The Prudential Regulation Authority's (PRA) new strong and simple regime aims to create a more proportionate prudential framework for non-systemically important banks and building societies. The PRA’s latest consultation discusses liquidity and disclosure requirements, and explores how a simpler regime could boost competition, while maintaining a safe and sound financial system. However, the strong and simple regime sits alongside Basel 3.1, and builds on many of the same themes. This raises the question of how to juggle the demands of Basel 3.1 and the strong and simple regime.
While Basel 3.1 and the strong and simple regime aim to achieve the same end result – namely a safe and sound prudential system – their approaches are different. Created in the aftermath of the financial crisis, the Basel reforms established a framework for best practice across international and systemically important banks. When transposing it into UK regulation, the PRA applied the principles across all banks and building societies, regardless of whether they were systemically important or not.
As a significant step towards post-Brexit divergence, the strong and simple regime aims to introduce greater proportionality for smaller firms. The PRA estimates that around 30 banks and 33 building societies could be eligible for the strong and simple regime (at the time of publication of CP4/23), highlighting this need for greater proportionality. Threshold criteria for the strong and simple regime is set out in Basel 3.1, including:
Basel 3.1 compliance is due by 1 January 2025, however, the strong and simple regime will have a staggered implementation with the first phase due in the second half of 2024. As the second phase is likely to fall after Basel 3.1, the PRA has given smaller banks and building societies an option. Firms meeting the strong and simple regime criteria on 1 January 2024, can either stay on the current Capital Requirements Regulation (CRR) through a Transitional Capital Regime (TCR), and adopt the strong and simple regime once it is finalised, or adopt Basel 3.1 and then switch to the strong and simple regime.
Adopting the TCR or Basel 3.1 is going to be tough decision for smaller banks, and largely depend on individual operating models, business activities and wider organisational strategies. For some, it will boil down to capital requirements. Applying the regimes in turn could require less capital in the short term, although these savings could be wiped out by the cost of implementation. Others may want to wait for the strong and simple regime, although there’s no guarantee that capital requirements will be any lower than under Basel 3.1. There’s also the question of business disruption, and the practicalities of implementing two prudential regimes in such short order.
We recently looked at the changes under Basel 3.1, and now look at recent proposals for the strong and simple regime to help smaller firms find the approach that’s right for them.
Under the current CRR framework, smaller firms can use a simplified net stable funding ratio (NSFR) that uses a smaller number of data points. But few firms have opted to do this, which suggests it may not be proportionate enough. To address the issue, the PRA suggested a new retail deposit ratio (RDR), which could be used in place of the NSFR, to measure how firms use their retail funding. The calculation would be the ratio of the firm’s retail funding (with an aggregate limit on small and medium enterprise deposits of £880,000) to its non-capital funding, which should ultimately be more stable than the NSFR.
Should a firm fall below 50% RDR (over four consecutive quarters), the PRA will assume the firm’s funding model has shifted to a wholesale focus and the NSFR will apply. New banks can apply to use the RDR at authorisation, and reassess the situation after a suitable period of operations post-restrictions. This will improve proportionality and boost competition, while maintaining financial resilience.
Firms under the strong and simple regime are likely to carry out less complex business activities, with greater limitations, than those under Basel 3.1. As such, Pillar 1 should adequately capture their liquidity risks, negating the need for Pillar 2 capital add-ons for most small banks and building societies. The PRA will introduce a simplified internal liquidity adequacy assessment process (ILAAP) document template, and supervisors will continue to review these for Pillar 2 risks, as per current CRR processes.
Simpler-regime firms will no longer need to complete some quarterly additional liquidity monitoring metrics (ALMM) returns (C67, C69, C70 and C71) as a matter of course. These returns are more relevant to larger firms, but regulators could request them after reviewing a firm’s ILAAP. Cutting them would improve proportionality and reduce reporting costs.
Approaches to liquidity reporting may change, as the Bank of England finalises its plans to transform data collection.
The PRA has proposed significant changes to Pillar 3 disclosures, in response to feedback to its DP1/21 discussion paper.
Listed simpler-regime firms must submit Pillar 3 disclosures (using UK OV1 and UK KM1 templates), to maintain transparency over capital, liquidity ratios and risk-weighted assets. This will help maintain market discipline and promote the PRA’s safe and sound agenda.
Non-listed simpler-regime firms will not need to make Pillar 3 disclosures, as the cost of production would outweigh the supervisory benefits.
The PRA feels that small and non-complex institutions (that aren’t simpler-regime firms) have less potential for significant financial disruption to wider markets and stability. As such, after an initial transition period, these firms won’t need to make Pillar 3 disclosures, but will need to follow the disclosure expectations for other institutions (as per the PRA Rulebook for CRR firms, section 433c on Disclosures).
Firms that fall in scope of the strong and simple regime must consider their options in terms of either following the transitional regime or adopting Basel 3.1 in the short term. This includes comparing the impact of reduced liquidity and disclosure requirements against Basel 3.1 to assess any potential cost savings, or opportunities to streamline processes. A cost-benefit analysis will help to identify the most cost-effective and practical route for the business, while ensuring key organisational goals continue to be met.
Whichever route firms choose to take, it’s important to remember that they must remain fully compliant with their chosen regime to allow for effective supervision and to maintain a sound financial system.
For more information and advice, contact Paul Young.
