The Prudential Regulation Authority (PRA) has taken a significant step towards the implementation of the Basel 3.1 standards by publishing the first of two near-final policy statements. This release covers key areas such as market risk, credit valuation adjustment risk, counterparty credit risk, and operational risk. The policies outlined are relevant to all PRA-regulated entities, including banks, building societies, investment firms, and financial holding companies.
The near-final policy statement reflects the PRA’s consideration of feedback received from its consultation paper (CP) on the Basel 3.1 standards, published in November 2022 (CP16/22). Engaging with 126 responses and maintaining ongoing communication with stakeholders, the PRA has made adjustments to its original proposals to address concerns, facilitate policy implementation, enhance the UK’s standing as an international business hub, and improve rule clarity.
Key Adjustments in Response to Feedback
- Market Risk Internal Modelling: The removal of market risk internal modelling for the default risk of exposures to sovereigns, aligning market risk and credit risk frameworks.
- Credit Valuation Adjustment (CVA) Risk Framework: Added flexibility through the introduction of an additional, optional, transitional arrangement to reduce operational burden on firms.
The PRA has reiterated its commitment to avoiding potential double-counting of capital requirements with existing firm-specific Pillar 2 requirements. The publication describes how the PRA plans to prioritize adjusting firm-specific Pillar 2 capital ahead of the Basel 3.1 implementation date in July 2025.
Based on the latest data, the PRA estimates a low impact of Basel 3.1 requirements, resulting in an average increase in Tier 1 capital requirements for UK firms of around 3% once fully phased in by 2030. This is notably lower than estimates from the European Banking Authority and US agencies.
Interim Capital Regime (ICR)
The publication includes the Interim Capital Regime rules related to market risk and operational risk, offering an alternative for Small Domestic Deposit Takers (SDDTs) until the implementation of the new Strong and Simple capital regime for SDDTs.
Sam Woods, Deputy Governor of Prudential Regulation and CEO of the PRA, emphasized the focus on capturing risk effectively across various firms and activities rather than solely on the aggregate amount of capital.
The PRA plans to release its second near-final policy statement in Q2 2024, covering remaining elements of the Basel 3.1 package, including credit risk, the output floor, reporting, and disclosure requirements. The Basel 3.1 standards are set to be implemented on July 1, 2025, with a 4.5-year transitional period ending on January 1, 2030.
This publication marks a crucial milestone in aligning the UK’s regulatory framework with international standards, promoting effective competition, and ensuring the safety and soundness of regulated firms. The adjustments made demonstrate the PRA’s commitment to a balanced and responsive regulatory approach.