PS17/23 – Implementation of the Basel 3.1 standards near-final part 1

The Prudential Regulation Authority (PRA) has published a first policy statement (PS17/23) which includes „near final rules“ to implement the remaining Basel III standards that have not yet been introduced into the regulatory framework for the prudential supervision of banks, building societies, investment firms, and financial holding companies in the UK. The document is a „first“ policy statement in that it does not cover all the issues that were addressed in the corresponding consultation (CP16/22) which was launched in 2022 and which covered topics ranging from the assessment of market, credit, counterparty, and operational risk for purposes of determining own funds requirements, to related disclosure and reporting obligations (EventID 18774). The key objective was thereby to modify the way risk weights are assigned for purposes of determining own funds requirements to
(a) make the weights and their assignments more appropriate for a given asset (or portfolio) risk and
(b) align the risk weights assigned under the internal model approach (IMA) with those of the standardized approach (SA) to come up with more comparable risk weighted capital ratios.
#### Specifically, this first policy statement now responds to the following proposals:
(1) the proposal to define the scope and levels of application of the retained EU Capital Requirements Regulation (CRR), including the new provisions of the assignment of risk weights, which suggested an application to firms only that are not classified as „simpler-regime firms“, now also called „Small Domestic Deposit Takers“ (SDDTs). These firms would be eligible to choose the adoption of the permanent strong and simple risk-based capital framework without having to implement Basel 3.1 standards. Accordingly, they would be eligible to apply for the application of the interim capital regime (ICR) that was put in place for smaller CRR firms following Brexit, until the new regime for smaller firms and the new requirements for larger ones in accordance with this new policy statement come into force (the ICR does not include the Basel 3.1 standards). The possible participation in the ICR would also apply for those firms, that meet the SDDT consolidated criteria (please see EventID 24257 in this context for more information on the SDDT regime).
(2) the proposal to introduce – for the purposes of determining market risk – new criteria for the assessment of market risk of positions allocated to the trading book. Specifically, the PRA sought to adopt the three (four) tier approach set out by the Basel Committee on Banking Supervision (BCBS) which includes the following:
– a simplified standardized approach (SSA) for firms with little trading activity which allows for a simplified calculation of market risk exposures;
– an advanced standardized approach (ASA) for firms with more trading activity which, however, aren’t permitted to use an internal model for the assessment of market risk;
– an internal model approach (IMA) with the assignment of risk weights based upon own models; and
– the advanced measurement approach (AMA) for operational risk – though not directly related to market risk – the approach allows banks with more sophisticated risk management systems to use their own internal models to estimate operational risk capital requirements.
In this context, the PRA sought to set out criteria to (a) determine whether or not a position should be assigned to the trading book altogether or should be handled as a non-trading book asset and the criteria that must be applied for purposes of the assignment of risk weights within each of these classifications.
(3) the proposal to remove the use of the internal model approach for purposes of calculating operational or credit valuation adjustment (CVA) risk own fund requirements due to the PRA’s expectations that such risks aren’t adequately addressed using the IMA. Instead, the PRA proposed to introduce three alternative methods to calculate CVA under the SA, with a fallback alternative for firms with limited non-centrally cleared derivatives exposures, a basic approach, and a standardized approach.
(4) the proposal to introduce a new standardized approach for all operational risk calculation, thereby replacing existing approaches under the IMA. Furthermore, the PRA proposed to „remove the mechanical link between operational risk capital requirements and historic operational risk losses“.
(5) the proposal to convert specified euro (EUR) and US dollar (USD) references in the CRR to pound sterling (GBP).
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#### Responses and modifications to the draft proposals
The PRA received extensive feedback to its consultation, including 126 formal written responses and responses from engagements in over 70 stakeholder meetings. Generally, respondents supported the proposals, but sought additional guidance in some areas and suggested some adjustments for more flexible, proportionate, and operationally feasible treatments of various risk components. As a consequence to the feedback, the PRA has made some modifications to its proposed new capital assessment rules under Basel 3.1, including the following:
– For purposes of determining market risk for exposures to sovereign bonds, the PRA has removed the permission to use internal models for such determination.
– The PRA has further introduced the option to include exposures to sovereign bonds, non-financial counterparties, and pension funds in new CVA methodologies immediately instead of after a transitional period, so that firms finding it easier to adjust to the new requirement to do so right away.
The PRA has also made numerous non-material changes for clarity purposes. It may be noteworthy that the PRA has also adopted a near final Statement of Policy to allow small deposit takers to access the interim capital regime, if so desired. Please also see EventID 24406 in this context for more information.
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The revisions to the CRR framework will come into force on July 1, 2025.