The Prudential Regulation Authority (PRA), the UK’s prudential authority for financial services, has begun reform of capital rules for insurers and banks, in its review of the Solvency II and Basel III standards which respectively set the level of capital buffers needed for each industry in order to better provisions against exposed risks.
In the UK Chancellor of the Exchequer’s ‘Autumn Statement’, Jeremy Hunt set out a reduction of the buffers needed to cover life insurance (65%) and general insurance (30%) which allow that capital to be used elsewhere.
Trevor Jones, head of insurance at KPMG UK, said in a statement, “KPMG analysis has suggested that UK insurers could unlock up to £35 billion of surplus capital from the reform of the Solvency II Risk Margin, and we are pleased to see major changes to this element of the rules today. Improvements to the Solvency II Matching Adjustment can help deliver greater investment for the future, as long as they go hand-in-hand with the right processes and oversight.”
The PRA then published a consultation paper on 30 November (CP16/22) setting out proposed rules and expectations that cover the parts of the Basel III standards that remain to be implemented in the UK. The PRA refers to them as ‘the Basel 3.1 standards’.
The CP is relevant to all PRA-regulated banks, building societies, investment firms and financial holding companies. The CP also includes revised criteria for determining which firms would be in scope of the future ‘strong and simple’ regime.
The proposals would implement the final package of banking prudential reforms developed by the Basel Committee on Banking Supervision (BCBS) in response to the global financial crisis. It is a comprehensive package of proposed measures that would make significant changes to the way firms calculate risk-weighted assets (RWAs) for the purposes of calculating risk-based capital ratios. The proposed changes are designed to improve the measurement of risk in internal models and standardised approaches and reduce excessive variability in the calculation of risk weights, thereby making firms’ capital ratios more consistent and comparable.
In addition, the proposals are intended to facilitate effective competition by narrowing the gap between risk weights calculated under internal models, which are typically used by the larger firms, and the standardised approaches, through:
- Removal of the use of internal models in some areas for example: operational risk, credit valuation adjustment (CVA) risk;
- Restrictions on the use of internal models in credit risk for portfolios where there is insufficient loss data to reliably model: for example, exposures to large corporates and other financial institutions;
- A more risk-sensitive set of standardised approaches for each risk area (credit, market, operational and CVA risks); and
- Introduction of a new ‘output floor’ to be phased in over five years designed to ensure total RWAs based on internal models cannot fall below 72.5% of RWAs derived under standardised approaches.
The PRA has said it does not expect the proposals set out in this CP to significantly increase overall capital requirements on average across UK firms. The PRA’s proposed implementation date for the changes resulting from this CP would be 1 January 2025, with transitional arrangements that give firms significant time to adjust to the new framework.
Sam Woods, deputy governor of prudential regulation and CEO of the PRA, said, “Alignment with strong international banking standards promotes economic growth by underpinning the competitiveness of the UK as a financial centre, supporting investors’ confidence in the UK banking system and ensuring that banks can finance the economy during downturns. Our proposals for implementing the latest Basel standards, with appropriate but limited adjustments for the UK market, aim to deliver these goals. We encourage anyone with an interest to send us their views and evidence.”
The PRA’s has said its proposals “take advantage of the flexibility afforded by the UK’s withdrawal from the EU to propose limited adjustments to the Basel 3.1 standards to reflect the specific characteristics of the UK where those could better capture risk and support the competitiveness and relative standing of the UK.”
Its consultation closes on 31 March 2023 – the consultation period has been extended to four months so that there is sufficient time for respondents to gather and submit data and evidence.
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