CP/22 – Implementation of Basel 3.1 standards – PRA consultation paper

On 30 November 2022 the PRA published a consultation paper,  CP/22 – Implementation of the Basel 3.1 standards, setting out proposed amendments to PRA rules and expectations that will be finalised following a period of consultation that is due to end on 31st March 2023.

The proposals address the implementation of the “final changes” to Basel requirements published by the BCBS in December 2017, updates to the minimum capital requirements for market risk issued in January 2019 and some changes to leverage ratio calculations. More specifically they cover:

• a revised SA for credit risk; 

• revisions to the internal ratings based (IRB) approach for credit risk; 

• revisions to the use of credit risk mitigation (CRM) techniques;

• removal of the use of internal models (IMs) for calculating operational risk capital requirements and a new SA to replace existing approaches; 

• a revised approach to market risk;

• the removal of the use of IMs for credit valuation adjustment (CVA) risk, replaced by new standardised and basic approaches; and

• the introduction of an aggregate ‘output floor’ to ensure total RWAs for firms using IMs cannot fall below 72.5% of RWAs derived under SAs, to be phased in over five years.

The aim of these changes in terms of risk measurement is:

• simplifying and reducing the range of approaches available for RWA calculations, thereby promoting the consistent application of approaches across firms through simpler and clearer requirements;

• improving the risk-sensitivity of SAs in the capital framework, resulting in RWAs that are more reflective of risk for firms using those approaches; 

• constraining the use of IM approaches in areas where RWAs cannot be modelled in a robust and prudent manner, to reduce unwarranted RWA variability; and

• introducing an output floor, limiting how low internally-modelled RWAs can fall below those produced under the revised SAs, thus reducing excessive variability and cyclicality in RWAs.

Other changes are intended to improve the measurement of market risk, address issues with regard the measurement of the leverage ratio as well as simplifying the calculation of capital requirements for operational risk.

The proposed changes are quite detailed, the document runs to 400 pages, not least because of the substantial changes made to the standardised and models-based approaches to calculating credit risk but also the need to include tweaks to requirements to address UK specific issues, such as what requirements should apply to smaller UK banks.

These requirements are expected to be finalised during 2023, though how long this will take will depend on the extent and the nature of feedback received, with implementation expected by 1 January 2025, and 1 January 2030 for the output floor.

It should be noted that these implementation dates go beyond those published by the BCBS, and agreed by BCBS members, which anticipated implementation of these requirements by 1 January 2023 and I January 2028 respectively, those does bring the UK in line with the dates proposed by the EU.