UK Basel 3.1: An overview of the near-final rules
On 12 September 2024, the Prudential Regulation Authority (PRA) published the second part of its near-final rules on the implementation of Basel 3.1 standards through Policy Statement 9/24 (PS9/24) which offers feedback on the responses received on Consultation Paper 16/22 (CP16/22) published on 30 November 2022. The first part of these near-final rules was issued on 2 December 2023, as part of PS17/23.
PS9/24 covers inter alia the near-final rules on credit risk, disclosures, and reporting as well as minor clarifications and corrections to the previous near-final rules published within PS17/23. The implementation date for Basel 3.1 standards has also been postponed to 1 January 2026.
1. Coverage:
This article summarises the key changes relevant for small- and medium-sized banks with limited or no trading book exposures. Items covered as part of this article include:
Credit Risk: Standardised Approach (SA)
Operational Risk: Standardised Approach
Credit Valuation Adjustment (CVA): Alternative Approach (AA-CVA) and the Basic Approach without hedging effect (‘Reduced’ BA-CVA)
Market Risk: Simplified Standardised Approach (SSA) and the Advanced Standardised Approach (ASA)
Pillar 3 disclosure requirements: For non-listed ‘other institutions’
Reporting changes: Update to reporting requirements
Items not covered as part of this article include:
Credit Risk: IRB approach
Credit Risk Mitigation (CRM)
Credit Valuation Adjustment (CVA): The Basic Approach with hedging effect (‘Full’ BA-CVA) and Standardised Approach (SA-CVA)
Market Risk: Internal Model Approach (IMA)
Pillar 3 disclosure requirement: For ‘large institutions’
Output floor: The objective of the output floor is to provide a backstop that limits the extent to which firms using the IM approaches (IM firms) can lower their Risk Weighted Assets (RWAs) relative to the revised SAs used by SA firms. As per this backstop, RWAs as per IM approaches cannot be lower than 72.5% of their SA RWAs on average across all exposures. The requirement is to be phased in over four years. Provisions relating to the ‘output floor’ are not covered in this article as they are only relevant for firms with IM permissions to calculate the capital requirements.
Pillar 2 framework: covered as a separate article.
2. Key changes:
2.1. Credit Risk
To make the SA more risk-sensitive, new exposure sub-classes# have been added, and a grading mechanism has been introduced for unrated corporates and institutions, based on an internal assessment/rating. Additionally, the PRA has also introduced due diligence requirements on the use of external credit ratings to ensure that the external ratings prudently reflect the credit risk of the counterparties.
Please follow the given links for further details on key changes. A summary of the existing and revised risk weights and movements in exposure sub-classes are outlined in Appendix 1 & 2 respectively.
Exposures to central governments and central banks:
The PRA now permits firms to apply a risk weight to an unrated central bank exposure corresponding to the risk weight assigned to the relevant central government.
Exposures to regional governments and local authorities:
Currently, exposure to regional governments or local authorities shall be treated as exposure to the central government:
in whose jurisdiction they are established;
where there is no difference in risk between such exposures because of the specific revenue-raising powers of the former; and,
the existence of specific institutional arrangements the effect of which is to reduce their risk of default.
The PRA has outlined that only the UK’s devolved administrations are those that should be treated as exposures to the UK central government. Therefore, Article 115(2) has been updated to reflect the following list of regional governments that shall be treated as exposure to central governments:
the Scottish Government;
the Welsh Government; and
the Northern Ireland Executive.
Changes relating to the following exposure classes are not covered in this article:
Exposures in the form of covered bonds
Items representing securitisation positions
# E.g. Retail exposures are bifurcated into ‘regulatory retail’ (transactor and non-transactor) and ‘other retail’ categories. Real estate exposures are categorised into ‘acquisition, construction, development (ADC)’, ‘regulatory real estate’ and ‘other real estate’ categories.
2.2. Operational Risk
All the existing operational risk approaches [Basic Indicator Approach (BIA), Standardised Approach (SA), and Advanced Measurement Approach (AMA)] are to be replaced by the new Standardised Approach (SA). A more detailed overview of the revised approach is provided in the Operational Risk article.
2.3. Credit Valuation Adjustment (CVA) and Counterparty Credit (CCR) Risk
Three new methodologies have been introduced to replace the current framework:
Alternative Approach (AA-CVA): Available to firms with limited non-centrally cleared derivatives
Basic Approach (BA-CVA): Available to all firms
Standardised Approach (SA-CVA): Available to firms with prior permission from the PRA. In addition, an annual attestation is required confirming that the firm continues to meet the requirements to use this approach.
The detailed calculations and a comparison between AA-CVA and BA-CVA are provided in the Credit valuation adjustment and counterparty credit risk article.
2.4. Market Risk
Key changes to the Market Risk framework include:
The existing Standardised Approach has been recalibrated and renamed as the Simplified Standardised Approach (SSA)
Introduced a new more comprehensive standardised approach - the Advanced Standardised Approach (ASA)
A clear distinction is provided between the trading and non-trading book. Prescribed a list of positions with an initial classification as trading and non-trading book.
Detailed calculations and a comparison between SSA and ASA are provided in the Market Risk article
2.5. Pillar 3 Disclosures
An overview of the current Pillar 3 disclosure requirements is provided in the UK Pillar 3 disclosure requirements article.
Additional disclosure requirements for non-listed ‘other institutions’ are outlined below:
** ‘Template’ is for quantitative information and ‘Table’ is for qualitative information.
2.6. Reporting changes
For each of the risk areas (e.g., credit, market, operational), there are several changes to reporting requirements. These changes are detailed in the Reporting changes article.
Appendix 1: Existing and revised risk weights across exposure classes under the standardised approach
1. Exposures to Institutions, MDBs and Corporates:
@ Or, an original maturity of 6 months or less and arose from the movement of goods, including within the UK.
* A risk weight of 30% may be assigned if the if the exposure is Grade A and the Common Equity Tier 1 Ratio >= 14%, and the Leverage Ratio >= 5%.
# Specialised lending exposure means a corporate exposure that is not a real estate exposure and has any of the following characteristics:
exposure was created specifically to finance and/or operate physical assets
the borrower has little or no independent capacity to repay the obligation, apart from the income that it receives from the asset(s) being financed
the terms of the obligation give the lender a substantial degree of control over the asset(s) and the income that it generates
Following are the sub-categories of specialised lending exposures:
‘Project finance’ means funding for which the lender looks primarily to the revenues generated by a single project, both as the source of repayment and as security for the exposure.
‘Commodities finance’ means short-term lending to finance reserves, inventories, or receivables of exchange-traded commodities (including crude oil, metals, or crops), where the exposure will be repaid from the proceeds of the sale of the commodity and the borrower has no independent capacity to repay the exposure.
‘Object finance’ means the funding of the acquisition of physical assets (including ships, aircraft, satellites, railcars, or fleets) where the repayment of the exposure is dependent on the cash flows generated by the specific assets that have been financed by and pledged or assigned to the lender.
** ‘High-quality’ includes whether the exposure is to an entity that can meet its financial commitments in a timely manner and its ability to do so is assessed to be robust against adverse changes in the economic cycle and business conditions; and that conditions covering the entity’s revenue and creditor protection are satisfied.
2. Retail exposures:
Existing and revised risk weights for retail exposures are outlined below:
3. Exposures in default:
Existing and revised risk weights for defaulted exposures are outlined below:
4. Real estate exposures:
Existing and revised risk weights for real estate exposures are outlined below:
* The relevant counterparty risk weights are 75% for retail SMEs and 85% for corporate SMEs.
# If the Bank does not hold a first charge, the RW shall be the LTV-based RW multiplied by a factor of 1.25 if the LTV > 50%.
@ If the Bank does not hold a first charge, the RW for the entire exposure will be: 100% (LTV ≤60%); 125% (≤60% LTV ≥ 80%); or, 137.5% (LTV > 80%).
5. Subordinated debt, equity and other own funds instruments
Existing and revised risk weights for subordinated debt and equity exposures are outlined below:
# Higher risk equity exposure means an equity exposure that is:
(a) not listed on a recognised exchange; and
(b) held to provide funding to a newly established enterprise - that existed for less than 5 years.
Appendix 2: Credit risk – standardised approach: Key changes to exposure class/sub-class
How We Can Help
Banks may face a variety of challenges when preparing for Basel 3.1. At Katalysys, we have a deep understanding of prudential regulatory requirements both from the perspective of rules and practical implementation. Our team is already supporting a range of clients in this area, and includes:
Workshops or training to cover new requirements.
Gap and impact analyses.
Guidance on implementing industry best-practice in relation to the Basel 3.1 standards.
Documenting or updating assumptions and interpretations in regulatory reporting.
Preparation of regulatory reporting policies and procedure notes.
Validation of the system outputs and calculations.
Review of regulatory returns, including post-implementation of Basel 3.1 changes.
For more information, please contact:
Josh Nowak
Managing Director, Risk & Regulatory Consulting
T: +44 (0)7587 720 988
Manish Patidar
Director, Regulatory Consulting
T: +44 (0)7766 001 643