Prudential Regulation Authority Business Plan 2022/23

Foreword by Chief Executive Sam Woods

This year starts for us all with the terrible events unfolding in Ukraine, as a result of Russia’s invasion. These events of course have an importance far beyond the bits of them with which the PRA is involved. Although we are, thankfully, far from the armed conflict itself, it is a worrying time for those of our staff with friends or family caught up in it. And for a larger number of staff, we have also been directly engaged in the response to the invasion – first through working closely with the government and fellow regulators at home and abroad in advising on and implementing the sanctions. And then, through closely monitoring the first- and second-order effects of the conflict and the sanctions as they affect the system.

In the context of the PRA, the war does also illustrate the need to expect the unexpected in our line of work. There is an operational aspect to this, in that significant supervisory resource has had to be diverted at high speed away from planned work and onto dealing with the new crisis. And there is also a deeper regulatory point, which is that at times like these – just as with the arrival of Covid and the economic shutdown that accompanied it – we are reminded why it’s vital to maintain high levels of resilience in the core of our financial system.

This touches on a central aspect of this year’s business plan for the PRA. We took a little time during Covid to conduct a strategic review of the PRA, to see what lessons we could learn from the organisation’s first eight years or so of existence. As a result of this we are making some changes to improve the efficiency and effectiveness of the PRA and to accommodate changes in the world around us. These include, importantly, the larger rule-making role that the government proposes we take on following Brexit, the greater attention we now pay to firms’ operational resilience including cyber resilience, and advances we need to make in our use of data and analytics.

Along with all these changes we have quite deliberately chosen, in refreshing our strategic priorities, to include: ‘retain and build on the strength of the banking and insurance sectors delivered by the financial crisis reforms’. Whether to include this wording was debated amongst the leadership team and at the Prudential Regulation Committee. Was it too backward-looking to refer to the financial crisis, given it is now well over a decade and several crises back? Have things moved on so far that the lessons of 2008 should slip down our priorities? We concluded the opposite – that for a prudential regulator, it is essential that we keep those lessons at the forefront of our minds, to make sure that the banking and insurance sectors can navigate the extraordinary challenges the world presents and avoid being a source of challenges for the rest of the economy.

Without forgetting our past, we need to be thoroughly forward-facing in order to deliver our remit. This business plan sketches the wide range of activities that this will entail over the coming year, but let me pick out four.

First, we very much support the government’s Future Regulatory Framework proposals, which – if Parliament approves them – will enable us to adopt a more British style of rule-making, with less fine detail in legislation and more ability for us to maintain and develop a coherent and dynamic rulebook. Second, we are already developing a simpler regime for smaller banks, which will be good both for safety and soundness and for competition – we call this ‘Strong and Simple’ because we have no interest in a weak regime. Third, we are putting a lot of effort into a review of Solvency II. The broad contours of the package are now coming into focus – a lower risk margin, a strengthened matching adjustment with wider eligibility, and improved, more proportionate reporting and approval requirements. Taken together and appropriately calibrated, this package will make an important contribution to investment and competitiveness in a way that is consistent with the PRA’s objectives. And lastly, we are committed to keeping pace with innovation and emerging risks, including the ongoing digitalisation of financial services and the growth of crypto assets, the increasing use of artificial intelligence and machine learning, and developments in FinTech. This includes our work to manage the risks to firms’ safety and soundness from climate change.

In order to deliver these, and in particular an expanded role as a rule-maker and an increased focus on operational resilience, we will need to increase our resources this year with a budget that will allow us to employ around 100 more staff than last year’s budget. We recognise that this results in a material increase in the levy (of around 8%), which we do not take lightly as we aim to run a lean operation – but the reality is that this change cannot be delivered without a slightly larger team. Levy-payers have the chance to offer any views on this in response to our fees consultation and I encourage them to do so, noting also the significant rebate we are providing for the year just passed.

It is going to be a very significant management challenge to staff up in this way in the current tight labour market and with increasing turnover following a period of fewer leavers during Covid. But as this plan outlines, this is a fascinating time to join the UK’s prudential regulator, and we hope to attract and retain colleagues with diverse backgrounds and experience. The PRA leadership team is very much focused on this task, but it is possible that it will take more than one year to achieve the increase in staffing levels. In which case, we will need to tailor the work programme set out in this business plan accordingly.

If the last two years are anything to judge by, some extraordinary event or other will intervene before next year’s business plan. Nonetheless, I think we will be able to move forward vigorously in all the areas set out in this year’s plan, and with thanks to all the staff in the PRA, I look forward to the year ahead.

Sam Woods
Deputy Governor and Chief Executive Officer

Overview of responsibilities and approach

The PRA has two primary objectives: a general objective to promote the safety and soundness of regulated firms, and an objective specific to insurance firms for the protection of policyholders. The PRA also has a secondary objective to facilitate effective competition in the market for services provided by PRA-authorised firms.

These objectives are delivered through regulation and supervision, and by developing standards and policies that set out expectations of firms. The supervisory process assesses whether firms are meeting expectations, the risks that they pose to the PRA’s objectives, and whether further supervisory or enforcement action is needed to reduce those risks. The PRA’s approach to supervision is forward-looking, judgement-based, and focused on the issues and firms that pose the greatest risk to the stability of the UK financial system and policyholders. This approach is set out in ‘The PRA’s approach to supervision of the banking and insurance sectors’.^{footnote [1]}

The PRA regulates 1,432 firms and groups.^{footnote [2]} These are 780 banks, building societies, credit unions, and designated investment firms (DIFs), and 652 insurers of all types (general insurers, life insurers, friendly societies, mutuals, the London market, and insurance special purpose vehicles (ISPVs)). Of the 1,432 firms, 236 have a deemed Part 4A permission in the Temporary Permissions Regime scheme (TPR)^{footnote [3]} and nine have a deemed Part 4A permission in the Supervised Run-Off (SRO) regime.

Regulatory focus is primarily at the individual firm and sector level, with the most important decisions taken by the Prudential Regulation Committee (PRC). The PRC works with other areas of the Bank of England (the Bank), including in its role as supervisor of Financial Market Infrastructures (FMIs), and its committees, including the Financial Policy Committee (FPC), which has responsibility for the stability of the UK financial system as a whole. The PRA also works closely with the conduct regulator, the Financial Conduct Authority (FCA).

Chart 1: PRA supervised deposit takers, as at January 2022

Chart 2: PRA supervised insurers, as at January 2022

The PRA’s strategy

Shaping the PRA’s strategy

Each year, the PRA is required by law to review, and if necessary, to revise its strategy in line with its statutory objectives:

• the general objective to promote the safety and soundness of PRA-authorised firms;
• specifically for insurance firms, to contribute to the securing of an appropriate degree of protection for those who are or may become policyholders; and
• a secondary objective to act, so far as is reasonably possible, in a way which facilitates effective competition in the markets for services provided by PRA-firms.

In addition to the statutory objectives, our strategy is shaped by other responsibilities, such as the requirement to implement legislation and other changes necessary to meet international standards, and to continue to adapt to market changes in areas such as climate change and FinTech. When considering how to advance its objectives, the PRA also has regard, where relevant and practical, to aspects of the government’s economic policy as recommended by HM Treasury (HMT).^{footnote [4]} Furthermore, as part of the Bank, the PRA contributes to the delivery of the Bank’s wider financial stability and monetary policy objectives.

Strategic priorities for 2022/23

The PRA undertook a strategic review in 2021, to consolidate lessons from its first eight years of existence. The review identified areas where the PRA needs to work differently to reflect the changing regulatory and external landscape. In particular, Brexit has significantly changed the context in which the PRA will operate in future, including additional rule-making responsibilities under the government’s proposed reforms to the UK’s regulatory framework. The PRA also needs to do more to mitigate risks that were not prominent when the post-crisis regulatory framework was being developed, such as operational resilience and climate change, and keep pace with innovation in the financial system, such as use of cryptoassets.

As a result of the review, the PRA has replaced the previous eight strategic goals with four strategic priorities (SPs). These are an evolution of, and broadly consistent with, the previous goals and explain how the PRA seeks to achieve its objectives:

• retain and build on the strength of the banking and insurance sectors delivered by the financial crisis reforms;
• be at the forefront of identifying new and emerging risks, and developing international policy;
• support competitive and dynamic markets in the sectors that we regulate; and
• run an inclusive, efficient, and modern regulator within the central bank.

This year’s business plan is structured around the new strategic priorities. These recognise that the resilience of the banking and insurance sectors are materially improved, after over a decade of financial crisis reforms, and the PRA’s focus has shifted to maintaining that improved level of resilience whilst tailoring rules more effectively to UK markets and firms. To keep the prudential framework fit for purpose, the PRA also seeks to be at the forefront of identifying and dealing with new and emerging risks. In pursuing these first two priorities, the PRA must balance its primary and secondary objectives by ensuring the safety and soundness of firms while fostering competition and innovation in the markets it regulates. Finally, to deliver these ambitious priorities, the PRA must have staff with the right skills and experience, working in an inclusive environment, and who are complemented by efficient technology and processes.

PRA Business Plan 2022/23

Retain and build on the strength of the banking and insurance sectors delivered by the financial crisis reforms

Over the decade following the financial crisis, the PRA designed and implemented extensive reforms, which materially improved the safety and soundness of firms, policyholder protection, and financial stability. The resilience of the banking and insurance sectors, and the importance of strong standards, were both apparent in the recent Covid-19 crisis.

The PRA’s focus has now shifted to maintaining that improved level of resilience, consistent with its objectives and those of the Financial Policy Committee (FPC). The PRA promotes a risk-aware culture in regulated firms, in which risk-taking should be conscious and controlled, and supported by adequate financial and non-financial resources. The PRA continues to ensure that firms are resilient operationally as well as financially.

The PRA is preparing to take on new rule-making responsibilities following the expected introduction of the Future Regulatory Framework (FRF), which will help keep the framework fit-for-purpose and will allow for more effective tailoring of rules to UK markets and firms.

Financial resilience – banks

Basel 3.1

During 2022, the PRA will consult on the implementation of Basel 3.1, the final package of banking prudential reforms developed in response to the 2008/09 financial crisis. This will make significant changes to the way banks calculate risk weighted assets (RWAs), using powers granted through the Financial Services Act 2021. The objectives of Basel 3.1 are to reduce excessive variability and improve comparability in the calculation of banks’ reported risk-weighted capital ratios, while not significantly increasing overall capital requirements. Basel 3.1 will: enhance the robustness and risk-sensitivity of the standardised approaches for credit, market and operational risk; control the use of internally modelled approaches; and complement risk-weighted capital ratios, with a revised output floor, to restrict the use of unduly low, modelled risk-weights, compared with banks using standardised approaches.

Leverage ratio

Part of the PRA’s ongoing support of the FPC’s annual statutory review of the UK leverage ratio includes framework updates that came into effect from 1 January 2022, reflecting revised international standards. These introduced a supervisory expectation that firms falling outside of the scope of the leverage ratio requirement should manage risk in a way that prevents their leverage ratios from falling below 3.25%. Further changes are due from 1 January 2023, when the scope of the minimum leverage ratio requirement will extend to firms with non-UK assets above £10bn, as well as consolidation groups and ring-fenced bank (RFB) sub-groups exceeding the foreign assets threshold on a consolidated or RFB sub-consolidated basis, as applicable.^{footnote [5]} The PRA is also assessing the risks from contingent leverage, through transactions or trade structures that receive a lower leverage ratio exposure measure value than economically equivalent alternatives, and will conduct a further exercise to gather data on large firms’ use of such trades.

Stress testing

The Bank and PRA will continue to test system-wide financial resilience using extreme but plausible scenario analysis, with the return of the annual cyclical scenario (ACS) stress test, following two years of Covid pandemic crisis-related stress testing. The 2022 ACS will test the resilience of the UK banking system to deep simultaneous recessions in the UK and global economies, large falls in asset prices, and higher global interest rates, as well as a separate stress of misconduct costs. In the light of uncertainty related to the Russian invasion of Ukraine, and in order to help lenders focus on managing the ongoing financial markets disruption associated with the invasion, the FPC and the PRC announced on 24 March 2022 that the launch of the 2022 ACS would be delayed. The FPC and the PRC intend to announce a revised timeline during Q2 2022.

Core assurance work

Core supervisory processes, such as periodic summary meetings and technical risk reviews, will also be used to assess whether firms remain adequately capitalised and have sufficient liquidity and stable funding profiles. In addition, work will be undertaken to further embed the leverage ratio, the supervisory approach to climate risks, and learnings from the Covid-19 pandemic. The PRA will continue to assess the resilience and vulnerabilities of firms under a range of scenarios and undertake thematic and firm-specific asset quality reviews, including in key vulnerable sectors and potentially higher risk portfolios or asset classes identified through horizon-scanning activities.

Internal models

The PRA has published a range of policy statements (PSs) on changes to internal ratings based (IRB) credit risk measurement over recent years. These cover the approaches to estimation of probability of default, loss given default, and exposure at default, treatment of defaulted exposures, definition of default, and the ‘hybrid’ approach for residential mortgage modelling. New requirements and expectations^{footnote [6]} applicable from 1 January 2022, require qualifying firms to submit IRB model applications in line with the timelines communicated by their supervisors. Deadlines for mortgage models and non-mortgage models are staggered and the PRA will work with firms on their model review processes and the subsequent updating of IRB permissions.

Banks’ use of and reliance on models and scenario analysis to assess future risks has significantly increased over the past decade, in part driven by new regulations and reporting requirements (eg IFRS 9) and regulatory expectations in respect of stress testing. The use of modelling has, however, often extended beyond the scope of current PRA guidance and the CRR, and the introduction of new, sophisticated modelling techniques has highlighted the need for sound model governance and effective model risk management practices. In order to support banks in the management of the risks associated with the use of models, and to raise the prudential standards at UK banks, the PRA plans to publish a supervisory statement (SS) in 2022 that will tie together all PRA expectations, rules, and requirements on model governance, model validation and general model risk management. The publication will provide an overarching supervisory framework that sets out the key principles and disciplines critical to establishing a robust approach for managing model risks.

Financial resilience – insurers

Review of Solvency II

In November 2020, HMT launched a review of Solvency II, with a call for evidence, and from the evidence received, published a response in July 2021. In April 2022, HMT will consult on a package of reforms to insurance regulation. The PRA expects to launch its own consultation in due course. The detailed package will retain the principles that underlie the existing regime. By improving the tailoring of key elements of the regime to the products supplied and the risks faced by the UK insurance sector, and by streamlining processes, the reforms will further the government’s objectives for its review while remaining consistent with the PRA’s statutory objectives. The main elements that the PRA expects to consult on are:

• a reduction in the level of the risk margin for long-term life insurance liabilities, making it less sensitive to interest rates;
• supporting sustainable investment by adjusting the design and strengthening calibration of the matching adjustment to better reflect actual risks retained by insurers, in particular uncertainty over the future level of credit defaults and idiosyncratic risks in individual assets;
• expanding the eligibility criteria for matching adjustment portfolios to include assets with prepayment options or variable construction phases, which will allow greater investment by the insurance sector in productive assets and in projects that support the transition of the economy to net zero;
• expanding the eligibility criteria for matching adjustment portfolios to include liabilities exposed to morbidity risk, such as income protection products;
• simplifying processes for the approval of internal models, and of matching adjustment eligibility for less complex assets, in order to remove barriers to investment and accommodate alternative risk assessment techniques for innovative assets; and
• facilitating effective competition by raising the threshold for the application of Solvency II, introducing a mobilisation process for new insurers, and reducing capital and reporting requirements for incoming branches.

Stress testing

The PRA will launch the next insurance stress test in May 2022, covering the largest general and life insurers. The test will follow a year of engagement with the insurance industry and requests for technical input. Results will be published in due course. The exercise will assess sector resilience to severe but plausible adverse scenarios: for life insurers focussing on a severe market disruption to rates and liquidity, followed by a longevity shock; and for general insurers focussing on natural catastrophes and potential cyber-attacks.

The results of the stress test will also guide supervisory activity, with findings on firms’ potential vulnerabilities being incorporated into supervisory priorities and work plans. They will enhance the PRA’s capabilities and firms’ ability to respond to future shocks, by using the information from stress tests to support analysis in assessing broader sector resilience, systemic impacts, and potential responses to future events. The PRA will also work on the design of the longer-term strategy for stress testing, taking into account the latest developments in relation to the government’s review of Solvency II.

Internal models

The PRA will continue its scrutiny of models used by insurers to quantify and manage their risks, recognising the limitations and costs of these models. Work will continue to monitor internal model drift, as a means of understanding the make-up of firms’ risk profiles, and to identify potential trends in the strength of firms’ calibrations. The PRA will also analyse internal model output to support comparisons between firms across different risk categories, and to target review work, as well as investing in its own quantitative and qualitative risk indicator frameworks.

Life insurance

As the full impact of Covid-19 on credit portfolios may not have emerged yet, the PRA will closely monitor credit risk and firms’ exposure to credit downgrades and defaults. There will be particular focus on credit concentration risks in longer-term annuity businesses, and the expectation that firms properly identify, measure, control, and report risks, in line with the prudent person principle (PPP).

A focus during 2022 will be to gather market risk sensitivity data for the largest life insurance firms, to better understand their solvency and exposure to market movements. Engagement with the industry in reviewing regulatory reporting requirements will help determine the most effective means of collecting and using regular reporting and ad-hoc data requests, and, where necessary, bring in new reporting requirements for newer risks that have been identified, or where new information needs to be captured (e.g. from IFRS17). A survey for firms with significant derivative holdings will improve the PRA’s understanding of potential margin calls and the impact on liquidity positions, in line with any changed outlook for inflation and longer-term interest rates.

General insurance

With levels of economic inflation higher than those experienced in recent years supervisors will focus on the impact of economic inflation on insurers. Social inflation^{footnote [7]} can result – and in some parts of the market has already resulted in rising insurer claim costs. There will be further engagement with firms, to understand how the economic inflation risk is monitored, how general and social inflation risk drivers are factored into reserving decisions, the impacts on the cost of claims, and the potential impacts on financial resilience.

During the earlier stages of the pandemic firms were exposed to business interruption claims where the market had many variations of policy wordings. The interpretation had to be resolved by the Supreme Court and firms were required to pay levels of claims higher than they had expected. The PRA will continue to assess how contract uncertainty risk is managed within general insurance firms.

Operational risk and resilience (including critical third party policy and cyber stress testing)

Operational disruption can impact financial stability, threaten the viability of individual firms and financial market infrastructures, or cause harm to consumers, policyholders, and other parts of the financial system. The PRA defines operational resilience as the ability of firms and the financial sector as a whole to prevent, respond to, recover, and learn from operational disruptions, including cyber threats.

The Bank, PRA, and FCA’s operational resilience policy, issued in March 2021,^{footnote [8]} requires firms to identify important business services, set impact tolerances for those services, and take action to continue to deliver them during severe but plausible disruptions. Updated policy on outsourcing and third party risk management^{footnote [9]} complements the wider operational resilience policy, and takes into account firms’ growing dependency on third parties, including cloud service providers. A focus of engagement during 2022 will be to assess whether firms had implemented the policy expectations by the time they came into force on 31 March 2022. This will include an assessment of firms’ plans to ensure they will be able to deliver important business services within impact tolerance, no later than 31 March 2025.

The PRA will continue to deliver its priorities around operational resilience through a broad range of industry and sector-based engagements such as the Authorities Response Framework, the Cross Market Operational Resilience Group, the Cyber Expert Group, and the Basel Committee for Banking Supervision Operational Resilience Group. As indicated by the FPC in 2021, the Bank, PRA, and FCA will publish a joint discussion paper outlining potential additional measures to enhance the oversight of the systemic risks posed by critical third party service providers. Joint authorities will also co-ordinate work on the longer-term approach to supervising cyber risks,and improving the collection of operational incident and outsourcing data.

Governance and risk management

Using outcomes from the recent evaluation of the Senior Managers and Certification Regime (SM&CR)^{footnote [10]} and the framework for variable remuneration, the PRA will make full use of senior accountability and prudent incentive setting as a mechanism for delivering better prudential outcomes across all regulated firms. This will underline the links between accountability and improved risk management, drawing on the lessons from the cross-firm deficiencies, particularly in respect of counterparty risk management, that were identified following the default of the Archegos Capital Management family office. In response to that default, the PRA and FCA sent a joint letter to CEOs of global equity finance businesses, published on 10 December 2021,^{footnote [11]} and will assess firms’ responses to the letter with a particular focus on the necessary improvements firms need to make to risk management, governance and culture.

Accurate, complete, and timely regulatory reporting also remains at the foundation of effective supervision. Over 2020/2021, the PRA asked firms to demonstrate how they deliver accurate regulatory returns, through the commissioning of a number of reports from skilled persons. The results revealed significant deficiencies across a range of firms’ processes for delivering regulatory data. The PRA’s letter to CEOs of banks and building societies, published on 10 September 2021^{footnote [12]} set out the thematic findings and expectations for all firms to consider and implement any work needed to improve governance and controls around the provision of regulatory reporting data. The PRA will focus on this specific area during 2022/23, including through continued use of skilled persons reviews, until there is sufficient assurance around the quality of regulatory data received. In addition, working with the FCA the PRA will continue to lead the joint transformation programme with industry, with the aim of transforming data collection from the UK financial sector over a longer timeframe.

From a supervisory perspective, diversity and inclusion is an important mitigant to group think, as it helps bring different perspectives, experiences, and concerns to the table, fostering constructive challenge and debate. The PRA considers diversity and inclusion to be an important part of corporate culture, and the way a firm manages its risk. Building on the joint Bank, PRA, and FCA discussion paper (DP) and data survey, it will consult in autumn 2022 on proposals to support diversity and inclusion in the financial services sector, with the final policy to be published during 2023.

Be at the forefront of identifying new and emerging risks, and developing international policy

The PRA maintains flexibility to adapt and respond to changes in the external environment, economic and market developments, and any other risks that may impact its statutory objectives or priorities. The horizon-scanning programme is at the heart of the delivery of this priority, allowing the PRA to identify emerging external risks, regulatory arbitrage, dangerous practices, and features of the regulatory regime that are not yet delivering the desired results, and allocate supervisory and policy resources to tackling the highest priority risks.

The war in Ukraine

Russia’s invasion of Ukraine, and the resulting impacts on the financial sector and markets, has led to the PRA reprioritising work to ensure the safety and soundness of regulated firms. Rapid escalation measures, with various cross-PRA and cross-Bank information sharing and decision-making groups, resulted in heightened levels of firm engagement and monitoring to ensure a proportionate response while progressing the business as usual work plan.

Across the banking and insurance sectors, the PRA will remain especially focused on the first and second order impacts of the war in Ukraine, and on assessing the extent to which this could impact the stability of financial institutions. Strong relationships with other UK authorities and international regulators have helped the PRA to be abreast of the issues on a global scale, and to ensure that collective approaches in promoting the continued resilience of regulated financial institutions are aligned.

Climate change

Climate change also presents a source of material and increasing financial risk to firms and to the financial system. Managing the risks to firms’ safety and soundness from climate change requires action, and remains a key PRA priority. Expectations around enhancing banks’ and insurers’ approaches to managing the financial risks from climate change were first set out in April 2019, in SS3/19.^{footnote [13]} The PRA has since provided further guidance and worked with industry through the Climate Financial Risk Forum to produce practical guides and tools. Progress has not been consistent across all firms, and it is important to focus not only on the business opportunities presented by climate change but also on the increasing business risk that is foreseeable and requires action now. The PRA expects firms to take a forward-looking, strategic, and ambitious approach to managing climate-related financial risks, which is proportionate to the scale of the risks and the complexity of a firm’s operations while recognising that some smaller firms, for example those with geographic or sectoral concentrations, may face greater climate-related financial risks than other similar-sized firms.

From 2022, the PRA’s approach to climate-related financial risk will switch from assessing implementation, to actively supervising against the threats. The assessment of a firm’s management of climate-related financial risks will be included in the relevant elements of the supervisory cycle, as outlined in the Climate Change Adaptation Report 2021.^{footnote [14]}

Over the course of the year, the PRA expects firms to refine, innovate, and integrate climate-related financial risk management practices, as regulators and firms collectively build their understanding of the risks, data, tools, and best practices. This includes dealing with the challenges of data gaps and firms using their judgement, expertise, and existing tools to quantify climate-related risks, and incorporate those risks into business strategies, decision-making, risk-taking and risk management, and firms’ own assessment of capital adequacy and risks. The largest firms will be asked to prepare a short report on how they have embedded the management of climate-related financial risks into their existing risk management frameworks alongside their 2021/22 ICAAP (deposit-takers) or own risk and solvency assessment (ORSA) (insurers). A sample of the remaining firms will also be asked to prepare a similar report proportionate to their size, the complexity of their business, and the extent of the climate-related financial risks that they face.

The PRA will continue to advance its own work, building on the initial views of the 2021 Climate Change Adaptation Report, to determine whether broader changes are needed to the design, use and calibration of the capital frameworks for firms to better capture climate-related financial risks. Progress will rely on input from industry, academics and others, and a research conference is planned for 19 October 2022.

In advancing its objectives, the PRA will, amongst other considerations, have regard to the UK government’s commitment to achieve a net zero economy by 2050^{footnote [15]} and to the government’s energy security strategy and the important role that the financial system plays in supporting the UK’s energy security as part of the UK’s pathway to net zero^{footnote [16]}.

The results of the 2022 Climate Biennial Exploratory Scenario (CBES) will be published by the middle of 2022. This exercise was launched in June 2021 to explore the resilience of major UK banks, insurers, and the financial system to these risks under three climate scenarios. The objectives of the CBES are to:

• size the financial exposures of individual firms and the financial system to climate change;
• understand how firms might respond to different climate scenarios and the impact on their business models and provision of financial services; and
• assist firms in enhancing their management of the financial risks from climate change.

The design of the CBES exercise (e.g. the 30-year time horizon and static balance sheet assumptions) and its exploratory nature mean it is not well suited to calibrate capital requirements in the way that the regular stress test is for deposit-takers. Rather, the learnings from the exercise will help to inform the PRA’s supervisory priorities and approach to supervisory policy in relation to financial risks from climate change, and guide further work between participants and supervisors to address any issues highlighted.

London interbank offered rate (LIBOR) transition

A significant milestone was reached in the transition from LIBOR at the end of 2021, when a number of LIBOR settings ceased to be published. The PRA recognises the work accomplished by the market in transitioning to robust risk-free rates, and that work remains to be done to mitigate the risks to financial stability and individual firms. Together, the Bank, the PRA, and the FCA will continue to support market-led efforts, and act with international authorities to remove barriers to transition, maintaining engagement through supervisory interactions and proportionate data collection. Work will focus on monitoring actions to: remove any remaining dependencies on LIBOR, including synthetic LIBOR; transitioning away from USD LIBOR by June 2023; and the transition to the most robust alternative rates, including monitoring use of credit sensitive rates.

Digitalisation

UK financial institutions are responding to pressures and opportunities related to the ongoing digitalisation of financial services. The PRA aims to be at the forefront of identifying and responding to the risks and opportunities faced by regulated firms as they seek to digitalise their processes to reduce costs, retain existing customers, and attract new customers by offering new and existing financial services through digital channels. During 2022, the PRA will monitor developments in key products (such as the impact of buy now pay later on unsecured lending) and the emergence of new banking business models with payments as a core component. Supervisors will work closely with the PRA horizon-scanning teams and other parts of the Bank, in particular the Fintech Hub, to exchange information and escalate issues arising from digitalisation to senior committees, and to inform discussions on digitalisation at international fora.

The PRA works closely with the Bank and the FCA to take a pro-active approach to digitalisation. The PRA has taken on board relevant recommendations from the 2019 Future of Finance report,^{footnote [17]} and the Kalifa review of UK fintech.^{footnote [18]} Through developing its digital skills strategy, the PRA is working with HMT, the FCA and other international bodies, to raise and address risks and opportunities arising from digitalisation, such as managing systemic risks stemming from concentrations of third party services provision to firms.

Digitalisation increases exposure to cyber risk, and the PRA will continue to use the threat-led penetration testing framework CBEST, alongside other cyber assessment tools, as a regular part of its supervisory approach to assess firms’ protection, detection and response capabilities to cyber scenarios.

In 2022, the PRA and FCA will consider a number of digitalisation risks to the insurance sector. Potential fragmentation of the value chain, due to more outsourcing of processes to InsurTechs, could lead to reduced access and oversight to these functions for both insurers and regulators. So far, losses incurred have been small in proportion to balance sheets, but in the coming year there will be more focus on the potential risks from large tech companies entering and disrupting financial markets, or generating unacceptable levels of concentration.

Financial inclusion will be another area of focus, where increased granularity of pricing could reduce access to insurance for higher risk individuals. Similarly, the use of granular personal data may lead to an increase in the risk of discrimination around the use of protected characteristics. There will also be increased monitoring around management’s understanding of complex non-linear and machine-learning models, and the outcomes for their customers, as well as the potential for capital and profit erosion for firms that are slower to adopt new technologies, challenging business model sustainability.

Ongoing supervision will oversee these risks through business model analysis, quarterly peer group analysis, firm-specific supervision, engagement with the FCA, the European Insurance and Occupational Pensions Authority (EIOPA), the Bank’s FinTech Hub, and through participation in the International Association of Insurance Supervisors (IAIS). All will consider whether additional supervisory principles, rules, or guidance are required for the insurance market.

The PRA will continue to contribute to the Bank’s work on cryptoassets. This will include oversight of the risks emerging from firms’ evolving levels of business and exposures in cryptoassets.^{footnote [19]} The PRA will also ask firms to report their cryptoasset exposures, treatments and future investment plans, and will engage with international partners, including at the Basel Committee on Banking Supervision, to establish a common, international framework for the treatment of cryptoasset exposures. Work will also continue in developing a regulatory framework that is ready for technological innovations, such as stablecoins.^{footnote [20]}

Artificial intelligence (AI) and machine learning

The PRA is considering its response to innovations in the increasing use of artificial intelligence in UK financial services, to ensure its safe adoption. A joint Bank, PRA, and FCA survey in 2019 found that two thirds of firms were already using AI models. In many cases, these had developed beyond the proof-of-concept stage and were being deployed in the business. Covid-19 has accelerated the overall pace of AI adoption both for in-house models and third-party providers, as well as the wider shift towards an online society and economy. The improved classification and predictive accuracy of AI models, as well as their ability to automate certain tasks, can bring benefits for households, firms, and the economy. But innovations also carry risk, with the speed, scale, and complexity of AI models, along with a range of data-related issues, amplifying existing consumer harm, risks to the safety and soundness of individual firms, and potentially generating systemic risks to financial stability.

The AI Public-Private Forum (AIPPF) was established in October 2020 as part of the Bank’s response to the Future of Finance Report, and comprises 21 experts from academia and the private sector.^{footnote [21]} The Forum is co-chaired by the Bank and FCA, with observers including HMT and the ICO. On 17 February 2022, the AIPPF published its final report,^{footnote [22]} which is the culmination of more than a year’s worth of meetings, workshops, and discussions on the various barriers to adoption, challenges, and risks related to the use of AI in financial services. The Bank and PRA are grateful to the members and observers for contributing their time, expertise and knowledge, and providing clarity that the private sector wants regulators to have a role in supporting and building on the safe adoption of AI in UK financial services. To support further discussion about what an appropriate role for regulators might look like, the PRA will publish a DP on AI later this year to build on the work of the AIPPF and broaden engagement to a wider set of stakeholders. The DP will give stakeholders an opportunity to share their views, and help in formulating any potential policy response, should one be needed.

Support competitive and dynamic markets in the sectors that we regulate

The PRA advances its primary and secondary statutory objectives through regulation to support competitive and dynamic markets in the sectors that it regulates. Under the FRF, the PRA is likely to have greater freedom to design and implement regulation in a way that is driven by its objectives and is better suited to the requirements of the UK market. As a result, the government has proposed a new secondary objective for the PRA, focused on facilitating international competitiveness and long-term growth. If approved by Parliament, this will allow the PRA to go further in tailoring prudential requirements, reducing the burden on firms where appropriate, and pursuing its existing secondary competition objective. The PRA is working on a number of initiatives, detailed below, to take advantage of those opportunities, including improving the overall accessibility of the rulebook, and developing a simpler and more proportionate regime for non-systemic banks and building societies. The PRA also remains committed to playing an active role in international standard-setting, given the important role of global rules in safeguarding the UK’s open economy through ensuring safe financial markets.

Regulatory change – the future regulatory framework review

The government launched HMT’s FRF review in July 2019, to ensure that the UK’s financial services regulatory framework continues to be fit for the future, after the UK’s departure from the European Union (EU). The review considered the overall policy framework, detailed regulatory standards, the transfer of rule-making powers to regulators, and an accountability framework to accompany those powers.

The review resulted in proposals for reform, including delegating broader responsibility for rule-making to regulators. The proposals were outlined in HMT’s consultation paper (CP) in November 2021.^{footnote [23]} As well as the introduction of a new secondary objective, changes included: incorporation of climate change into the existing regulatory principles to ensure that growth occurs in a sustainable manner consistent with achieving a net zero economy by 2050; enhanced accountability and scrutiny mechanisms for the PRA; and a power for HMT to repeal parts of retained EU law to enable regulators to replace those provisions with its own rules. The HMT consultation closed on 9 February 2022 and will form the basis of a new Financial Services Bill, expected to go before Parliament later in 2022.

Developing the PRA’s policy approach

As the government prepares to finalise the FRF and seek Parliament’s agreement to enact its proposals through legislation, the PRA has started to consider its approach to prudential policymaking under the new framework.

Proposals under the FRF will allow the PRA to be more responsive, targeted, and proactive in its approach to furthering its objectives. In particular, greater discretion over rule-making will allow for policy responses that are tailored to the specific characteristics of UK financial markets. This includes taking regulatory action where it is required to safeguard resilience, and adopting a proactive approach to furthering safe, open and competitive markets.

The PRA will consult with stakeholders to understand views on how best to deliver its new responsibilities and meet any new statutory objectives. To aid this, the PRA will publish a DP in 2022, setting out some views on the longer-term approach to prudential policymaking under the FRF. Work will start in the meantime on adopting coherent and consistent language for all policies, and a new website for the PRA Rulebook. To improve accessibility, the PRA will also deliver an index of prudential and resolution policies. This index will divide policies relating to prudential regulation and the UK’s resolution regime into sectors and topic areas. It will then list relevant policies into dedicated topic area pages on the Bank’s website.

Strong and simple regime

As explained in the PRA Business Plan for 2021/22, the PRA is working on creating a simpler but resilient prudential framework for smaller, non-systemic banks and building societies. This started with a discussion paper in April 2021,^{footnote [24]} suggesting how to develop a simpler prudential framework for smaller and less complex UK banks and building societies. The DP generated a large number of responses, which were summarised in a feedback statement (FS1/21) published in December 2021.^{footnote [25]}

Feedback was broadly supportive of the ideas in the DP. Taking account of that, work has commenced on the policy options for the ‘Strong and Simple’ regime, and the PRA plans to publish a CP in 2022/23. This will set out the proposed scope and criteria for the firms that would be eligible to use the ‘simpler regime’, with access available to a defined set of banks and building societies that are neither systemic nor internationally active, and provide standard lending or deposit banking products to UK customers. 

In the insurance sector, the PRA will pursue initiatives to enhance competition by simplifying and expediting the authorisations process, consulting on a mobilisation regime that will reduce barriers to entry for new retail firms, and raising thresholds for the application of Solvency II requirements. After the completion of the government’s current review of Solvency II, the PRA will also consider the case for a simpler regime for smaller insurers and friendly societies.

Ring-fencing regime

The independent Skeoch report ^{footnote [26]} reviewing ring-fencing and proprietary trading was published in March 2022, and makes recommendations for the authorities (HMT, the Bank as Resolution Authority, the PRA, and the FCA) to consider. HMT established a task force, together with the Bank, to inform the government’s response to the recommendations. The PRA will be working closely with HMT in the next year, to examine the recommendations, and respond to any changes that the government may make.

Ease of entry and exit

The PRA will continue work to develop a market which firms can easily enter and exit. A reliably safe exit process is a vital corollary of ease of entry, as it allows a more accommodating environment to new entrants. The point of ‘exit’ for this purpose is defined as the point at which a firm leaves the market because its business is unviable and it will not sustainably meet Threshold Conditions. While this often ultimately ends in winding-up proceedings, in most cases there is much that can be done beforehand to ease firms’ transition out of the market. The PRA will do more in the coming years to increase confidence that firms can exit the market without disturbing it, in an orderly way and without having to rely on the backstop of an insolvency or resolution process. It will review the approach to wind-down and run-off planning, building this into core supervisory activity and tools, and looking at whether there is scope to reform any aspects of the protection framework offered by the Financial Services Compensation Scheme (FSCS), to ensure that depositors and policyholders are appropriately protected in insolvency, and paid in a timely fashion.

International engagement

The PRA plays a leading role in influencing international regulatory standards, and will continue to participate actively in global standard-setting bodies, such as the Basel Committee for Banking Supervision (BCBS) and the IAIS. Where required, it will also continue supporting the Bank’s work at international policy fora, such as the Financial Stability Board. Over the coming year, the PRA’s engagement will focus on identifying and addressing emerging risks, further reflecting on the lessons from the ongoing evaluation work in relation to the Covid-19 stress. There will also be continued focus on promoting consistency in the implementation of Basel 3.1, the development and monitoring of the IAIS’s Insurance Capital Standard, the implementation of its common framework for the supervision of internationally active insurance groups (ComFrame), and a holistic framework for assessing and mitigating systemic risk in the insurance sector.

Effective international collaboration remains crucial to addressing global risks, and is central to maintaining UK financial stability and the safety and soundness of internationally active firms, and reducing regulatory arbitrage. The PRA will expand the list of jurisdictions with which it will agree memorandums of understanding (MoUs), and more broadly promote international collaboration through supervisory colleges and crisis management groups.

The development and implementation of global standards through international engagement supports the ability of UK firms to compete abroad on a level playing field, and vice-versa, thus facilitating effective competition. In 2021, the PRA authorised a number of banking and insurance branches that previously operated in the UK under EU passporting rules. Throughout 2022 and 2023, the PRA will take the remaining EU banking and insurance branches in the temporary permissions regime (TPR) through the authorisation process, working with the FCA and EU authorities to ensure that these firms are fully authorised and can continue to operate safely in the UK at the end of the TPR.

Run an inclusive, efficient and modern regulator within the central bank

In order to deliver the ambitious priorities set out above, the PRA needs staff with the right skills and experience, complemented by efficient technology and processes. The PRA leadership team will keep working to ensure that the PRA is a place where staff feel safe and empowered, where decisions are taken at the right level, and that is inclusive in every sense of the word. Change will take into account developments in regulatory technology, addressing inefficiencies, and leveraging the benefits of being a regulator within the UK’s central bank.

Delivery of the PRA strategic review

The PRA is taking action to strengthen its supervisory approach by being more risk-based and flexible in the way it is resourced. It will deploy a more confident and consistent supervisory approach, and make its governance and organisational structure more effective. In the longer term, the PRA will: transform its approach to policy making, to make it more accountable, responsive, and accessible; increase its confidence in the ability of mid-sized and smaller firms to exit the market in an orderly way; and strengthen its use of data and technology to support the delivery of its statutory objectives.

Data-related capability

The PRA’s ambitious programme of work to strengthen and transform its data-related capabilities builds on various strands of work completed over the past few years. It follows the establishment of a new, dedicated RegTech, Data & Innovation Division in 2021, to deliver, by 2026, a wide-ranging programme of work to bolster the PRA’s efficiency, effectiveness, and data culture, through phased investment in tools, technology, processes, and skills. This involves a number of activities, including embedding governance and collaboration mechanisms across the PRA between specialist teams and front-line supervision, and using those mechanisms to deliver, via a hub-and-spoke model, work to make best use of quantitative data, narrative information, and processes through automation.

The PRA’s RegTech and Data work informs, and is an important component of the Bank’s wider data agenda, which, in 2022/23 will include early pilots and production tools, including identification and visualisation of information from a range of data sources, using modern data science techniques such as machine learning. It will also involve delivering the first year of a new digital skills strategy for all PRA staff, underpinned by a three-pronged learning curriculum with courses on tools and technical knowledge, behaviour and business skills, and the digital economy. The PRA is developing processes to track the benefits from these changes in a way that is consistent with the related Bank strategic priority to modernise its ways of working. The PRA will increase its resourcing around RegTech and data to support this package of work, and will ramp up its engagement across academia and industry.

Diversity and inclusion

The PRA continues to take action to strengthen its culture and working environment in support of the Bank’s vision to become ‘more human, more humble and in step with the changing world’. The Bank’s Court review into ethnic diversity and inclusion reported its findings in July 2021. The PRA is committed to implementing the recommendations of this review, which aim to improve development and promotion outcomes and workplace culture, to further racial and ethnic inclusion. To support this, the PRA is implementing inclusive recruitment practices, supporting talent and development, and will make a more psychologically safe environment for its staff. The organisation will report on progress on the recruitment and career progression of female employees, and those from different ethnic backgrounds.

Strong operational controls

The PRA will continue to strengthen its operational controls by enhancing its risk frameworks including its approach to operational risks and horizon-scanning. Enhancements to the PRA’s authorisations process will include an improved control framework, which aims to drive up quality standards for core regulatory transactions and change management. The PRA will also work with the FCA to further automate and improve its core approach to master data management.    

Robust planning and financial management will ensure that the PRA has a clear business plan and an accurate, realistic budget to deliver it. The PRA’s executive receives information on quantitative and qualitative measures and indicators on a regular basis, to assess delivery against the business plan, statutory objectives, and risk tolerances. This enables the PRC to report to the Chancellor on the adequacy of resources, and to provide information on supervisory processes and outcomes. Decision-making processes are regularly assessed to ensure that they remain informed by relevant precedents, and that decisions are properly documented. The PRA also assesses its supervisory approach through peer reviews, and independent challenge by third parties such as the International Monetary Fund.

PRA Budget 2022/23

The PRA’s budget for 2022/23 is £320.9 million including implementation and transaction fees of £8.4 million. This is an increase of £24.3 million (8.2%) on the 2021/22 budget.

The PRA’s costs have increased, principally due to: its responsibilities for establishing a robust regulatory regime following the UK’s withdrawal from the EU, including the proposed expansion in its role as a rule-maker; proactively preparing for emerging risks in the financial system such as operational and cyber resilience; and the development of its data analytics and technology capabilities. Budgeted headcount for the PRA will increase from 1,341 in 2021/22 to 1,440 in 2022/23, driven by increasing headcount in its supervisory risk specialist, policy, and data science areas. Delivering this increase in capacity in the current, very tight labour market conditions will be a major challenge for the PRA over the course of this year.

The PRA explains how it proposes to fund its budget in the annual fees consultation paper. It includes proposals for allocating the cost of the PRA’s 2022/23 ongoing regulatory activities across PRA fee payers.

Abbreviations

Contacting the Bank of England and the PRA

Please send any enquiries related to this publication to PRA.Communications@bankofengland.co.uk.