UK Basel 3.1: Near-final rules Phase 1 (PS17/23)
Overview
On 12 December 2023, the Prudential Regulation Authority (PRA) published near-final rules on the implementation of Basel 3.1 standards through Policy Statement 17/23 (PS17/23) which offers feedback on the responses received for Consultation Paper 16/22 (CP16/22) published on 30 November 2022.
PS17/23 covers near-final rules on:
Market risk;
Credit valuation adjustment (CVA) and counterparty credit risk (CCR);
Operational risk;
Interactions with the PRA’s Pillar 2 framework; and,
Re-denomination of currency references to pound sterling (GBP).
As part of the second phase, the PRA plans to release near-final rules in Q2 2024 for the following aspects:
Credit risk, including credit risk mitigation and output floor;
Disclosure (Pillar 3); and,
Reporting
The implementation date for Basel 3.1 standards was initially proposed as July 1, 2025. However, the implementation date of these changes as part of Basel 3.1 standards has been postponed to January 1, 2026, as outlined in PS9/24.
Key changes
This section provides an overview of significant modifications to the draft rules. There are a few elements where the PRA has revised naming conventions, such as the change from 'strong and simple' regime to 'Small Domestic Deposit Takers' (SDDT) regime. Additionally, 'Transitional Capital Regime' (TCR) has been updated to 'Interim Capital Regime (ICR).'
Market Risk, CVA, CCR and Operational Risk
Following are the key revisions to the proposed rules, in addition to various minor wording adjustments aimed at improving clarity.
Market Risk – Internal Model Approach – removed permission to use internal models for the default risk of exposures to sovereigns.
CVA – Introduced an optional transitional arrangement to include exposures to sovereigns, non-financial counterparties, and pension funds in new CVA methodologies immediately instead of after a transitional period for simplicity.
Operational Risk - confirmation about PRA exercising its discretion to internal loss multiplier (ILM) as 1, banks can apply to the PRA to exclude divested activities from the business indicator (BI) calculations, and use business estimates where audited figures are not available.
For more information on the requirements under Basel 3.1 rules pertaining to Market Risk, CVA, CCR and Operational Risk, please use the following links:
UK Basel 3.1: Credit valuation adjustment and counterparty credit risk
UK Basel 3.1: Operational risk
Interactions with Pillar 2 framework
This section outlines the PRA's plan to address the impact on firms’ Pillar 2 requirements arising from potential double counting. To prevent gaps or duplications, the PRA plans to undertake an off-cycle review of firm-specific Pillar 2 capital requirements before the implementation date of Basel 3.1 standards, i.e., before July 1, 2025.
The PRA aims to address it using the following options:
- Adjust firms’ Pillar 2 capital requirements to rectify identified instances of double counting; and/or
- Rebase[1] firms' variable Pillar 2A requirements and PRA buffer, ensuring that the changes to Pillar 1 RWAs do not lead to unjustified modifications in Pillar 2A requirements when the underlying risk level remains unchanged.
Operational Risk - Pillar 2A:
The PRA aims to mechanically align the Pillar 2A operational risk requirements of firms with any changes in Pillar 1 RWAs. This ensures that the overall nominal operational risk requirements for most firms remain unchanged.
Market Risk, Credit concentration risk and interest rate risk in the banking book - Pillar 2A:
The PRA intends to rebase these requirements.
PRA Buffer:
The PRA plans to rebase firms’ PRA buffer as well.
Refined methodology to Pillar 2A:
The PRA intends to reassess the methodologies for Pillar 2A, and further information will be furnished during the second phase of the near-final rules publication i.e. by Q2 2024.
SDDT - Pillar 2A:
The PRA will continue utilising the current Pillar 2A framework for eligible SDDT firms, until the final risk-based capital framework for SDDTs comes into effect. Consequently, ICR firms would not be subject to the off-cycle review referenced earlier.
[1] Rebasing means taking firms’ existing nominal Pillar 2 requirement and rescaling it as a fixed percentage of projected RWAs under the Basel 3.1 standards.
Interim Capital Regime (ICR)
In PS17/23, the PRA has revised the terminology of the 'Transitional Capital Regime' (TCR) to be known as the 'Interim Capital Regime' (ICR). The ICR is relevant to firms that meet the SDDT criteria and are willing to apply for Modification by Consent (MbC). Such firms are not required to apply the Basel 3.1 standards. Instead, they remain subject to existing regulations derived from the UK on-shored CRR until the implementation of the final risk-based capital framework for SDDTs (SDDT capital rules).
For more information SDDT regime please follow the link given below:
How We Can Help
Banks may face a variety of challenges when understanding or applying the new requirements, including assessing the impact on the Bank’s governance, systems, data sourcing, training etc. At Katalysys, we have a deep understanding of upcoming changes from the perspective of both regulatory rules and practical implementation.
Our team is supporting a range of clients in this area. Our support can be in the form of:
workshops or training to cover the new requirements;
gap/Impact analysis;
guidance on implementing industry best-practice in relation to Basel 3.1 standards;
documentation of the bank-specific assumptions and interpretation;
preparation of overall procedure notes;
validation of the systems/calculations; or,
review of the regulatory returns.
For more information, please contact:
Josh Nowak
Managing Director, Risk & Regulatory Consulting
T: +44 (0)7587 720988
Manish Patidar
Director, Regulatory Consulting
T: +44 (0)7766 001643