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
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