CP9/24 – Streamlining the Pillar 2A capital framework and the capital communications process

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Responses are requested by 12 December 2024.

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Responses can be sent by email to: CP9_24@bankofengland.co.uk

Alternatively, please address any comments or enquiries to:
Pillar 2 Policy Team
Prudential Policy Directorate
Prudential Regulation Authority
20 Moorgate
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EC2R 6DA

1: Overview

1.1 This consultation paper (CP) sets out the Prudential Regulation Authority’s (PRA) proposal to streamline the Pillar 2A capital framework and capital communications process. This is relevant to all PRA-regulated banks, building societies, designated investment firms, and all PRA-approved or PRA-designated holding companies.

1.2 Therefore this CP is also relevant to Small Domestic Deposit Takers (SDDTs),^{footnote [1]} firms who meet the SDDT criteria and are considering becoming an SDDT, as well as firms that anticipate being subject to the Interim Capital Regime (ICR). The PRA has issued a separate consultation, entitled CP7/24 – The Strong and Simple Framework: The simplified capital regime for Small Domestic Deposit Takers (SDDTs), covering proposals on capital-related measures under the Strong and Simple framework. These proposals include simplifications to Pillar 2 for SDDTs, in addition to those proposed in this CP. Please refer to CP7/24 on the specific proposals for SDDTs.

1.3 This CP is structured into the following chapters. The draft rules and related policy materials are included in the relevant appendices. The proposals in this CP include:

• Chapter 2 – retiring the 'refined methodology’ to Pillar 2A (introduced in policy statement (PS) 22/17 – Refining the PRA’s Pillar 2A capital framework);
• Chapter 3 – streamlining firm-specific capital communications (Voluntary Requirements under s55M(5) FSMA (‘VReqs’) and directions under s192C FSMA (‘s192C Directions’)); and
• Chapter 4 – minor clarifications to the interest rate risk in the banking book (IRRBB) and pension obligation risk Pillar 2A approaches.

1.4 The chapters contained in this CP, the policy material they propose to change, and the appendices containing the draft amended policy, are listed in the table below:

1.5 As set out in PS17/23 – Implementation of the Basel 3.1 standards near-final part 1, the PRA is planning to review the Pillar 2A methodologies after the PRA’s rules to implement the Basel 3.1 standards are finalised. The PRA plans to review and update the relevant policy documents (eg SS31/15, Pillar 2 SoP) more comprehensively in this review. For the avoidance of doubt, this CP does not form a part of this Pillar 2A methodologies review, nor does it provide any details about the SME lending adjustment and the infrastructure lending adjustment to Pillar 2A. Please refer to PS9/24 – Implementation of the Basel 3.1 standards near-final part 2, for further details of these adjustments.

1.6 None of the PRA statutory panels were consulted about the proposals in this CP.

1.7 The PRA has a statutory duty to consult when changing rules (FSMA s138J) or new standards instruments (FSMA s138S). When it is not making rules, the PRA has a public law duty to consult widely where it would be fair to do so. 

1.8 In carrying out its policymaking functions, the PRA is required to comply with several legal obligations. The analysis in this CP explains how the proposals have had regard to the most significant matters, including an explanation of the ways in which having regard to these matters has affected the proposals. These analyses are detailed in Chapters 2–4 of this CP.

Equality and diversity

1.9 In developing its proposals, the PRA has had due regard to the equality objectives under s.149 of the Equality Act 2010. The PRA considers that the proposals do not give rise to equality and diversity implications.

Impact on Mutuals

1.10 FSMA requires that the PRA assesses whether, in its opinion, the impact of its proposed rule changes on mutual societies would be significantly different from the impact on other firms (s138K FSMA). It is the PRA’s view that the proposed changes would not have a significantly different impact on mutual societies compared to other authorised firms.

Implementation

1.11 The PRA proposes to align the implementation date for retiring the refined methodology to Pillar 2A (set out in Chapter 2) with the date of the PRA’s implementation of the Basel 3.1 standards. As set out in PS17/23 and PS9/24,^{footnote [2]} this would be Thursday 1 January 2026 for all firms, except Interim Capital Regime (ICR) firms and ICR consolidation entities.^{footnote [3]}

1.12 For ICR firms and ICR consolidation entities,^{footnote [4]} the proposed implementation date for retiring the refined methodology would align with the proposed implementation date for the simplified capital regime for SDDTs, as set out in CP7/24,^{footnote [5]} which is proposed to be Friday 1 January 2027. This proposed implementation date would apply to both ICR firms that are SDDTs, which the PRA is proposing to move onto the Pillar 1 framework set out in CP7/24, and ICR firms that are not SDDTs, which the PRA is proposing to move onto Basel 3.1 standards in full (see CP7/24) on the same date. This means that the proposal in this CP to retire the refined methodology for SDDTs is predicated on the PRA implementing its proposals in relation to applying the Basel 3.1 standardised approach (SA) to credit risk to SDDTs, which is subject to the outcome of CP7/24.

1.13 For the proposals to streamline firm-specific capital communications (set out in Chapter 3), the PRA proposes that the changes to the PRA Rulebook (including to the Capital Buffers Part and in relation to the Additional Leverage Ratio Buffer (ALRB)) would come into force on Monday 31 March 2025. The proposed simpler communications that result would apply when firms’ Pillar 2 capital is reset, and would therefore apply to firms’ next Pillar 2 resetting after that date. For many firms this would apply for the first time when they are subject to the Basel 3.1 Pillar 2 off-cycle review ahead of the PRA’s Basel 3.1 implementation date of Thursday 1 January 2026, unless their Pillar 2 capital happens to have been reset earlier in 2025 (between the proposed rule changes coming into force and the Basel 3.1 Pillar 2 off-cycle review).

1.14 The simpler communications for ICR firms would also apply for firms’ next Pillar 2 resetting after 31 March 2025; however, those firms would not be subject to the PRA’s planned Basel 3.1 Pillar 2 off-cycle review in 2025. If their Pillar 2 capital is not reset in the meantime, the simpler communications would be introduced for ICR firms ahead of the proposed revocation of the ICR and the implementation of the simplified capital regime for SDDTs, which is proposed to be Friday 1 January 2027.

1.15 The PRA proposes to implement the changes set out in Chapter 4 (IRRBB and pension obligation risk Pillar 2A approaches – minor clarifications) on Thursday 1 January 2026.

Responses and next steps

1.16 This consultation closes on Thursday 12 December 2024. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP9_24@bankofengland.co.uk.

1.17 When providing your response, please tell us whether or not you consent to the PRA publishing your name, and/or the name of your organisation, as a respondent to this CP.

1.18 Please also indicate in your response if you believe any of the proposals in this consultation paper are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

2: Retiring the refined methodology to Pillar 2A

2.1 In this chapter, the PRA sets out its proposals to retire the refined methodology to Pillar 2A when firms implement the Basel 3.1 standards. The PRA proposes to delete paragraphs 5.12A-C of SS31/15 – The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP). (See Appendix 1 for the proposed changes to SS31/15, including the different implementation date for ICR firms.)

2.2 The PRA implemented the refined methodology in 2018 to address concerns at the time about the potentially conservative nature of the current credit risk SA compared with the internal ratings-based (IRB) approach, especially for asset classes that are considered lower risk, such as residential real estate exposures with a low loan-to-value (LTV) ratio.

2.3 Under the refined methodology, the PRA exercises its supervisory judgement to adjust some firms’ aggregate variable Pillar 2A add-ons to ensure that the total amount of capital required does not exceed the amount necessary to adequately capitalise their risks. This aims to promote the safety and soundness of firms, as well as facilitating effective competition in the banking sector.

2.4 As set out in PS9/24, the Basel 3.1 standards are intended to take effect from 1 January 2026. Furthermore, the PRA proposed under CP7/24 to apply the Basel 3.1 standardised approaches to credit risk (except the due diligence requirements) and operational risk to SDDTs from 1 January 2027. The PRA considers that the Basel 3.1 standards – in particular the updated SA and IRB approach to credit risk, and the introduction of the output floor^{footnote [6]} – together with changes to IRB modelling of real estate exposures (stemming from hybrid modelling^{footnote [7]} and the IRB roadmap)^{footnote [8]}, would address the safety and soundness, and competition concerns that the refined methodology sought to mitigate in a more straightforward and transparent way. Together, they significantly reduce the gap in risk weights between the SA and IRB approach, thereby reducing SA risk weights, especially for low-risk lending activities, and increasing IRB risk weights. Therefore, the PRA considers that the refined methodology should be retired because the Basel 3.1 standards would serve a broadly similar function, and also because the refined methodology is particularly complex for both the PRA and firms to implement.

Background

2.5 The PRA sets Pillar 2A capital for risks that are either not captured, or not fully captured, by Pillar 1. In accordance with the PRA’s Internal Capital Adequacy Assessment (ICAA) rules, and in conjunction with SS31/15, a firm must carry out the Internal Capital Adequacy Assessment Process (ICAAP) to assess on an ongoing basis the amounts, types, and distribution of capital that it considers adequate to cover the level and nature of the risks to which it is, or might be, exposed. The PRA assesses those risks as part of the Supervisory Review and Evaluation Process (SREP), in light of both the calculations included in a firm’s ICAAP document and the PRA’s Pillar 2A methodologies set out in its statement of policy – The PRA’s methodologies for setting Pillar 2 capital (Pillar 2 SoP).

2.6 In 2018, the PRA implemented the ‘refined methodology’ (including by updating SS31/15 as set out in PS22/17) to address known concerns about the potentially conservative nature of the SA compared to the IRB approach, especially for certain asset classes that are considered lower risk. This feature was particularly acute in the residential mortgage market, where a large gap between risk weights was identified for lower-LTV residential real estate exposures, in particular relative to the smaller gap for high-LTV residential real estate exposures. This raised concerns around the safety and soundness of firms using the SA because they could be incentivised to concentrate on riskier exposures where the gap between SA and IRB approach was much smaller. This feature also raised competition concerns, as firms using IRB models appeared to specialise in low-LTV mortgage lending, an area in which they had a comparative advantage.

2.7 To address these concerns, the refined methodology allows some firms that are considered relatively low risk and well managed to compare their SA risk weights with those derived from ‘IRB benchmarks’, which are drawn from data the PRA has on the risk weights generated by firms’ IRB models. When making an overall assessment of the adequacy of their total capital requirements, the firm and the PRA can consider that comparison and assess whether there is any excess conservatism inherent in some aspects of the credit risk SA risk weights. The PRA may then exercise supervisory judgement to adjust some firms’ variable Pillar 2A add-ons to ensure that the total amount of capital required does not exceed the amount necessary to adequately capitalise its risks.

2.8 When the PRA introduced the refined methodology, it recognised that the Basel Committee on Banking Supervision (BCBS) revisions to Pillar 1 credit risk approaches as part of the Basel 3.1 standards would not be timely enough to address its concerns. The PRA expected the proposed revisions to the SA and IRB approach (and the introduction of the output floor) as part of the Basel 3.1 standards to lead to smaller differences in capital requirements between the two approaches, particularly for low-LTV mortgages. The PRA therefore anticipated that the size of the adjustments brought by the refined methodology would become much smaller with the introduction of the Basel 3.1 standards, and stated its intention to consider whether refinements to its Pillar 2A framework would be needed once the Basel 3.1 standards were implemented.

2.9 In November 2022, the PRA published CP16/22 – Implementation of the Basel 3.1 standards, which set out the PRA’s proposed rules and expectations with respect to the implementation of the Basel 3.1 standards.^{footnote [9]} While the PRA did not make any new policy proposals in Chapter 10 – Interactions with the PRA’s Pillar 2 framework, the PRA re-stated its intention to consider whether it was appropriate to retain the existing refined methodology in its current form.

2.10 In December 2023, the PRA published PS17/23 – Implementation of the Basel 3.1 standards near-final part 1, which included responses to feedback on certain chapters of CP16/22. As set out in PS17/23, 13 respondents requested clarification on the future of the refined methodology. In response to this, the PRA indicated its plan to review it in light of the changes proposed to the Pillar 1 credit risk framework and to provide more details when PS9/24 was published. Therefore, this CP has been published alongside PS9/24, which sets out the near-final policy for credit risk for non-SDDT firms, and CP7/24, which sets out the credit risk proposals for SDDT firms, ie to apply the Basel 3.1 SA for credit risk to SDDTs, except the due diligence requirements.

2.11 This CP sets out the PRA’s proposal to retire the refined methodology in light of the implementation of the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24) and broader reforms which promote safety and soundness, and address competition concerns in a more straightforward, transparent, and consistent way. Given that most of the firms that are currently subject to the refined methodology also meet the SDDT criteria (SDDT-eligible firms), retiring the refined methodology (ie a complex and opaque capital adjustment between Pillar 1 and Pillar 2A) is also consistent with the PRA's efforts to simplify the capital framework for SDDTs.

The PRA’s proposals

2.12 The PRA will continue to exercise supervisory judgement when setting a firm’s Pillar 2A capital, as assessed by applying the PRA’s methodologies for risks captured in Pillar 2A and considering firms’ risk profiles, in order to ensure that the required amount of total capital supports sound management and the effective coverage of risks.

2.13 The PRA considers that the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24), together with other changes to IRB modelling of residential real estate exposures, would significantly reduce the gap between the IRB approach and SA risk weights, in particular for lower-LTV residential real estate exposures. As a result, the safety and soundness, and competition concerns that the refined methodology sought to mitigate would be addressed in a more straightforward, transparent, and consistent way.

2.14 As part of implementing the Basel 3.1 standards, the PRA would introduce a more structured and granular exposure allocation and greater risk sensitivity to the credit risk SA, including for real estate exposures. These changes would bring SA risk weights for real estate exposures closer to those under the IRB approach, particularly for low-risk residential real estate exposures. The PRA considers that the more risk-sensitive treatment under the SA would introduce clarity, consistency, and risk-weighted assets (RWAs) which would reflect the relative riskiness of exposure. The PRA also considers that any changes to firms’ RWAs would be warranted based on risk.

2.15 With regard to the IRB approach, changes that aim to reduce unwarranted variability in RWAs across banks, such as the introduction of hybrid modelling and the IRB roadmap, have increased average IRB risk weights of residential real estate exposures through the cycle. Furthermore, under the Basel 3.1 standards, the PRA would introduce an aggregate ‘output floor’ so that total RWAs for firms using internal models and subject to the floor cannot fall below 72.5% of RWAs derived under SAs.

2.16 In February 2023, the PRA published a Bank Overground post – Mind the (smaller) gap? Implications of the narrowing gap between modelled and standardised residential mortgage risk weights to share its internal analysis of how the Basel 3.1 credit risk proposals, as set out in CP16/22, along with other changes to the IRB modelling of residential real estate exposures, are expected to narrow the gap between SA and IRB approach risk weights.

2.17 The analysis showed that for owner-occupier mortgages with LTV ratios below 50%, the gap could narrow from SA risk weights being around 5.5 times higher than average risk weights under the IRB approach to between 1.5 and 2.5 times higher by 2025, depending on firms’ responses to IRB policy changes. A broadly similar pattern would be observed all along the LTV spectrum, including in the 70%-90% LTV range, within which many new mortgages are issued. For buy-to-let mortgages with LTV ratios below 50%, the gap could narrow from SA risk weights being approximately 4.5 times higher than average risk weights under the IRB approach to between 2 and 3 times higher. The PRA considers that the results of this analysis remain relevant for Basel 3.1 credit risk near-final policy,^{footnote [10]} and expects the gap between SA and IRB approach firms’ total capital requirements to potentially narrow further with the implementation of the output floor, which would be phased in from 2026 to 2030.

2.18 The PRA considered the alternative of retaining the refined methodology after firms implement the Basel 3.1 standards. Some respondents to CP16/22 noted that, while the Basel 3.1 standards and other changes to IRB modelling of residential real estate exposures would narrow the gap between SA and IRB risk weights, they would not eliminate it. However, the PRA considers that the portfolios of IRB firms are often different to those of SA firms, and therefore IRB risk weights are not directly comparable with SA risk weights.^{footnote [11]} Typically, SA risk weights would include a margin of conservatism over the IRB approach, which the PRA considers prudentially appropriate. Most importantly, even if the refined methodology were retained, the IRB benchmarks would need to be updated.

2.19 Taking into account the incoming changes to SA and IRB approach risk weights, the PRA estimates that the reduction in RWAs that the refined methodology would deliver for firms would be very limited (estimated to be no more than 1/12th of the current size of the adjustment for a selected sample of firms; please see para 2.36 – 2.37 for further details). Given the complexity, and therefore cost, of retaining the refined methodology, alongside greatly diminished benefits, the PRA proposes to retire the methodology.

2.20 Respondents to CP16/22 also suggested that the PRA retain the refined methodology to offset any increase in Pillar 1 credit risk RWAs or any potential conservatism stemming from the Basel 3.1 standards. Examples include the treatment of higher-LTV regulatory residential real estate exposures that are materially dependent on the cash flows generated by the property, and the increase in conversion factors for unconditionally cancellable commitments. However, the PRA considers that any changes to firms’ Pillar 1 RWAs resulting from the implementation of the Basel 3.1 standards would be warranted based on the risk. Furthermore, the PRA’s analysis^{footnote [12]} indicated that average IRB approach risk weights could be higher than SA risk weights for some buy-to-let mortgages with higher LTVs, suggesting that any assessment of conservatism would need to be considered holistically. Therefore, the PRA does not consider it appropriate to retain the refined methodology for the purposes of offsetting any increase the firms may see in their Pillar 1 RWAs as this could undermine safety and soundness.

2.21 There are resource and complexity costs associated with retaining the refined methodology. The application of the refined methodology is assessed by firms during the ICAAP and then by supervisors during the SREP process. This assessment is heavily reliant on supervisory judgement, and the process is resource-intensive and complex. This includes determining whether firms are eligible for the methodology and calculating the offsets. Moreover, retaining this complex capital adjustment would make it difficult for small firms to understand the final Pillar 2A requirement that is set and prevents the PRA from simplifying the capital framework for SDDTs.

2.22 On balance, the PRA considers that the refined methodology would continue to be complex and costly to maintain, but the benefits of retaining it would now be much lower. Especially given that the original policy intention of the refined methodology would be largely addressed under the Pillar 1 framework when the Basel 3.1 standards are implemented (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24).

2.23 The PRA acknowledges that retiring the refined methodology could have a larger impact for firms using the International Financial Reporting Standards (IFRS).^{footnote [13]} However, the PRA considers that the intention of the refined methodology is to address the safety and soundness, and competition concerns arising from the risk weight gap between the credit risk SA and IRB approach. This gap would narrow for all firms, including those using IFRS. Furthermore, the refined methodology was not primarily designed to address any differences that may arise due to accounting standards. The PRA also notes that only a very small number of firms using IFRS are subject to the refined methodology.

PRA objectives analysis

2.24 The PRA considers that the proposal to retire the refined methodology when firms implement the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24) would advance the PRA’s safety and soundness objective. The PRA considers that the implementation of the Basel 3.1 standards would be a key driver in reducing the gap between SA and IRB approach risk weights and would largely address the previous safety and soundness concerns (regarding firms using the SA being incentivised to concentrate in riskier exposures) under Pillar 1 in a more straightforward way. Retiring the refined methodology when firms implement the Basel 3.1 standards would continue to ensure that the level of capital that firms are required to maintain is adequate in relation to the risks to which they are exposed.

2.25 The PRA has assessed whether the proposal in this chapter would facilitate effective competition. The PRA considers that the Basel 3.1 standards (including the introduction of the output floor) and other changes to IRB modelling of residential real estate exposures would narrow the gap between SA and IRB approach risk weights. This would reduce the comparative advantage IRB firms have for certain asset classes. The competition concerns that motivated the refined methodology would therefore largely be addressed, and any remaining gap is judged to be small enough to not undermine competition. For this reason, the PRA does not consider that the proposal would undermine its competition objective.

2.26 The PRA has also assessed whether the proposal in this chapter facilitates the international competitiveness of the UK economy and the growth of the economy in the medium to long term. Retiring the refined methodology would mean that firms’ capital requirements would be more aligned to the Basel 3.1 standards (instead of being adjusted based on an assessment that compares a firm’s RWAs with the IRB benchmarks). This in turn improves alignment with international standards and consistency with other jurisdictions which also apply the Basel standards, promoting international competitiveness.

2.27 Overall, the PRA considers that the implementation of the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24), together with retiring the refined methodology, would result in a risk-sensitive and operationally proportionate approach. This will enable firms to lend through the economic cycle and will facilitate effective competition, as well as international competitiveness and growth.

Cost Benefit Analysis (CBA)

2.28 The PRA has considered the costs and benefits of retiring the refined methodology. Where it is reasonable to do so, the PRA has produced quantitative estimates associated with the proposals set out in this chapter. Where the PRA considers it would not be reasonable or practicable to quantify certain costs and benefits, the chapter describes those costs and benefits qualitatively, as well as the reasons why it is not reasonable or practicable to produce quantitative estimates. In some cases, the chapter presents quantitative facts to support the qualitative descriptions of costs and benefits.

2.29 The costs and benefits are defined relative to a baseline (or counterfactual). The PRA has considered two baselines for its analysis:

• First, the primary baseline for this analysis is the regulatory framework that firms would face if the refined methodology were retained while the PRA’s Basel 3.1 standards are implemented, ie retaining the refined methodology while implementing the Basel 3.1 standards in full for firms that are not SDDTs (as set out in PS17/23 and PS9/24), and implementing the Basel 3.1 SA to credit risk (except for due diligence requirements) and operational risk for SDDTs (as proposed in CP7/24). At the same time, the PRA considers that the implementation of Basel 3.1 is a pre-requisite for retiring the refined methodology. Absent the implementation of the Basel 3.1 standards, the PRA would retain the refined methodology.
• As Basel 3.1 implementation and retiring the refined methodology are intrinsically linked, to supplement this CBA analysis, the PRA considers it is also relevant to consider a second baseline when assessing the impact on overall capital requirements. The analysis under this second baseline would be comparing the combined impact of retiring the refined methodology (ie the proposal set out in this chapter) and the implementation of the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24), relative to the current capital requirements.

2.30 The PRA recognises the different proposed implementation date for retiring the refined methodology for ICR firms, since the refined methodology is applicable to SDDT-eligible firms as well as to firms that are not eligible. For simplicity, the CBA analysis assumes costs and benefits apply to all firms currently subject to the refined methodology on the same date (1 January 2026), as the PRA is not certain how many and which firms will opt in to the ICR instead of moving to the PRA’s Basel 3.1 standards (as set out in PS17/23 and PS9/24).

Benefits of retiring the refined methodology

2.31 Reduced burden on firms and the PRA. Currently, during the ICAAP and SREP process, the firm and the supervisor assess Pillar 2A on a risk-by-risk basis, followed by a comparison and assessment to see whether there is evidence of excess conservatism inherent in some aspects of the existing Pillar 1 RWAs. This assessment process is resource-intensive and complicated for firms and the PRA. The PRA considers that retiring the refined methodology would simplify the Pillar 2A setting process. The PRA considers that there would be additional savings across firms from reduced complexity and effort during the ICAAP and SREP process.

2.32 Safety and soundness. The refined methodology currently provides for a reduction in firms’ Pillar 2A capital requirements. As set out in this CP, the Basel 3.1 standards would address the safety and soundness concerns that the refined methodology sought to mitigate in a more straightforward, transparent, and consistent way. Therefore, retiring the refined methodology would support firms’ resilience by ensuring that the level of capital, which firms are required to maintain, is adequate relative to the risks to which they are exposed.

2.33 Capital requirements better tailored to individual firms. The PRA’s Basel 3.1 credit risk SA would be more structured, granular, and risk-sensitive, especially for real estate exposures. SA firms’ RWAs would be calculated based on the risk characteristics of specific assets (eg LTV and whether repayment is materially dependent on cash flow generated by the property), rather than based on IRB benchmarks where the risk characteristics of the portfolios underlying those benchmarks are different from those of SA firms. This should support improved firm resilience to shocks.

Costs of retiring the refined methodology

2.34 The PRA considers that retiring the refined methodology would not impose any additional operational compliance costs on firms or the PRA. Any additional costs that could be incurred by firms would be related to the impact on overall capital requirements, discussed below.

2.35 Impact on overall capital requirements. The PRA has attempted to estimate the overall impact on firms’ capital requirements in two ways: (1) the rough size of the Pillar 2A adjustment that could be delivered by the refined methodology, if it were retained after the PRA’s implementation of the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24); and (2) the estimated impact on firms’ capital requirements and buffers of the PRA’s implementation of Basel 3.1 and the removal of the refined methodology relative to current requirements and buffers.

2.36 (1) Pillar 2A adjustments if the refined methodology were retained after the PRA’s implementation of Basel 3.1. The PRA can only produce uncertain estimates in this scenario as the IRB benchmarks would need to be substantially updated to reflect the multiple changes to the IRB approach discussed above. In order to update the benchmarks, the PRA would require IRB firms’ regulatory returns after the implementation of the Basel 3.1 standards. There are also practical challenges to comparing SA and IRB approach outcomes under the Basel 3.1 standards, such as the introduction of definitional changes to certain SA asset classes, the introduction of the output floor, and the removal of IRB modelling for some asset classes.^{footnote [14]} As a result, for the purpose of this CBA, the PRA has, on a best-efforts basis, attempted to estimate the IRB benchmarks for residential real estate exposures and personal loans only, based on regulatory data, supervisory intelligence, firms’ disclosures, and staff calculations.

2.37 Based on a selected sample of firms, the PRA estimated that, even if the refined methodology were retained, the Pillar 2A adjustment that it could deliver would be on average 1/12th of the current size of the adjustment.^{footnote [15]} This cannot be extrapolated for the entire population of firms currently subject to the refined methodology to estimate an aggregate cost as the selection of firms was not random. Instead, these sample firms were selected because: (1) they have a higher concentration of assets in residential real estate exposures (ie the type of lending the refined methodology was introduced to address); (2) they have limited exposures in asset classes which would no longer be benchmarkable (eg sovereigns); and (3) their adjustments were determined mechanically based on the benchmarking methodology with minimal supervisory overlay (which is otherwise hard to replicate). Therefore, the PRA caveats that this is a broad indication as the amount of a firm’s refined methodology adjustment is materially dependent on a firm’s credit portfolios, and that supervisory judgment also plays a significant role.

2.38 (2) Estimated impact relative to firms’ current capital requirements and buffers. The PRA has also modelled the impact on firms’ total capital requirements by considering the impact of removing the refined methodology alongside the implementation of the Basel 3.1 standards, relative to firms’ current capital requirements and buffers. The PRA acknowledges that the proposal to retire the refined methodology would be expected to increase Pillar 2A requirements of all firms that currently benefit from it. However, the Basel 3.1 standards would, in most cases, reduce Pillar 1 requirements for these firms. This feature of reduced Pillar 1 requirements would be what allows Pillar 2A to increase with the retirement of the refined methodology. As the two policy changes are linked, the PRA considers it is also relevant to look at the net capital impact.

2.39 This analysis, as set out in more detail in Box 1, shows that the impact on total capital requirements and buffers would be broadly neutral on average.

Box 1: Estimated impact on firms’ capital requirements and buffers of the implementation of Basel 3.1 and the removal of the refined methodology relative to current requirements and buffers

The PRA has modelled the net impact on firms’ capital requirements and buffers of (1) the implementation of the Basel 3.1 standardsfootnote [16] (as set out in PS17/23 and PS9/24 and proposed for SDDTs in CP7/24); and (2) retiring the refined methodology. The PRA considers that the capital impacts of these changes should be considered together because the retirement of the refined methodology is subject to the PRA’s implementation of the Basel 3.1 standards. Chart A shows that the change in nominal capital requirements and buffers when comparing the implementation of the Basel 3.1 standards and the removal of the refined methodology with current requirements (including the application of the refined methodology) averages to zero across firms. This is consistent with the PRA’s view that the refined methodology is broadly compensating for high risk weights under the current SA, which the revised Basel 3.1 SA risk weights would remedy. This analysis is limited to the cohort of firms that were subject to the refined methodology as of end-December 2023, and many of these firms meet the SDDT criteria. While this analysis includes SDDTs’ proposed application of Basel 3.1 credit risk SA and operational risk SA, this does not cover the estimated impact of other parts of the proposals of the simplified capital regime relative to the capital regime that would apply outside of the SDDT regime, as set out in CP7/24 (eg proposals for the Single Capital Buffer and simpler Pillar 2A methodologies). In this analysis, the PRA assumed that the current Pillar 2A adjustments under the refined methodology would be removed. This allows the PRA to provide an estimate for the overall impact, given the challenges (set out above) of estimating what these adjustments would be when the Basel 3.1 standards are implemented. At the same time, most firms would expect to see a decrease in Pillar 1 capital requirements when the SA changes resulting from the Basel 3.1 standards are implemented. Chart A: Range of estimated impacts on firms’ capital requirements and buffers for firms that are currently subject to the refined methodology Footnotes Source: PRA regulatory returns, PRA analysis and calculations. Note: The whisker on top is drawn up to the highest estimate within 1.5*interquartile range of the 75th percentile and the whisker below is drawn down to the lowest estimate within 1.5*interquartile range of the 25th percentile. Key caveats and limitations: The analysis was conducted based on firms’ regulatory returns from end-2022 and PRA staff assumptions. This covers the impacts which relate to both the Basel 3.1 credit risk SA and operational risk SA versus the current standardised approaches on a best endeavours basis. Given that the Basel 3.1 standards introduce definitional changes to certain credit risk SA asset classes, assumptions were made based on firms’ existing data. The analysis reflects the end-state impacts of the Basel 3.1 standards. However, the resulting impacts may be different as the analysis adopts a ‘fixed’ balance sheet assumption. Should firms re-allocate their portfolios towards a lower risk asset mix they would likely see a commensurate reduction in minimum requirements (making the impacts shown in Chart A lower). This analysis included estimated changes to firms’ PRA buffers. However, there are still uncertainties around how firms’ PRA buffers could change after the implementation of the Basel 3.1 standards, as more data and analysis would be needed to understand the behaviour of the new risk weights under stress.

2.40 The PRA acknowledges that firms with different business models would be affected by the combination of the implementation of the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24) and retiring the refined methodology differently. While some firms may see an increase in capital requirements because of the introduction of Basel 3.1 standards, the PRA considers that this would be warranted based on risk. While the PRA acknowledges that residential mortgage lending is the type of lending the refined methodology was introduced to address, it considers that any changes in RWAs resulting from the introduction of the Basel 3.1 standards would be warranted and would better reflect the risk of the exposures.

2.41 Due to the more granular approach to allocating exposures and greater risk sensitivity of the SA, firms (many of which are building societies) concentrated in low-LTV residential real estate exposures which are not materially dependent on the cash flow generated by the property (eg owner-occupied), may see a reduction in RWAs if the Basel 3.1 standards are implemented. Equally, firms that have a significant share of residential real estate exposures which are materially dependent on the cash flow generated by the property, especially with higher LTV, may see an increase in RWAs under the Basel 3.1 standards.

2.42 Overall, with both the implementation of the Basel 3.1 standards and proposed retirement of the refined methodology, the PRA would expect mutuals’ capital requirements to fall marginally, on average.

‘Have regards’ analysis

2.43 In developing these proposals, the PRA has had regard to its framework of regulatory principles. The regulatory principles that the PRA considers are most material to the proposals include:

• Proportionality. The PRA considers that the resource and complexity costs associated with the refined methodology are no longer proportionate to the capital adjustments that the methodology would bring when firms implement the PRA’s Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24). Therefore, retiring the policy would promote proportionality.
• Transparency. The PRA considers that retiring the refined methodology would enhance transparency since Pillar 2A adjustments under the refined methodology are currently reviewed at every SREP cycle and assessed based on supervisory judgement. As the safety and soundness, and competition concerns that the refined methodology sought to mitigate would be addressed by the Basel 3.1 standards directly in Pillar 1 (and set out in the PRA Rulebook), the determination of firms’ capital requirements would be more transparent, making capital planning simpler.
• Efficient use of PRA resources. The PRA considers that retiring the refined methodology would enhance efficiency given that less time would be spent carrying out complex assessments and adjustments to firms’ Pillar 2A requirements. Furthermore, the PRA considers that maintaining this resource-intensive and complicated methodology would not be an efficient use of resources as the capital adjustments that the methodology would bring would be very limited when the Basel 3.1 standards (as set out in PS17/23 and PS9/24, and proposed for SDDTs in CP7/24) are implemented.

2.44 The PRA has had regard to other factors as required. Where analysis has not been provided against a ‘have regard’ for this proposal, it is because the PRA considers that ‘have regard’ to not be a significant factor for this proposal.

Question: Do you have any comments on the proposal set out in this chapter?

3: Streamlining firm-specific capital communications

3.1 This chapter sets out the PRA’s proposals to simplify the content and process of firm-specific capital communications, with no impact on firms’ capital requirements. The PRA proposes to:

• amend the Capital Buffers Part of the PRA Rulebook to reflect any Pillar 2A capital and systemic buffers^{footnote [17]} set by the PRA; and
• amend the Leverage Ratio – Capital Requirements and Buffers Part of the PRA Rulebook to set out the Additional Leverage Ratio Buffer (ALRB) requirements, including the calculation methodology.

3.2 The changes proposed do not impact firm-specific capital requirements but simplify the regulatory framework when Pillar 2A and systemic buffers are applied. In case of rule changes, the new framework would facilitate implementation, reducing the burden on firms and the PRA.

3.3 The changes would also deliver simpler Pillar 2A capital communications, therefore enabling stakeholder engagement, facilitating policy implementation, and supporting transparency and clarity in the delivery of the PRA objectives.

3.4 The proposals in this chapter would amend the following parts of the PRA Rulebook (Appendix 4):

• The Glossary Part, to add the definitions of ALRB, G-SII buffer and O-SII buffer. These are then used in the Capital Buffers Part, the Leverage Ratio – Capital Requirements and Buffers Part, the Own Funds and Eligible Liabilities (CRR) Part, and the Disclosure (CRR) Part and the Reporting (CRR) Part.
• The Capital Buffers Part, to reflect in the rules on capital conservation measures and Maximum Distributable Amounts (MDAs) any Pillar 2A minimum requirement and systemic buffers set by the PRA. The PRA also proposes to take the opportunity to update obsolete references to the CRR.
• The Leverage Ratio – Capital Requirements and Buffers Part, to transfer to the PRA Rulebook the requirements associated with the ALRB when systemic buffers are set by the PRA. The rules would specify that the ALRBs apply to a firm (or a PRA approved holding company (Holdco)^{footnote [18]}) on which a systemic buffer has been imposed. Having the formula in rules would then mean that changes to the systemic buffers will automatically read across to the ALRB.
• The Disclosure (CRR) Part and the Reporting (CRR) Part, to transfer to the PRA Rulebook the additional disclosure and reporting obligations triggered when an ALRB is set.
• The Own Funds and Eligible Liabilities (CRR) Part, to reflect that the ALRB requirements would not be implemented under sections 55M and 192C of FSMA but would be set out in the Leverage Ratio – Capital Requirements and Buffers Part of the Rulebook.

3.5 The proposals in this chapter would result in the deletion of the Capital Buffers and Pillar 2A Model Requirements (Model Requirements), the Qualifying Parent Undertakings Capital Buffers and Pillar 2A Model Direction (Model Directions), Additional Leverage Ratio Buffer Model Requirements (Leverage Ratio Model Requirements), and Qualifying Parent Undertakings Additional Leverage Ratio Buffer Model Direction (Leverage Ratio Model Direction), as well as the cancellation of related existing Modifications by Consent (MBCs).

3.6 The proposals in this chapter would result in minor consequential changes to SS31/15 – The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP) (Appendix 1) and to SS45/15 – The UK Leverage Ratio Framework (Appendix 2).

Background

3.7 The Capital Buffers Part of the PRA Rulebook prevents firms from using their CET1 capital resources to meet simultaneously their minimum requirements and their combined buffer. It imposes limits (Maximum Distributable Amounts, or MDAs) on a firm’s ability to make discretionary distributions that reduce Common Equity Tier 1 (CET1) when a firm starts using its combined buffer. These distributions include payment of bonuses, Additional Tier 1 (AT1) coupons, or discretionary pension benefits.

3.8 However, currently the Capital Buffers Part of the PRA Rulebook only reflects Pillar 1 as a minimum requirement, while the definition of the combined buffer only includes the Capital Conservation buffer (CCoB) and the Countercyclical capital buffer (CCyB). When the PRA sets a Pillar 2A requirement (which counts as a minimum requirement) or a systemic buffer (which becomes part of the combined buffer), the regulatory framework is modified for individual firms through Model Requirements and Model Directions,^{footnote [19]} which are referenced and incorporated via links in firm-specific Pillar 2A capital communications (Pillar 2A is set exercising PRA powers under s55M(5) FSMA (‘VReqs') for firms, and under s192C FSMA for Holdcos (‘s192C Directions’)). To prevent any potential conflict between the Model Requirements and Directions, the capital conservation, and the MDA rules as set out in the Capital Buffers Part, the PRA asks firms and Holdcos to take up Modifications by Consent (MBC) that disapply the capital conservation and MDA rules in the Capital Buffers Part.

3.9 This brings about a complex regulatory set-up and adds complexity to firm-specific capital communications, with additional effort for both firms and the PRA. It also means that any change to, for example, the rules setting out the calculation of MDAs in the Capital Buffers Part for these firms and Holdcos also has to be made to the Model Requirements and Model Directions; the VReq notices and s192C Directions then need to be updated for all relevant firms and Holdcos to effect the change.

3.10 To remove some of this complexity, the PRA proposes to reflect Pillar 2A and the systemic buffers in the Capital Buffers Part. After these changes, the PRA would continue to use firm-specific VReq notices and s192C Directions to set Pillar 2A and the systemic buffers. However, these capital communications would be simpler without the references to, and incorporation of, the Model Requirements and Model Directions; and the MDA framework set out in the Capital Buffers Part would apply to the relevant firms when the PRA sets Pillar 2A and the systemic buffers.

3.11 The Additional Leverage Ratio Buffer (ALRB) is intended to ensure that the leverage ratio framework is consistent with the risk-based capital buffer framework by mirroring in the leverage framework any systemic buffers applied to systemically important firms on the risk-weighted side. For setting the ALRB, the PRA has a similar process as set out for the systemic buffers above. The ALRB is set through firm-specific VReq notices and s192C Directions that refer to the systemic buffer rates. There are also similar Leverage Ratio Model Requirements and Leverage Ratio Model Directions. To simplify this process, the PRA proposes to set out the ALRB requirements, including the calculation methodology, in the rules; and dispense with the Leverage Ratio Model Requirements and Directions, and the VReqs and s192C Directions process for ALRB.^{footnote [20]}

The PRA’s proposals

3.12 The changes described in this Chapter would not affect firms’ outcomes, but they should make the process of capital setting easier for firms and the PRA. They reflect the transfer of existing definitions and obligations currently set out in the Model Requirements, Model Directions, Leverage Ratio Model Requirements and Leverage Ratio Model Directions, and incorporated into the firms’ VReq notices and s192C Directions, to the PRA Rulebook.

• Glossary. The PRA would introduce definitions for the ALRB, the G-SII buffer, and the O-SII buffer as these concepts are not currently defined in the Rulebook. The G-SII and O-SII buffer definitions would refer to the systemic buffer that a firm or Holdco is required to calculate by the PRA under VReqs and s192C Directions. The ALRB definition would refer to a new Leverage Ratio - Capital Requirements and Buffers Part rule, which sets out how to calculate the ALRB (see below).
• Leverage Ratio – Capital Requirements and Buffers Part. The PRA would transfer the obligations set out in the Leverage Ratio Model Requirements and Leverage Ratio Model Directions to the Leverage Ratio – Capital Requirements and Buffers Part as follows:

(i) By introducing a new rule setting out how to calculate the ALRB. The rule would set the ALRB amount as 35% of any applicable systemic buffer rate (or the higher of the G-SII or O-SII buffer rates where both are applicable), multiplied by the total (leverage) exposure measure. The rule would also prevent firms and Holdcos from using the CET1 capital that is required to meet the ALRB to also fulfil the minimum leverage ratio requirement or the countercyclical leverage ratio buffer.

(ii) By amending the notification and the capital plan chapters to reflect the ALRB when set by the PRA. After the change, firms and Holdcos would continue to be required to include the ALRB in the calculations when assessing whether capital has reduced below the amount required to meet the minimum and buffer requirements for the leverage ratio. However, the requirement would be located in the rules instead of being implemented through VReq notices and s192C Directions.

• Disclosure (CRR) Part. The PRA proposes to amend the Disclosures (CRR) Part to reflect the disclosure requirements currently in the Leverage Ratio Model Requirements and Direction.
• Reporting (CRR) Part. The PRA proposes to amend the Reporting (CRR) Part to reflect the reporting requirements that are currently in the Leverage Ratio Model Requirements and Direction.
• Capital Buffers Part. The proposed changes would amend the definition of the combined buffer to capture the G-SII and O-SII buffers when these are set. As a result of these changes, any reference to the combined buffer in the Capital Buffers Part would include these additional elements if such systemic buffers are set by the PRA. The PRA would transfer the content of the Model Requirements and Model Direction to the Capital Buffers Part as follows:

(i) By introducing definitions for Pillar 1 and Pillar 2A requirements that are relevant for the application of various rules in the Capital Buffers Part. The Pillar 1 definition would refer to Article 92(1) of the UK CRR, while the Pillar 2A definition would refer to the Pillar 2A requirements imposed by the PRA in the exercise of its powers under s55M(5) or s192C FSMA.

(ii) By amending Chapter 4 (Capital Conservation Measures) to reflect Pillar 2A requirements and systemic buffers when these are set. This change would amend the rule setting out how a firm does not meet its combined buffer, as well as the practical calculation of the combined buffer quartiles that trigger MDA restrictions. The formula in the Capital Buffers Part would not change; however, the elements captured in the calculation would change as each quartile would reflect additional systemic buffers when these are set.

(iii) Finally, the PRA would take the opportunity to remove some obsolete elements: in Chapter 2 (Capital Conservation Buffer), to remove transitional provisions which expired in 2018; and in Chapter 5 (Application on an Individual and Consolidated Basis), to delete some obsolete references to the UK CRR (to reflect that certain provisions relating to large exposures and the leverage ratio framework are no longer part of the UK CRR).

• Own Funds and Eligible Liabilities (CRR) Part. The proposed changes would reflect that the ALRB requirements would not be implemented under sections 55M and 192C of FSMA but would be set out in the Leverage Ratio – Capital Requirements and Buffers Part of the Rulebook.

3.13 These changes are mechanical and there would be no change to firms’ capital requirements, although they would simplify and streamline PRA communications to firms. Overall, the changes would:

• simplify the communications on Pillar 2A and the systemic buffers (VReq notices and s192C Directions) by removing any reference to the Model Requirements, Model Directions, and related MBCs;
• remove the need for VReq notices and s192C Directions completely for the ALRBs; and
• avoid the need to update VReq notices and s192C Directions for all relevant firms and Holdcos when amending the capital conservation and MDA rules.

3.14 Pillar 2A and the systemic buffers are firm-specific: their calculations cannot be embedded in a rule as they require supervisory or policy judgement. This is why the PRA will continue to exercise its powers under s55M(5) and s192C FSMA to ensure that the P2A requirements and systemic buffers set by the PRA are legally enforceable.

Cost Benefit Analysis (CBA)

3.15 The PRA has considered that some PRA resource would be required to make the rule changes, and to develop and implement the simpler VReq notices and s192C Direction templates. However, such costs would be one-off and small, and the ongoing benefit of the simplifications – through reducing and simplifying the set of communications needed – would outweigh such costs. Due to the minimal significance of the implementation costs for both the firms and the PRA, the PRA has not carried out a CBA for the changes proposed in this chapter.

PRA objectives analysis

3.16 The PRA considers that the proposed changes do not impact firm-specific capital requirements but facilitate the process to change them, or the capital conservation and MDA rules, when needed, therefore reducing the burden on firms and the PRA. The changes would deliver simpler Pillar 2A capital communications and simplify the implementation of the ALRB, therefore enabling stakeholder engagement, facilitating policy implementation, and supporting transparency and clarity in the delivery of the PRA’s primary objective of ensuring safety and soundness.

3.17 The PRA has assessed whether the proposals in this chapter would further its secondary objectives of facilitating effective competition and the international competitiveness of the UK economy and the growth of the economy in the medium to long term. The PRA considers that the changes would be marginally beneficial to these secondary objectives as the PRA would streamline the policy references and allow simplifications in the process and content of the firm-specific communications, which we expect to reduce firms’ costs.

‘Have regards’ analysis

3.18 In developing these proposals, the PRA has had regard to its framework of regulatory principles. The regulatory principles that the PRA considers are most material to the proposals include:

• Transparency. The PRA considers that the proposed simplifications set out in this chapter would improve the content and process for firm-specific communications and increase their transparency, allowing firms to better understand the PRA’s determinations on Pillar 2A and the systemic buffers applicable to them.
• Efficient and economic use of PRA resources. The PRA estimates that the proposed changes would simplify the implementation of changes to firms’ Pillar 2A and systemic buffers, therefore reducing the burden on the PRA. In particular: (i) there would be no need to issue firm-specific communications when amending the capital conservation and MDA rules; (ii) there would be no need to send firm-specific communications to firms when changing the ALRB; and (iii) there would be no need to request and manage a large number of MBCs – which are now required to prevent any potential conflict between the Model Requirements and Model Directions and the relevant sections of the PRA Rulebook – when setting or amending the Pillar 2A requirements or systemic buffers.
• Proportionality. The PRA considers that by reducing and simplifying the set of capital communications, the proposals in this chapter can reduce resource and complexity costs for firms, promoting proportionality. The changes would remove references to multiple documents by deleting the Model Requirements, Model Directions and Leverage Ratio Model Requirements and Directions; reduce the occasions when VReq notices or S192C Directions are needed; and reduce administrative complexity by removing the MBCs.
• Diversity of business models. The PRA has not identified any differential impact of the simplifications on businesses carried on by different persons (including different kinds of persons such as mutual societies and other kinds of business organisation).

3.19 The PRA has had regard to other factors as required. Where analysis has not been provided against a ‘have regard’ for this set of proposals, it is because the PRA considers ‘have regard’ to not be a significant factor for this set of proposals.

4: IRRBB and pension obligation risk Pillar 2A approaches – minor clarifications

4.1 In this chapter, the PRA proposes to clarify its existing Pillar 2A approaches for IRRBB and pension obligation risk. The proposed changes are intended only to clarify the existing policy and do not reflect a proposal to change the PRA’s approaches to these risks.

4.2 The proposals in this chapter would result in amendments to:

• Chapter 2 of SS31/15 – The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP) (Appendix 1); and
• Chapters 7 and 8 of SoP – The PRA’s methodologies for setting Pillar 2 capital (Pillar 2 SoP) (Appendix 3).

The PRA’s proposals

4.3 The PRA proposes some minor clarifications to the scope of application, methodology, and specific terms for the approach to IRRBB. The PRA also proposes to update a reference to the PRA Rulebook in the pension obligation risk section. These clarifications are also reflected in the draft SoP – The PRA’s methodologies for setting Pillar 2 capital for Small Domestic Deposit Takers (SDDTs), and the draft SS – The Internal Capital Adequacy Assessment Process (ICAAP), and the Supervisory Review and Evaluation Process (SREP) for Small Domestic Deposit Takers (SDDTs) in CP7/24.

Minor clarifications to SS31/15 –The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP) on IRRBB

4.4 The PRA proposes to update an obsolete reference to the UK CRR and replace it with a reference to the PRA Rulebook in paragraph 2.7A of the IRRBB section regarding the small trading book business. The PRA also proposes to update a link to SS20/15 – Supervising building societies’ treasury and lending activities in footnote 9 to reflect the latest updates to the SS.

4.5 The PRA also proposes to clarify some terms to enhance firms’ understanding of the ICAAP expectations. In paragraph 2.8B(v), the PRA proposes to replace ‘cashflow slotting criteria’ with ‘the way the repricing dates are determined for the purpose of calculating IRRBB’. This is intended to clarify the expectations regarding what firms’ systems and processes should allow them to monitor.

4.6 In paragraph 2.9A, the PRA proposes to add ‘Basel Committee on Banking Supervision’s’ to the description of the standardised framework used in the PRA Rulebook . This is intended to differentiate between this approach and the PRA’s standard approach for smaller firms and firms with less complex IRRBB exposures.

4.7 The PRA also proposes to make minor editorial changes in paragraph 2.7B to clarify the situations in which outlier firms would be identified.

Minor clarifications to SoP – The PRA’s methodologies for setting Pillar 2 capital on IRRBB

4.8 The PRA proposes changes to the text of the standard approach, which is applicable to smaller firms and firms with less complex IRRBB exposures, in paragraphs 7.4 and 7.27. These clarifications are intended to enhance transparency around how the standard approach is applied.

4.9 The PRA also proposes one minor formatting change in paragraph 7.13, under which ‘Basis risk’ should be the title of the next immediate subsection.

Minor clarification to SoP – The PRA’s methodologies for setting Pillar 2 capital on pension obligation risk

4.10 The PRA proposes to update a reference to the PRA Rulebook, regarding the deduction of pension scheme surplus from CET1 capital of a firm, in paragraph 8.5 of the pension obligation risk section.

PRA objectives analysis

4.11 The PRA considers that ensuring the clarity and completeness of its policy material helps firms understand and comply with PRA rules and provides confidence to firms in following those policies, which contributes to the PRA’s statutory objective to promote the safety and soundness of PRA-authorised firms.

4.12 The PRA does not expect that these proposals would have any significant impact on its secondary objectives, as they only clarify, rather than change, existing policy.

Cost Benefit Analysis (CBA)

4.13 The PRA considers that the benefits of making the proposed amendments to SS31/15 and Pillar 2 SoP are proportionate to the costs. The benefits arise from avoiding costs to firms of any potential misinterpretation of the Pillar 2 framework. The proposed amendments would not result in additional costs to firms, as the PRA has already set out its approaches to setting Pillar 2 capital and the expectations of firms undertaking an ICAAP in the Pillar 2 SoP and SS31/15, respectively. The changes simply provide clarity and completeness to firms on how these approaches and expectations apply to them.

‘Have regards’ analysis

4.14 In developing these proposals, the PRA has had regard to its framework of regulatory principles. The regulatory principle that the PRA considers is most material to the proposals include:

• Transparency. The PRA considers that the proposed clarifications set out in this chapter would improve the clarity of the Pillar 2 capital setting approaches and the expectations of firms undertaking an ICAAP, as described in the PRA’s policy material, therefore making the PRA’s approaches and expectations as transparent and clear as possible.

4.15 The PRA has had regard to other factors as required. In instances where analysis has not been provided against a ‘have regard’ for these proposals, it is because the PRA considers ‘have regard’ to not be a significant factor for this proposal.