Published on 23 January 2020
Pillar 2 capital: Updates to the framework - PS2/20
Overview
This Prudential Regulation Authority (PRA) Policy Statement (PS) provides feedback to responses to Consultation Paper (CP) 5/19 ‘Pillar 2 capital: Updates to the framework’ (see page 2 of 2). The PS contains the final amendments to the Pillar 2 framework and the updates to the following Statement of Policy (SoP) and Supervisory Statements (SS):
- SoP ‘The PRA’s methodologies for setting Pillar 2 capital’, (Appendix 1);
- SS31/15 ‘The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP)’, (Appendix 2); and
- SS6/14 ‘Implementing CRD IV: Capital buffers’, (Appendix 3).
This PS is relevant to PRA-authorised banks, building societies and PRA-designated investment firms (firms). It is not relevant to credit unions, insurance and reinsurance firms.
The PRA received five responses to CP5/19. Respondents sought further clarification on setting the PRA buffer for the hurdle rate in stress, buffer interactions and usability.
Changes to draft policy
Following consideration of the respondents’ comments, the PRA has made a few minor changes to the proposals. The PRA has updated the SoP to clarify that:
- in general, the PRA will use the leverage exposure measure as the single scaling base for operational risk and interest rate risk in the banking book (IRRBB) because the PRA considers it to be a more robust and representative scaling base. This has been clarified in Table E -‘Pillar 2A scaling bases’;
- in setting the PRA buffer, factors in addition to a firm’s hurdle rate(s) will be considered. These include, but are not limited to: the firm’s leverage ratio; Tier 1 and total capital ratios; risks associated with double leverage; and the extent to which potentially significant risks are not captured fully as part of the stress test. This is set out in paragraph 9.44;
- the purpose of the PRA buffer and its interaction with the combined buffers is set out in paragraph 9.1 and 9.28-9.31;
- in general, the PRA takes the approach of using the risk weighted assets (RWAs) at the start of the stress and that this may be adjusted to reflect changes to the balance sheet as set out in paragraph 9.32;
- the example illustrating the process of calculating the PRA buffer is a stylised example and does not represent an exhaustive scenario as set out in paragraph 9.32.
In addition to the changes above, the PRA has decided to add a reference to its existing policy related to managing climate-related financial risks. This is referenced in SS31/15 in paragraph 2.41.
The PRA has made no changes to the draft policy for SS6/14.
These changes are explained in Chapter 2. The PRA does not consider these changes significant enough to have any additional material impact on the costs or benefits on firms or mutuals, and so has not provided an updated cost-benefit analysis.
Implementation
The changes in this PS take effect from publication date on Thursday 23 January 2020.
The policy set out in this PS has been designed in the context of the current UK and EU regulatory framework. The PRA will keep the policy under review to assess whether any changes would be required due to changes in the UK regulatory framework, including those arising once any new arrangements with the European Union take effect.
In the event that the UK leaves the EU with no implementation period in place, the PRA has assessed that the policy would not need to be amended under the EU (Withdrawal) Act 2018 (EUWA). Please see PS5/19 ‘The Bank of England’s amendments to financial services legislation under the European Union (Withdrawal) Act 2018’ for further details.
The final SSs and SoP attached to this PS should be read in conjunction with SS1/19 ‘Non-binding PRA materials: The PRA’s approach after the UK’s withdrawal from the EU’.
Policy Statement 2/20Appendices
Appendix 1: Update to Statement of Policy ‘The PRA’s methodologies for setting Pillar 2 capital’.
Appendix 2: Update to Supervisory Statement 31/15 ‘The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP)’.
Appendix 3: Update to Supervisory Statement 6/14 ‘Implementing CRD IV: Capital buffers’.
Published on 13 March 2019
Pillar 2 capital: Updates to the framework - CP 5/19
Update 22 October: The final policy has been delayed from the end of October 2019. The PRA intends to publish the final policy in due course.
Update 20 August: Following comments from firms and other industry participants on Consultation Paper 5/19 ‘Pillar 2 capital: Updates to the framework’ the final policy has been delayed. It will be published by the end of October 2019, rather than on Tuesday 1 October 2019 as originally specified.
Overview
In this consultation paper (CP), the Prudential Regulation Authority (PRA) proposes to update the Pillar 2 capital framework to reflect continued refinements and developments in setting the PRA buffer (also referred to as Pillar 2B).
Since the PRA published its approach to setting the PRA buffer, the Bank of England’s (Bank’s) approach to stress testing has evolved. There have been changes to the stress testing hurdle rate and the way microprudential and macroprudential buffers interact. This in turn has implications for the way that the PRA buffer is calculated.
The PRA also proposes to clarify its approach to assessing weaknesses in risk management and governance, explain the process for updating the benchmarks used to calculate the Pillar 2A requirement for credit risk and correct some minor drafting errors that have been identified in previous publications.
This CP is relevant to PRA-authorised banks, building societies and PRA-designated investment firms (‘firms’). This CP is not relevant to credit unions, insurance and reinsurance firms.
Background
The PRA buffer is an amount of capital that firms should maintain in addition to their total capital requirements to absorb losses that may arise under a severe stress scenario, while avoiding duplication with the combined buffers. It may also be increased where the PRA assesses a firm’s risk management and/or governance to be significantly weak.
In 2015, the PRA set out the methodologies used in setting Pillar 2 capital for firms. This document was the first significant step towards increasing the transparency of the Pillar 2 capital framework. The proposals in this CP offer further clarity on the way that the PRA buffer is set. The PRA is not proposing to alter the purpose of the PRA buffer through these changes.
Purpose
The purpose of these proposals is to bring greater clarity, consistency and transparency to the PRA’s capital setting approach. In promoting a greater level of transparency, the PRA seeks to promote financial stability, the safety and soundness of PRA-authorised firms, and facilitate more informed and effective capital planning for banks.
Implementation
The PRA proposes to implement the proposals in the CP by Tuesday 1 October 2019.
Responses and next steps
This consultation closed on Thursday 13 June 2019. The PRA invites feedback on the proposals set out in this consultation. The PRA is particularly interested in respondent’s views on areas where further clarity is needed.
Please address any comments or enquiries to CP5_19@bankofengland.co.uk.