Navigating Regulatory Change: An Insight into PRA’s Policy Statements on Basel 3.1 Standards

The Basel 3.1 standards introduced by the UK Prudential Regulation Authority (PRA), closely align with the principles set forth by the Basel Committee on Banking Supervision (BCBS) and are intended to ensure that UK banks are well-capitalised, adequately prepared for financial shocks, and able to withstand economic downturns.

The opinions expressed here are those of the authors. They do not necessarily reflect the views or positions of UK Finance or its members.

These reforms are expected to be fully implemented by 1 July, 2025, factoring in a six-month extension from the original deadline of 1 January, 2025. Further, as part of the reform process, the PRA proposed a simpler set of standards for smaller firms.

PS17/23 and the Road to Basel 3.1: What financial institutions need to know

The PRA released the first part of the near-final Policy Statement (PS17/23) in December 2023 addressing key aspects such as Credit Valuation Adjustment (CVA), Counterparty Credit Risk (CCR), and Market Risk. The second part of the near-final Policy Statement, scheduled for release in Q2 2024, will cover Credit Risk and the Output Floor, completing the regulatory response to the consultation process.

1. Market risk

  • The PRA has proposed aligning with the Basel 3.1 standards by introducing new requirements for consistent assignment of positions to the trading book or non-trading book.
  • Additionally, the PRA has opted to broaden the scope of permissible third parties for the external party approach (EPA), contingent upon the validation of data accuracy by an external auditor, with minimal alterations from the original proposition.

2. Credit valuation adjustments and counterparty credit risk

  • The PRA has chosen to uphold the current threshold calculation method as detailed in the Alternative (AA)-CVA approach.
  • Regarding Basic (BA)-CVA, the PRA has refined the near-final regulations to explicitly clarify that the maturity floor does not affect collateralised transactions, aligning with international norms.
  • The PRA has decided to broaden the definition to include both UK pension scheme arrangements (PSAs) and any third-country funds eligible for PSAs status if situated in the UK.

3. Operational risk

  • Excluded divested activities from the computation of the business indicator (BI) in instances of entity or activity disposals.
  • Employing business estimates to calculate the BI and its sub-components when audited data is not accessible.

4. Impact of Basel Pillar 1 changes on Pillar 2

The PRA recognises the need for adjustments in firms' Pillar 2 capital requirements alongside the implementation of Basel 3.1 standards. In response the PRA has outlined the following actions:

  • Conducting an off-cycle review of firm-specific Pillar 2 capital requirements prior to the implementation of Basel 3.1 standards.
  • Mechanically adjusting firms' Pillar-2A operational risk requirements to align with any changes in Pillar 1 RWAs and adjustments related to market risk and CVA addons.

5. Currency redenomination

  •  No changes to the PRA’s proposals as outlined in CP16/22.

6. Transitional Capital Regime (TCR)

  • Only minor adjustments were suggested.
  • Importantly, going forward, the PRA will use the term Interim Capital Regime (ICR) instead of TCR in the near-final instrument and statement of policy.

PS15/23 and impact for Small Domestic Deposit Takers (SDDTs) 

Policy Statement PS15/23 outlines the Strong and Simple Framework for small non-systemic firms, now referred to as Small Domestic Deposit Takers (SDDTs). These firms have the option to adopt a more simplified reporting process instead of navigating the complexities of the Basel 3.1 reporting regime. The PRA has set out the criteria for SDDT qualification, emphasising that participation in this regime is voluntary. The initial phase of these regulations, focusing on non-capital and disclosure aspects, as outlined by the PRA came into effect on 1 January, 2024, with the subsequent phases scheduled for the second quarter of 2024. Additionally, the PRA remains committed to exploring further opportunities to simplify these policies in the future.

Basel III reforms, particularly Basel 3.1, herald significant changes in risk management and capital adequacy standards, tailored to the unique dynamics of the UK financial market. To meet the deadline of 1 July, 2025, firms will need to keep moving forward. By working with their reporting solutions partner, firms can navigate these reforms efficiently, ensuring compliance and bolstering financial resilience in the face of evolving regulatory landscapes.