The deregulation of financial systems during the 1970s and 1980s exposed their banks to a more competitive and riskier environment, that led to concerns about the stability of banks. These concerns motivated the establishment of the BCBS (in 1974) and its development of a new regime of prudential supervision that included a capital requirement. Capital provides a bank with a cushion to absorb losses and so provides it and the prudential regulator with an opportunity to resolve the risk the losses pose for the bank’s depositors. Two years after it introduced its capital requirement (in 1986), the RBA modified the requirement in line with the BCBS’s Capital Accord by basing the 8 per cent capital requirement on the risk-weighted value of a bank’s assets rather than on the total value of its assets (see RBA 1988; 1989). The requirement is the ratio of a bank’s capital (as defined) — the numerator — to its risk-adjusted assets as the denominator. This approach related (if crudely) the capital requirement to the risk-management aim of prudential supervision.

The risk-adjustment under the Capital Accord initially employed five rule of thumb credit-risk categories (subsequently reduced to four) into which a bank’s assets were allocated. Low risk weights (zero and 20 per cent) were established for less-risky assets. Loans secured by residential mortgages were assigned a risk weight of 50 per cent, whereas all other loans were given a risk weight of 100 per cent. The denominator also included the credit-equivalent value of a bank’s off-balance sheet exposures, such as its derivatives and standby credit facilities drawn down at the initiative of the bank’s client, by including the resulting amounts in the respective asset risk categories according to the identity of the counterparty.

In July 1998 the RBA’s responsibility for bank supervision and the state-based supervisory responsibilities for credit unions and building societies were transferred to APRA, which was established following a public enquiry into the functions of the financial system and its evolving nature. This organisation became the prudential supervisor of all ADIs in Australia (except branches of foreign-owned banks) and to which it continued to apply the requirements of the Basel Accord. Stability of Australia’s financial system remained one of the responsibilities of the RBA. (RBA 2008b: 67–71)