The UK Prudential Regulation Authority Publishes The First Of Two Policy Statements For The Implementation Of The Basel 3.1 Standards

The near-final policy statement takes account of feedback received to the PRA’s consultation paper (CP) on the Basel 3.1 standards published in November 2022 (CP16/22). The PRA received 126 responses to the CP and had extensive engagement with interested parties during and after the consultation period. As a result, the PRA has adjusted its original proposals in a range of areas to:

• amend the proposals where respondents provided evidence suggesting they did not appropriately and/or proportionately reflect risks,
• facilitate policy implementation where feedback suggested prudent but less burdensome alternative approaches were available,
• enhance the relative standing of the UK as a place for internationally active firms to operate; and
• improve the clarity of rules.

The most material of these adjustments include:

• the removal of market risk internal modelling for the default risk of exposures to sovereigns, aligning the market risk and credit risk frameworks and addressing capital requirements for some sovereigns put forward under the original proposals; and
• added flexibility in the credit valuation adjustment risk framework through the introduction of an additional, optional, transitional arrangement to reduce operational burden on firms.

In CP16/22, the PRA made clear that when introducing Basel 3.1 it intended to avoid any potential double-counting of capital requirements with existing firm-specific Pillar 2 requirements. Today’s publication reaffirms that intention and describes how the PRA will approach it in practice by prioritising adjusting firm-specific Pillar 2 capital ahead of implementation in July 2025.

Based on its latest data, the PRA estimates that the impact of Basel 3.1 requirements will be low and result in an average increase in Tier 1 capital requirements for UK firms of around 3% once fully phased in (ie in 2030). This is lower than the European Banking Authority’s estimate^footnote[1] of a Tier 1 increase of around 10% in the EU and the US agencies’ estimate^footnote[2] of a CET 1 increase of around 16% for US firms.

The near-final rules will facilitate effective competition by narrowing the gap between the risk weights calculated under internal models (typically used by the larger firms) and the standardised approaches and support international competitiveness by aligning with international standards. They will also promote the safety and soundness of the firms the PRA regulates and make capital ratios more consistent and comparable.

The Interim Capital Regime

Today’s publication also includes the Interim Capital Regime (ICR) rules relating to market risk and operational risk.^footnote[3] The ICR provides firms that meet the Small Domestic Deposit Taker (SDDT) criteria an alternative to implementing the Basel 3.1 standards until the implementation date of the new Strong and Simple capital regime for SDDTs. The ICR near-final policy is relevant to UK banks and building societies that meet SDDT criteria and choose to opt into the alternative regime.

Sam Woods, Deputy Governor of Prudential Regulation and CEO of the PRA said:

‘The rules published today implement the latest Basel standards in the UK and include appropriate adjustments to take on points raised by respondents to our consultation. The focus of these rules is not on the aggregate amount of capital in the system but on making sure that risk is properly captured across a range of firms and activities.’

Next steps

The PRA intends to publish its second near-final policy statement in Q2 2024 on the remaining elements of the Basel 3.1 package, which includes credit risk, the output floor, reporting and disclosure requirements.^footnote[4] The timeline for Basel 3.1 standards implementation is on 1 July 2025 with a 4.5-year transitional period ending on 1 January 2030.

Background

1. Basel 3.1 Policy statement, 12 December 2023
2. The PRA has not made final rule instruments at this stage because HM Treasury is required to first revoke the relevant parts of the Capital Requirements Regulation by way of statutory instrument before the PRA can replace them in the PRA rules. Once the statutory instrument has been made, the PRA intends to make all the final policy materials, rules, and technical standards in a single, final policy statement.
3. The near-final rules are designed to implement elements of the final package of banking prudential reforms developed by the Basel Committee on Banking Supervision in response to the global financial crisis. The PRA refers to them as the ‘Basel 3.1 standards’. The changes address concerns related to the measurement of RWAs by improving the risk-sensitivity of internal model and standardised approaches and reducing excessive variability in the calculation of risk weights. They will thereby advance the PRA’s primary objective of promoting the safety and soundness of the firms it regulates and make firms’ capital ratios more consistent and comparable.
4. For more information on SDDT criteria, see policy statement 15/23 - The Strong and Simple Framework: Scope Criteria, Liquidity and Disclosure Requirements
5. Timings of Basel 3.1 implementation in the UK
6. The PRA consults on proposals for implementation of the Basel 3.1 standards