On 29 April 2022, the UK Prudential Regulation Authority (PRA) published its first consultation (CP5/22) on a proposed simpler prudential regime for non-systemic UK banks and building societies, termed by the PRA as the “Strong and Simple Framework” (see also our post on its original announcement). The consultation follows a Discussion Paper (DP1/21) in April 2021 and a Feedback Statement (FS1/21) in December 2021 and proposes a definition of “Simpler-regime firms”, the smallest banks (and building societies) to which the new regime would apply. This drive to simplify the prudential requirements under the UK capital requirements regime seems to be a key focus of the PRA- see our post on the PRA’s recent speech emphasising the benefits of a simpler prudential framework.
As set out in the Discussion Paper, the PRA is seeking to address the ‘complexity problem’ arising under the current prudential regime, where similar prudential requirements apply to all firms in-scope of the prudential regime regardless of their size and resources. The current regime therefore sets the cost of compliance disproportionately high for smaller, less financially risky, banks and building societies. The new regime is intended to introduce a simplified and proportionate regime for smaller banks, while also maintaining their resilience.
The proposed regime will be developed in phases and the PRA envisages it would have several “layers” of increasingly stringent requirements. The focus of the consultation paper is on the scope of the first layer of the new regime that would apply to the smallest banks and building societies, termed by the PRA as “Simpler-regime firms”. The PRA proposes to define such a firm as a UK bank or building society that: (i) has reported average total assets over a 36 month period of up to £15 billion; (ii) has at least 85% of its credit exposures located in the UK; (iii) has only limited trading activities and foreign exchange positions; (iv) does not hold any positions in commodity derivatives, apply the Internal Ratings Based (IRB) Approach to calculate its credit risk or provide certain market infrastructure services to other financial institutions in the UK (such as clearing, transaction settlement, custody or payment systems); and (v) where the firm is a subsidiary, it is a subsidiary of a UK undertaking. The PRA proposes to apply the test on a solo basis to firms which are not part of a group. For firms that are part of a group, the quantitative thresholds would be tested at the highest level of the UK consolidation group on a consolidated basis, as well as on a solo basis for each UK bank and building society in the consolidation group.
The proposals are at an early stage and, until the PRA publishes proposals on the simplified regime’s prudential requirements (which will follow in a subsequent consultation), it is difficult to assess whether the proposed definition of “Simpler-regime firm” appropriately addresses the complexity problem. Nonetheless, the consultation merits several observations:
- Flexibility: the PRA envisages a considerable degree of flexibility in determining whether to apply the simpler regime to a particular firm. The consultation suggests the flexibility would operate at least at four levels. First, the PRA would consider whether to exercise its powers under The Financial Services and Markets Act 2000 (FSMA) to require smaller firms to comply with more significant prudential requirements where justified by the PRA’s objectives. Secondly, UK subsidiaries of groups based outside the UK would not be within the simplified regime by default but could apply for a specific waiver to be included. Thirdly, fast-growing firms could opt out of the regime if they wished to comply with more stringent prudential requirements (the PRA intends to consult on the exact mechanism for this). Finally, the introduction of the new regime will very likely follow the implementation of the Basel 3.1 rules. The PRA intends that firms falling within the definition of Simpler-regime firm could opt to apply these rules without delay or a transitional period (the PRA intends to consult on this point as well). It is worth noting that the PRA is also very likely to develop criteria, and potentially apply its discretion, in relation to the transition of Simpler firms to the next level of prudential requirements within the new regime. These are yet to be consulted on by the PRA, but the key takeaway seems to be that the prudential classification of small firms under the PRA’s proposals would not always be a simple and straightforward proposition.
- Calibration of the assets threshold: the total asset threshold of £15bn in the proposed definition of “Simpler-regime firm” is at the higher end of the proposals summarised in the Feedback Statement (which on average recommended a threshold of £5bn). The PRA estimates that approximately 61 authorised banks and building societies would be below the threshold if the rules were in place today, most of which have assets considerably below £15bn and therefore would have room to grow. Setting the threshold at a relatively high level should prove helpful for start-up banks seeking authorisation, as it would mean that most would be subject to the simplified prudential rules for a considerable time following authorisation, and especially so given that the total assets for the purposes of the threshold are calculated as a 36 months average.
- Test for international presence: the PRA decided to quantify international presence by reference to the geographical location of the firm’s credit exposures (i.e. the location of the immediate obligor). The test would mean that even the smallest start-up banks would be outside the simplified regime where more than 15% of their credit exposure is located outside the UK. This could lead to a somewhat counter-intuitive development for small international banks seeking authorisations in the UK. A firm with an existing but relatively small international client base would be outside the simplified regime immediately following its authorisation in the UK (before its UK client base grows to reach the 85% threshold) but could become subject to the simplified regime if its growth in the UK significantly outpaces the growth of its non-UK activities (provided it obtains the PRA waiver, as required for subsidiaries of international groups). It is also worth noting that the definition of the United Kingdom for these purposes does not include Crown Dependencies and the British Overseas Territories. Any credit exposures located in those territories would therefore not count towards the 85% threshold.
- Interaction with approach to supervision of non-systemic banks: the PRA will have to consider how the new proposed regime will be built into the existing rules and principles for the supervision of smaller banks, such as those set out in Chapter 4 of the Supervisory Statement SS3/21 (which sets out the PRA’s supervisory approach to “new and growing” banks (broadly, those considering authorisation or subject to authorisation for up to five years)). For example, it is arguable that less stringent capital requirements for Simpler-regime firms could translate to lower regulatory tolerance for dependence on outside capital in the post-authorisation stages. Similarly, simplified prudential requirements would also affect the dynamics between the regulator and the applicant banks in the mobilisation stage of the authorisation process as, in light of lower capital and liquidity requirements, the PRA could reasonably insist on greater readiness to meet the standards of operational resilience.
- Resolution: It is noteworthy that the PRA has opted (for the moment) not to introduce into the definition of the “Simpler-regime firm” any express criterion relating to the firm’s resolution arrangements, despite a general agreement in the feedback to the Discussion Paper that the simpler regime should be available only to firms assigned to the modified insolvency resolution strategy.
These initial observations aside, the consultation seems to be an appropriate first step on the path towards a simpler prudential regime. It suggests that the challenge before the PRA will be to resolve the tension between two principal drivers behind the proposed reform: simplifying the existing regime on the one hand (which naturally leads to broad classifications and prudential categories) and treating each firm proportionately to its circumstances on the other (which would require a system of resource-intensive regulatory discretion and case-by-case assessments).