The Prudential Regulation Authority (PRA) has released its Policy Statement on Reconciling capital requirements and macroprudential buffers following its February Consultation Paper 2/20, to which UK Finance responded on members? behalf.

The Consultation Paper proposed that the one per cent increase in the structural level of the countercyclical buffer (CCyB) in the 'standard? risk environment from be offset by a reduction, in most cases, of the Pillar 2A capital add-ons.

However, since then the Financial Policy Committee has reduced the CCyB to 0 per cent in light of the current Covid-19 stress. In addition, the PRA announced that it had changed the way in which firms 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 particularly benefit Internal Ratings Based banks, whose credit risk models may deliver increased RWA based capital requirements which may not take into account the wide and unprecedented government support measures now available to households and businesses.

In light of the uncertainty about how the Covid-19 associated economic stress will evolve, the Policy Statement announces that the PRA will temporarily increase the PRA buffer for all firms that receive a P2A reduction. The buffer will increase by 56 per cent of the firm's total P2A reduction (firms are required to hold 56 per cent of their Pillar 2A capital in Core Equity Tier 1 (CET1)) - until the UK CCyB rate begins to increase towards 2 per cent. It should be borne in mind however that once this happens the CCyB (unlike Pillar 2A) must be met entirely by CET 1.

Although there will be no impact on bank capital requirements as a result of the CCyB change until March 2022 at the earliest, UK Finance welcomes the PRA's reiteration of its commitment to offset the impact of the one percentage point CCyB uplift.

The effect of this is that more of a bank's CET1 is in buffers and therefore useable in the event of a stress. Indeed the PRA has made it quite clear that the very considerable capital and liquidity buffers that have been built up over the past decade are there to be used in exactly the type of stress the economy is facing . It would not expect those buffers to be built back up again in full until a significant time after the end of the current stress.

So far so good. However, the PRA Buffer and CCyB are just a couple of mechanisms in the complex and interwoven buffer toolbox that supervisors can deploy. Others include the capital conservation buffer, the running down of which may result in dividend restrictions, and the systemic risk buffer applying to large banks and building societies. These buffers may apply variously at group level, at the level of the ring fenced bank  or to an individual subsidiary and may be based on risk weighted assets or leverage metrics and either of which may will have implications for the amount of expensive bail-in-able capital, such as the MREL that a bank must hold.

In my view, the capital stack and how these different buffers interact has become overly complex, in part because the buffers serve different masters: micro prudential and macro prudential regulation as well as the resolution of potentially failing banks. The PRA will review the use of Pillar 2A in 2024 once Basel 3.1 has been implemented. It has also confirmed that it will review its approach to setting MREL around the end of this year and the Leverage Ratio shortly thereafter. This is welcome, but even more welcome would be a joined up, contemporaneous review of these different metrics that enabled the complexity of their interplay to better acknowledged and addressed.

Nonetheless, we should all acknowledge that buffers give supervisors confidence that if things start going wrong a bank has sufficient capital to bolster it whilst they are put right without it breaching its minimum requirements. Lower buffers will only become a reality when regulators, and politicians have more confidence in resolvability - as the ease of resolution increases and its costs decrease buffers should go down too.