Regulated firms: a matter of life and death

Banks operating in the UK are regulated by the PRA, whose objective is to promote their safety and soundness, focusing on the adverse effects that they can have on the stability of the UK’s financial system. New banks are born when they receive authorisation from the PRA to operate in the UK, and there have been many births since Brexit. These banks are bound by the PRA’s prudential regime during its lifetime; and they’re also required to prepare for an orderly death, ensuring that it can wind down without disrupting the system in which it operates. Most will agree that the PRA’s pathway to achieving its objective often appears to be more on the safety and soundness of banks during their lifetime, in comparison to their births or deaths. However, with Brexit, this might soon change.

The UK is now flying solo, so to maintain (or even enhance) the attractiveness of the UK’s financial sector, the PRA intends to make banks’ lives easier. This is easier said than done – there aren’t many who’d like to return to the woes of 2008. As the pandemic has shown, banks have proven themselves to be more resilient than firms operating in most other sectors – which is a testament to the PRA’s efforts so far. Loosening the burden of regulation on banks to the extent that the stability of UK’s financial system is put at risk again, is well beyond the PRA’s risk appetite. So, the question becomes, how will the PRA make banks’ lives easier, without compromising their objective? 

Supervisory authorities and the Government have tested the water with various ideas. Most recently, there has been some noise around the possibility of dissolving remuneration rules, but this idea does not seem to have gathered much momentum yet. Interestingly, Sam Woods, Deputy Governor for Prudential Regulation at the Bank of England, mentioned a very interesting plan in his Mansion House speech; and this plan revolves around more closely managing banks exit from the financial system.

If we think about what could really bring the system to its knees, it’s perhaps not about how well banks operate, but rather how much harm might be caused when they fail. When a bank fails, depositors may suddenly lose their deposits, and thus be unable to settle their obligations (such as rent, mortgages or taxes) or pay for goods and services (such as for gas and electricity, entertainment, new clothing or travel). This challenges the financial viability of companies that trade in these sectors, including the Government. It may lead to redundancies, that will further compound the adverse systemic impacts until the Government resorts to borrow, and then inject cash into the system hoping for a revival.

As such, a planned and managed failure, to the extent that it does not trigger such a disruptive chain reaction, will go a long way to mitigate any additional risks to the PRA’s objectives that might be brought about by applying a more streamlined approach to regulating small and medium-sized banks during their lifetime. 

Small and medium-sized banks should therefore expect the PRA to be much more involved in the review and appraisal of their plans for exiting the market without disturbing it. It is also likely, that the PRA (now in its capacity as the rule-maker rather than the rule-taker) will introduce new rules in their rulebook around such plans.

Questions that firms should be prepared to answer include: 

1. What is their estimated cost of winding down; how frequently is this calibrated; how are these funds protected; and how liquid are these reserves?
2. What are the wind down-centric Early Warning and Key Risk Indicators; and how do they blend in with their existing Risk management Frameworks and governance arrangements? 
3. What are the specific actions that will be taken when the aforementioned indicators are breached; who might be responsible for taking them; how frequently is the viability of such actions tested; is there any key-person risk; and how might the Board monitor the progress of such actions? Amongst many more.