Basel 3.1 – Understand the regulation
In this series of short articles, our Prudential Regulation Consulting team delves into the implications of Basel 3.1 changes on banks.
Pillar 2
The PRA has disclosed that they intend to review the Pillar 2 capital framework by 2024 at the latest. It is worth noting that these timelines are incredibly tight when aligned with the planned implementation of Basel 3.1 on 1 July 2025.
The capital framework is viewed by regulatory authorities holistically. Materially the underlying risk exposure of firms will not have changed on either side of Basel 3.1 implementation. Therefore, the overall balance of risk and capital should largely remain the same.
A good example of this can be found in operational risk. Increased requirements in Pillar 1, stemming from the beefed-up standardised approach, are likely to reduce firms Pillar 2. However, given the limited risk sensitivity stemming from neutralising the ILM, it appears that requirements in Pillar will remain material. This may cause frustration at some firms given the fact that the PRA’s Pillar 2 operational risk calculation remains something of a black box with quantitative guidance remaining very sparse. Another area which may change is credit risk. For firms on the standardised approach, there is an open question about whether the increased risk sensitivity of the Basel 3.1 proposals will reduce the need for material Pillar 2 assessments. This may include benchmarking and stress testing analysis. On the flip side, there are some risk stripes that are often linked to calculations based on nominal (for example, non-risk weight dependent) requirements. This includes interest rate risk in the banking book, although current circumstances around the failure of Silicon Valley Bank and the near demise of Credit Suisse may encourage regulators to revisit this risk type more generally. Finally, the Bank of England’s own, excellent, blog site – Bank Underground – has been openly suggesting that the current calculation of credit concentration risk is inadequate in the calculation of sectoral or geographic add-ons, for smaller firms in particular. Again, given concentration risk is once again front and centre after the collapse of Silicon Valley Bank, this element of Pillar 2 seems ripe for significant overhaul by the regulatory authorities. For Strong and Simple firms all of this could be moot. These firms can enter the Transitional Capital Regime, with requirements that are substantively the same as the existing Pillar 1 and 2 frameworks in the CRR, until the implementation date for a permanent risk-based capital regime for the simpler regime. The PRA is expected to provide much more detailed guidance around the capital regime for the Strong and Simple framework in 2024. |
What banks should consider: • The PRA is essentially looking to implement the Strong and Simple regime in tandem with the Basel 3.1 reforms. Therefore, smaller firms that may be potentially eligible for both, need to give themselves enough time and resources to run suitable cost/benefit analysis to understand which regime may suit them best. • Given that the risk sensitivity of the new standardised approach is being neutralised by the PRA, firms should expect that their Pillar 2 operational risk calculation will continue to be material, from both a qualitative and quantitative perspective, and plan accordingly. • Firms should be aware that the Pillar 2 review may cover risk stripes not directly addressed by the Basel 3.1 implementation, including IRRBB and credit concentration risk. |
Get in touch
If you have any further questions regarding Basel 3.1, please contact us via the button below and a member of our team will be in touch.
Market risk
Under Basel 3.1, the Prudential Regulation Authority has proposed to implement changes to how firms measure market risk. These include an amended version of the preexisting simplified standardised approach (SSA) and two new calculation methodologies – an advanced standardised approach (ASA), and a new internal model approach (IMA).
Removal of the SME support factor
The PRA intends to remove the CRR SME supporting factor under the Standardised and IRB approaches to credit risk. This discount factor was introduced to limit disruption to the flow of credit to SMEs when stricter requirements were introduced after the Global Financial Crisis, in 2008.
Key contacts
Freddie Blake Associate Director – Financial Services Consulting
