On 12 June 2019, the PRA published a Dear CEO letter detailing findings from its review of fast growing non-systemic deposit taking firms (FGFs). The review aimed to test the financial resilience of FGFs and enhance the PRA’s knowledge of the funding and lending markets in which they operate. The review was split across three elements, the findings of which were:
- stress testing:
- most FGFs were overly optimistic about the potential impact of a stress scenario on their business. This was most apparent in their assumptions about stressed impairment rates that could emerge and their ability to raise capital, dispose of parts of their business, or widen their margins in the context of a market-wide stress;
- many FGFs did not demonstrate an understanding of the stress drivers for their business, were unable to explain the assumptions made in their stress testing models, and/or to analyse the sensitivities of their business models to these assumptions; and
- where FGFs identified management actions to be taken in the event of stress, these tended to be poorly defined and lacking clear trigger points for when the action would be undertaken.
- asset quality review:
- risk appetite frameworks were still evolving and generally reflected the particular FGF’s stage of development and maturity. Risk appetite statements of these FGFs tended to be high level and did not fully capture risks or include sufficiently granular metrics to enable the level of risk to be adequately monitored;
- many FGFs had untested collections capability and it was unclear how effective their plans for scaling up collections activity would be under stress; and
- some FGFs displayed weaknesses in underwriting of commercial loans. The PRA observed a number of instances of weak financial analysis, limited evidence of challenge and high levels of lending outside of policy (on the basis of exceptions).
- funding and lending analysis:
- a number of FGFs exhibited a lack of diversity in funding sources, being almost entirely reliant on funding from competitively priced, short-term fixed rate retail deposits. FGFs were not found to be disproportionately reliant on wholesale funding;
- most FGFs’ pursuit of aggressive balance sheet growth targets was driven from the asset side of the balance sheet requiring firms to maximise funding from all available funding sources including non-core funding such as secured funding, wholesale funding, SME and corporate deposits, all of which could increase execution and refinance risks; and
- better firms took into account various market pressures as well as their own ability to differentiate pricing on both sides of the balance sheet in both their baseline and stress testing projections.
The PRA will be providing feedback on its review at its upcoming conference session for Chairs and Non-Executive Directors of non-systemic UK Banks and Building Societies in July. The PRA expects supervisory teams to discuss with firms the points raised in this letter as part of ongoing supervisory engagement.