Small Domestic Deposit Taker Regime (SDDT) – Key changes in credit, concentration and operational risks

Credit risk

The PRA are proposing a shift away from the IRB benchmarking approach and towards a greater focus on credit risk stress testing in the ICAAP. Currently, the PRA expects that firms conduct a ‘short, sharp’ 12-month stress test as part of their P2A analysis. However, firms often ignore this guidance. This is mainly because stress testing analysis is more complicated than IRB benchmarking. In addition, the regulator doesn’t often pick up on the fact it is missing in the ICAAP. What this means that there are some SDDT firms out there who do not conduct this analysis and would need to develop this area of their ICAAP document to meet the proposed expectations of the SDDT regime.

Credit concentration risk

The proposals set out a new approach which will consist of a simple add-on with components for retail and wholesale exposures. There may be further capital overlays for both Single Name and Sector Concentration depending on the risk exposures of each individual firm. The Single Name Concentration will now be aligned with the Large Exposure limit and additional scrutiny would be given in instances when firms which have Large Exposures above 300% of their Tier 1 capital. For Sector Concentration, firms with significant wholesale exposures will now have to include this in their P2B stress scenario analysis. Failure to do so may result in an additional capital add-on for Sector Concentration.

Operational risk

Firms will now be placed in 1 of 3 different risk buckets based on their existing operational risk capital requirements and PRA judgement. Their capital requirement will be a percentage of total assets, with this figure aligned to the risk bucket they are assigned. While firms will welcome greater clarity from the PRA on how operational risk capital is calculated, operational risk scenario analysis will still need to be performed in the ICAAP. Therefore, from an ICAAP drafting perspective, the amount of work required, is unlikely to significantly change.

Removal of the 'refined approach'

The 'refined approach' currently allows firms that are demonstrably overcapitalised for their Pillar 1 credit risk (identified via IRB benchmarking analysis), to receive a capital offset for their Pillar 2A add-on. The 'refined approach' is being removed under the SDDT proposals. Some firms will be significantly impacted and may see their capital requirements materially increase. This will be especially true for low risk building societies and banks which make up the majority of firms currently on the 'refined approach'.

Conclusion

While the proposals are not set in stone, early evidence suggests that material changes are going to be made to the SDDT capital regime. However, it is worth noting that for some firms, especially those currently on the refined approach, the capital impact of SDDT may well result in higher requirements going forward.

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