use or sale of the asset.

Interest rate swap

An agreement between two parties to exchange
fixed and variable interest rate payments on a notional principal amount over an agreed period of time.

Johnson Report

The 2009 report of the Australian Financial Centre Forum, Australia as a financial centre: Building on our strengths, chaired by Mr Mark Johnson.

Leverage ratio

A minimum ratio of tier 1 capital to total exposure required under Basel III.

Liquidity coverage ratio

A requirement under Basel III for banks to have sufficient high‑quality liquid assets to withstand a stressed funding scenario that is specified by the regulator (based on the stock of high quality liquid assets and the capacity of these assets to cover expected cash outflows over the 30 day scenario).

London interbank offer rate

A rate that indicates the cost of unsecured borrowing in the London interbank market. It is used as a benchmark globally for short term interest rates.

Low‑doc loan

A loan that requires less financial documentation than that required for other loans. Primarily for borrowers who do not meet the standard loan application criteria, such as the self‑employed and other borrowers whose income could not be readily verified.

Market risk

The risk of loss owing to changes in the general level of market prices or interest rates.

Market value

Often defined as the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length. For property valuations, it is the estimated amount for which an asset should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion (International Valuation Standards 2011).

Net stable funding ratio

A longer-term structural ratio under Basel III intended to encourage banks to use stable funding sources (i.e. reduce their dependency on short-term wholesale funding).

Non-performing asset

From a lender's perspective, a debt obligation where the borrower has not been making any previously agreed repayments (principal or interest) for an extended period of time.

Operational risk

The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. It includes legal risk, but excludes strategic and reputational risk.

Pillar 1

The measures contained in Basel II and III that relate to the core amount of capital that banks are required to hold against credit risk, operational risk and market risk.

Pillar 2

The principles in Basel II and III for supervisory review of banks' internal assessments of the risks in their business.

Pillar 3

The measures contained in Basel II and III intended to encourage greater market discipline by improving the degree of transparency in banks' public reporting.

Price‑to‑book ratio

A measure which compares a firm's share market value to its book value.

Regulatory capital

Total amount of capital determined by regulators that an ADI must hold for a certain level of risk‑weighted assets. It consists of tier 1 and tier 2 capital. In Australia, it is imposed by prudential standards made by APRA.

Repo

See repurchase agreement.

Repurchase agreement

Often referred to as repos. They involve the sale or purchase of securities with a commitment to reverse the transaction at an agreed date in the future and at an agreed price. The RBA uses repos to conduct its domestic market operations (i.e. to ensure that the actual cash rate is close to the target cash rate).

Residential mortgage‑backed securities

A type of security backed by a pool of residential mortgages. See securitisation.

RMBSle funding ratiothe cost of isk-weighted assets

Measure of a bank's assets in terms of risk that is used to calculate required regulatory capital. Assets that are considered to be riskier are given a higher weighting.

Securitisation

Securitisation involves bundling illiquid assets and converting them into a package of securities that can be issued into the capital markets. The cash flow from the securitised exposures is used to service obligations to different tranches of creditors where one class of creditors is entitled to receive payments from the pool before other subordinated creditors.

Tier 1 capital

Core capital, such as ordinary shares and retained earnings; intended to be capable of absorbing losses while the ADI continues to operate. It is comprised of common equity tier 1 capital and additional tier 1 capital.

Tier 2 capital

Supplementary components of capital that do not qualify as tier 1 but nonetheless contribute to the overall ability of an ADI to absorb losses. Tier 2 capital includes subordinate debt and preference shares.

Tier 3 capital

A capital tier allowed under Basel I and II (although not recognised by APRA) but abolished by Basel III. It included instruments that cover some market risks, such as foreign currency and commodities risk.

Volcker rule

Section 619 of the US Dodd-Frank Act. Will prevent banks that take retail deposits that are federally insured in the US from: (a) engaging in proprietary trading that is not directly related to the market making and trading they do for customers; and (b) owning or sponsoring hedge funds or private equity funds.

Wallis Inquiry

The 1997 Financial System Inquiry, chaired by Mr Stan Wallis.