Introduction

It is a real pleasure to be here with you today. I’d like to thank Robin and his colleagues at the Building Societies Association (BSA) for organising this event. As the voice for building societies and credit unions that provide financial services to a diverse range of 26 million customers right across the UK, the BSA is one of the Prudential Regulation Authority’s (PRA’s) key stakeholders.It will therefore come as no surprise to you that I am eager to take this opportunity to talk about some important policy announcements we have made recently at the Prudential Regulation Authority.

On 12 September, we published a package of policy publications on how we set capital requirements within the banking sector. Included in the package are publications that cover two of the PRA’s flagship policies for banking reforms. The first is our last near-final policy statement on the implementation of Basel 3.1 in the UK. The second is a consultation paper (CP) setting out our proposals, under our Strong and Simple framework, to materially simplify the capital regime that will apply to Small Domestic Deposit Takers, or ‘SDDTs’, as they are ‘snappily’ known.

My colleague Phil Evans talked about the Basel 3.1 publication in his speech the other day^footnote[1], setting out how we will implement the final set of multi-decade global reforms drawn up in response to the Global Financial Crisis. I highly recommend his remarks to you.

Therefore, to sit alongside Phil’s speech, I will take this opportunity to cover the other key part of the publication – our CP about the capital aspects of our Strong and Simple framework. The proposals complete the package by building on our policy covering liquidity and disclosure requirements for SDDTs^footnote[2] which we finalised last December and which are already available to eligible firms. Now, for the first time, all of the elements of the Strong and Simple framework can be seen together.

Key elements of the overall framework include:

·A clear definition of an SDDT and a simple 'opt-in’ gateway through which qualifying firms can elect to join and access all the benefits of our Strong & Simple framework;

·A material reduction in the volume of liquidity reporting requirements for SDDTs. This includes removing existing requirements for these firms, which are by definition mainly retail funded, to report the net stable funding ratio (NSFR) and the deletion of four of the five reporting templates in the Additional Liquidity Monitoring Metrics (ALMM) returns;

·The removal of the requirement to make Pillar 3 disclosures for SDDTs with no listed securities; and

·Our new proposals for material simplifications across all aspects of our capital framework including Pillar 1, Pillar 2A, capital buffers, the calculation of regulatory capital, and a tailored reporting regime for capital.

Overall, taking all the changes together, the Strong and Simple framework will deliver meaningful benefits for the smallest, domestically-focused deposit takers in the UK by significantly reducing the costs and complexity of regulation they currently face. Most importantly, it will do so in a way which maintains SDDTs’ resilience. This will not only bring a real benefit to smaller firms, but also to the wider economy by enhancing the banking sector’s ability to support economic activity and growth within the UK. The package will therefore advance all of the PRA’s objectives, both primary and secondary.

Today, I intend to focus my remarks on the simplifications to the capital regime that we proposed in the recently published consultation.

Reflections on the package of publications

Before I do so, I would like to briefly turn my attention to what the package of publications represents and why it is a significant shift in the design of prudential regulation of banks and building societies in the UK. It marks the first major set of reforms to banking regulation we have delivered since the introduction of the UK’s Smarter Regulatory Framework (SRF) – which was legislated for in the Financial Services and Markets Act (FSMA) 2023. FSMA 2023 has enabled the government to repeal assimilated law relating to financial services so that the PRA can replace it within its Rulebook. This process aims to deliver a new regulatory framework that is better suited to the UK-specific context and gives regulators the ability to be more responsive to domestic risks and opportunities, amending rules where needed. We have taken advantage of this to tailor our proposals to the unique nature and specificities of the small deposit takers sector in the UK.

Why do we want to create the Strong and Simple regime?

The flexibility and responsiveness provided by the SRF has allowed us to deliver on a long-held ambition to deliver the Strong and Simple framework.

It is no secret that the current prudential framework is complex for small banks and building societies.This is partly because the current framework is based on the full suite of international standards. I have sat on the Basel Committee, which sets these international standards, for a number of years. Its standards are designed for internationally active banks and are not directly targeted at smaller, domestically-focused, lenders. The PRA itself has also made rules that have tended to focus on internationally active banks. And under our current approach, which has been in place since the UK was a member of the EU, we broadly apply the same prudential regime to all firms, regardless of their size or risk profile.^footnote[3] And whilst many elements of the international regime are important and useful for banks of all sizes, some are less relevant for the smallest firms.

As explained in our 2021 Discussion Paper (DP) 1/21, which asked for input on whether and how we should pursue a simplified regime for smaller firms, this uniform approach can present a ‘complexity problem’.^footnote[4] This is when the costs of understanding and operationalising regulation are higher relative to the associated public policy benefits for smaller firms when compared with larger firms. 

This, however, needs to be set in the context of the importance of the resilience that our current prudential framework provides; we remain firmly of the view that robust prudential regulation is essential for the safety and soundness of PRA-regulated firms and is the bedrock of the PRA’s reputation as a trusted regulator. Events last year in banking sectors around the world further highlighted the importance of maintaining robust prudential standards for all deposit taking institutions, whatever their size.^footnote[5]

Complexity comes with costs – there's the cost of understanding complex requirements, and then there is the cost of operationalising them. These costs tend to be proportionally higher for smaller firms than larger ones; that is, the latter benefit from economies of scale. As a result, smaller firms can be burdened with complex regulatory requirements, even where there is only a marginal prudential benefit. And this problem could both reduce the resilience of small firms and diminish effective competition in the UK banking sector. This may disincentivise firms from innovating and driving productivity, which in turn could adversely impact growth.

Having considered the responses to our DP, we concluded that one size should not fit all when it comes to the prudential regulation of banks and building societies. We are confident that we can achieve the same level of resilience for smaller firms in a much simpler way. So, we have sought to design a strong and proportionate prudential framework for smaller firms with simpler business models. And that’s why we introduced the Strong and Simple initiative.

But, as it turns out, the process of delivering a framework of this type is more complex than you might imagine. In particular, we have had to strike a balance between achieving meaningful simplification for SDDTs (the ‘simple’) and maintaining the overall resilience of these firms (the ‘strong'). This included considering carefully the definition of an SDDT and therefore the balance to be struck between the size and complexity of firms that can ‘opt-in’ and the level of simplification they can benefit from.

We have also had to juggle the task of avoiding, where we can, introducing unintended barriers to growth. If we were to roll back requirements for SDDTs to a radical degree, for example by completely removing some important requirements, this could create a ‘cliff edge’ between the regimes for SDDTs and other firms. This may deter smaller firms from growing in size or in breadth of activities, which could reduce competition. In line with this concern, the majority of respondents to our DP said they would prefer an adjusted or ‘streamlined’ version of our prudential framework to an entirely new one. You can think of this as something akin to slimming down each chapter of the Rulebook, rather than creating entirely new chapters for SDDTs.

Moreover, we remain committed to developing a simplified framework that is aligned with the Basel Core Principles for Effective Banking Supervision, which apply to all banking institutions. This is because that alignment with international standards underpins the UK’s international reputation and is integral to international competitiveness and growth.

Despite these challenges, we have made substantial progress. In 2023, the PRA published the finalised SDDT criteria that firms need to meet to benefit from the SDDT regime – for example, an eligible bank or building society must be domestically-focused and have total assets below £20bn on a three-year moving average basis. Our analysis indicates that around 80 firms are eligible for the SDDT regime and that SDDT-eligible firms account for less than 2% of UK banking assets.

In the same policy statement, we published our SDDT simplification measures relating to liquidity and disclosure requirements, which have now been implemented. These simplifications already offer a meaningful benefit to SDDTs in their own right – I set out a few of these at the beginning of my remarks. Since the beginning of this year, eligible firms have been able to choose to become SDDTs. As of 22 August, 32 firms have become SDDTs. It is great that firms have already seen the value in joining Strong & Simple and taking advantage of the simplifications already in place.

With the publication of our most recent CP, we are completing the framework so SDDTs now have more clarity about the PRA’s plans for the capital regime for them.

What are the proposals for the simplified capital regime?

This brings me, at last, to the CP we recently published, where there are three key points I want to make about our proposals: 

1.They will significantly simplify the capital regime for SDDTs whilst maintaining SDDTs’ overall resilience; 

2.They provide a comprehensive offering that simplifies all aspects of the capital stack including Pillar 1, Pillar 2A, buffers, and the calculation of regulatory capital (see Figure 1 in Annex); and 

3.They advance both the PRA’s primary and secondary objectives, including the secondary competitiveness and growth objective that became effective in 2023. 

Pillar 1

On Pillar 1, we have proposed that risk weighted assets will largely be calculated using Basel 3.1 rules.Under our proposals, SDDTs would be subject to the Basel 3.1 standardised approaches to credit risk and operational risk.

We have consistently said, throughout the development of the framework, that we were minded to use the Basel 3.1 standardised approach to credit risk as the starting point for the simplified capital regime for SDDTs. This is not because, philosophically, we want to automatically apply international standards designed for large banks to smaller ones. It is because we believe that our Basel 3.1 Pillar 1 approach is a robust, well-designed package that aligns capital requirements with the underlying risks more accurately than our current approach. And ultimately, the riskiness of a certain asset is not affected by whether a small firm or a large firm is holding it.

But we have not simply replicated all the Basel 3.1 rules for SDDTs. Under our proposals, Pillar 1 will be simplified in some areas. This will be done through the disapplication of the due diligence requirements in the Basel 3.1 standardised approach to credit risk, as well as the disapplication of capital requirements for market risk, counterparty credit risk (CCR) for most derivatives exposures and credit valuation adjustment (CVA) risk. We recognise that the Basel 3.1 requirements for these risks are complex for small firms to calculate, and that these risks will not be material for SDDTs because, by definition, they will have minimal trading activity. For items in small trading books, the application of the Basel 3.1 credit risk standardised approach would mean trading book positions would be adequately capitalised.^footnote[6]

Pillar 2A

Next, we have proposed material simplifications to our methodologies for calculating Pillar 2A, which addresses risks not captured by Pillar 1. We know from responses to the 2021 DP and our industry engagement that firms find the current Pillar 2A approach complicated. This is in part due to the methodologies involved, which can be complex and not well-tailored to the risks that smaller, simpler, domestically-focused firms are exposed to. And this issue is compounded by complex offsets and adjustments within Pillar 2A in relation to the so-called ‘refined methodology’ and the countercyclical capital buffer (CCyB). Although these adjustments are intended to avoid an overly conservative calibration in firms’ total capital requirements and buffers, they can make it more challenging for small firms to understand their capital requirement for Pillar 2A.

In order to address this complexity, we have proposed substantial simplifications to existing Pillar 2A methodologies for credit risk, operational risk, and credit concentration risk – all of which are areas small firms have told us they find particularly burdensome. We focused on the use of simplified methodologies for calculating requirements as our analysis indicated this would offer the most meaningful benefit for firms. For example, we have proposed to replace the mouthful, both verbally and analytically, that is the Herfindahl-Hirschman Index (HHI) – one of the measures we use to calculate credit concentration risk – with a simpler bite-sized calculation. We have received consistent feedback that the current calculation is overly complex and disproportionate for smaller domestically-focused firms, so we believe this simplification would be a material benefit for these firms.

In addition to the methodology simplifications, we have also proposed to remove two of the complex Pillar 2A adjustments in our current framework for SDDTs.^footnote[7] The first is the complex adjustment between buffers and Pillar 2A relating to the CCyB. This will no longer be needed because, as I will explain later, we are proposing to replace the current buffer framework for SDDTs, including the CCyB, with a much simpler one. The second is the ‘refined methodology’ which will also no longer be needed given the more risk-sensitive and better calibration of Pillar 1 requirements I have outlined already.

Overall, these proposals should increase the transparency and predictability of Pillar 2A calculations for SDDTs whilst ensuring they remain capitalised for the risks they are exposed to. It would also mean SDDTs would spend less time and effort on understanding how those risks contribute to their Pillar 2A requirements than they would if they were outside of the SDDT regime.

Capital buffer framework

The capital buffer framework is another prime example of where we plan to deliver a material simplification benefit for SDDTs.

Smaller firms have told us they find the current capital buffer framework – which consists of the capital conservation buffer (CCoB), CCyB, and the PRA buffer – very complex. We have therefore made the radical proposal for this framework to be replaced with a new firm-specific 'Single Capital Buffer' (SCB) that will provide a more constant and predictable capital buffer for SDDTs. A single capital buffer will be easier for SDDTs to understand and will deliver a material simplification in the capital framework for them.

As is currently the case for the PRA buffer, the SCB will be informed by stress testing to ensure adequate risk sensitivity is maintained in the SDDT capital regime. But, unlike today, those stress tests will be based on a scenario which will not vary with the economic cycle. To do this we propose to set non-cyclical stress test scenarios that, assuming an SDDT's risk profile and balance sheet remained broadly unchanged, generate a constant impact across a firm's Internal Capital Adequacy Assessment Process (ICAAP) and Supervisory Review and Evaluation Process (SREP) cycles. To ensure that the buffer is set at a level that maintains an appropriate level of resilience in the system, our analysis has indicated that the buffer should be set at a minimum of 3.5% of a firm's risk weighted assets. This stress test based approach, together with the removal of the CCyB, should enable SDDTs to calculate a relatively constant capital buffer regardless of the point in the economic cycle, and result in SDDTs having less variability in their capital requirements and buffers over time.

This reduced variability and greater certainty is important because we know that some firms choose to hold relatively large management buffers because they struggle to adjust their capital levels as requirements change. In other words, they choose to hold ‘buffers-on-buffers’. By making capital requirements more stable, we recognise actual capital levels may fall to some degree, even if average requirements do not, because firms may choose to hold smaller management buffers and deploy the excess capital to build their business and support their customers.

The eagle-eyed PRA-watchers amongst you, and yes I know they do exist, will have spotted that our proposals on capital buffers contain a clear ‘nod’ in the direction of the Bufferati vision that Sam Woods set out in 2022, that envisaged a simpler capital framework based around a single capital buffer.^footnote[8] In line with that vision, the SCB will also mean buffers will be simpler to calculate, less volatile and more predictable. This in turn, should enable firms to operate with lower management buffers, and reduce the inclination to maintain expensive “buffers on buffers” as a form of self-insurance against potential increases in regulatory buffers.

Other simplifications

In addition to these proposed simplifications, there are a host of others included in the CP. These include:

·simplifications to the ICAAP and a reduction in the review frequency of the Internal Liquidity Adequacy Assessment Process (ILAAP);

·simplifications to complex threshold calculations used to calculate capital deductions; and

·simplifications to reporting requirements, including descoping of SDDTs from a number of templates, and the creation of more tailored and proportionate reporting templates and instructions for them.

The overall benefits of the CP proposals

Overall, as I said at the beginning of my speech, I believe our latest proposals (see Table A in Annex) represent a comprehensive package that will genuinely deliver meaningful benefits for the smallest, domestically-focused deposit takers in the UK by significantly reducing the costs and complexity of regulation they currently face. Most importantly, it will do so in a way which maintains SDDTs’ resilience. We have achieved this by stripping out complexity across the capital stack where it makes sense to do so.

The merits of the package extend beyond lower compliance costs and regulatory hurdles. By maintaining the resilience of small banks and building societies and reducing their costs, we are supporting smaller firms’ capacity to turn their attention to pursuing innovation and growth. This will not only bring a real benefit to smaller firms, but also to the wider economy, where smaller firms play an important role. They do so, for example, by providing financial services to specific or underfinanced sectors, or they might be drivers of innovation in the banking sector. By improving the proportionality of regulation for these firms, the framework will facilitate SDDTs’ ability to compete effectively, offer the best possible service to their clients, and grow. This in turn will enhance the banking sector’s ability to support economic activity and growth within the UK. The package will therefore advance all of the PRA’s objectives, both primary and secondary.

Next Steps

Now, in terms of next steps, the ball is in your court – and we are very eager to hear from you. Our consultation closes on 12 December, and our hope is that we get as much engagement on that as possible. As part of our consultation process, we will be engaging with firms and trade associations to run through our proposals, generate live feedback, and encourage formal responses.

Our proposed implementation date for our proposals is 1 January 2027, a date that would provide sufficient time following the publication of the finalised rules to enable a smooth transition to the simplified capital regime for SDDTs. That said, we are keen to hear your thoughts on our proposed implementation date in your CP responses.

It is particularly important that SDDT-eligible firms engage with the package – because you will have an important decision to make about which capital regime you want to operate under in the future; one tailored for SDDTs, or the more complex Basel 3.1 regime which will apply to firms more generally. To be clear, there is nothing mandatory about Strong and Simple, though we do think it offers an attractive package for many. SDDT-eligible firms are able to opt into the regime by consenting to the PRA’s offer of a modification by consent (MbC) to become an SDDT.

On a related point, the second near-final Basel 3.1 policy statement includes further details about the Interim Capital Regime, a key initiative that will allow firms eligible to be SDDTs to choose to remain on the current Pillar 1 framework until the SDDT capital regime is implemented. Without joining the ICR, small firms that intend to join Strong and Simple would end up implementing the Basel 3.1 package, only for a more tailored set of capital rules for them to be introduced later. The ICR therefore allows firms to avoid ‘digging up the road twice’, so I would strongly encourage SDDT-eligible firms that wish to take advantage of the new regime to refer to the ICR chapter in the second near-final Basel 3.1 policy statement for details on the joining process. More details will be provided when we finalise the Basel 3.1 rules.

In the CP, we also stated that, as we suggested in DP1/21 and CP4/23, we will consider whether our primary and secondary objectives would be advanced by applying any of the CP proposals to a wider range of larger firms that are not internationally active.^footnote[9] The PRA gathered views from relevant stakeholders on this topic last year, and we expect to communicate further on this in due course.

Conclusion 

And so, to conclude, what are the key messages that I’d like to leave with you today? In short, that the September package of publications represents a significant shift in the design of prudential regulation of banks and building societies in the UK. The Strong and Simple elements of the package, taken together with the changes we implemented last year, deliver meaningful benefits for smaller, domestically-focused deposit takers in the UK by reducing complexity and costs, as well as provide greater certainty on their capital requirements. And, in doing so, the package will advance all of the PRA’s objectives, both primary and secondary.

And with that, I’ll close by thanking you for your attendance today; and look forward to your engagement with our consultation. 

Thank you.

I would like to thank Sadia Arif, Mike Burke, Tamiko Bayliss, Andrew Carey, Phil Evans, Charlotte Gerken, Michelle Ogunyemi, Philip Ridgill, Anjli Shah, Paul Viljoen, Laura Wallis, Allen Wesson, Matthew Willison, Sam Woods and Omer Ziv for their assistance in preparing these remarks.