PRA CP 7/24 – Completing the Simpler regime

Alongside the second package (PS9/24) of ‘near-final’ rules for the UK implementation of Basel 3.1, the PRA has published a consultation (CP7/24) on capital proposals for Small Domestic Deposit Takers (SDDTs) and SDDT consolidation entities. These proposals are the final component of the ‘Simpler Regime’ first outlined in Sam Woods’ November 2020 Mansion House speech. They will be of particular interest to firms already registered as SDDTs, firms that meet the SDDT criteria and are considering registering as an SDDT, firms that anticipate being subject to the Interim Capital Regime (ICR) and entities that do business with SDDTs.

The PRA finalised the eligibility criteria for SDDT firms and the non-capital related elements (i.e. liquidity and disclosure requirements) of the proposed prudential framework in PS15/23. In this new consultation, it sets out proposals for the capital-related elements of the regime and offers additional liquidity simplifications for SDDTs.

In line with responses to Discussion Paper (DP) 1/21, the PRA has followed a “streamlined approach”, aiming to simplify current prudential requirements rather than creating a new and bespoke prudential framework for SDDTs that is significantly different from the one that applies to other firms.

Most importantly, CP7/24 confirms that Basel 3.1 risk weights should be used as the starting point for the Pillar 1 framework for SDDTs, subject to a small number of simplifications. Phil Evans, PRA Director of Prudential Policy, notes in his accompanying speech that “if Basel 3.1 is our best estimate of the risk weights, then that is going to be true whether large firms or small firms are doing the activity”.

However, the PRA also proposes widespread simplification of all elements of the capital stack for SDDTs including Pillar 1, Pillar 2A, buffers and the calculation of regulatory capital.

The overall capital requirements for SDDTs are expected to remain similar under the new system, to maintain their resilience against shocks. The PRA’s intention was never to dramatically reduce the amount of capital required, but rather to focus on minimising the operational burden for smaller firms. Following one-off implementation costs, the extensive simplifications should result in lower reporting requirements and the ability to hold lower management buffers.

CP7/24 clarifies that the SDDT regime operates on an opt-in basis. It also sets out the proposed revocation of the Interim Capital Regime (ICR) from 1 January 2027 – at this point, firms opted into it the ICR would be required to implement either the full Basel 3.1 standards or the simplified SDDT capital regime. 

The consultation closes on 12 December 2024 with implementation proposed from 1 January 2027. 

The most significant announcements relate to:

1. Leveraging Basel 3.1 risk weights

The PRA proposes to base the Pillar 1 framework for SDDTs on the Basel 3.1 standardised approaches (SAs) to credit risk and operational risk as set out in PS9/24 and PS17/23 respectively. 

• From an ideological standpoint, the PRA maintains that risk weights should remain consistent regardless of whether large firms or small firms are doing the activity – “the risk is the risk”.
• This approach offers a significant advantage in that there will be no difference in risk weights for firms seeking to transition in or out of the SDDT regime.

2. Simplification of the capital stack

The PRA proposes to:

• Simplify the Pillar 1 framework for SDDTs through the disapplication of the due diligence requirements in the standardised approach to credit risk (CR SA), simplifications to the market risk framework, the disapplication of capital requirements for counterparty credit risk for derivatives (with some minor exceptions) and credit valuation adjustment (CVA) risk, and consequential changes to the Leverage Ratio and Large Exposures rules.
• Simplify the Pillar 2A methodologies for credit risk, credit concentration risk, and operational risk.
• Introduce a new Single Capital Buffer (SCB) framework to replace the current buffers framework (consisting of the Capital Conservation Buffer (CCoB) and Countercyclical Capital Buffer (CCyB), which together make up the combined buffer, and the PRA buffer), and the removal of automatic capital conservation measures under the maximum distributable amount (MDA) framework.
• Replace the current cyclical stress testing framework with a non-cyclical framework.
• Remove the CCyB adjustment between buffers and Pillar 2A to make the capital stack much simpler for SDDTs to understand.
• Simplify the Internal Capital Adequacy Assessment process (ICAAP) and a reduction in the frequency of the Internal Liquidity Adequacy Assessment Process review (ILAAP).
• Simplify certain complex capital deduction rules.
• Simplify reporting requirements, in line with the proposals set out above.

As noted above, the overall capital requirements for SDDTs are expected to be similar to the current system under the new regime. However, after consideration of one-off implementation costs, there would be a range of benefits from the proposed simplifications including:

• More constant and predictable capital requirements –this would improve challenges that small firms currently face in raising new regulatory capital quickly in response to changes in regulatory buffers – as there may not be a deep market for their capital instruments always available, or their access to external funding opportunities are limited.
• Lower costs due to reduced reporting requirements and a simpler supervisory process.

3. Clarification of opt-in basis

The CP clarifies that the SDDT regime operates exclusively on an opt-in basis. Firms meeting the SDDT criteria (SDDT-eligible firms) can enter the regime by consenting to a Modification by Consent (MbC). 

4. Revocation of the ICR

The ICR is an optional and temporary regime that offers SDDT-eligible firms the choice to remain subject to the existing CRR capital provisions until the SDDT capital regime is implemented. This avoids the need for firms to implement the full suite of Basel 3.1 standards before subsequently moving over to the new regime.

The ICR is intended to be in place only between the implementation date for Basel 3.1 (1 January 2026) and the proposed implementation date for the SDDT capital regime (1 January 2027). At the end of this period, CP7/24 proposes that the ICR would cease to apply and the rules that give it effect would be revoked. 

ICR firms that have taken up SDDT MbC would immediately move onto the simplified capital regime for SDDTs, while ICR firms that have not taken up the SDDT MbC would move onto full Basel 3.1 standards.

Note for clarification: In CP16/22 (November 2022), the ICR was referred to as the Transitional Capital Regime (TCR). The TCR was renamed as the ICR in Section 8 of PS17/23 (December 2023) and an accompanying Statement of Policy.