Last week the Prudential Regulation Authority (PRA) announced it had changed the way in which it requires firms to hold Pillar 2A capital from an amount that varies with changes in Risk Weighted Assets (RWAs), to a fixed amount based on pre Covid-19, end-2019 RWAs. This will apply for the next two years and reflects the PRA's belief that RWAs are not a good proxy for the evolution of the risks specifically captured in Pillar 2A in a stress.

Pillar 2A requires banks to hold extra prudential capital over and above the Pillar 1 amounts held for credit, market and operational risk, for instance against concentration risk, counterparty risk and interest rate risk in the banking book. Pillar 2A requirements are agreed between the firm and the PRA as part of the regular Supervisory Review and Evaluation Process (SREP).

The Bank of England's recent desktop forecast suggests that the UK faces the biggest quarterly GDP contraction on record in Q2, with 25 per cent of the workforce being paid by the UK government which is also guaranteeing banks? new lending to Covid-19 affected businesses. To date more than 1.6 million people (as of 14 May) have had their mortgage payments temporarily suspended and 700,000 have been granted credit card payment holidays by their bank. Although we do not yet understand how customers will be affected in the longer run, these measures are designed to ensure that disruption suffered by businesses and households as a result of the Covid-19 pandemic will not cause lasting economic harm. However, some may suffer more permanent financial stress, making loans to them riskier for banks and increasing their RWAs requirements.

The PRA's move away from setting Pillar 2A capital requirements based on RWAs to a fixed amount means that if RWAs do increase, the amount of capital that banks have to hold does not increase too. This is important as forward-looking risk assessments, as required by Pillar 1 and Pillar 2, are procyclical. Consequently, as capital requirements for banks increase, the amount of new loans that banks can provide reduces. This potentially exacerbates the credit cycle in a downturn when businesses and households may need to borrow more. So UK Finance welcomes this move to setting a fixed nominal Pillar 2A capital requirement which will not impose extra capital requirements on banks if RWAs do rise

Banks and building societies with a SREP this year will not have to apply to change their Pillar 2A, but those with SREPs scheduled for next year should apply to the PRA for a conversion of their current Pillar 2A requirement into a nominal amount.