What is the large exposure limit under APS 221?

APRA's APS 221 limits a single counterparty exposure to 25% of the ADI's Tier 1 capital. Exposures to connected counterparties are aggregated. Breaches must be reported to APRA immediately and rectified within a timeframe agreed with the regulator.

What is the difference between the standardised and IRB approaches under APS 112?

The standardised approach uses fixed APRA-prescribed risk weights based on external credit ratings and asset class. The Internal Ratings-Based (IRB) approach allows accredited ADIs to use their own models for probability of default (PD), loss given default (LGD), and exposure at default (EAD), subject to APRA approval and ongoing validation requirements.

How should ADIs classify impaired loans?

APRA expects ADIs to classify loans across five categories: performing (no signs of stress), watch (early warning signs), substandard (well-defined weakness, possible loss), doubtful (collection in full is improbable), and loss (uncollectable, to be written off). Provisioning requirements increase with each category, and the classification must be reviewed at least quarterly.

What credit risk stress testing does APRA require?

APRA expects ADIs to conduct regular credit risk stress tests including sensitivity analysis on key portfolios, scenario analysis covering economic downturns, and reverse stress testing to identify conditions that would cause material credit losses. Results must be reported to the Board and integrated into capital planning under the ICAAP process.

Credit Risk Management for Australian ADIs: APS 112, Large Exposures, and Loan Classification

By Pranjal | Updated March 2026 | 12 min read

Credit risk remains the single largest risk exposure for Australian Authorised Deposit-taking Institutions. APRA's prudential framework - anchored by APS 112 (Capital Adequacy: Standardised Approach to Credit Risk) and its IRB counterpart APS 113 - prescribes how ADIs must measure, manage, and hold capital against credit losses. Getting this wrong means regulatory action, capital add-ons, or worse.

Need to check your credit risk documentation against APRA requirements? Ask our AI compliance chatbot - it covers APS 112, APS 113, APS 221, and related prudential standards with clause-level references.

APS 112: Credit Risk Capital Requirements

APS 112 sets out the standardised approach to calculating credit risk capital charges. Every ADI that has not received APRA accreditation for IRB must use this framework. The core mechanism is straightforward: each credit exposure is assigned a risk weight based on its asset class and, where applicable, its external credit rating.

Key Asset Classes and Risk Weights

Asset Class	Risk Weight	Notes
Claims on Australian Government	0%	AGS, state/territory government guaranteed
Claims on ADIs (rated AA- or above)	20%	Based on external credit assessment
Standard residential mortgages (LVR ≤ 80%)	35%	Owner-occupied, standard eligible
Higher LVR residential (80-90%)	50%	With lenders mortgage insurance considerations
Commercial property	100%	Standard commercial exposures
Past due exposures (>90 days)	100-150%	Depending on specific provisioning level

The risk-weighted amount directly determines how much Common Equity Tier 1 (CET1) capital the ADI must hold. With the minimum CET1 ratio at 4.5% (plus the capital conservation buffer of 3.5% for D-SIBs), risk weight accuracy is not optional - it is a capital efficiency question worth billions in aggregate.

Standardised vs IRB Approach

APRA allows accredited ADIs to use the Internal Ratings-Based (IRB) approach under APS 113. The four major banks and Macquarie are IRB-accredited. The differences are material:

Standardised (APS 112): Fixed risk weights prescribed by APRA. Simpler to implement but less risk-sensitive. No model validation burden, but generally higher capital requirements for low-risk portfolios.
Foundation IRB: ADI estimates probability of default (PD); APRA prescribes loss given default (LGD) and exposure at default (EAD). Requires APRA accreditation.
Advanced IRB: ADI estimates PD, LGD, and EAD using internal models. Requires extensive data history (minimum 5-7 years), ongoing model validation, and annual APRA review. Produces the most risk-sensitive capital charges.

Practical impact: An IRB bank might risk-weight a prime residential mortgage at 25%, while a standardised bank applies 35%. On a $500 billion mortgage book, that difference translates to billions in capital that could otherwise be deployed or returned to shareholders.

Loan Classification and Provisioning

APRA expects every ADI to maintain a rigorous loan classification framework. The standard five-tier model is embedded in supervisory expectations and maps directly to provisioning requirements:

The Five-Tier Classification

Performing: No signs of credit stress. Borrower meeting all obligations. Collective provisioning applies based on portfolio-level expected loss models.
Watch: Early warning indicators present - deteriorating financials, industry downturn, covenant breach. Enhanced monitoring required. May require elevated collective provisioning.
Substandard: Well-defined credit weakness that jeopardises repayment. The loan is inadequately protected by the current net worth or paying capacity of the borrower. Specific provisioning required.
Doubtful: Full collection is improbable based on existing conditions. Significant specific provision, typically 50% or more of the exposure. Active workout or recovery strategy required.
Loss: The exposure is considered uncollectable. Full write-off or 100% provisioning. Remaining recovery efforts continue but are not factored into asset valuation.

Under AASB 9 (the Australian adoption of IFRS 9), ADIs must also apply the expected credit loss (ECL) model with its three stages: 12-month ECL for performing loans, lifetime ECL for loans with significant increase in credit risk, and lifetime ECL with interest on net carrying amount for credit-impaired loans. The APRA classification and AASB 9 staging must be reconciled.

Large Exposure Limits: APS 221

Concentration risk is one of the fastest ways to destroy an ADI. APS 221 (Large Exposures) sets hard limits:

Single counterparty limit: 25% of the ADI's Level 1 Tier 1 capital
Connected counterparties: Exposures to entities connected by control or economic dependence must be aggregated against the 25% limit
Reporting threshold: Exposures exceeding 10% of Tier 1 capital must be reported to APRA
Sovereign and ADI exposures: Certain sovereign and highly-rated ADI exposures may be excluded or receive concessional treatment

APRA can impose tighter limits on individual ADIs where it identifies heightened concentration risk. Breaches are treated seriously and must be reported immediately with a remediation plan.

Counterparty Credit Risk

Beyond traditional lending, ADIs face counterparty credit risk through derivatives, securities financing transactions, and long-settlement transactions. APS 112 and APS 180 (Capital Adequacy: Counterparty Credit Risk) require ADIs to calculate exposure using one of three methods:

Standardised Approach for Counterparty Credit Risk (SA-CCR): The default method, replacing the older Current Exposure Method. Uses replacement cost plus a potential future exposure add-on.
Internal Model Method (IMM): Available to APRA-accredited ADIs. Uses Expected Positive Exposure (EPE) modelled over the margin period of risk.
Credit Valuation Adjustment (CVA): An additional capital charge for the risk of mark-to-market losses due to counterparty credit quality deterioration, even without default.

Credit Concentration Management

Beyond the hard limits in APS 221, APRA expects ADIs to actively manage credit concentration across multiple dimensions:

Industry concentration: Overexposure to a single sector (mining, property development, agriculture) creates correlated default risk
Geographic concentration: Regional ADIs are particularly exposed - a single weather event or local economic shock can impair an outsized portion of the book
Product concentration: Heavy reliance on a single product (e.g., interest-only investment lending) creates systemic vulnerability
Collateral concentration: Over-reliance on a single collateral type, particularly residential property in a single market

The Board must receive regular reporting on all concentration dimensions and approve limits that sit well inside prudential maximums. CPS 220 (Risk Management) requires that the risk appetite statement explicitly addresses credit concentration tolerances.

Credit Risk Stress Testing

APRA's supervisory expectations for stress testing have intensified since the 2020 COVID stress tests. ADIs must conduct:

Sensitivity analysis: Single-factor shocks to key credit parameters - what happens if PDs double, LGDs increase by 10 percentage points, or property values fall 30%?
Scenario analysis: Multi-factor macroeconomic scenarios including severe recession, property market collapse, and specific sectoral stress (e.g., commercial real estate downturn)
Reverse stress testing: Identifying the conditions under which the ADI's credit losses would breach capital minimums or threaten viability
Portfolio-level and name-level stress: Both top-down portfolio stress and bottom-up analysis of the largest individual exposures

Stress test results must feed directly into the Internal Capital Adequacy Assessment Process (ICAAP) under APS 110, and the Board must review and challenge results at least annually.

Board Oversight Requirements

APRA's expectations for Board-level credit risk governance are clear and non-negotiable:

Credit risk appetite: The Board must approve a credit risk appetite statement that is specific, measurable, and integrated into the overall risk appetite framework under CPS 220
Credit policy approval: Major credit policies (including large exposure limits, concentration limits, and provisioning methodology) require Board approval
Regular reporting: The Board must receive at minimum quarterly reporting on portfolio quality, classification migration, provisioning adequacy, concentration levels, and stress test results
Independent review: Credit risk management must be subject to independent review by internal audit, with findings reported to the Board Audit Committee
Accountability under FAR: Under the Financial Accountability Regime, specific accountable persons must be designated for credit risk management, with clear accountability statements lodged with APRA

Scan Your Credit Risk Framework Against APRA Requirements

Upload your credit risk policy, ICAAP, or Board risk appetite statement. GoComply checks against APS 112, APS 221, CPS 220, and 110+ other rules in seconds.

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Common Compliance Gaps

From scanning hundreds of credit risk documents, the most frequent gaps we identify are:

Stale concentration limits: Limits set years ago that no longer reflect portfolio composition or market conditions
Missing connected counterparty aggregation: Failing to identify and aggregate exposures to economically connected entities
Inadequate ECL model documentation: AASB 9 models without sufficient documentation of management overlays, forward-looking adjustments, or staging criteria
No reverse stress testing: Sensitivity and scenario testing exist, but reverse stress testing is absent or perfunctory
Board reporting gaps: Credit risk reports that lack actionable metrics, trend analysis, or clear links to risk appetite limits

GoComply's scanner checks for these gaps automatically. Our 150 compliance rules cover APS 112, APS 221, CPS 220, APS 110, and the Financial Accountability Regime. See pricing.