The PRA delays Basel 3.1 – again. What should banks do now?

Audience:

Chairs of Board Risk Committees, CEOs, CFOs, CROs, CIOs, CCOs, Heads of Basel Programmes, Heads of Regulation, Heads of Regulatory Reporting, Heads of Model Development, Heads of Model Validation.

At a glance:

The PRA has delayed the implementation of Basel 3.1 by six months to 1 July 2025, aligning with proposals in the US. The PRA has also announced that it will publish its near-final rules in two tranches, in Q4 2023 and Q2 2024. 

Many banks still have considerable work to complete in their Basel 3.1 programmes, particularly in building and implementing RWA calculators that are capable of coping with the new requirements for Standardised Credit, Market and Operational Risk RWAs, and the strategic and operating model aspects of Basel 3.1 implementation.

Some banks are waiting for the PRA to issue final rules before finalising their programmes, however this approach may not leave banks with enough time to achieve compliance by the implementation date.

While the delay to the implementation date provides a helpful additional period for banks to develop and implement compliant systems and processes and, for those who need it, to build up reserves to ensure capital ratios remain robust, we recommend that banks maintain the momentum of their Basel programmes to deliver against existing timelines and use the additional time for remediation work and/or parallel runs to ensure systems are fully functional on 1 July 2025, as we expect the PRA to have high expectations that banks will be in full compliance with the rules on the new implementation date.

Introduction

The PRA has announced a delay in the implementation date for Basel 3.1 in the UK, to 1 July 2025. At the same time, the PRA has decided to shorten the transition period for the phasing in of the output floor by six months, so that the transition period will still end on 1 January 2030.

The PRA expects to publish its near-final rules for Market Risk, Counterparty Risk, Credit Valuation Adjustments and Operational Risk in Q4 2023. The near-final rules for Credit Risk, Output Floor, Reporting and Disclosure will follow in Q2 2024.

This will give banks approximately one year from full publication of near-final rules to implementation of compliant solutions for “live” capital calculations.

Implications for EU implementation

The PRA’s decision to delay creates a timing difference between the implementation of Basel 3.1 in the UK and the anticipated implementation of CRD6/CRR3 in the EU. While June’s announcement of a provisional agreement on some key elements of the EU Banking Package may make a further delay in the EU’s implementation more complicated, it would seem that the UK announcement adds to the rationale for the EU to similarly delay its implementation. Having a single implementation date across the US, UK and EU would reduce one area of programme complexity for EU banks that operate globally at relatively little cost to EU regulators and politicians.

Where banks are now and implications of the delay for Basel 3.1 programmes

Many banks have made good progress with the regulatory interpretation and impact assessment streams of their Basel 3.1 programmes, and larger multinational banks have made good progress with requirements definition and systems architecture design.

However: most banks still have considerable work to do in the data sourcing and systems build streams of their programmes, especially the build and implementation of calculators that can produce fully compliant RWAs under the Standardised approaches for Credit, Market and Operational Risk – all of which change significantly when moving from the current rules to Basel 3.1.

Banks with internal model permissions face the additional challenge of building a calculation infrastructure capable of producing both standardised RWAs for all assets, as well as modelled RWAs for portfolios with model permissions, and calculating the output floor, and is capable of delivering those calculations in a period-end timescale that meets the requirements for internal MI and regulatory reporting submissions.

For those banks whose capital requirements increase, the delay to H2 2025 for the implementation will allow additional time to adjust their portfolio mix and build up reserves to ensure capital ratios are maintained above regulatory and market expectations. In addition, the additional time will allow banks to consider how risk appetite, risk limits and decisioning and pricing will be affected. These are areas where the industry is, in general, less advanced.

Some banks are waiting for the PRA to publish final rules before finalising their work programmes. Given that the PRA will still only publish its complete set of near-final rules approximately one year before implementation, this would be a high-risk approach. The proposals set out in CP 16/22 provide a good indication of the shape of the final rules and banks would be well advised to progress their programmes on the basis of the proposals in the CP, while building in flexibility to be able to adjust for changes in the final rules, rather than waiting for certainty about the PRA’s approach.

Some banks may take the view that a six month delay in the implementation timescale allows for diversion of scarce data and IT resource and priority away from their Basel programmes and toward other priority programmes, of which there are currently numerous examples, including (but certainly not limited to): IRB repair, section 166 reviews on regulatory reporting, review of politically exposed persons / de-banking, implementation of consumer duty in the back book, changes to APP fraud reimbursement et al.

Having announced a second delay in the implementation date for Basel 3.1, the PRA’s expectations of banks’ compliance with the rules on day one can only realistically be expected to increase, so diverting resource away from Basel programmes would not be advisable. The amount of work that remains for many banks is significant, and the additional six months will, for many banks, only really allow for more/better remediation of any issues found in testing and a longer parallel run where the real-world effects of the changes to RWAs can be assessed. The last time the capital regime changed for credit, market and operational risk at the same time was when Basel 2 was implemented, and regulators expected banks to have a one-year parallel run period.  While that is not a requirement for the implementation of Basel 3.1, banks that are able to demonstrate they have fully compliant RWA calculations ahead of the revised implementation date will be well set for conversations with their supervisors and other stakeholders.

The PRA was at pains to emphasise that it was open to feedback and suggestions through the consultation process on CP 16/22, so it is not entirely surprising that it has deferred the implementation date. In response, banks should ensure they make the most of the additional time by making sure their programmes deliver accurate, timely RWA outputs in good time ahead of day one – 1 July 2025.