UK regulatory reform pushes on, with its key drivers of bolstering the UK’s position as a global financial centre and, as the UK Chancellor stated in a Speech in July 2021, a financial services sector that is ‘open, competitive, technologically advanced and sustainable.’, as well as being required by legislation. Further developments will be seen in 2022 including in relation to the proposed small banks prudential regime and independent review of the UK's bank ring-fencing regime, as well as the comprehensive review of the UK's regulatory framework (covered in our separate 'UK regulatory reform in 2022 (part 2)' blog).
Small banks’ prudential regime
After announcing the same in late 2020, the UK prudential regulatory, the Prudential Regulation Authority (PRA) published in 2021 its proposals and initial feedback statement and initial feedback statement on a simplified and graduated prudential regime for smaller banks and building societies.
The drivers of the regime are very much focused on encouraging growth and competition in the sector, while maintaining robust but proportionate prudential requirements for such firms. It builds on the PRA’s supervisory policy in relation to ‘new and growing’ banks published in April 2021 and takes account of the Bank of England’s updated MREL policy (see further item 3), both of which are intended to achieve the same. It is also consistent with a global shift in prudential regulation where a number of jurisdictions, including Switzerland, Canada and Australia, have developed similar regimes for smaller banks, and marks a divergence from the EU’s approach, which broadly applies the same prudential requirements to all banking firms irrespective of their size or activities.
The proposed regime would apply to ‘non-systemic domestic’ banks and building societies, focusing on the smallest of these firms initially and being extended to larger, but still non-systemic and domestic, firms in time. Its central intention is to reduce the complexity and, therefore, the proportionately higher costs, of the prudential requirements that apply to such firms by omitting those requirements which do not reflect the financial risks they face and do not, therefore, make a material contribution to their resilience (those requirements reflecting the failure of larger banks on which the current prudential regime is based).
The regime is also intended to avoid barriers to growth when a bank is ready to move out of the simplified regime and is then ‘hit’ by significantly greater, and therefore more costly, requirements. Proposals include the introduction of a limited number of interim requirements to ‘bridge the gap’ between the simpler regime and regime applying to larger banks and an option to ‘opt-out’ of the simplified regime if a bank knows at the outset (potentially at authorisation) that it is likely to grow.
This issue may, of course, in the longer-term fall away, or at least be reduced, if, as the PRA envisages, the UK’s prudential regime as a whole comprises a number of layers from the small banks regime up to the full Basel standards through which banks can move gradually as they grow.
The proposed regime marks a significant change in UK prudential policy and the PRA’s discussion paper and subsequent feedback statement are deliberate in order to gather industry views on the options and their wider implications, and inform more developed proposals on which it will then consult. The regime will also, as a result, take a number of years to design and implement and, therefore, while it will be welcomed by established smaller banks, new entrants and prospective entities looking to enter the sector, it will be some time before its impact is seen and assessed in practice.
Independent review of the UK’s ring-fencing regime
The UK government commissioned in 2021 an independent review of the UK’s ring-fencing regime, as required under the Financial Services (Banking Reform) Act 2013, to consider the impact of the regime on: (i) UK banking sector competition, including the benefits and barriers that the regime presents; (ii) UK mortgage market competition, including mortgage pricing and risk-taking incentives created by the regime; and (iii) the UK banking sector’s international competitiveness.
The review is being led by Ken Skeoch, ex-CEO of Standard Life Aberdeen, with a panel of policy and industry representatives. The Panel published a call for evidence earlier in 2021 requesting stakeholder feedback on the regime’s impact on financial stability, competition and customers, and its operation in practice. A summary of responses was published in July 2021 and the panel aims to report on its recommendations by February 2022.
The review has generated significant interest in the UK banking industry, particularly given the significant costs for banks subject to the regime, both from a restructuring and compliance perspective, with a number of banks lobbying for particular regime changes. Of particular interest is whether the Review will recommend an increase to the current ‘entry’ threshold of £25bn of core deposits over a three-year period (banks are reported to be lobbying for at least a £40bn threshold); a tiered set of requirements individually applicable as banks’ core deposits increase; and a reduction in the current restrictions on the activities ring-fenced banks can undertake, the exposures they can incur to the broadly defined range of ‘relevant financial institutions’, and the entities they can set up overseas.
All of these aspects would have a significant impact on UK banking firms’ ability to grow, attract investment and remain competitive. This would be the case for newer and smaller banks coming close to the current threshold and larger established investment and retail banks whose retail business expansion is currently being limited so as avoid reaching the regime entry threshold.
“[The regime’s] central intention is to reduce the complexity and, therefore, proportionately higher costs, of the requirements applying to [small banks].”