CRR2 - Treatment of prudently valued software assets
Note [updated 30-Dec-2020] - In a rare exception, the PRA have issued a statement about its intention to revert back to the old position (pre CRR2) of fully deducting all software intangible assets from capital. Banks have been advised to take this intention (fully deducting all software assets from capital) into consideration in preparing their capital management plans (e.g. 3 year business plan), dividend plans and lending decisions. The PRA, after due consultation, will publish its position on this in due course.
CRR treatment [Article 36(1)(b)]: Software assets are considered as intangible assets, and these are deducted from Common Equity Tier-1 (CET-1) capital.
CRR2 treatment [Article 36(1)(b)]: Software assets that are prudently valued, the value of which is not negatively affected by resolution, insolvency or liquidation of the bank, is exempt from CET-1 deduction.
The EBA final draft Regulatory Technical Standards (RTS) (EBA/RTS/2020/07) outlines the various approaches, including the recognition of the difference in accounting amortisation and the proposed prudential amortisation.
The RTS outlines an approach based on ‘prudential amortisation’, under which the positive difference between the prudential and the accounting accumulated amortisation would be fully deducted from capital, while the residual amount of the carrying amount of the software would be risk weighted. The useful life of software will be lower of the life estimated for accounting purpose and the prudential amortisation period. The maximum prudential amortisation period is 3 years, assuming a straight line amortisation.
Example to calculate ‘prudential amortisation’
Prudential amortisation is a simple straight line amortisation over a period that is lower of (a) the accounting amortisation period or (b) 3 years
Assume that the software asset was available for use from 1-Nov-2019 with a value of £12 million, and an initial accounting useful life of 6 years (6 x 365 = 2190 days). The initial prudential useful life is considered as 3 years (3 x 365 = 1095 days). If we are doing this evaluation on say 1-Nov-2020, 1 year of useful life of the software has already elapsed (i.e. the elapsed prudential useful life is 1 year = 1 x 365 = 365 days).
The prudential accumulated amortisation = { Amount of software initially recognised / [Lower of accounting initial useful life in days or prudential initial useful life in days] } x number of days prudential useful life elapsed
In the example, the accumulated prudential amortisation will be = { £12,000,000 / 1095 } x 365 = £4,000,000.
Example of CET-1 deduction and residual amount risk weight
Let us consider a software asset that meets all the operational and valuations requirements, with an initial value of £12 million that was acquired on 1 January 2020. From an accounting perspective the bank has assumed straight-line amortisation with life of 6 years. Based on this, we calculate the ‘prudential amortisation’ and the amount for capital deduction and the residual that should be risk weighted as shown below:-
Implementation timeline: As per CRR2, this was planned to be implemented 12 months after the RTS was to be published. However, due to Covid-19, the EU implemented a ‘quick fix’ on 24 June 2020 (EU 2020/873) and brought the date of implementation forward and this will be effective from the data when the “draft” RTS will be published. Hence, this is applicable from 14 October 2020.