Letter from David Bailey and Charles Woods ‘UK Deposit Takers Supervision: 2023 priorities’

The Prudential Regulation Authority, PRA, has published a Dear CEO Letter addressed at chief executive officers (CEOs) of PRA-regulated financial institutions. Therein, the PRA specifies its 2023 (supervisory) priorities regarding depository institutions the key ones of which are briefly summarized below:
(1) Credit risk: As global inflation and interest rates are at very high levels and as economic uncertainty continues to prevail, the PRA particularly urges financial institutions to review their risk management processes with respect to their loan portfolios and enhance their credit scrutiny. In this context, the PRA notes that it will particularly focus on reviewing the practices of institutions as regards higher risk portfolios such as unsecured loans, leveraged lending, and lending to smaller and medium size firms (SMEs).
(2) Financial resilience: Given the headwinds noted above, banks and building societies are highly recommended to review their risk management processes as regards their financial resilience. This also includes the evaluation of existing concentrations in both credit arrangements and financial instrument exposures. Therefore, the PRA’s key focus will lay upon the supervision of such practices as well as the assessment of firms‘ capital and liquidity positions. The annual stress test will provide further information on institutions‘ resilience.
(3) Operational risks and resilience: As far as operational resilience is concerned, the PRA primarily names three issues that will be of focus: institutions‘ practices as regards the identification and mapping of important business services (IBS) and the setting of corresponding tolerances as outlined in Supervisory Statement (SS1/21) – Operational resilience: Impact tolerances for important business services, the resilience in connection with the use of third-party service providers, and the offering of crypto products to customers. The PRA announces a close monitoring of the measures firms have put in place to remain resilient to operational risks and reminds of the issues primarily of relevance in that regard (e.g. IT-system controls, stress tests).
(4) Model risk: As models are the key components to risk assessments of financial institutions, the PRA has launched a consultation in 2022 (CP6/22) on Model risk management principles for banks (please see Event ID 16115 in this context). The finalized principles are expected to be published in the first half of 2023. Institutions are expected to review their own models an the basis of the principles and make corresponding adjustments where ever needed. In this context, the PRA also notes that it will focus its supervisory practices on „new Fundamental Review of Trading Book (FRTB) models“ and models used in the implementation of the Basel 3.1 standards.
(5) Financial risks arising from climate change: As with international banks, one of the key areas of focus, so the PRA, will be the supervision of firms with respect to the management of financial risks arising from climate change. In this context, the PRA expects institutions to continue their efforts to embed climate-related risks in their risk management practices and in their disclosures. Particular attention should thereby be paid to sudden risks such as this year’s sharp increase in commodity prices and the consequences on financial risks.
As these are only the key priorities of the PRA for 2023, please consult the original Dear CEO Letter for more detailed, comprehensive information.