Policy statement 17/23 – Basel 3.1 near-final rules part 1

Below we outline the key amendments, based on the relevant responses to consultation paper 16/22 (CP16/22). The Prudential Regulation Authority (PRA) has also released a comparison document detailing all changes between the draft rules set out in CP16/22 and near-final rules.

1. Internal modelling of default risk for sovereign exposures has been removed.

Firms with internal model approach (IMA) permissions on trading desks with sovereign exposures will have to use the advanced standardised approach for the default risk component. The PRA has also made small amendments to the expected shortfall and non-modellable risk factors components of IMA for market risk.

2. Alternative CVA transitional arrangement removing the exemption for legacy trades.

CP16/22 proposed a CVA transitional arrangement where legacy trades (exposures to pension funds, non-financial corporates, and sovereigns) would be exempt from CVA capital requirements, in the first five years of Basel 3.1 implementation. Based on responses regarding operational challenges in separating legacy from non-legacy trades, firms can now use an alternative arrangement where firms can include legacy trades in CVA capital requirement calculations from the onset. Firms will be required to choose one transitional approach and apply it consistently until 1 January 2030 (the end of the transitional period).

3. The business indicator component of the operational risk standardised approach changed.

The PRA will maintain operational risk model which consists of a business indicator component (BIC) and an internal loss multiplier (ILM). Amendments have been made to the BIC, such that firms can now exclude divested activities from business indicator calculations (subject to supervisory approval) and use internal business estimates when audited figures are not available. Despite resistance, the PRA has maintained the ILM equal to 1, arguing that historical losses are not a good predictor for future losses.

4. PRA will collect Pillar 2 data from firms as part of an off-cycle review of firm-specific capital requirements.

PS17/23 expands on the PRA’s plan to review Pillar 2 methodologies. To avoid unwarranted higher or lower capital requirements, the PRA will first look to understand the impact of Basel 3.1 Pillar 2 using existing methodologies. It will then conduct a full review of the Pillar 2A framework after Basel 3.1 rules are finalised, which will be by the end of Q2 2024.

5. Name change for the transitional capital regime.

The transitional regime for Small Domestic Deposit Takers (SDDT) not subject to Basel 3.1 is now called the Interim Capital Regime (ICR).