UK Basel 3.1: Near-final Rules Part 2 (PS9/24) - Key Changes
Overview
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.
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.
This article focuses on the key changes in comparison to the PRA’s earlier consultation paper(s), in each of the major risk areas: credit, market, operational, and credit valuation adjustment (CVA) risks, and counterparty credit risk (CCR). Further updates will follow covering reporting, disclosures and credit risk mitigation.
Key Changes
This section provides an overview of notable modifications to the draft and previous near final rules. Considering the changes implemented in the final rules by the PRA, it is likely that banks will see some overall benefit or reduction in own funds requirements when comparing to the original proposed rules detailed in CP16/22.
Credit Risk
The following list covers the key revisions to the proposed rules, in addition to various minor wording adjustments aimed at improving clarity.
Exposures to Small- and Medium-sized Entities (SME)
The PRA introduces in these new rules, a definition of ‘SME’ for the calculation of risk weighted exposures. Now, an SME shall mean [Glossary Part of the PRA Rulebook]:
“a micro, small or medium enterprise with an annual turnover of not more than GBP 44 million where: (1) the annual turnover shall be calculated on the basis of the highest consolidated accounts of the group to which the enterprise belongs, if any, according to the rules on accounting consolidation in the applicable jurisdiction; and (2) an enterprise shall be considered to be any undertaking regularly engaged in an economic activity irrespective of its legal form, including without limitation: self-employed persons and family businesses engaged in craft or other activities, and partnerships or associations of natural persons.”
A bank-specific adjustment shall be applied by the PRA under the Pillar 2 framework (via Pillar 2A own funds requirements), to be known as the ‘SME Lending Adjustment’ to ensure that the removal of the SME support factor under Pillar 1 does not result in an increase in overall own funds requirements for such exposures. The PRA will invite banks, as part of an ‘off-cycle’ re-evaluation of their Pillar 2 capital requirements, to submit the necessary data for the PRA to calibrate this adjustment. [PS9/24, 2.162 and 2.179]
Rule changes see a removal of the 100% risk weight floor for SME exposures secured by commercial real estate (provided repayment is not materially dependent on the cash flows from the property and meets the regulatory real estate definition). This is expected to result in significantly lower risk weights for certain SME exposures, e.g., lending secured on an SME’s own commercial premises.
Real estate exposures
The definition of ‘residential real estate’ is amended to remove provisions that had excluded specific types of property from the definition including care homes, purpose-built student accommodation, and property that was predominantly used for holiday letting. [Credit Risk: Standardised Approach (CRR), 1.1] However, in near final amendments to SS10/13 ‘Standardised Approach’ (January 2026), the PRA clarifies its expectation that property subject to any usage restrictions that would prevent it from being occupied as a residential dwelling on a permanent and continuous basis would preclude the exposure being classified as ‘residential real estate.’ [SS10/13, 5.10]
‘Regulatory residential real estate’ exposures that are materially dependent on cash flows generated by the property and that are in the loan-to-value (LTV) range of 60% to 80% will see their risk weights redefined from 45% to the below split, which the PRA believes will improve risk sensitivity:
60% < LTV ≤ 70% — risk weight = 40%.
70% < LTV ≤ 80% — risk weight = 50%.
‘Regulatory commercial real estate’: the PRA has revised the treatment of commercial real estate, removing the 100% minimum risk weight for certain cases. It now distinguishes between SME and non-SME exposures. For SMEs not reliant on property cash flows, firms must split the loan, assigning a 60% risk weight to the portion up to 55% of the property value, and apply the counterparty's risk weight to the remainder. For non-SMEs, firms must apply the greater of the counterparty's risk weight or 60%, or the risk weight for cash flow-dependent exposures if higher (100% or 110%, depending on LTV).
‘Multiple types of property collateral’: the PRA has clarified its approach to loans secured by a mixture of residential and commercial real estate. It is now required to split mixed real estate exposures into separate residential and commercial categories. Firms must use a value-weighted allocation approach to proportionally assign the loan amount for each type of real estate collateral, with each part needing to meet regulatory requirements to be risk-weighted as real estate exposures. If one part does not meet the criteria, both parts will be risk-weighted as ‘other real estate exposures’.
The PRA’s proposed treatment for ‘other commercial real estate’ received feedback on the basis that secured exposures should not receive a higher risk weight than unsecured exposures. The PRA has decided to amend the treatment for ‘other commercial real estate’ (assuming such exposures are not materially dependent on the cash flows generated by the property), which had previously been floored at 100%, to 75% for retail SMEs, 85% for corporate SMEs, and the higher of 60% or the counterparty’s risk weight for non-SME exposures. [Credit Risk: Standardised Approach (CRR), Article 124J]
The PRA has simplified and clarified the meaning of ‘materially dependent on the cash flows generated by the property’ to make it easier for firms to assess.
A ‘residential real estate’ exposure is materially dependent except where it is inter alia [Credit Risk: Standardised Approach (CRR), Article 124E(2)]:
Secured on a property of natural persons that is the obligor(s)’s primary residence.
Made to an entity, the specific purpose of which is to finance or operate immovable property, and natural person(s) act as a guarantor and are the sole beneficiaries of the real estate, and subject to a three property limit.
Extended to natural persons subject to a three property limit.
Commercial real estate is materially dependent except in the case that the property is used by the borrower for its own business purposes. [Credit Risk: Standardised Approach (CRR), Article 124E(6)]
Substantial changes are made to the requirements around valuation of real estate collateral. In particular, banks shall be required to obtain a new valuation of the property for the purposes of computing LTV ratios at a minimum every 5-years,* save where the loan is material (i.e., in excess of £2.6 million or 5% of the bank’s own funds) — every 3-years — or if the most recent valuation was obtained due to a decrease in market prices (i.e., if the bank estimates that the value of the property has fallen by more than 10% since the last valuation) — 3- or 5-years after either the revised or other most recent valuation. [Credit Risk: Standardised Approach (CRR), Article 124D]
Firms must, under revised rules, have procedures in place to monitor that real estate exposures are adequately insured against the risk of damage in order for them to qualify as ‘regulatory real estate’. [Credit Risk: Standardised Approach (CRR), Article 124A(1)f]
Self-build mortgages are reclassified, subject to satisfying other criteria, from ‘other real estate’ to ‘regulatory real estate.’ [Credit Risk: Standardised Approach (CRR), Article 124A(1)a(iii)]
Credit Conversion Factors (CCF) — the PRA has amended certain conversion factors based on respondents’ feedback including amending CCF for ‘other commitments,’ aside from UK residential mortgage commitments, from 50% to 40% (aligning with the BCBS standards) and CCF for other transaction-related contingent items that do not have the character of credit substitutes (including trade letters of credit), which were previously split based upon maturity, but have now been uniformly aligned to a CCF of 20%. [Credit Risk: Standardised Approach (CRR), Article 111, Table A1]
Exposures to institutions concerning movement of goods — the PRA has amended the draft rules to allow exposures arising from the movement of goods within the UK to be treated the same way as exposures arising from the movement of goods across national borders. [Credit Risk: Standardised Approach (CRR), Articles 120(3) and 121(4)]
Risk weights for unrated central banks — the PRA will now permit firms to apply a risk weight to an unrated central bank exposure corresponding to the risk weight assigned to the relevant central government. [Credit Risk: Standardised Approach (CRR), Article 114(2A)]
Due diligence on external ratings — the PRA has amended the proposed rules to exempt exposures to multilateral development banks (if they receive a 0% risk weight) and international organisations from the proposed credit ratings due diligence requirements. [Credit Risk: Standardised Approach (CRR), Article 110a(5)]
Exposure class hierarchy — the PRA has defined a formal hierarchy for firms to follow when allocating exposures to exposure classes. Where an exposure meets the criteria for more than one exposure class, it must be assigned to the exposure class that has the highest position in the PRA’s table. [Credit Risk: Standardised Approach (CRR), Article 112(2)]
Equity exposures — the PRA has retained the proposal to risk weight equity exposures at either 250% or 400% (subject to transitional provisions); however, it has removed previous references to ‘venture capital exposures’ and replaced these with the concept of ‘higher risk equity exposures,’ which are also the subject of a new definition focussing on length of existence of the entity rather than its underlying activity as had been the case for the venture capital group. [Glossary Part of the PRA Rulebook, and Credit Risk: Standardised Approach (CRR), Article 113(3)]
* This means that a firm will be required to update pre-existing valuations for regulatory real estate exposures that are older than 5-years (or 3-years if the exceptions apply) on the implementation date. [PS9/24, 2.230]
Market Risk and Operational Risk
Changes in the previous near final rules described in PS17/23 are largely minor, reflecting changes in certain defined terms, noting revocation of certain articles currently embedded in the CRR, and other corrections.
Credit Valuation Adjustment (CVA) Risk and Counterparty Credit Risk (CCR)
Changes in the previous near final rules described in PS17/23 reflecting changes in certain defined terms and other insignificant corrections. In addition, the PRA has proposed to introduce certain transitional provisions in the Credit Valuation Adjustment Risk Part of the PRA Rulebook for transactions exposed to CVA risk and entered into prior to the implementation date with non-financial and certain other counterparty types allowing for a discount to be applied to the CVA risk own funds requirements over the period 2026 to 2029 inclusive. The PRA has also elected to make changes to the proposed amendments made under PS17/23 to the Counterparty Credit Risk (CRR) Part of the PRA Rulebook, in connection with changes in CVA risk, i.e., to amend the transitional discounts and timelines to align these between CVA risk and CCR. [Credit Valuation Adjustment Risk Part of the PRA Rulebook, Chapter 7 Transitional Provisions; and, Counterparty Credit Risk (CRR) Part of the PRA Rulebook]
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 720988
Manish Patidar
Director, Regulatory Consulting
T: +44 (0)7766 001643