The UK Prudential Regulation Authority (PRA) today released a consultation paper which sets out proposed changes to the PRA’s Pillar 2 framework for the UK banking sector, including changes to rules and supervisory statements. Under the Pillar 2 framework, the PRA assesses those risks either not adequately covered, or not covered at all, under Pillar 1 capital requirements, as well as seeking to ensure that firms can continue to meet their minimum capital requirements throughout a stress. It also introduces the content of a proposed new statement of policy: The PRA’s methodologies to setting Pillar 2 capital. This sets out the methodologies that the PRA proposes to inform its setting of firms’ Pillar 2A capital requirements.
The proposed policy is intended to ensure that firms have adequate capital to support the relevant risks in their business and that they have appropriate processes to ensure compliance with the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD). It is also intended to encourage firms to develop and use better risk management techniques in monitoring and managing their risks. Pillar 2 therefore acts to further the safety and soundness of firms, in line with the PRA’s objectives. The PRA intends that the publication of its proposed methodologies to set Pillar 2 capital will help firms to understand the rationale for the PRA’s decisions and plan capital accordingly.
This consultation is relevant to banks, building societies and PRA-designated investment firms (‘firms’). The paper includes:
- Overview and background on the proposed Pillar 2 framework.
- Pillar 2A methodologies, including the proposed new approaches the PRA will use for assessing Pillar 2A capital for credit risk, operational risk, credit concentration risk and pension obligation risk, alongside the existing approaches for market risk, counterparty credit risk and interest rate risk in the non-trading book (usually referred to as interest rate risk in the banking book (IRRBB)). It also details the proposed associated data requirements.
- The PRA buffer and how the PRA proposes to operate this new buffer regime.
- Governance and risk management, including proposals to tackle significantly weak governance and risk management under Pillar 2.
- Disclosure, including the impact of the proposed Pillar 2 reforms on capital disclosure and proposals for a more transparent regime.
- Analysis on the impact of the proposed reforms.
The paper provides an excellent summary of the current thinking in terms of pillar 2 regulation, and it will further increase the capital required to be held by UK banks. There are implications for financial services companies and regulators in other jurisdictions. We discussed the implications of these capital changes recently.
The UK consultation closes on Friday 17 April 2015.
