Background on Discussion Paper 1/21
In December 2021, the PRA issued a response to DP 1/21, “A strong & simple prudential framework for non-systemic banks and building societies”. The original discussion paper explored options for recalibrating the prudential risk framework in the UK whilst maintaining the resilience of the firms who would be affected by these changes.
The paper outlined a longer-term vision for prudential risk management and showcased the broad range of options that are being considered. Interested parties were invited to submit their responses to the discussion paper and these have now been summarised in Feedback Statement 1/21.
The Feedback Statement does not provide any new guidance or policies from the PRA, but the publication does give valuable insight into the views of the respondents. Overall, there is a large level of consensus on some of the more problematic areas of the existing prudential framework, such as calculating Pillar 2 capital requirements, ICAAP & ILAAP documents and regulatory reporting.
There is widespread agreement that the existing approach to managing prudential risk presents a complexity problem for smaller firms.
This type of feedback should not come as a surprise as it has been acknowledged that smaller firms suffer disproportionately to larger firms under the existing set of rules. Smaller firms pose a lower risk to the financial markets than larger more complex firms, but they are still measured against the same standards. With fewer resources available – both financial and human – smaller firms believe they are unduly burdened by the application of a one-rule-suits-all approach.
Streamlined vs Focused Approach
Presenting their vision of a possible new regulatory landscape, the PRA provided two differing approaches which are summarised in the diagram below.
The PRA reports that the vast majority of replies favoured the streamlined approach. This appears to be driven by the fear that a focused approach would force the PRA to implement a generic process, and that these generalities would lead to higher levels of financial requirements than if a streamlined approach were adopted. It was also noted by the respondents that growing firms, who would migrate up through the simpler regulations in a layer approach, would find it more difficult to adjust their organisations if a focused approach was adopted.
Pillar 2A requirements
There appears to be widespread agreement that the current approach for calculating capital requirements under P2A are overly complex and, indeed, penal for smaller firms. Two areas are highlighted as particularly concerning, concentration risk capital add-on and operational risk. Firms report that using the standardised approach to calculate concentration risk, known as the Herfindahl-Hirshman Index (HHI), can unduly penalise UK focused firms. In a similar fashion, the standardised approach for estimating operational risk capital requirements is seen as overly complicated and dependent on too many assumptions.
Both of these examples support the preference of a streamlined approach, where the existing set of regulations are modified to better reflect the risks of smaller, simpler firms.
ICAAP & ILAAP processes
Other notable feedback is the strong support for reforms in the regulatory reporting space. Again, the responses received seem to support the retention of the ICAAP and ILAAP reports but with a different approach. The use of standardised templates and the removal of overly complex liquidity requirements appear to be the preferred solution for smaller firms.
Data collection through regulatory reporting has been growing every year, and the burden placed on smaller firms is frequently mentioned in feedback sessions Jaywing has with our clients. The DP acknowledged that changes would be considered under a possible new framework and that the feedback provided supports the streamlined approach over the focused one. It’s a case of ‘less is more’ from the perspective of the smaller banks. Based on the feedback published, a more tailored COREP report along with other regulatory reports is certainly the message that has been delivered to the PRA.
The Feedback Statement does not state preferred intentions of how the new prudential regulation framework will be developed. Changing the framework will never be a fast-moving event, and we can be confident that the PRA will take their time to consider all feedback received and to scan the wider world for feedback on initiatives taken in different countries.
There appears to be no stern opposition to the ideas presented back in 2021 and it is safe to say that we can expect more announcements later in 2022 or even as late as 2023.
If you’d like to learn more about the strong & simple prudential framework, you can read the PRA’s full statement here.