The Prudential Regulation Authority (PRA) has put forward a package of banking reforms that will address the final elements of the Basel III standards that remain to be implemented in the UK.
The proposed package aligns closely with the Basel 3.1 standards, but gives a specific UK twist in areas where the regulator believes this will capture risk more effectively and promote the competitiveness and relative standing of the UK.
These UK refinements seek to take advantage of flexibility created by the UK’s withdrawal from the European Union to propose limited adjustments to the Basel 3.1 standards “to reflect the specific characteristics of the UK”.
Specifically, these proposed changes aim to improve risk measurement in internal risk models and standardised approaches and to reduce excessive variability in risk weight calculations. The intention is to “make firms’ capital ratios more consistent and comparable”, according to the PRA.
Additionally, these are designed to encourage competition by reducing the gap between risk weights calculated through internal models, typically employed by larger firms, and those calculated through standardised approaches.
For example, this will no longer allow internal models to be used to calculate risk weights for some areas, including operational risk and credit valuation adjustment risk. The proposals also limit use of internal models for credit risk for asset portfolios where there is insufficient loss data to model effectively.
The PRA proposes an output floor to ensure total risk-weighted assets (RWAs) cannot fall below 72.5 per cent of RWAs calculated through standardised approaches, with this lower limit to be phased in over a five-year period.
It also intends to make standardised approaches more risk-sensitive for market, credit, operational and credit valuation adjustment risks.
The regulator predicts that the proposals outlined in the consultation paper will not significantly increase overall capital requirements, on average, across UK firms.
It intends that changes forthcoming from this set of proposals will be implemented on 1 January 2025, with transitional arrangements in place to give firms time to adjust to the revised framework.
To gauge market reaction to these proposals, the PRA has issued a consultation paper, CP16/22, with respondents asked to provide their feedback by close of business on 31 March 2023.
Sam Woods, CEO of the PRA and deputy governor of prudential regulation at the Bank of England, says: “Alignment with strong international banking standards promotes economic growth by underpinning the competitiveness of the UK as a financial centre, supporting investors’ confidence in the UK banking system and ensuring that banks can finance the economy during downturns.
“Our proposals for implementing the latest Basel standards, with appropriate but limited adjustments for the UK market, aim to deliver these goals. We encourage anyone with an interest to send us their views and evidence.”
