Non-linear models: understanding and exceeding regulator requirements
Risk predictions 2021
PRA supervisory priorities for 2021 - what does this mean for lenders?
25 January 2021
In December 2020 the PRA wrote to all UK deposit-taking firms outlining their supervisory priorities for 2021. We examine the six key topics and what these mean for lenders in the next 12 months.
- Financial Resilience – Levels of capital held by UK lenders demonstrates strong resilience and the ability to continue to support the economy through the current disruption. The FPC announced that the countercyclical capital buffer would remain at 0 for the next 12 months, providing additional capacity for firms to support the economy. The distribution restrictions placed on firms in 2020 are to be tentatively lifted, but there is concern over the impact when government support for businesses is eventually removed. BoE stress testing will return following the delay in 2020.
Firms should ensure they understand the changes to distribution rules and plan accordingly. The stress testing requirements have the greatest impact on participating firms, but all firms should consider the scenarios used in the BoE stress testing at the minimum as a benchmark against their own scenario planning.
- Credit Risk – The expected increase in arrears and default as government restrictions are lifted means there is renewed focus on risk management and measurement of impairment. Specifically, the management of model risk, the quality and range of scenarios used and staging criteria as defined in the PRA’s thematic review on IFRS 9 ECL. Wider thematic reviews will also continue covering buy-to-let SME, retail collections and Covid related payment deferrals.
Firms should ensure their risk appetite is reflective of their lending activities and to update IFRS 9 frameworks to incorporate the thematic review findings.
- Operational risk and resilience – Covid-19 tested the frameworks of firms as the significant disruption of 2020 impacted the industry. Expect a renewed focus on the effectiveness of risk and control frameworks in both the current environment and in light of any material residual risks that could have an impact. Policy on operational resilience is expected in 2021 following the disrupted consultation process in 2019/2020.
Firms should review the impact of Covid-19 and their response to it to further refine their frameworks and ensure risk appetite remains appropriate.
- Competition and future regulatory frameworks – The PRA intend to finalise their supervisory approach to new and growing banks in the first half of 2021 following the consultation in 2020. This aims to increase competition in the market. The consultation described simplification of Risk management, Governance, Capital and Liquidity adequacy expectation and for smaller firms over their first 5 years of life providing they have a solvent wind-down plan at the point of authorisation. The MREL and Leverage Ratio frameworks will also be reviewed in 2021.
Firms should consider the impact of the proposed changes and contribute to the consultation process where appropriate.
- Financial risks arising from climate change – following the supervisory statement in 2019 and letter in 2020, the expectations for firms to meet governance, risk management, scenario testing and disclosure requirements by the end of 2021 have been clearly set. The letter in 2020 identified the key areas of challenge and pointed to guidelines and best practise for firms to follow.
Firms should focus resource on implementing the capability to perform scenario testing considering both transitional and physical risk over both short and long term horizons. The BoE announced the Climate Biennial Exploratory Scenario (CBES) for 2021 which bring significant additional requirement for participating firms. For other firms, this is a useful guide for understanding the scale of a 30-year modelling horizon, but should be considered in relation to the size and complexity of their business model.
- Transition from LIBOR to alternative risk-free rates – The disruption in 2020 has meant there is little time remaining to prepare for the transition with firms falling behind in areas such as client engagement. The PRA will monitor the progress through the targets set by the Working Group on Sterling Risk Free Reference Rates (RFRWG) and through review of the management of transition risk.
Firms should review transition plans and identify areas that are at risk. The PRA has stated the expectation that there will be an intensive effort in 2021 to make up for the disruption and delay caused in 2020.
Jaywing has a wealth of experience in IFRS9 model development, assessment and monitoring as well as model validation and governance. You can read about our work with Starling Bank, Hampshire Trust or Skipton Building Society with their regulatory models, or talk to us today about how our consultancy and IFRS9 modelling technology can help you respond to the PRA’s findings.