SDDT regime – Is the single capital buffer a game changer? - Forvis Mazars

For SDDT eligible firms, the SCB will replace the current buffer framework (i.e. the countercyclical, combined and PRA buffer). This currently applies to all UK banks regardless of size or sophistication. We explore how the buffer will be calculated and whether it is a significant change in the current regime.

How will the SCB be calculated?

The SCB will be set at a minimum of 3.5% RWAs and the calculation will be informed by 3 components:

Stress impact component - The focus will be on understanding CET1 capital depletion during stress scenarios and using that calculation to quantify the SCB required. This component is very similar to how the current stress analysis in an ICAAP informs whether a firm needs a PRA Buffer over and above their Countercyclical and Combined Buffers. This component means that stress testing will continue to be the most important determinant when calculating P2B Buffers.
Risk management and governance – This component in many respects is no different to the current risk management and governance scalar that is applied by the supervision team when they think a firm has material risk management and/or governance shortcomings. We expect this assessment will continue to be focused on issues that sit outside of the capital risk profile of the firm.
Supervisory judgement – This component seems to be most likely to take place when the PRA does not believe the firm's stress test results are a fair reflection of its risk profile. Long story short, they aren’t considered severe or plausible. It links back to the stress impact component.

There is one other key aspect of the SCB that should be highlighted and marks a divergence with the current regime. The regulator has been keen to emphasize the fact that firms utilising their SCB in a stress event would not automatically trigger any PRA actions. This includes, for example, suspension of dividend or bonus payments.

Is this a significant change for firms?

The Bank of England believes that this proposal will be a significant benefit for firms because it will make the Pillar 2B capital requirement more consistent and easier to understand. However, we have reservations this will be the case:

Reduced buffer clarity for firms - Currently, the CRDIV buffer regime is very clear. The buffer requirements are standardised, fixed amounts meaning they are easy to follow and understand. On the other hand, the SCB is idiosyncratic and more subjective.
Limited impact on buffer utilisation in stress - Firms are likely to still focus on ensuring they don’t enter their SCB during stress. Under current capital risk management frameworks, utilisation of buffers means that firms need to spin up action plans for stress and recovery management actions. This is something that senior management will want to avoid, even under the new framework.

Conclusion

Overall, the introduction of the SCB brings with it a significant amount of noise. However, while it is a big headline change, we remain unconvinced that the fundamental dynamics currently associated with the CRDIV regime will be altered for SDDT regime firms under the new proposals.