A ‘strong and simple’ prudential regime for small banks and building societies in the UK

But for small firms, those costs often exceed the associated social benefit. Moreover, a fixed element of these costs may mean that the average cost is higher for them than larger institutions. This impairs their competitiveness against the dominant banks.

Although efforts have been made to introduce proportionality measures, including within the updated Capital Requirements Regulation (CRRII), the PRA appears to want to go further.

Post-Brexit supervisory approach

During his Mansion House speech in November 2020, Sam Woods, Deputy Governor of the Bank of England and Head of the Prudential Regulation Authority (PRA) shared the PRA’s intention to implement a 'Strong and Simple' regime for regulating small UK banks and building societies following the end of the Brexit transition period. However, the Deputy Governor reiterated that the PRA has no intention of using Brexit as an opportunity to weaken prudential regulation, stating that the UK has a global responsibility to maintain high prudential standards, as the host of a very large international financial centre.

He put forward three key principles for any future regulation:

• High regulatory standards, always…
• Responsible openness, i.e. keeping the UK open and attractive to financial services while ensuring this works safely
• Dynamism, i.e. the ability to innovate, adapt to new developments and allow firms to enter and exit the market

Sam Woods believes that the UK's exit from the EU provides the PRA with more leeway to better tailor rules to UK financial firms and in particular, to:

• Progress the design of a UK-specific prudential regime for small banks and building societies
• Reconsider the current European approach of applying the “full weight” of regulation to firms of all sizes to ensure harmonisation

Key considerations for defining a ‘strong and simple’ regime

A more proportionate approach for small banks and building societies could be achieved with a “graduated regime” in which banks gradually migrate from a very simple prudential regime to the full Basel framework, as they become larger or involved in more complex activities.

The first step in implementing such a regime would be the introduction of the simplest regime for the smallest firms followed by additional steps to reach a fully graduated regime in due course.

The PRA will have to decide on two things:

• Which firms are in the regime – a measure based on total assets may be one good proxy given that it is simple. Other factors to consider include whether the firm is systemically important, internationally active, involved in trading activities. But each of these elements can be debated at length before reaching an agreement.
• How to simplify the requirements – should the PRA replace existing requirements with simpler versions and/or narrow the set of applicable requirements?

Finally, in the long run, if the PRA strips parts of the prudential regime away for small firms, this could create new barriers for firms as they grow out of the “small” category and need to take on additional regulation.

Next steps

This speech has certainly triggered a debate on whether or not such a regime should be introduced, if so, what it could look like, and what the potential drifts could be.

Depending on initial feedback to Sam Woods’ speech, the PRA could issue a discussion paper in the spring.

Reference
https://www.bankofengland.co.uk/speech/2020/sam-woods-city-banquet