The December Financial Stability Report announced that the Financial Policy Committee (FPC) now expects the structural level of the countercyclical buffer (CCyB) in the 'standard? risk environment to be at two per cent. Because the FPC believes that the current UK risk environment is 'standard? it has raised the UK CCyB from one per cent to two per cent. This will come into effect on 16 December 2020.

Furthermore, a recent speech by an external member of the FPC considered it would be difficult to get to the 3.5 to five per cent CCyB that would have been required prior to the crisis from a one percent starting point in standard times.

In CP2/20 the Prudential Regulation Authority (PRA) is consulting on its intention to reduce Pillar 2A capital add-ons, in the light of the greater additional resilience associated with the higher countercyclical buffer requirements. It intends to apply the Pillar 2A reduction at the same time as, or before, the two per cent CCyB rate comes into effect.

If a firm's minimum requirement for own funds and eligible liabilities (MREL) exceeds total capital requirements (TCR), the PRA proposes to reduce variable Pillar 2A capital requirements by 50 per cent of the firm-specific UK CCyB rate increase.

For low-risk firms - those whose MREL is equal to their TCR - the intention is that the one per cent CCyB will be offset in total by the reduction of the variable component of Pillar 2A.

This would also have the consequence of changing the mix of capital, requiring more to be held in equity -  as opposed to other forms of Tier 1 capital - for the largest banks.

The proposed reduction is a one-off adjustment associated with the change in the 'standard? risk environment CCyB level. Any subsequent changes to CCyB will not be neutralised.

The PRA recognises that up to 50 per cent of all firms - those whose LAC is determined by the leverage ratio, or smaller firms with small or zero variable Pillar 2A requirements - will not be able to benefit in full from the proposed offset. 13 per cent of firms will, under the proposals, receive no Pillar 2A reduction at all.

It is helpful that the PRA has reiterated that it does not expect firms to maintain additional ?management? capital buffers to avoid using the PRA or combined buffer (including CCyB), emphasising that buffers can be drawn down in a stress. This may be one route to consider as boards consider whether or not they feel comfortable in reducing the extra capital headroom they currently hold, in order to mitigate the capital impacts of where they are unlikely to benefit from the full CCyB offset.

The banking system is already well capitalised. Imposing a requirement that unnecessarily increases capital further will have an impact on the cost of lending and the ability of specialist banks and building societies to compete with each other, and with the larger ring-fenced banks. This should be avoided, and we need a creative response to the CCyB conundrum. UK Finance will work together with its members and the regulator to find the silver bullet which ensures that firms are not penalised by the planned increase.