How to Pass the ACA Business Planning: Banking Module: Prudential and Conduct Regulation Including Reporting Requirements for Banks

The Regulatory Framework for UK Banks

• Regulation aims to prevent excessive risk-taking and systemic bank failures.
• PRA and FCA collaborate globally on prudential standards.

Group of Twenty

• G20 focuses on global economic stability and financial regulation.
• Prudential regulation has been a priority since 2008.

Financial Stability Board

• Promotes international financial stability by coordinating national regulators.
• Focuses on identifying risks, developing policies, and monitoring implementation.

Basel Committee on Bank Supervision

• Sets global standards for bank regulation.
• Basel I introduced capital requirements; Basel II added supervision and disclosure.
• Basel III enhanced capital and liquidity rules post-2007/08 financial crisis.
• Implemented in the UK through CRD and CRR.

UK Regulators

• Financial Policy Committee (FPC): Identifies risks and recommends stress tests for major UK banks.
• Prudential Regulation Authority (PRA): Supervises 1,500 financial institutions to ensure safety and soundness.
• PRA Enforcement: Has powers to impose sanctions, fines, and authorisation withdrawals.
• Financial Conduct Authority (FCA): Supervises conduct and prudential matters for 51,000 firms; focuses on consumer protection, market integrity, and competition.

Prudential Regulation

• UK banks must meet PRA’s Threshold Conditions for capital, liquidity, and risk management.
• Minimum capital is set as a percentage of risk-weighted assets based on asset type and risk.

Basel I

• Set global banking stability standards with an 8% capital requirement based on risk-weighted assets.
• Introduced Tier 1 and Tier 2 capital, with 50% of capital needing to be Tier 1.

Basel II

• Added complexity and flexibility, allowing standard or model-based risk assessments.
• Introduced three pillars:
  • Pillar 1: Minimum capital calculation.
  • Pillar 2: Supervision and internal risk management.
  • Pillar 3: Market disclosure for better risk analysis.

Pillar 1

• Defines minimum capital requirements for various risks, including credit, market, operational, counterparty, and securitisation exposures.
• Total minimum capital required is the sum of capital for each risk type.
• Banks must hold at least 8% of total risk-weighted assets (RWAs) as capital, with at least 4% in Tier 1 and 2% in CET1.
• Tier 2 capital includes subordinated debt.
• EL-P deduction ensures Core Tier 1 reflects foreseen credit losses.

Credit Risk

• Standardised Approach: Banks apply risk weights to assets based on credit ratings.
• Internal Ratings-Based (IRB) Approach: Uses internal models to assess risk, involving PD, LGD, EAD, and M.
• Foundation IRB and Advanced IRB approaches available.

Market Risk

• Two methods: standardised coefficients or internal models (e.g., VaR).
• Assets categorised into banking book (long-term) and trading book (held for trading).
• Covers losses from market price volatility.

Operational Risk

• Defined as losses from internal failures or external events.
• Three calculation methods: Basic Indicator Approach, Standardised Approach, and Advanced Measurement Approach.

Counterparty Risk

• Potential loss from a counterparty defaulting on a derivative or securities transaction.

Securitisation Exposures

• Risk from dealing with asset-backed securities.

Pillar 2

• Supervisory review to evaluate additional capital needs.
• Includes ICAAP and SREP, which set Total Capital Requirement (TCR).
• Pillar 2A: Covers risks like Credit Counterparty Risk and Interest Rate Risk in the Banking Book.
• Pillar 2B: Capital Planning Buffer (CPB), replaced by PRA buffer under Basel III.

Pillar 3

• Requires public disclosure of risks, capital, and risk management.

Lessons from the Global Financial Crisis of 2007/08

• Excessive leverage and inadequate liquidity highlighted vulnerabilities.
• Weak governance and inappropriate remuneration structures.
• Basel Committee issued principles for liquidity management and launched Basel III.

Basel III

• Introduced to address weaknesses exposed by the financial crisis.
• Phased implementation, fully effective from 1 January 2019.

Changes to Pillar 1

• Improved capital quality, with CET1 as the highest quality capital.
• Tier 1 capital supports bank operations during stress; includes CoCo bonds.
• Tier 2 capital ensures depositor and creditor repayment.

Minimum Capital Requirements

• CET1: 4.5% of RWA.
• Tier 1: 6% of RWA.
• Total Capital: 8% of RWA.

Changes to Pillar 2

• Enhancements in governance, stress testing, and risk management.
• Introduced capital buffers like PRA buffer, CCyB, and CCoB.

Pillar 2A Capital

• Covers risks not in Pillar 1.
• Must be met at all times.

Changes to Pillar 3

• Enhanced disclosure requirements for transparency.

Leverage Ratio

• Basel III introduced a non-risk-based leverage ratio of at least 3%.
• PRA version for UK banks includes additional capital for systemic risks.

Liquidity Requirements

• LCR ensures sufficient HQLA for 30 days of stress.
• NSFR promotes stable funding over one year.

Regulatory Reporting

• Uniform reporting under CRR ensures fair competition.
• UK banks report data electronically via GABRIEL.
• Modules include financial reporting (FRP001), capital (COR001), leverage (COR002), and more.

Capital Management

• Overseen by ALCO and Board-level committees.

Impact of Acquisitions on Regulation

• PRA approval needed for acquiring control of authorised firms.

Prospective Regulation

Basel 3.1

• Finalises Basel 3 reforms, also known as Basel IV.
• Introduces an output floor phased over five years.

Climate Stress Testing

• Bank of England's CBES assesses resilience to climate risks.
• Highlights data challenges and best practices.

Conduct Regulation and Penalties

FCA Handbook

• Consolidates rules and guidance, including BCOB and COBS.
• High Level Principles set overarching standards.

Conduct Supervision

• Supervision based on firm risk, including systematic framework, event-driven work, and product issues.

LIBOR Transition

• Banks must manage LIBOR transition risks, with SONIA as the UK replacement.

Enforcement Penalties

• FCA can impose fines, prohibitions, and other sanctions.
• CRD V allows significant fines and management bans.

Accounting for Penalties and Redress

• High-risk area for material misstatements.

Senior Managers and Certification Regime (SM&CR)

• Applies to UK banks and investment firms.
• PRA approval required for senior management functions.

Mandatory SMFs

• Includes Chairman, Chief Executive, Chief Finance, and others.
• Governance maps must outline responsibilities.

Certification Regime

• Applies to significant risk takers, excluding SMFs.

Ring-Fenced Banks

• PRA requires separation of retail banking from investment banking.
• Applies to banks with core deposits over £25 billion.

Next Steps

Mastering risk management principles is essential for passing the ACA Business Planning: Banking module. Apply these concepts to real-world scenarios and practice exam questions. For additional resources and tailored support, explore our subscription plan. Equip yourself with the expertise needed for success!

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