Simplified Capital Regime for Small Domestic Deposit Takers (SDDTs)
Introduction
The Prudential Regulation Authority (PRA) is introducing the Strong and Simple Framework for domestic-focussed banks and building societies that are non-systemic. The banks and building societies that meet the PRA’s eligibility criteria are classified as Small Domestic Deposit Takers (SDDT). This framework is fully consistent with the Basel Core Principles, but simpler than the that applicable to larger and internationally active banks.
In December 2023, the PRA published Policy Statement 15/23 (The Strong and Simple Framework: Scope Criteria, Liquidity and Disclosure Requirements). This specified the SDDT eligibility criteria and prudential regulations for aspects not relating to capital requirements (e.g., liquidity and disclosures).
On 12 September 2024, along with publication of the second part of the near final rules on the implementation of Basel 3.1 – which also included details of the Interim Capital Regime (ICR), which is relevant to SDDTs from 1 January to 31 December 2026 – the PRA also published Consultation Paper 7/24 (The Strong and Simple Framework: The simplified capital regime for Small Domestic Deposit Takers (SDDTs)) as part of its Phase 2 of announcements, which sets out the proposed simplified capital regime.
Together with Phase 1, the PRA considers that these rules create a significantly simplified prudential regime for SDDTs, promoting a dynamic, diverse and competitive UK banking sector. The SDDT framework is designed to provide significant regulatory relief for the smallest, domestically-focused deposit takers in the UK. By simplifying current regulations, the framework offers meaningful benefits, while still ensuring these firms remain resilient and stable.
While firms may already opt-in to become an SDDT, and may already benefit from the simplifications set out in PS15/23, other changes for SDDTs such as the simplified capital regime for SDDTs are subject to change as part of the PRA’s consultation process, and are expected to become effective from 1 January 2027.
Since SDDTs are not to be directly captured by the Basel 3.1 implementation, now scheduled for 1 January 2026, the ICR based around pre-existing requirements will be in force for a 1-year period between Basel 3.1 implementation and the effective date of the simplified capital regime.
A summarised timelime is shown below:
This article focuses on the proposed simplifications to the capital regime, as outlined in the latest consultation (CP9/24); however, an overarching view of all key changes is shown below in the section titled ‘Summary of SDDT Simplifications’. In addition, the next section describes at a high level the ICR.
Interim Capital Regime
The PRA has outlined how the ICR will work for firms that meet the SDDT criteria during the period leading up to the full implementation of the Basel 3.1 standards. Firms that meet the SDDT eligibility criteria can opt-in to the ICR via a request for a Modification by Consent (MbC), allowing them to avoid full implementation of the Basel 3.1 rules on 1 January 2026.
The ICR allows firms to continue following Pillar 1 capital requirements that are substantially similar to the existing Capital Requirements Regulation (CRR) as well as applying the existing Pillar 2A framework, including refined methodologies, to firms and consolidation entities in the ICR until the SDDT capital regime is introduced.
The ICR will remain in place from the Basel 3.1 implementation date (1 January 2026) until the SDDT capital regime is rolled out, expected to be 1 January 2027. Once the SDDT regime is in effect, the ICR will be revoked by the PRA.
On the effective date of the SDDT capital regime, firms on the ICR will have two options, either:[1]
To move directly onto the SDDT capital regime; or,
To leave the ICR/SDDT framework and therefore fully implement the Basel 3.1 standards[2].
[1] CP7/24, 8.8 to 8.15.
[2] A bank may also elect to leave the ICR in advance of 1 January 2027; in this case, it would be required to request a revocation of relevant MbCs and it should liaise with the PRA to agree timelines, since it would immediately become captured by the full Basel 3.1 rules at the point of revocation.
Simplified Capital Regime
Pillar 1
As part of the simplified capital regime, the PRA has proposed that Pillar 1 capital requirements would be broadly aligned with the implementation of the Basel 3.1 standards, as outlined in PS17/23 and PS9/24, with the aim of improving risk measurement and calculation of risk-weighted assets (RWAs), making them more robust for both large and small firms. This consistent approach is intended to foster competition and promote the ongoing resilience of SDDTs.
Key Aspects of the Pillar 1 Proposals:
Basel 3.1 Standardised Approach: SDDTs will primarily calculate RWAs using the Basel 3.1 standardised approaches for credit risk and operational risk. This approach offers a more accurate alignment between capital requirements and the actual risks associated with a bank’s assets, irrespective of the size of the institution.
Simplifications for SDDTs:
Notwithstanding the above, the simplified capital framework introduces several key simplifications for SDDTs:
Credit Risk Due Diligence: The Basel 3.1 due diligence requirements on credit ratings will not apply.
Exemption from Market Risk, Credit Valuation Adjustment (CVA) Risk and Counterparty Credit Risk (CCR): SDDTs will not be subject to capital requirements for market risk, CCR (for most derivative exposures) or CVA risk as the SDDT eligibility criteria require a firm to have minimal levels of market risk and trading activity, and as most SDDTs engaging in derivatives transactions will be doing so for risk management purposes.
Pillar 2A
The PRA has set out to simplify aspects of the Pillar 2A framework for SDDTs enabling them to assess risks within their ICAAP in a more straightforward and proportionate manner, whilst maintaining resilience. As a result, the PRA has proposed to introduce a new Statement of Policy (The PRA’s methodologies for setting Pillar 2 capital for Small Domestic Deposit Takers).
The existing Pillar 2A approach involves methodologies that can be unnecessarily complicated, particularly for smaller institutions with less complex risk profiles, in addition to opaque offsets or adjustments, such as the refined methodology and interactions with the countercyclical capital buffer (CCyB), make it burdensome for firms to compute and evaluate their Pillar 2A capital requirements.
As a result, the PRA proposes to streamline this process and enhance clarity, with several material simplifications to credit risk, operational risk, and credit concentration risk methodologies, as described below.
Over and above the changes to Pillar 2 methodologies, prior to implementation of the SDDT capital regime, the PRA will conduct an ‘off-cycle’ review of banks’ Pillar 2 capital requirements (a similar exercise is to be done for Basel 3.1 firms prior to the separate implementation) to adjust this element of own funds requirements and buffers, which will include the PRA’s proposed SME lending adjustment (and infrastructure lending adjustment) if applicable to ensure that own funds requirements for SME (and infrastructure) lending do not increase (CP, para. 8.25)
Credit Risk
As per the CP, para. 3.19, the PRA proposes the following changes to the Pillar 2A credit risk assessment:
Removal of the Internal Ratings Based (IRB) benchmarking methodology as set out in the existing Pillar 2 SoP, thus eliminating the need to the submit the FSA076 (Pillar 2 Credit risk standardised approach wholesale) and FSA077 (Pillar 2 Credit risk standardised approach retail) returns.
Apply use of credit scenarios which should focus on high-severity tail events, over a 12-month horizon, with particular focus on how these events may result in credit losses for higher risk lending which is not captured under Pillar 1.
Where SDDTs meet set criteria (as set out in the draft of the SDDT Pillar 2 Statement of Policy and the SDDT Supervisory Statement on the Internal Capital Adequacy Assessment Process (ICAAP), which include if the SDDT is a new or growing firm, or predominantly engaged in unsecured retail lending or other high-risk lending), the PRA expects firms to apply a focused assessment to assess its risk profile and whether a credit risk add-on under Pillar 2 would apply.
Credit Concentration Risk (CCoR)
To simplify the calculation of credit concentration risk (CCoR) for SDDTs, the PRA proposes the following changes (CP, para. 3.31):
Replacement of the Herfindahl-Hirschman Index (HHI) methodology with simpler approach which will consist of a base add-on for CCoR with distinct components for retail and wholesale exposures. It is proposed the wholesale add-on would be set at 3.5% of relevant RWAs and a retail add-on of 1% of relevant RWAs. As a result of the removal the HHI methodology, specific reporting requirements will also be removed i.e., FSA078 and FSA079.
In addition to the base add-on, the PRA will periodically assess single-name and sector concentration risks using data from the existing large exposure and stress testing frameworks, as described in the draft SDDT ICAAP Supervisory Statement.
Operational Risk
The PRA proposes a new approach for calculating operational risk capital requirements for SDDTs:
Initially the PRA will make use of the SDDT’s ICAAP to categorise the firm into one of three risk buckets, based on its risk profile, with corresponding capital requirements based on total assets (CP, para. 3.43). In summary the bucket criteria are set as:
Once the total operational risk capital requirement is established, the Pillar 2A add-on will consist of any remaining capital after accounting for the Pillar 1 operational risk requirement under Basel 3.1 (CP, para. 3.45).
As per the draft ICAAP Supervisory Statement, the PRA still expects firms to provide and document operational risk scenario analysis, information on management of operational risk and recent/expected loss events (CP, para. 3.47).
For scenario analysis, the PRA expects firms to assess low-frequency, high-severity events – or a combination of events – which should be tailored to align with the firm's most significant risks. Together the with the management information, loss information and supervisory judgment, the PRA expects this to allow SDDTs to estimate losses for each scenario and understand their overall risk exposure and risk management approaches.
Pillar 2B - Capital Buffer Framework
The PRA is proposing several significant changes to the capital buffer framework for SDDTs to enhance the simplicity and effectiveness of these own funds requirements:
Introduction of the Single Capital Buffer (SCB): The existing multiple capital buffers will be replaced by the SCB, which will be part of the Pillar 2B capital framework. The SCB will be set at a minimum of 3.5% of RWAs, and will be determined based on stress tests over a 3- to 5-year time horizon (see below). Additional add-ons relating to risk management and governance scalars and supervisory judgment would also apply as part of the SCB requirement.
As a result of the changes in capital requirements, the capital stack will be updated as follows:
Non-Cyclical Stress Testing Framework: The current cyclical stress testing framework will be replaced with non-cyclical stress tests. This new approach will establish a severity benchmark to aid SDDTs in developing their own stress scenarios as part of their ICAAPs, and is also intended to produce a relatively stable buffer requirement irrespective of financial cycles.
Methodology for New and Growing Banks: Similar to pre-existing frameworks, the specific methodology for calculating the SCB for new and growing banks will be based around 6-months of projected operating expenses, but must be no lower than 3.5% of RWAs as for other SDDTs.
Removal of Automatic Capital Conservation Measures: SDDTs will be de-scoped from the automatic capital conservation measures linked to certain buffers and part of the Maximum Distributable Amount (MDA) framework.
The Internal Capital Adequacy Assessment Process (ICAAP)
The PRA currently expects firms to conduct and update their ICAAP at least annually, with more frequent reviews in response to significant changes in business or operational conditions. However, recognising that many SDDTs have simple and stable business models, the PRA believes these requirements may be overly burdensome and proposes to simplify expectations for these banks.
Document Frequency: The PRA proposes to reduce the frequency of ICAAP updates for SDDTs from annually to every 2-years, while still requiring Pillar 2A and Pillar 2B (including stress testing) to be updated annually.[4]
Referencing the ILAAP: SDDTs will be allowed to reference relevant sections of their ILAAP in their ICAAP documents to avoid unnecessary duplication, streamlining the process while ensuring liquidity risks are adequately addressed. This does not apply in the case that there are liquidity risk concerns which must also be separately assessed in the ICAAP.
Reverse Stress Testing (RST): The frequency and documentation of RST will be reduced from annually to every 2-years. SDDTs can perform qualitative RSTs rather than full quantitative analyses, focusing on scenarios that could lead to failure without needing extensive numerical data.
New Optional Structure for ICAAP: The PRA will introduce an optional example structure for ICAAP documents to guide SDDTs, which may be particularly useful for new banks. This structure suggests how to conduct risk assessments proportionately and indicate where to reference other documents such as the ILAAP.
Despite these proposed changes, SDDTs must ensure their ICAAP (and ILAAP) documents remain current and relevant, with the PRA retaining the discretion to request more frequent updates if deemed necessary, particularly in cases of poor quality or governance.
[4] To ensure alignment with the ICAAP, the required frequency of the ILAAP will also be reduced from at least annually to at least every 2-years, but provisions remain that this should be done more frequently if needed.
Capital Deductions
Currently, banks must deduct specific items when calculating their regulatory capital resources. For instance, when determining the value of Common Equity Tier 1 (CET1) capital, firms need to subtract intangible assets, deferred tax assets (DTAs), and holdings of regulatory capital instruments from other financial institutions. These deductions are necessary because their value can be uncertain during stressful situations, which may reduce the amount of loss-absorbing capacity when it is most needed.
Some deductions from own funds are straightforward; however, for other items, deductions only apply above specific thresholds, making capital calculations more complex, which the PRA considers unduly onerous and disproportionate for SDDTs, which do not currently hold significant levels of such items.
As a result, the PRA proposes to simplify the deduction requirements as follows:
Single Group for Deductions: All items subject to threshold calculations or optional risk weightings will be combined and treated as a single group. This includes:
DTAs dependent on future profitability;
Holdings in regulatory capital instruments of financial sector entities (including CET1, Additional Tier 1, and Tier 2 instruments);
Qualifying holdings outside the financial sector;
Certain securitisation positions; and,
Free deliveries.
Single Threshold: The total value of the Single Group (see above) will be compared against a single threshold of 25% of the firm's CET1 capital.[5]
Deduction Amount: SDDTs must deduct from their CET1 capital any amount that exceeds the Single Threshold, with the deduction allocated proportionally amongst the respective items identified in the single group. Items below the Single Threshold will be risk-weighted at 250% for Non-Significant Investment, Significant Investment and DTA items, and 1,250% for other items, which further simplifies the calculations.
[5] Draft PRA Rulebook: CRR Firms: SDDT Regime Instrument 2025: Article 45A 4(b) - the threshold amount is 25% of the CET1 items of the SDDT calculated after applying the adjustments and deductions in Articles 32 to 36 in full.
Reporting
The PRA has proposed changes aimed at streamlining reporting requirements for SDDTs and reflecting the various changes discussed above. These proposals focus on minimising unnecessary reporting, ensuring the PRA can still assess SDDTs risks, and simplifying the overall reporting framework.
Changes include de-scoping SDDTs from 38 reporting templates, replacing most Counterparty Credit Risk (CCR) reporting with a simplified template, and updating a further 24 templates and instructions (six of which are instruction-only changes). These revisions are designed to reduce the reporting burden while maintaining essential levels of information for oversight.
A brief summary of the key changes for SDDTs’ reporting is as follows:
Net Stable Funding Ratio (NSFR): SDDT firms that secure 50% or more of their funding via retail deposits are exempt from calculating and submitting the NSFR (this is replaced with the Retail Deposits Ratio (RDR)).
Pillar 2 Liquidity: The PRA expects to generally not apply Pillar 2 liquidity guidance for SDDT firms nor request related returns, such as intra-day liquidity. However, firms must continue to assess liquidity risks not captured under Pillar 1 (LCR).
Capital Simplifications: Updates to the C01 template remove certain complexities, such as the introduction of a simplified capital deduction threshold. The introduction of a Single Capital Buffer simplifies related reporting.
Counterparty Credit Risk: For SDDTs, counterparty credit risk reporting is replaced with a new template for most firms (C34.XXS). Similarly, CVA reporting has been eliminated for SDDTs.
Market Risk Reporting: There is significant de-scoping in market risk reporting for SDDTs, with only templates OF 22.00[6] and OF 90.00 [7] being retained.
Pillar 2 Reporting: Simplifications include removing the requirement to submit Pillar 2 returns (FSA072 to FSA080) and updates to templates such as FSA071 and PRA111.
[6] Renamed under PS9/24 from C 22.00 to OF 22.00
[7] New templated specified under PS9/24, OF 90.00 MARKET RISK: AUTHORISATIONS, which relates to which market risk methodologies banks are applying, and to collect information on the relevant eligibility requirements for the derogations for small trading book business and the exemptions from the SA. This was previously referred to as CAP 25.11 under the initial Basel 3.1 consultation (CP16/22).
Overall Summary of SDDT Simplifications
How We Can Help
Banks may encounter a range of challenges connected to the Strong and Simple Framework: from evaluating their eligibility, to understanding the benefits and drawbacks of opting in, to making sense of the substantial changes arising across the prudential risk management framework including the ICAAP and ILAAP, and evaluating the impacts to own funds and other prudential requirements including regulatory reporting.
At Katalysys, we are experts in prudential risk management and regulatory reporting and specialise in working with small- and medium-sized banks who may fit into the category of an SDDT firm.
With a substantial level of analysis required and critical business decisions for banks approaching rapidly, our team is ready to assist you in ensuring that your bank is well-placed to make informed strategic decisions and effectively navigating the changing landscape of prudential requirements in the UK.
For more information, please contact:
Josh Nowak
Managing Director, Risk & Regulatory Consulting
T: +44 (0)7587 720988
Ravi Patel
Vice President, Risk and Regulatory Consulting
T: +44 (0)7387 972729
