Earlier today the Prudential Regulation Authority (PRA) released its near final Policy Statement and Rulebook that will implement Basel 3.1 in the UK. (Near final as it can only be finally finalised once HM Treasury’s Statutory Instrument (a draft of which was also released today) has made its way through the Parliamentary process. 

As the suite of documents released today tops 1,700 pages in length and addresses the 600 or so issues raised in CP responses there is still a lot to digest.  

But it was good to see that the PRA has recognised the importance of bank lending to Small and Medium sized entities (SME). SMEs are a key engine of growth for our economy, so we had not supported the PRA’s proposals to withdraw the SME supporting factor (SMESF). It is a hang over, but a useful one for lenders and borrowers, from the days when the UK was part of the EU.  Although the PRA has decided to continue with its plans to withdraw the SMESF, which is sub-equivalent to the internationally agreed Basel framework, it has committed to ensure that there is no overall rise in capital requirements for SME lending in the future. Whilst the exact mechanism for doing so, via Pillar 2 reductions, needs further clarification this is a very welcome undertaking by the regulator, which should ensure that the cost of borrowing for SMEs does not rise as a result of the introduction of the Basel 3.1 package.  

The PRA also confirmed that credit conversion factors (CCF) for trade finance exposures will not be increased to the extent previously proposed, recognising that the evidence we and others had provided confirms that trade finance related transactions are not as risky as the proposed CCFs had assumed. 

Residential mortgages are one of the largest components of any bank’s balance sheet so this area of the PRA’s response was keenly awaited. The original Basel Framework, finalised as long ago as 2017, required banks to use the valuation at origination of the property being financed for Loan to Value (LTV) calculation purposes. The rise in lifetime mortgages, which can last for a number of decades, and are a response by the banking industry to borrowers’ keenness perhaps to withdraw equity from their home, penalises banks that provide these very long term products as they cannot reflect any  rise in property valuation in the LTV calculation. This in turn requires them to hold the same amount of capital for its entire term although , in a rising property market, the underlying risk has reduced. So the proposals to introduce a ‘backstop’ revaluation event every few years is very welcome, as is the continuing ability to use Automated Valuation Models in this process. 

The PRA has also listened to our arguments and reviewed the evidence that the industry presented in the treatment of Buy-to-Let (BTL) residential real estate financing. It has introduced more granular risk weights in medium-range LTV BTL lending which is very welcome. It helps avoid the risks we had identified in our response that BTL lending rates would increase, reducing the stock or increasing the cost of rentable accommodation, with a possible knock-on effect that further strain was placed on the supply of social housing as renting became more unaffordable. 

The delay by six months of the implementation date until the beginning of 2026, is welcome too.  We are pleased the PRA has listened to our assertion that firms need at least 12 months from the finalisation of the Rulebook to implement these complex and interlinked change effectively. The extra few months will give firms extra time to ensure that they have sufficient time to fully understand the PRA’s requirements, undertake the necessary coding and rigorously test updated regulatory reporting systems before go-live, as well as adapting their business and strategic plans in the light of revised capital requirements.  

Today's finalisation by the PRA of the most impactful change to prudential regulation for a decade marks a period of intense activity for the industry and the PRA . We have worked cooperatively together to come up with a package that balances the need for prudence with the impacts of regulation on competition and growth. I think the right balance of not too much capital, but not too little either has been struck. 

Whilst the past few years have been intellectually interesting as we have debated the new requirements together, I hope this is the last time in my career I’ll be called upon to lead the industry’s response to a package of proposed prudential rule changes! We need a period of regulatory stability to let the requirements bed in, and for firms and the PRA to understand the impact on business models, credit supply and competition once the Basel 3.1 package is implemented in the UK.