News release
The Prudential Regulation Authority (PRA) has today unveiled a series of possible options to make it easier for mid-sized firms to scale-up and compete in the residential mortgage market, and is now opening a wide discussion with industry on how best to do so.
As announced earlier this month, the PRA has now published a discussion paper to explore different options that affect how firms can determine capital requirements for residential mortgage loans (“exposures”) under the internal ratings based (IRB) approach.
Any amendments that the PRA decides to take forward, informed by feedback to the discussion paper, would represent less complex regulatory requirements for many firms, and should speed up the approval process compared with the current framework.
Currently, firms using the IRB approach model their capital requirements for their exposures to credit risk. This is in contrast to the “standardised approach” which sets capital requirements for firms, and typically has higher average capital requirements for residential mortgages.
Today’s discussion paper looks at two IRB components: ‘loss given default’ (i.e. how much money a lender expects to lose if the borrower does default) and ‘probability of default’ (ie how likely it is that a borrower will fail to repay a loan). Firms must estimate both to obtain IRB permission.
For loss given default the PRA is considering a “foundation IRB approach”. This would allow firms to use PRA-prescribed values for loss given default instead of estimating their own. This would significantly reduce the amount of modelling, time and resourcing required to obtain IRB permission, making it easier for mid-sized firms to obtain it.
Questions asked around loss given default include which firms it should be available to, whether the approach should differentiate between buy-to-let and owner-occupied mortgages, and whether the PRA should look beyond residential mortgages and towards other retail exposures for this approach.
Firms would still need to model probability of default but the PRA is also considering amendments to address challenges faced by firms in estimating this.
The PRA is keen to facilitate an open discussion on the costs and benefits of each option, and so is not committing to any specific options at this stage. It will decide which options, if any, to take forward to consultation in light of the feedback it receives on the discussion paper.
David Bailey, Executive Director for Prudential Policy at the Prudential Regulation Authority, said: “Mortgages are one of the most important financial products in the country and among the biggest decisions people make about their finances. The options set out in this discussion paper could have a positive impact on competition and growth whilst maintaining an appropriate level of resilience, and result in more people getting access to the finance they need to buy a new home.”
“Once we have feedback to this discussion paper, we will look to take forward the best options to support effective competition among UK lenders.”
Today’s paper builds on the Bank of England’s recent announcements earlier this month of a package designed to promote banking resilience, competition and growth. The announcements include an implementation date of 1 January 2027 for most of Basel 3.1 and for Strong and Simple, the new capital regime for smaller firms that is designed to create a straightforward system that gives smaller firms the space to grow.
The Bank of England also announced at the same time an increase to the indicative thresholds for the minimum requirement for own funds and eligible liabilities from £15-25 billion in total assets to £25-£40 billion, which is designed to provide greater clarity and flexibility for mid-sized firms.
Notes to editors
1. The PRA has today (Thursday 31 July) published a Discussion Paper on Internal Ratings Based Models, which will close on 31 October.