On 7 April 2021, the PRA published Consultation Paper 7/21 ‘Credit risk: The identification of the nature, severity and duration of an economic downturn for the purposes of Internal Ratings Based (IRB) models’ (CP7/21).

The PRA considers that it is important to reduce unwarranted variability from IRB models, and has previously set out its implementation of parts of the IRB roadmap, for example in Policy Statement 7/19 ‘Credit risk: the definition of default’ (PS7/19) and in Policy Statement 11/20 ‘Credit risk: Probability of Default and Loss Given Default estimation’ (PS11/20).

One of the products from the EBA’s IRB roadmap relates to the specification of an economic downturn: the final draft Regulatory Technical Standards (RTS) on the specification of the nature, severity and duration of an economic downturn in accordance with Articles 181(3)(a) and 182(4)(a) of the Capital Requirements Regulation. The EBA published its final draft RTS on 16 November 2018, and then its opinion on the European Commission’s amendments relating to the final draft RTS on 31 August 2020.

The PRA noted in PS11/20 that the RTS was in draft at the time of publication. PS11/20, which included relevant changes to Supervisory Statement 11/13 ‘Internal Ratings Based approaches’ (SS11/13), assumed that the RTS would be made before the end of the transition period in the same form as the draft. At that time PS11/20 stated that further changes to SS11/13 would be considered if the final RTS differed from the draft, and that the requirements of the RTS would only apply once the final RTS had entered into force and applied in the UK. The final RTS was not finalised in the EU before the end of the transition period, and therefore it did not get automatically converted into UK law as ‘retained EU law’ under the European Union (Withdrawal) Act 2018.

The PRA considers that it is appropriate to introduce requirements for identifying an economic downturn in order to foster greater comparability of capital requirements across firms. Therefore, in CP7/21 the PRA sets out its proposed approach to implementing appropriate requirements as UK technical standards, and to update its expectations in SS11/13 accordingly. In order to improve efficiency for firms, the PRA has used the version of the RTS in the EBA’s 2020 opinion paper as a start point for developing its proposed technical standards, and has provided additional clarity in some areas to further advance its statutory objectives.

The proposals in CP7/21 would result in new UK Technical Standards (Appendix 1) and amended expectations in SS11/13 (Appendix 2). The PRA is also proposing to make additional minor changes to SS11/13 to reflect the UK’s exit from the EU, which are summarised in Chapter 3 of CP7/21 and set out in Appendix 2.

The deadline for comments on CP7/21 is 7 July 2021.

The PRA proposes that the implementation date for the changes resulting from CP7/21 would be 1 January 2022, in line with the implementation deadlines set out in PS11/20 for IRB firms to implement all changes from the IRB roadmap (except in respect of the RTS on materiality thresholds for firms only using the standardised approach, where the implementation deadline was 31 December 2020). Firms should continue to submit model change applications in line with the submission timings communicated by their supervisors.