The Bank of England (BoE) has published a speech given by Sam Woods, BoE Deputy Governor, Prudential Regulation and PRA Chief Executive Officer. The speech is entitled Looking both ways.In the first half of his speech Mr Woods takes a “whistle-stop” tour through the twentieth century to examine the increasing role that supervision has played in the regulation of financial institutions and why it remains an essential ingredient of the regulatory framework in the UK.
In the second half of his speech Mr Woods discusses today’s supervisory challenges including Brexit. Mr Woods makes it clear that whilst the UK’s withdrawal from the EU will change many things, it will not change the PRA’s statutory objectives. Supervisors will maintain the normal supervisory approach and focus on the biggest risks at each firm. He acknowledges that for some businesses, Brexit will be a key risk and will warrant supervisory attention. He also notes that equally, firms’ management should remain focussed on the full spectrum of risks that they face. As with any other identified risk, there will be discussions with firms about their contingency plans as part of their regular supervisory interaction.
Mr Woods also highlights further issues, some of which are particularly relevant for building societies. These include:
- net interest margins at building societies are coming under increasing pressure and, although they are still well above levels seen in 2010, the trend seems to have turned downwards;
- across the wider market, the BoE has observed, not from all firms but definitely from a few (including from some building societies), a shift in credit risk appetite as lenders compete with each other to find ways of widening the pool of available borrowers, increasing the size of loans available to them, or reducing the credit premium charged for inherently more risky loans;
- the BoE has noticed that some institutions are now moving on-balance-sheet financing to off-balance-sheet formats using special purpose vehicles, derivatives, agency structures or collateral swaps. Some of these structures might meet the requirements for calculating a specific financial ratio whilst others may have a harmless motivation. But the BoE has noticed that some carry material credit risk which escapes the detailed aspects of the capital framework. Mr Woods warns that when setting up these transactions, firms should be prepared for questions from supervisors about the substance, as well as form, of their proposals; and
- the BoE is aware of some banks seeking out funding that matures just beyond the time horizon used to calculate regulatory liquidity requirements. These include the liquidity coverage requirement’s 30-day window. Mr Woods states that extending the term of a deposit by a few days to mature exactly just after the boundary of the liquidity risk measure is compliant with the letter of the regulation but argues that the overriding principle of safety and soundness must be considered. He adds that firms should expect supervisors to ask this question and they should be prepared to defend their compliance, not only with the letter of the regulation, but also with the principles of prudence, effective risk management and adequacy of financial resources at all times.
View Looking both ways, 10 July 2017