The Prudential Regulation Authority’s (PRA’s) consultation on “The Strong and Simple Framework: a definition of a simpler-regime Firm” is the first step towards introducing a new prudential regime for non-systemic domestic banks and building societies. By Michelle Adcock, Prudential Banking Sector Lead, KPMG Financial Services Regulatory Insight Centre.
Defining a “Simpler-regime Firm” and introducing this definition to the PRA rulebook may seem relatively simple, but it paves the way for major change to prudential policy which could lead to a significant reduction in the regulatory burden for the UK’s smaller banks and building societies. The consultation highlights the PRA’s drive to become a more proportionate, outcomes-focused regulator and deliver against its competition objective.
The current prudential regime for banks is predominantly a “one size fits all” approach, based on Basel standards and applied through the UK Capital Requirements Regulation (UK CRR). The PRA is seeking to mitigate the “complexity problem” that can arise when some prudential requirements designed with larger firms in mind are applied to all firms equally. The costs of understanding, interpreting and operationalising these prudential requirements are proportionally higher for smaller firms than they are for larger firms.
The 2021 Discussion Paper (DP) presented a vision for a framework made up of a series of layered and proportionate prudential regimes, reflecting the diversity of size and business model of firms. The feedback the PRA received was supportive of a layered approach and also of starting with the smallest and simplest firms. The PRA has taken this on board and is starting with the Simpler regime in order to apply the benefits of simplification to the largest number of firms as soon as possible.
In its response to the DP, the Building Societies Association (BSA) cited the comparable EU concept of small and non-complex banks (SNCBs) as defined under the EU Capital Requirements Regulation (CRR2). The BSA referred to the “timid tinkering” of CRR2 concessions to SNBCs, notably the setting of the total asset threshold for inclusion at under €5bn, and encouraged the PRA to be bold and seize the opportunity to pursue genuine proportionality. It appears to have done so, and has proposed a maximum threshold of £15bn total assets (as defined under FINREP). This should ensure that firms have room for growth within the simpler regime.
In addition to the threshold criteria, firms must:
• Be focused on deposit-taking, retail and commercial lending and not active in wholesale markets. On-and-off balance sheet trading book business should be equal to or less than both of 5% of the firm’s total assets and £44 million. The sum of a firm’s overall net foreign exchange position should be equal to or less than 2% of the firm’s own funds and the firm should have no commodity positions
• Not use the internal ratings based (IRB) approach. However, firms can continue to operate under the Simpler regime definition while waiting for IRB approval
• Not provide certain clearing, settlement and custody services, including operating payment systems
• Operate primarily in UK domestic markets and have at least 85% of credit exposures to obligors in the UK
Based on these criteria, the PRA estimates that 61 firms, including 34 building societies, would currently fall within the scope of the new regime. For most firms meeting the Simpler-regime Firm definition, the new regime would be applied as the default. However, the PRA would be able to exclude firms on a case-by-case basis.
The Simpler regime is intended to apply to small banks and building societies, not small units of large groups. Therefore, the PRA proposes to apply the scope criteria on a solo basis for standalone firms and at the highest level of the UK consolidation group for subsidiaries of larger groups. The consultation notes also that the Simpler regime could be the appropriate prudential regime for a firm that is a UK subsidiary of a group based outside of the UK (including a firm that has a holding company outside of the UK) if it suffers from the complexity problem.
The consultation closes on 22 July 2022, with the definition of a Simpler-regime Firm expected to be written into final policy in late 2022 or early 2023. In 2023, the PRA will consult on further non capital-related aspects of the new framework. Capital will be addressed in a second set of proposals in 2024. The PRA also intends to consult on an approach that would enable Simpler-regime Firms to stay under requirements substantially the same as UK CRR between the implementation of Basel 3.1 and the introduction of the Simpler regime, rather than switching regimes twice in short succession. It will also consider an opt-out mechanism and proposals for how firms should transition from one regime to another.
Why are changes needed?
The current prudential regime for banks is predominantly a “one size fits all” approach, based on Basel standards and applied through the UK Capital Requirements Regulation (UK CRR). The PRA is seeking to mitigate the “complexity problem” that can arise when some prudential requirements designed with larger firms in mind are applied to all firms equally. The costs of understanding, interpreting and operationalising these prudential requirements are proportionally higher for smaller firms than they are for larger firms.
How will it work?
The 2021 Discussion Paper (DP) presented a vision for a framework made up of a series of layered and proportionate prudential regimes, reflecting the diversity of size and business model of firms. The feedback the PRA received was supportive of a layered approach and also of starting with the smallest and simplest firms. The PRA has taken this on board and is starting with the Simpler regime in order to apply the benefits of simplification to the largest number of firms as soon as possible.
In its response to the DP, the Building Societies Association (BSA) cited the comparable EU concept of small and non-complex banks (SNCBs) as defined under the EU Capital Requirements Regulation (CRR2). The BSA referred to the “timid tinkering” of CRR2 concessions to SNBCs, notably the setting of the total asset threshold for inclusion at under €5bn, and encouraged the PRA to be bold and seize the opportunity to pursue genuine proportionality. It appears to have done so, and has proposed a maximum threshold of £15bn total assets (as defined under FINREP). This should ensure that firms have room for growth within the simpler regime.
In addition to the threshold criteria, firms must:
• Be focused on deposit-taking, retail and commercial lending and not active in wholesale markets. On-and-off balance sheet trading book business should be equal to or less than both of 5% of the firm’s total assets and £44 million. The sum of a firm’s overall net foreign exchange position should be equal to or less than 2% of the firm’s own funds and the firm should have no commodity positions
• Not use the internal ratings based (IRB) approach. However, firms can continue to operate under the Simpler regime definition while waiting for IRB approval
• Not provide certain clearing, settlement and custody services, including operating payment systems
• Operate primarily in UK domestic markets and have at least 85% of credit exposures to obligors in the UK
Based on these criteria, the PRA estimates that 61 firms, including 34 building societies, would currently fall within the scope of the new regime. For most firms meeting the Simpler-regime Firm definition, the new regime would be applied as the default. However, the PRA would be able to exclude firms on a case-by-case basis.
The Simpler regime is intended to apply to small banks and building societies, not small units of large groups. Therefore, the PRA proposes to apply the scope criteria on a solo basis for standalone firms and at the highest level of the UK consolidation group for subsidiaries of larger groups. The consultation notes also that the Simpler regime could be the appropriate prudential regime for a firm that is a UK subsidiary of a group based outside of the UK (including a firm that has a holding company outside of the UK) if it suffers from the complexity problem.
What happens next?
The consultation closes on 22 July 2022, with the definition of a Simpler-regime Firm expected to be written into final policy in late 2022 or early 2023. In 2023, the PRA will consult on further non capital-related aspects of the new framework. Capital will be addressed in a second set of proposals in 2024. The PRA also intends to consult on an approach that would enable Simpler-regime Firms to stay under requirements substantially the same as UK CRR between the implementation of Basel 3.1 and the introduction of the Simpler regime, rather than switching regimes twice in short succession. It will also consider an opt-out mechanism and proposals for how firms should transition from one regime to another.
