United Kingdom (and EU regulation)

Pillar 2 capital: Updates to the framework

By Simon Lovegrove (UK) and Jochen Vester (UK) on January 24, 2020 Posted in Capital adequacy, United Kingdom

On 23 January 2020, the PRA published Policy Statement 2/20: Pillar 2 Capital: Updating the Framework (PS2/20). In PS2/20 the PRA provides feedback to the responses to Consultation Paper 5/19: Pillar 2 capital: Updates to the framework, which set out refinements to the PRA buffer (also referred to as Pillar 2B). In its consultation the PRA made proposals in five areas: the hurdle rate in stress; buffer interactions and usability; the risk management and governance assessment; updating benchmarks for assessing Pillar 2A credit risk; and minor corrections to drafting.

In PS2/20 the PRA reports that after taking into account respondents’ comments some minor changes have been made to its proposals. The PRA has updated Statement of Policy: The PRA’s methodologies for setting Pillar 2 capital (SoP) to clarify that:

in general, the PRA will use the leverage exposure measure as the single scaling base for the operational risk and interest rate risk in the banking book (IRRBB) Pillar 2A components of the hurdle rate in stress because the PRA considers it to be a more robust and representative scaling base. This has been clarified in Table E – ‘Pillar 2A scaling bases’;
in setting the PRA buffer, factors in addition to a firm’s hurdle rate(s) will be considered. These include, but are not limited to: the firm’s leverage ratio; Tier 1 and total capital ratios; risks associated with double leverage; and the extent to which potentially significant risks are not captured fully as part of the stress test. This is set out in paragraph 9.44 of the SoP;
the purpose of the PRA buffer and its interaction with the combined buffers is set out in paragraph 9.1 and 9.28 – 9.31 of the SoP;
in general, the PRA takes the approach of using risk weighted assets at the start of the stress and that this may be adjusted to reflect changes to the balance sheet as set out in paragraph 9.32 of the SoP; and
the example illustrating the process of calculating the PRA buffer is a stylised example and does not represent an exhaustive scenario as set out in paragraph 9.32 of the SoP.

The PRA has also added a reference in Supervisory Statement 31/15: The Internal Capital Adequacy Assessment Process and the Supervisory Review and Evaluation Process (paragraph 2.41) to its existing policy on managing climate-related financial risks. The PRA has made no changes to the draft policy for Supervisory 6/14: Implementing CRD IV: Capital buffers.

The changes on PS2/20 took effect from 23 January 2020.