The Australian Prudential Regulation Authority (APRA) has published new guidelines for authorised deposit-taking institutions (ADIs) on the measurement of credit risk weighted assets relating to insurance standby letters of credit (L/Cs).

The guidelines focus on what credit conversion factor should be used to determine the regulatory capital of insurance standby L/Cs.

Direct credit substitute

The regulator says an insurance standby L/C is issued by an ADI to an insurer whereby the ADI 'guarantees' payment to the insurer in the event that its reinsurer defaults.

Insurance standby L/Cs fall into the category of 'direct credit substitutes', which means that a 100 per cent credit conversion factor is to be applied under the standardised approach.

Rationale and warning

This is because the primary purpose of the L/C is to support the claims paying ability of the reinsurer, which is a monetary or financial obligation.

On the basis of this guideline, APRA says it now expects that all insurance standby L/Cs are to be assigned a credit conversion factor of 100 per cent irrespective of the approach taken by the issuing ADI to determining regulatory capital requirements.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.