We look at the key developments in capital and liquidity for challenger banks and building societies, including the latest on the Prudential Regulation Authority (PRA) Strong and Simple regime and progress towards Basel 3.1 requirements following the PRA’s publication of draft requirements in CP16/22 and the implications for balance sheet optimisation.
Strong and Simple regime
The PRA’s Strong and Simple regime remains a work in progress. The original discussion paper provided a glimpse of a new regime that might benefit firms of a certain size and scale. But firms were sceptical of how useful it would be – many details were missing and there was an emphasis on ‘strong’ rather than ‘simple’.
Subsequent developments defined which firms would be eligible for the regime, and in its Basel 3.1 publication (see below), the PRA sought to expand the eligibility criteria by increasing the size threshold to firms below £20bn (whereas the previous threshold had been £15bn).
In Spring 2023, the Strong and Simple regime progressed further when we saw the proposals in respect of liquidity risk, particularly on liquidity reporting. These were finalised in December – reducing some of the reporting burdens on firms and removing the NSFR requirement. However, to steal a culinary metaphor, it is fair to say that the liquidity rules were very much the entrée for most firms and we still eagerly await the main course – which is what amendments the Strong and Simple regime will bring to the capital framework.
Until we get further clarity on this (and further clarity on the Basel 3.1 regime – on which more below), challenger banks may be forgiven for feeling that they are ‘flying blind’ and this is reflected in a degree of uncertainty as to when, and whether, to adopt the new regime.
We can hopefully expect some further news on the capital aspects of the Strong and Simple regime in Q2 2024 when the PRA finalises its Basel 3.1 proposals. Until then, the jury is still out on how widespread the adoption of this new regime will be or what impact it will have on the challenger bank and building society landscape. Watch this space.
Edinburgh reforms - redux
These were unveiled in Autumn 2022, but we have had to wait until 2023 to see the further detail on alignment of ring-fencing with the recovery and resolution frameworks. In the end this was more of a damp squib unfortunately given many challenger banks do not have significant corporate or investment banking activities that would fall outside the ring-fence.
In other news, the PRA has followed through on its plans to scrap the non-performing loans backstop, a sign of it flexing its independence post-Brexit, but one which will have limited real impact.
So from a capital perspective, in spite of the fanfare, there is little to get too excited about in the reform proposals.
Where there may be more interest going forward is in the proposals around the securitisation capital framework where the PRA looks like it wants to amend the calibrations which would make the cost of synthetic protection more attractive and might serve to increase the balance sheet velocity for challenger banks. This of course is a direct response to the key change on the prudential horizon – Basel 3.1.
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Basel 3.1
Since the PRA published its weighty pre-Christmas tome in 2022 (CP 16/22), which ran to well over 1,000 pages setting out how it intends to implement Basel 3.1 (still known by some as Basel 4), it has received significant feedback from the industry. Much of this has been focused on issues pertinent to challenger banks, around the treatment of real estate lending, the removal of the SME support factor and development lending.
The head of the PRA, Sam Woods, indicated in a speech recently that they had “listened” to industry commentary and suggested that changes might be coming in the finalised text which is due out in Q1 2024. Whilst the PRA continues to espouse close alignment with the original Basel proposals (in contrast with the EU proposals for CRR3/CRD6), this does indicate that there may be some amendments that industry will find attractive.
Whilst they wait to hear how the PRA responds to their feedback, many firms have spent 2023 performing impact assessments, navigating through the details and doing the gap analyses so that they can prepare for implementation in 2024. Underpinning all this is the expectation that much of the CP will remain ‘as is’ when this moves to a policy statement and final rules (as much as the hopes may be otherwise!).
The other big news over 2023, of course, concerns timelines – with the PRA pushing the start date back 6 months (to July 2025) to align with the US (although it remains a distinct possibility that US timelines could slip even further back). The prevailing sentiment among firms though remains one of caution rather than complacency. In general firms have used the additional time to continue with “no regrets” work, particularly on data sourcing, lineage, technology and governance to meet the July 2025 implementation timeline.
No end to the challenging climate
Coupled with the ‘cost of living’ issues expected to put pressure on capital levels through increased impairments, this continues to provide for a challenging climate. With the future capital requirements uncertain (but almost certainly higher) and lending being done now that will be impacted in the medium term, firms are taking a hard look at their forward business mix and strategy. The upshot of this is that we expect to see (and already are seeing) an increased focus on capital efficiency (including the use of structuring and risk transfer methods), together with a big focus on pricing and interest rate risk management as firms continue to chart their course through another uncertain year ahead.
