Bank of England | Prudential Regulation Authority Page 1

PS9/24 – Implementation of the

Basel 3.1 standards

Near-final part 2 policy statement 9/24

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Table of Contents

1: Overview ............................................................................................................. 5
Background ......................................................................................................... 7
Summary of responses ....................................................................................... 9
Changes to draft policy ....................................................................................... 9
Structure of the policy statement ....................................................................... 13
Accountability framework .................................................................................. 13
Interactions with other frameworks.................................................................... 17
Implementation and next steps ......................................................................... 19
2: Credit risk – standardised approach ................................................................. 21
Introduction ....................................................................................................... 21
Exposure class allocation .................................................................................. 23
External credit ratings and due diligence .......................................................... 25
Exposure values for off-balance sheet items .................................................... 31
Exposures to central governments, central banks, regional governments, local
authorities, PSEs, and MDBs ............................................................................ 41
Exposures to institutions and covered bonds .................................................... 45
Exposures to corporates and specialised lending ............................................. 50
Exposures to individuals and small and medium-sized enterprises .................. 65
Real estate exposures ...................................................................................... 81
Capital instruments, defaulted exposures, and high-risk items ....................... 108
3: Credit risk – internal ratings based approach ................................................. 117
Introduction ..................................................................................................... 117
Implementation timelines ................................................................................ 119
Permission to use the IRB approach ............................................................... 122
IRB exposure classes and sub-classes........................................................... 125
Restrictions on IRB modelling ......................................................................... 131
Roll-out, permanent partial use, and reversion ............................................... 135
Calculation of risk-weighted assets and expected loss ................................... 140
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General requirements for use of the IRB approach ......................................... 149

Definition of default ......................................................................................... 151
Input floors ...................................................................................................... 153
Probability of default estimation ...................................................................... 156
Loss given default estimation .......................................................................... 161
Exposure at default estimation ........................................................................ 165
Maturity ........................................................................................................... 167
Specialised lending ......................................................................................... 169
4: Credit risk mitigation ....................................................................................... 178
Introduction ..................................................................................................... 178
Methods for recognising credit risk mitigation ................................................. 182
Funded credit protection ................................................................................. 186
Unfunded credit protection .............................................................................. 196
5: Output floor ..................................................................................................... 203
Introduction ..................................................................................................... 203
Implementation of an output floor .................................................................... 205
Scope and levels of application ....................................................................... 208
Application of the output floor to minimum requirements and buffers.............. 212
Application of the output floor to securitisation exposures .............................. 215
Transitional arrangements .............................................................................. 215
6: Pillar 2............................................................................................................. 218
Introduction ..................................................................................................... 218
Pillar 2 review .................................................................................................. 218
Update on the off-cycle review of firm-specific capital requirements ............... 219
7: Disclosure (Pillar 3)......................................................................................... 222
Introduction ..................................................................................................... 222
Credit risk ........................................................................................................ 224
Market risk ...................................................................................................... 225
Credit valuation adjustment ............................................................................. 225
Counterparty credit risk ................................................................................... 226
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Operational risk ............................................................................................... 227

Output floor ..................................................................................................... 227
Consequential updates to capital summary disclosures .................................. 228
Additional feedback ......................................................................................... 228
8: Reporting ........................................................................................................ 230
Introduction ..................................................................................................... 230
Credit risk ........................................................................................................ 232
Market risk ...................................................................................................... 233
Credit valuation adjustment ............................................................................. 236
Counterparty credit risk ................................................................................... 239
Operational risk ............................................................................................... 239
Output Floor .................................................................................................... 241
Capital+ ........................................................................................................... 242
Taxonomy implementation .............................................................................. 242
Additional feedback ......................................................................................... 244
9: Interim capital regime ..................................................................................... 246
Introduction ..................................................................................................... 246
Updates to the Interim Capital Regime near-final rule instrument ................... 247
Time window for joining the Interim Capital Regime ....................................... 248
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1: Overview
1.1 This Prudential Regulation Authority (PRA) near-final policy statement (PS)
provides feedback to responses to the following chapters of consultation paper (CP)
16/22 – Implementation of the Basel 3.1 standards:

• Chapter 1 – Overview
• Chapter 3 – Credit risk – standardised approach
• Chapter 4 – Credit risk – internal ratings based approach
• Chapter 5 – Credit risk mitigation
• Chapter 9 – Output floor
• Chapter 11 – Disclosure (Pillar 3)
• Chapter 12 – Reporting

1.2 This near-final PS also contains feedback to responses on the parts of Pillar 2
relating to the Pillar 2A credit risk methodology, use of internal ratings based (IRB)
approach benchmarks, and the interaction with the output floor.

1.3 This PS is the second of two near-final PSs related to Basel 3.1. On 12
December 2023, the PRA published the first PS – Near-final PS17/23 –
Implementation of the Basel 3.1 standards near-final part 1. It provided feedback
to responses to the following policy areas covered in CP16/22: scope and levels of
application, market risk, credit valuation adjustment (CVA) and counterparty credit
risk, operational risk, and currency redenomination.1 It also included feedback to
responses on Pillar 2 relevant to those areas. Following that publication, the PRA
has made some minor clarifications and corrections to the near-final rules published
within PS17/23. These have been incorporated into the following parts of the
comprehensive Near-final PRA Rulebook instrument, covering all of the Basel 3.1
standards, included in Appendix 2: (i) the Market Risk Parts (Trading Book (CRR)
Part, Market Risk: Advanced Standardised Approach (CRR) Part, Market Risk:
Internal Model Approach (CRR) Part), (ii) the Credit Valuation Adjustment Risk Part,
and (iii) the Counterparty Credit Risk (CRR) Part.

1PS17/23 set out that references to euros (EUR) and US dollars (USD) in the Basel 3.1 standards
had been redenominated in the near-final rules based on the following rates: £1 = $1.26, £1 = €1.14.
These rates have also been applied for the purpose of the near-final rules in this PS.
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1.4 The Appendices to this PS contain the PRA’s additional near-final policy material
relevant to the above chapters, as follows:

• near-final PRA Rulebook: CRR Firms: (CRR) Instrument [2024] (Appendix 2);
• summary of the purpose of the rules – Basel 3.1 (Appendix 3);
• corresponding CRR rules – Basel 3.1 (Appendix 4);
• CRR restatement provisions – Basel 3.1 (Appendix 5);
• near-final amendments to supervisory statement (SS) 10/13 – Credit risk
standardised approach (Appendix 6);2
• near-final amendments to SS13/16 – Underwriting standards for buy-to-let
mortgage contracts (see footnote 2) (Appendix 7);
• near-final SS3/24 – Credit risk definition of default (Appendix 8);3
• near-final SS4/24 – Credit risk internal ratings based approach (see footnote
3) (Appendix 9);
• near-final amendments to SS17/13 – Credit risk mitigation (see footnote 2)
(Appendix 10);
• near-final amendments to SS12/13 – Counterparty credit risk (Appendix 11);
• near-final updated disclosure templates and instructions (Appendix 12);
• near-final mapping of reporting template codes (Appendix 13);
• near-final updated reporting templates and instructions (Appendix 14);
• near-final SS34/15 – guidelines for completing regulatory reports (Appendix
15);4
• near-final PRA Standards Instrument: Technical Standards (Economic
Downturn) Revocation Instrument [2024] (Appendix 16);
• near-final PRA Rulebook: CRR Firms: SDDT Regime (Interim Capital
Regime) Instrument [2024] (Appendix 17);
• corresponding CRR rules – Interim Capital Regime (Appendix 18); and
• CRR restatement provisions – Interim Capital Regime (Appendix 19).

1.5 The PRA has not made final rule instruments at this stage because HM Treasury
(HMT) is required to first revoke the relevant parts of the Capital Requirements

2 The current version of the supervisory statement will apply in respect to firms subject to the Interim
Capital Regime.
3 This SS does not apply in respect to firms subject to the Interim Capital Regime, except to the extent

those firms are applying for an IRB permission.

4 The existing SS would continue to apply to ICR firms and ICR consolidation entities (as defined in

Chapter 9 – Interim Capital Regime).

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Regulation (CRR)5. HMT will make commencement regulations6 to revoke the

relevant provisions of the CRR before the PRA can replace them in PRA rules. Once
the commencement regulations have been made, the PRA intends to make all the
final policy materials, rules, and technical standards (covering the areas in this near-
final PS and those in PS17/23) in a single, final PS.

1.6 The near-final rules included in Appendix 2 are relevant to PRA-authorised

banks, building societies, PRA-designated investment firms, and PRA-approved or
PRA-designated financial holding companies or mixed financial holding companies
(firms). As set out in Chapter 9 – Interim Capital Regime,7 they do not apply to UK
banks and building societies that meet the Small Domestic Deposit Taker (SDDT) 8
criteria and choose to be subject to the Interim Capital Regime (ICR) (see Appendix
17 for the near-final rules applicable to such firms). As set out in CP16/22 and
described in CP7/24 – The Strong and Simple Framework: The simplified capital
regime for Small Domestic Deposit Takers (SDDTs), the PRA intends to use the
Basel 3.1 rules as the basis for the SDDT capital regime.

Background
1.7 In CP16/22, the PRA set out its proposals to implement the parts of the Basel III
standards that remain to be implemented in the UK. The PRA refers to them as the
‘Basel 3.1 standards’. The proposals addressed the final elements of the Basel III
standards concerning the measurement of risk-weighted assets (RWAs) – the
denominator of risk-based capital ratios.9 They aimed to address concerns over the
credibility of RWA calculations and firms’ reported capital ratios by improving the
measurement of risk in both the internal models (IM) approaches and standardised
approaches (SAs), and the comparability of risk measurement across firms. These
goals link closely to the PRA’s primary objective by promoting safety and soundness

5 In this near-final PS, CRR refers to the onshored and amended UK version of Regulation (EU) No
575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements
for credit institutions and investment firms and amending Regulation (EU) No 648/2012.
6 Under section 1 of the Financial Services and Markets Act 2023, assimilated law on financial

services is revoked, with revocation to be commenced by HMT.

7 The ‘Interim Capital Regime’ is the new name for the ‘Transitional Capital Regime’ (TCR) proposed

in CP16/22. In this near-final PS, ‘TCR’ refers to proposals in CP16/22.

8 ‘Small Domestic Deposit Takers’ is the new name for firms referred to as ‘Simpler-regime Firms’ in

CP16/22. In this near-final PS, ‘Simpler-regime Firms’ refers to proposals in CP16/22.

9 The denominator of risk-based capital ratios, RWAs are an estimate of risk that determines the

minimum level of regulatory capital a firm is required to maintain to deal with unexpected losses.
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and support its secondary objective to facilitate effective competition by increasing

the alignment of modelled and standardised approaches.

1.8 In developing its proposals, the PRA targeted an implementation that was
aligned with international standards, with adjustments which are tailored to the UK
financial system and advance the PRA’s objectives while supporting key
considerations including growth and competitiveness.

1.9 For the CP16/22 chapters relevant to this near-final PS, the PRA proposed the
following:

• Credit risk – standardised approach: a more risk-sensitive approach to risk

weighting residential mortgage exposures, changes to the valuation of real
estate, revisions to the risk weights for corporate exposures including to small
and medium-sized enterprises (SMEs), the introduction of specific treatments
for ‘specialised lending’ exposures, removal of assumptions of implicit
sovereign support for exposures to banks, changes to the risk weights for
equity exposures, changes to off-balance sheet conversion factors (CFs), and
proposed due diligence requirements.
• Credit risk – internal ratings based approach: restrictions on the use of the
IRB approach for equities and low default portfolios, such as exposures to
banks and other financial institutions, large corporates, and sovereign
exposures. Other proposals included revisions to the approaches for
corporate exposures including to SMEs, amendments to the treatment of
‘specialised lending’ exposures, changes to the risk parameters used in IRB
modelling, including new input floors for probability of default (PD), loss given
default (LGD) and exposure at default (EAD), and greater specification of
parameter estimation practices to reduce variability in RWAs for portfolios
where the IRB approach remains available.
• Credit risk mitigation: changes to the treatment of both funded and
unfunded credit protection and amendments to the PRA’s expectations with
respect to credit risk mitigation (CRM) to introduce greater clarity regarding
the application of the framework.
• Output floor: the implementation of an output floor with respect to firms’
calculation of RWAs that would limit the aggregate RWA reductions available
to firms through their application of IMs.
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• Disclosure (Pillar 3): updates to the UK Pillar 3 disclosure requirements to

reflect the proposals set out in CP16/22 and align them to the Basel 3.1
standards.
• Reporting: alignment of the PRA supervisory reporting requirements with the
other proposals set out in CP16/22.

1.10 The PRA did not propose any policy changes with respect to its Pillar 2
framework in CP16/22, but it provided a high-level description of the implications for
Pillar 2 of the changes proposed to the Pillar 1 framework, including aspects related
to the Pillar 2A credit risk methodology, use of IRB benchmarks, and the interaction
with the output floor.

Summary of responses
1.11 The PRA received formal written responses to CP16/22 from 126 respondents.
In addition, the PRA received responses through various other channels including
holding over 70 meetings with stakeholders to discuss their views.

1.12 Respondents were generally supportive of the overall approach the PRA set out
in CP16/22; however, they raised questions and concerns about a range of issues in
the policy areas addressed in this near-final PS. These included requests for
additional guidance and clarification on certain proposals and adjustments to specific
proposals in favour of treatments that respondents considered would be more
flexible or proportionate, less operationally burdensome, or which would reduce the
capital impact on firms in order to reflect what respondents considered to be the
prudential risk. Some responses focused on the interaction of the package of Basel
3.1 proposals with the PRA’s objectives and the matters to which it must have regard
when making policy and rules (‘have regards’). Some provided new evidence for the
PRA to take into account when drafting the near-final rules.

1.13 The substantive issues raised in the responses are addressed in detail in the
relevant chapters of this near-final PS. Where the PRA has made material changes
to its draft policies, it has updated the relevant objectives and have regards analysis
in the relevant chapters.

Changes to draft policy

1.14 When making rules, the PRA is required by the Financial Services and Markets
Act (FSMA) 2000 to have regard to representations made to it, and to publish an
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account, in general terms, of its feedback to them. Where the final rules differ from
the draft in the CP in a way that the PRA considers is significant, FSMA 200010
requires the PRA to publish:

• details of the difference together with a cost benefit analysis (CBA); and
• a statement setting out in the PRA’s opinion whether or not the impact of the
final rule on mutuals is significantly different to: (i) the impact that the draft rule
would have had on mutuals; and (ii) the impact that the final rule will have on
other PRA-authorised firms, and if so, details of the difference.

1.15 The publication requirement however does not apply if the PRA considers that
(making the appropriate comparison), there will be no increase in costs or there will
be an increase in costs, but that increase will be of minimal significance.11

1.16 Taking into account the responses to CP16/22, the PRA has made a number of
adjustments and corrections to the draft policy where it considers this to be
appropriate. These changes reflect the evidence and arguments stakeholders have
provided in their responses and in meetings with the PRA. The PRA welcomes the
high level of engagement with stakeholders that has informed and enabled these
changes, in line with the PRA’s objectives. The most material changes to the policy
proposed in CP16/22 include:

• Amendments to the treatment of SME lending to reduce the operational

burden for firms and lower capital requirements. The near-final policy
includes: (i) a new firm-specific structural adjustment to Pillar 2A (the ‘SME
lending adjustment’) to ensure that the removal of the SME support factor
under Pillar 1 does not result in an increase in overall capital requirements for
SME exposures; (ii) a new, simplified definition of SME to reduce the
operational burden for firms applying the definition and broaden the scope of
exposures which qualify for preferential treatment as an SME; and (iii) the
removal of the requirement that SA risk weights for commercial real estate
(CRE) exposures should be no lower than 100% for exposures where
repayment is not materially dependent on cashflows from the property,
resulting in lower risk weights.

• Amendments to the treatment of infrastructure lending to lower capital

requirements. The near-final policy includes: (i) a new firm-specific structural

10 Sections 138J(5) and 138K(4) of FSMA 2000.

11 Section 138L(3) of FSMA 2000.
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adjustment to Pillar 2A (the ‘infrastructure lending adjustment’) to ensure that

the removal of the infrastructure support factor under Pillar 1 does not result in
an increase in overall capital requirements for infrastructure exposures; and
(ii) a new lower risk weight of 50% for ‘substantially stronger’ project finance
exposures under the slotting approach, which is a reduction from the
CP16/22-proposed risk weight of 70% for qualifying exposures.

• Lower, more risk-sensitive CFs for off-balance sheet items to better

reflect empirical data provided by respondents. The near-final rules: (i)
assign a 20% CF for ‘transaction-related contingent items’, a reduction from
the 50% CF proposed in CP16/22; and (ii) assign a 40% CF for ‘other
commitments’ (except for UK residential mortgage commitments), a reduction
from the 50% CF proposed in CP16/22.

• A more risk-sensitive and operationally simpler approach to the

valuation of residential real estate under the credit risk SA. The near-final
rules: (i) include a ‘backstop’ revaluation event requiring firms to obtain a new
valuation once five years (or three years in certain cases) has passed since
the last revaluation event, which will prevent products without natural
refinancing events (eg lifetime mortgages) from being unjustifiably
disadvantaged; (ii) remove the requirement for firms to adjust a valuation to
reflect the value of the property that would be sustainable over the life of the
loan; and (iii) clarify downward revaluation requirements, making them more
mechanistic, and therefore simpler, by requiring firms to revalue properties if
they estimate (through their regular monitoring) that the market value of the
property has decreased by more than 10% relative to the value recorded at
the last valuation event.

• An approach to calculating the output floor which enhances consistency

between SA approaches and the output floor. The near-final rules adjust
the output floor calculation to reflect the different treatment of accounting
provisions under the SA and the IRB approach.

1.17 The PRA considers that the changes to the draft policy, including those listed
above, are appropriate to reflect risks in a more proportionate manner, reduce
operational burden on firms, enhance the relative standing of the UK and improve
the clarity of rules in a manner that aligns with the PRA’s statutory objectives. The
changes reflect the evidence and arguments that firms provided during the
consultation period. Further details on all substantive issues raised in responses,
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and any related amendments to the draft policy, are set out in the relevant chapters
of this near-final PS.

1.18 The PRA has also made a number of less substantive changes and
clarifications to the draft policy which are not described in the chapters of this near-
final PS. These are reflected in the near-final PRA Rulebook: CRR Firms: (CRR)
Instrument [2024] in Appendix 2 and in the relevant near-final SSs. The document
titled Comparison of Draft PRA Rulebook (CRR) Instrument [2023] against the
near-final PRA Rulebook: CRR Firms (CRR) Instrument [2024]12 contains a
comparison of the near-final rules with the draft rules as set out in CP16/22 for ease
of identifying all of the rule-related changes made.

1.19 The PRA has also made a number of amendments and clarifications to
reporting and disclosure templates not all of which are described in this near-final
PS. Amendments and clarifications to the reporting templates and instructions are
included in the near-final updated reporting templates and instructions (Annex 14).

1.20 The PRA has considered the aggregated CBA presented in CP16/22 in light of
the adjustments to the proposals within this near-final PS and PS17/23 and finds it
remains appropriate. In the PRA’s view, the adjustments would not significantly
increase costs for firms relative to the costs implied by the proposals in CP16/22.
The significant majority of the changes to CP16/22 are intended to result in a more
proportionate treatment for firms and the PRA has adjusted some of its proposals to
reduce operational burden on firms. Comparing the costs implied by the proposals in
CP16/22 with the costs implied by both PS17/23 and this near-final PS, the PRA
considers that that there will be minimal, if any, increase in overall costs, and that
many firms should see a reduction in costs. Therefore, a fully revised CBA and
mutuals statement has not been produced. Where amendments to individual policies
have changed their impact and/or where the PRA has undertaken further analysis of
their impact, the PRA has included analysis within the relevant chapter of this near-
final PS.

1.21 The PRA does not consider that the impact of the near-final policy and rules in
this near-final PS would have a significantly different impact on mutuals relative to

12The comparison of the draft PRA Rulebook Instrument against the near-final PRA Rulebook
Instrument is provided due to the exceptional nature of the Basel 3.1 package, comprising multiple
changes to PRA rules, and to respond to industry feedback.
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the impact of the draft policy and rules on mutuals, or relative to the impact of the
near-final policy and rules on other PRA-authorised firms.

Structure of the policy statement

1.22 This near-final PS is structured into the following chapters. The near-final rules
and related policy material are included in the relevant appendices.

• Chapter 2 – Credit risk – standardised approach

• Chapter 3 – Credit risk – internal ratings based approach
• Chapter 4 – Credit risk mitigation
• Chapter 5 – Output floor
• Chapter 6 – Pillar 2
• Chapter 7 – Disclosure (Pillar 3)
• Chapter 8 – Reporting
• Chapter 9 – Interim Capital Regime

Accountability framework
1.23 The near-final policy and rules set out in this near-final PS have been
developed by the PRA in accordance with its statutory objectives and informed by
the regulatory principles and the matters to which it must have regard when making
policy and rules as set out in FSMA 2000. In CP16/22, the PRA set out details of the
applicable accountability framework in Appendix 6 – PRA statutory obligations and
provided its assessment of relevant considerations separately in each chapter. The
PRA has provided a summary of its updated overall assessment below, having
considered the consultation responses. More detailed, updated explanations are
included in the relevant chapters of this near-final PS, where the PRA has made
changes to the draft policy.

1.24 The PRA considers that the near-final policy and rules in this near-final PS will
advance its primary objective to promote the safety and soundness of the firms it
regulates. They address shortcomings in the RWA framework revealed by the global
financial crisis, including inadequate Pillar 1 capital requirements in some areas and
a ‘worrying degree of variability’ in the calculation of risk weights noted by the Basel
Committee on Banking Supervision (BCBS) in December 2017.13 Addressing these
shortcomings is important to underpin confidence that firms are adequately

13 BCBS – Basel III: Finalising post-crisis reforms.

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capitalised, given the risks to which they are exposed, which in turn supports
financial stability. In particular, the near-final policy and rules will advance the PRA’s
primary objective by:

• simplifying and reducing the range of approaches available for RWA

calculations, thereby promoting the consistent application of approaches
across firms through simpler and clearer requirements;
• improving the risk-sensitivity of the credit risk SA, resulting in RWAs that are
more reflective of risk;
• constraining the use of the credit risk IRB approach in areas where RWAs
cannot be modelled in a robust and prudent manner (such as for central
government and central bank exposures). This will reduce unwarranted RWA
variability across firms; and
• introducing the output floor, limiting how low internally modelled RWAs can fall
below those produced under the revised SAs and thereby reducing excessive
variability and cyclicality in RWAs.

1.25 The near-final policy and rules within this near-final PS will also advance the
PRA’s secondary objective to facilitate effective competition by:

• increasing risk-sensitivity under the credit risk SA, which aims to ensure firms
using the SA calculate RWAs that are better aligned to the risk of their
exposures and to those calculated by firms with permission to apply the IRB
approach;
• requiring more robust and prudent modelling practices within the IRB
approach, and limiting the reduction in RWAs that can be achieved through its
use, thereby reducing the potential competitive advantage that firms using the
IRB approach currently have over firms using the SA;
• promoting a more consistent and level playing field by introducing an output
floor, which would ensure RWAs for firms with IM permissions do not fall
below a defined percentage of the RWAs calculated under the SAs; and
• reducing barriers to entry for SA firms to use the IRB approach, for example
by permitting the roll-out of the IRB approach by individual roll-out classes in
certain circumstances, rather than requiring roll-out across all credit risk
exposures, and by changing the approval threshold for new IRB permissions
to ‘material compliance’ from ‘full compliance’.

1.26 Changes to the PRA’s accountability framework under the FSMA 2023 to add
international competitiveness and growth (subject to alignment with international
Bank of England | Prudential Regulation Authority Page 15

standards) as a secondary objective, do not formally apply to the near-final policy

and rules set out in this near-final PS. These provisions are disapplied by regulation
4 of the FMSA 2023 (Commencement No. 2 and Transitional Provisions)
Regulations 2023 as amended by regulation 18 of the FSMA 2023
(Commencement No. 4 and Transitional and Saving Provisions) (Amendment)
Regulations 2023.

1.27 Nevertheless, as the PRA noted in CP16/22 and PS17/23, international

competitiveness and growth considerations, and alignment with international
standards, are factors the PRA must ‘have regard’ to. These factors, alongside the
relative standing of the UK as a place for internationally active firms to operate, were
strongly considered by the PRA in developing the near-final policy and rules on the
Basel 3.1 standards.

1.28 In considering these factors and the characteristics of the UK’s financial system,
the proposals in CP16/22 included some adjustments relative to international
standards to support the international competitiveness of the UK, while advancing
the PRA’s primary objective. For the elements of CP16/22 relevant to this PS, these
included, for example, targeted measures to address concerns with respect to the
risk-weighting of exposures to unrated corporates under the credit risk SA.

1.29 The cumulative changes to the draft policy in this near-final PS, informed by
evidence submitted during the consultation process, represents a significant further
step in facilitating growth and competitiveness. This includes, for example, changes
to CFs to align more closely with those of other jurisdictions. And with the
introduction of the SME lending adjustment and the infrastructure lending
adjustment, such that the removal of the infrastructure and SME support factors
does not result in an increase in overall capital requirements for infrastructure and
SME lending, the near-final package represents a material change from the draft
policy which will provide stability and certainty for firms to continue to lend to those
important sectors of the UK economy.

1.30 In PS17/23, the PRA estimated, based on data submitted by firms, that the
package of policies to implement Basel 3.1, as set out in CP16/22, would result in a
3.2% increase in Tier 1 capital requirements for major UK firms at the end of the
transitional period on 1 January 2030. This estimate took into account the policies
within CP16/22 and the PRA’s general principle that it would not require firms to
calculate capital requirements for the same risks under both the Pillar 1 and Pillar 2
Bank of England | Prudential Regulation Authority Page 16

frameworks. Both of these considerations decreased the estimated impact.14 It did

not take into account the changes in either PS17/23 or this near-final PS relative to
CP16/22. Those changes will further reduce the expected impact on capital
requirements of Basel 3.1 implementation. The PRA now estimates that the Tier 1
capital requirements for major UK banks in aggregate are likely to increase by less
than 1% by 1 January 2030. By comparison, the European Banking Authority (EBA)
has estimated the latest EU proposals would increase Tier 1 minimum capital
requirements for EU firms by 9.9% when fully phased-in, and by 5.6% while EU-
specific transitional arrangements are in place.15 US regulatory agencies are in the
process of adjusting their original proposals and intend to publish the revised
proposals for re-consultation alongside proposed changes to the globally systemic
important bank (G-SIBs) surcharge. Taken together, regulatory agencies estimate
these proposals would lead to a 9% increase in CET1 capital requirements for G-
SIBs. For other large banks that are not G-SIBs, the new proposals would result in
an estimated increase of 3.5-4.5%.16

1.31 The PRA considers that the near-final policy and rules still align with
international standards, including by removing pre-existing deviations. As set out in
PS17/23, alignment with international standards supports the UK’s international
competitiveness, including the relative standing of the UK as a global financial
centre, by:

• strengthening key stakeholders’ confidence in the UK banking system, by

addressing widespread and long-standing concerns around the credibility of
the calculation of RWAs;
• assuring regulators in other jurisdictions of UK authorities’ commitment to
robust standards, which allows for deep interconnections between the
financial systems of their jurisdictions and the UK;
• minimising operational complexities for firms that operate across multiple
jurisdictions; and
• providing stability and predictability to firms and other stakeholders through
the implementation of internationally aligned standards. This promotes a high-

14 The PRA outlined this principle in chapter 10 in CP16/22, chapter 6 in PS17/23, and Chapter 6 –
Pillar 2 in this near-final PS.
15 European Banking Authority, September 2023, Basel III monitoring report, Annex – analysis of

EU specific adjustments.
16 Next Steps on Capital – Speech by Michael Barr, Vice Chair for Supervision, Federal Reserve

Bank, 10 September 2024

Bank of England | Prudential Regulation Authority Page 17

trust environment in the UK, where firms and stakeholders can confidently
conduct their business over the medium term.

1.32 By delivering a package that includes evidence-based adjustments to reflect the

UK’s financial system, but remains aligned with international standards, the PRA
considers that the near-final rules will both support competitiveness and facilitate the
flow of capital within the UK banking system. A vibrant banking system in turn
underpins core economic activities in the UK and supports a healthy and growing
domestic economy. Consumers and businesses can borrow, invest, and manage risk
with confidence that individual institutions within the sector are sufficiently robust to
withstand economic shocks and can therefore maintain lending to the real economy
during downturns.

1.33 The PRA has included in this near-final PS a summary of the purpose of the
proposed rules (set out in Appendix 3), a statement identifying CRR restatement
provisions (set out in Appendix 5), and a statement identifying corresponding CRR
rules (set out in Appendix 4).

Interactions with other frameworks

Leverage ratio
1.34 Effective as of 1 January 2022, following the 2021 Financial Policy Committee
(FPC) and PRA review, the PRA implemented most of the changes to the calculation
of the leverage exposure measure17 that were made to international standards in the
process of finalising Basel 3.1. However, some of the changes to those international
standards were not implemented at that time as they related to changes to the credit
risk SA in the risk-weighted capital framework set out in this near-final PS. While the
PRA is not including policy with respect to the leverage ratio requirement in this
near-final PS, the changes to the treatment of off-balance sheet items (ie CFs) in
Chapter 2 – Credit risk – standardised approach will flow through to the leverage
framework.

17 The denominator of the leverage ratio which is defined as the ratio of capital to exposures.
Bank of England | Prudential Regulation Authority Page 18

Large exposures
1.35 The large exposure requirements in the CRR have already been transferred to
PRA rules and amended to implement the Basel III standards. However, the Basel
3.1-related large exposure standards were not implemented at that time because
they depend on changes to the credit risk SA in the risk-weighted capital framework
set out in this near-final PS. The PRA is not including changes to the large exposure
requirement in this near-final PS, however changes to prudential standards will have
a consequential impact on the large exposure requirements. For example, CRM
techniques set out in Chapter 4 – Credit risk mitigation for calculating capital
requirements will also be used for calculating net large exposures, subject to the
broader conditions in the large exposure requirements.

Liquidity risk
1.36 Effective as of 1 January 2022, the PRA implemented the Basel III net stable
funding ratio (NSFR) standard in PRA rules, and it transferred the BCBS liquidity
coverage ratio (LCR) standard into PRA rules. The Basel 3.1 standards did not make
amendments to either liquidity standard. Where relevant, however, the changes to
prudential standards set out in this near-final PS will automatically flow through to the
LCR and NSFR, including in relation to risk weights for mortgage loans under the
credit risk SA.

Stress testing
1.37 The PRA buffer (also referred to as Pillar 2B) is an amount of capital firms
should maintain in addition to their total capital requirement and the combined buffer.
The PRA buffer absorbs losses that may arise under a severe stress scenario, while
avoiding duplication with the combined buffers. Its size is informed by a range of
factors including the results of relevant stress-testing, an assessment of whether a
firm has significant risk management and governance weaknesses, and supervisory
judgement. A number of measures in the PRA’s near-final rules, including
transitional arrangements, the more risk-sensitive credit risk SA, and the output floor,
may increase complexities in assessing how RWAs may evolve under a severe
stress scenario for some UK firms. This, in turn, could impact the size of the PRA
buffer.

1.38 The PRA acknowledges the interaction between Basel 3.1 and dynamics in
stress. The PRA will provide firms with more guidance in due course on what to
Bank of England | Prudential Regulation Authority Page 19

assume for Basel 3.1 in forming their stress test projections as part of the next
concurrent exercise involving firm submissions of stressed projections.

Implementation and next steps

1.39 The policy material in this near-final PS is published as near-final. The PRA
does not intend to change the policy or make substantive alterations to the
instruments before the making of the final policy material.

1.40 The PRA intends to publish the final rule instruments, technical standards
instrument and policy in a single, final PS covering the entire Basel 3.1 package,
once HMT has made commencement regulations to revoke the relevant parts of the
CRR that the final PRA rules will replace. The PRA has also published supporting
materials relating to new or revised Authorisations processes.

1.41 In CP16/22, the PRA consulted on an implementation date of 1 January 2025,

with a five-year transitional period. In PS17/23, the PRA took into account feedback
from firms on the need for sufficient time to robustly implement the Basel 3.1
standards and the latest information at that time on the implementation timelines of
other major jurisdictions, and moved the proposed implementation date for the Basel
3.1 standards back by six months to 1 July 2025 with a 4.5 year transitional period.

1.42 Since the publication of PS17/23, the PRA has continued to monitor the
implementation timelines of other jurisdictions and to assess the adequacy of the
period between publication of PRA rules and their implementation. Having
considered these issues, the PRA has decided to move the implementation date for
the Basel 3.1 standards by a further six months to 1 January 2026 with a transitional
period of 4 years to ensure full implementation by 1 January 2030 in line with the
proposals originally set out in CP16/22.18

18 Appendix 2 near-final PRA Rulebook: CRR Firms: (CRR) Instrument [2024], includes the 4-year
transitional arrangements beginning 1 January 2026 and ending 31 December 2029 for the following
areas:
- the output floor (Required Level of Own Funds (CRR) Part);
- the treatment of equity exposures under the credit risk SA (Credit Risk: General Provisions (CRR)
Part);
- the treatment of equity exposures under the credit risk IRB approach (Credit Risk: General
Provisions (CRR) Part); and
- the treatment of previously exempt legacy trades under the CVA framework (Credit Valuation
Adjustment Risk Part) and the corresponding value of alpha (Counterparty Credit Risk (CRR) Part).
Bank of England | Prudential Regulation Authority Page 20

1.43 Any references related to the UK’s membership of the EU in the SSs and
Statement of policy (SoP) covered by the near-final policy in this near-final PS will be
updated as part of the final PS to reflect the UK’s withdrawal from the EU. Unless
otherwise stated, any remaining references to EU or EU-derived legislation are to the
version of that legislation which forms part of assimilated law in the UK.19

Appendix 2 also includes updated near-final rules delaying the application of the profit and loss
attribution tests (PLAT) for the purposes of calculating market risk capital requirements (but not for
reporting on them) until one year after the new implementation date for the internal model approach
(IMA) requirements (Market Risk: Internal Model Approach (CRR)).
19 For further information please see: Transitioning to post-exit rules and standards.
Bank of England | Prudential Regulation Authority Page 21

2: Credit risk – standardised approach

Introduction

2.1 This chapter provides feedback to responses to Chapter 3 of consultation paper

(CP)16/22 – Implementation of the Basel 3.1 standards, which set out proposals
to change the standardised approach (SA), for calculating risk-weighted assets
(RWAs) for credit risk in the Capital Requirements Regulation (CRR) and the
Prudential Regulation Authority’s (PRA) expectations, in response to the Basel 3.1
standards. This chapter also sets out the PRA’s near-final policy on the SA for credit
risk following the consultation.

2.2 In CP16/22, the PRA proposed to introduce changes to enhance the risk
sensitivity and robustness of the SA, including:

• the introduction of a more structured and granular exposure allocation and

increased risk sensitivity of the treatment for real estate lending;
• a more risk-sensitive treatment for exposures to unrated corporates;
• changes to deliver a simpler, more risk-sensitive and prudent approach for
risk-weighting infrastructure lending, including the introduction of specific
treatments for ‘specialised lending’ and the removal of the infrastructure
support factor;
• changes to deliver a simpler, more transparent and prudent mechanism for
determining risk weights for lending to small and medium-sized enterprises
(SMEs), including the removal of the SME support factor;
• the introduction of a more risk-sensitive approach to risk-weighting equity
exposures, including a prudent treatment for higher-risk ‘speculative unlisted
equity’;
• changes to off-balance sheet conversion factors (CFs) aligned to local UK
market conditions; and
• changes to reduce mechanistic reliance on external ratings and the
introduction of new due diligence requirements.
Bank of England | Prudential Regulation Authority Page 22

2.3 The PRA received 87 responses to its proposals on the SA for credit risk.
Responses covered a wide range of the PRA’s proposals. Comments focused
particularly on the following points:

• the proposed treatment of unrated corporate exposures;

• the proposals to remove the SME support factor and infrastructure support
factor and other aspects of SME lending;
• the proposed changes to the treatment of real estate exposures (including the
proposed risk weight treatment and the proposal to require that the value of
the property be the value at origination); and
• the proposals to change the CFs for certain types of off-balance sheet items.

2.4 Having considered the responses to the consultation, the PRA has decided to
make significant amendments to the draft rules and draft supervisory statements
(SSs) in response to the feedback and evidence provided by respondents. This
chapter describes the comments and amendments that the PRA considers most
material. As described in Chapter 1 – Overview, the PRA has also made a number of
less substantive amendments and clarifications to the draft rules, which are not
described in this chapter. These amendments are reflected in the near-final PRA
Rulebook: CRR Firms: (CRR) Instrument [2024] in Appendix 2. Please refer to the
document titled Comparison of Draft PRA Rulebook (CRR) Instrument [2023]
against Near-final PRA Rulebook: CRR Firms (CRR) Instrument [2024], which
contains a comparison of the near-final rules with the draft rules as set out in
CP16/22 for ease of identifying all of the changes made.

2.5 The appendices to this near-final policy statement (PS) contain the PRA’s near-
final policy, which will:

• introduce a new Credit Risk: Standardised Approach (CRR) Part of the PRA
Rulebook (Appendix 2) relating to the SA approach to replace CRR articles
that HM Treasury (HMT) plans to revoke;
• introduce a new Credit Risk: General Provisions (CRR) Part of the PRA
Rulebook (Appendix 2) relating to general provisions for credit risk to replace
CRR articles that HMT plans to revoke;
• amend the existing Credit Risk Part of the PRA Rulebook (Appendix 2);
• remove the existing Standardised Approach and Internal Ratings Based
Approach to Credit Risk (CRR) Part of the PRA Rulebook;
Bank of England | Prudential Regulation Authority Page 23

• amend SS10/13 – Credit risk standardised approach (Appendix 6), SS13/16 –

Underwriting standards for buy-to-let mortgage contracts (Appendix 7) and
SS17/13 – Credit risk mitigation (Appendix 10); and
• introduce a new SS3/24 – Credit risk definition of default (Appendix 8).

2.6 The sections below have been structured broadly along the same lines as
chapter 3 of CP16/22, covering the main areas where the PRA received comments
from respondents as follows:

• exposure class allocation;

• external credit ratings and due diligence;
• exposure values for off-balance sheet items;
• exposures to central governments, central banks, regional governments, local
authorities, public sector entities (PSEs), and multilateral development banks
(MDBs);
• exposures to institutions and covered bonds;
• exposures to corporates and specialised lending;
• exposures to individuals and SMEs;
• real estate exposures; and
• capital instruments, defaulted exposures, and high-risk items.

2.7 Unless specified otherwise, the near-final rules and near-final amendments to
SSs are consistent with those in CP16/22 and therefore the PRA considers its
analysis of its objectives and ‘have regards’ in CP16/22 with respect to the areas
mentioned in the paragraph above remains appropriate.

Exposure class allocation

2.8 The PRA proposed an exposure class hierarchy for reporting purposes in
chapter 12 of CP16/22, but it did not propose to introduce an explicit provision in its
draft rules on how firms should allocate exposures to the appropriate exposure class.

2.9 The PRA received one response to this proposal, requesting more clarity on the
correct allocation of exposures among exposure classes.

2.10 Having considered the response, the PRA has amended its draft rules to
include an exposure class hierarchy to promote a consistent allocation across firms.
The near-final rules set out the criteria to determine how exposures will be assigned
to an exposure class. Where an exposure meets the criteria for more than one
Bank of England | Prudential Regulation Authority Page 24

exposure class, it will be assigned to an exposure class, in the following order of

precedence:

• securitisation positions;
• exposures in the form of units or shares in collective investment undertaking
(‘CIUs’);
• subordinated debt, equity and other own funds instruments;
• exposures associated with particularly high risk;
• exposures in default;
• exposures in the form of eligible covered bonds;
• real estate exposures;
• exposures to international organisations;
• exposures to MDBs;
• exposures to institutions;
• exposures to central governments or central banks;
• exposures to regional governments or local authorities;
• exposures to public sector entities;
• retail exposures;
• exposures to corporates; and
• other items.

2.11 In the near-final rules, the PRA has decided to make the following amendments
to the relative precedence of each exposure class that was proposed for reporting
purposes:

• move the ‘units or shares in CIUs’ exposure class up the hierarchy to reflect
the intent of the near-final rules in relation to this exposure class;
• clarify that firms must allocate exposures to the ‘subordinated debt, equity and
other own funds instruments’ exposure class ahead of the ‘exposures
associated with particularly high risk’ exposure class. The PRA considers that
this appropriately reflects the relative risk weight treatments for each exposure
class in the near-final rules;
• remove the ‘institutions and corporates with a short-term credit assessment’
exposure class as these exposures will be treated under the institutions
exposure class or corporate exposure class, as appropriate;
• add exposure classes that were omitted from the hierarchy proposed for
reporting purposes to clarify their position in the exposure class hierarchy; and
• move the ‘other items’ exposure class to the bottom of the hierarchy.
Bank of England | Prudential Regulation Authority Page 25

PRA objectives analysis

2.12 The PRA considers that the introduction of an exposure class hierarchy in its
near-final rules will advance its primary objective to promote the safety and
soundness of regulated firms by improving the consistency of firms’ allocation of
exposures, resulting in capital requirements that appropriately reflect the risk of
exposures.

2.13 The PRA also considers that its decision to introduce an exposure class
hierarchy in its near-final rules will advance its secondary objective to facilitate
effective competition. Providing clarity and certainty on the approach to exposure
class allocation will result in a more consistent calculation of capital requirements
across firms.

‘Have regards’ analysis

2.14 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers that the hierarchy for
exposure class allocation in the near-final rules is aligned with the Basel 3.1
standards.

External credit ratings and due diligence

2.15 The PRA proposed a number of changes to enhance the robustness of the use
of external credit ratings and introduce due diligence requirements. The PRA
received 21 responses to this section of CP16/22. The substantive issues raised by
respondents are set out below.

Nomination of external credit assessment institutions

2.16 The PRA proposed that firms should use credit ratings of their nominated
external credit assessment institutions (ECAIs) consistently for all types of
exposures, for risk management and risk-weighting purposes. The PRA received 11
responses to its proposals:

• four respondents supported the proposals;

• one respondent requested that the PRA clarify the interaction between its
proposed requirements and the high-level requirements for using the internal
Bank of England | Prudential Regulation Authority Page 26

ratings based (IRB) approach, which state that internal ratings should play an
essential role in the risk management process;
• one respondent did not support the proposal to require nominated ECAIs to
be used consistently across exposure classes, arguing the requirements
would reduce competition between ECAIs by favouring those with larger
ratings coverage; and
• two respondents requested that the PRA clarify the procedure and timeline for
firms to change their nominated ECAIs, with one arguing that firms needed
assurance that they could change nominated ECAIs easily.

2.17 Having considered the responses, the PRA has decided not to amend its draft
rules in relation to the process by which firms nominate ECAIs. However, it has
amended its draft rules to clarify that the nomination of ECAIs for risk weighting
purposes should be consistent with the firm’s use of ECAIs for general risk
management purposes. The near-final rules do not restrict or place additional
requirements on the use of ECAIs for risk management purposes and broader
business decisions (including the high-level requirements for using the IRB
approach). In particular, if a firm does not use an ECAI for its risk management
purposes or broader business decisions, it will not be required to do so under the
near-final rules and the firm will be free to use multiple ECAIs (beyond those
nominated for risk-weighting purposes) for risk management purposes. However, a
firm will not be able to ‘cherry-pick’ a different ECAI for risk-weighting purposes from
one of those it already relies on for general risk management purposes.

2.18 The PRA does not consider that its near-final rules disproportionately favour the
use of ECAIs with wider ratings coverage, given firms can nominate multiple ECAIs.
Where two credit ratings are available for a particular exposure from nominated
ECAIs, the one resulting in the higher risk weight will be assigned. Where more than
two credit ratings are available from nominated ECAIs, the two that would produce
the lowest risk weights will be referred to and the higher risk weight of the two shall
be assigned. This reduces the potential for firms to ‘cherry-pick’ their use of ECAI
ratings to lower RWAs without inappropriately penalising firms for nominating
multiple ECAIs (firms are not required to use the most conservative rating where
more than two ratings from nominated ECAIs are available).

2.19 The PRA also considers that its near-final rules provide sufficient clarity on the
process by which firms can nominate ECAIs. The PRA’s near-final rules do not
prohibit firms revoking such a nomination, provided firms are not seeking to change
ECAIs for the purpose of reducing capital requirements.
Bank of England | Prudential Regulation Authority Page 27

Credit ratings for institutions

2.20 The PRA proposed to align with the Basel 3.1 standards and not permit the use
of credit ratings for institutions that incorporate assumptions of implicit government
support. The PRA received the following responses in relation to these proposals:

• one respondent argued that the PRA should apply a five-year transitional
period where firms could continue to use credit ratings that consider implicit
government support, arguing this would align with a national discretion in the
Basel 3.1 standards and the approach taken by other jurisdictions;
• one respondent requested that the PRA clarify if firms could use a credit rating
that considers implicit government support in its methodology, if the ECAI has
assigned no benefit from such implicit support in determining the credit rating;
• one respondent requested that the PRA clarify if a rating for an institution that
assumes no implicit government support should always be used instead of an
issue-specific rating that assumes implicit government support; and
• one respondent requested that the PRA clarify the definition of implicit support
and how it defined a publicly-owned bank.

2.21 Having considered the responses, the PRA has decided to maintain its overall
proposal that firms are not permitted to use credit ratings that incorporate
assumptions of implicit government support, and to not introduce any transitional
arrangements. The PRA considers this to be a proportionate approach that
advances its primary objective and notes that a number of ECAIs have already
launched, or announced their intention to launch, credit ratings that do not
incorporate assumptions of implicit government support.

2.22 The PRA has clarified in its near-final amendments to SS10/13 (Appendix 6),
that firms may use credit ratings which consider implicit government support in their
methodologies, provided the ECAI’s credit assessment is clear that, while the
existence of implicit government support has been considered, no benefit for implicit
government support has been included in the credit assessment. The PRA expects
firms to continue to monitor whether such ratings assign any benefit for implicit
government support as part of their due diligence.

2.23 The PRA acknowledges that there could be cases where prohibiting the use of
a directly applicable issue-specific credit rating that considers implicit government
support results in an inappropriate reduction in the risk weight assigned to an
exposure. It has therefore decided to amend its draft rules to clarify that if all
Bank of England | Prudential Regulation Authority Page 28

available issue-specific credit ratings incorporate assumptions of implicit government

support then firms must use the issue-specific credit rating if it would lead to a higher
risk weight than if it were disregarded. This will ensure that risk weights are not
lowered due to use of ratings that assume implicit government support, while still
appropriately reflecting issue-specific risks.

2.24 Regarding the definition of implicit government support, the PRA considers that
its draft rules are sufficiently clear and so has not made any amendments other than
those set out above. Aligning the level of detail prescribed in the near-final rules with
that in the Basel 3.1 standards and in the implementation of these standards by
other jurisdictions will support UK firms having access to a wide range of credit
ratings. However, the PRA will consider providing further guidance if evidence
emerges of inconsistent application between firms.

External credit assessment institution mapping

2.25 The PRA proposed not to amend the mapping of external credit ratings to the
credit quality steps (CQS) set out in Commission Implementing Regulation (EU)
2016/1799 of 7 October 2016.

2.26 Two respondents requested that the PRA update the approach to mapping
external credit ratings to CQS, arguing that the existing UK approach is difficult to
navigate as it is no longer aligned with the EU. Having considered the responses, the
PRA has decided not to amend the mapping of external credit ratings as part of this
near-final PS. However, the PRA intends to consult on its policy on the allocation of
credit assessments to an objective scale of CQS in H2 2024 within a consultation on
proposed changes to the CRR for banks, building societies and investment firms.

Other issues relating to external credit ratings

2.27 Alongside considering the responses to its proposals on the use of external
credit ratings, the PRA has decided to make minor amendments to its draft rules to
clarify when credit ratings that are not directly applicable or issue-specific are to be
used, and when short-term credit ratings are to be used. The PRA considers that this
will support consistent application of its near-final rules across firms.

Due diligence
2.28 The PRA proposed to introduce due diligence requirements comprising two
elements: (i) a requirement for monitoring counterparties; and (ii) for externally-rated
exposures, a requirement to increase risk weights in cases where a firm’s due
Bank of England | Prudential Regulation Authority Page 29

diligence indicates that an exposure has higher credit risk than the external credit
rating would imply.

2.29 The PRA received 18 responses to its proposals. Six respondents requested
that the PRA clarify aspects of the proposed due diligence requirements, with five
respondents arguing this was necessary to ensure they were proportionate for
smaller firms. In particular, two respondents requested that the PRA clarify the
factors that should determine the sophistication of due diligence assessments and
one respondent requested further guidance on how and when firms would be
expected to increase risk weights in cases where a firm’s due diligence indicates that
an exposure has higher credit risk than the external credit rating would imply.

2.30 Having considered the responses, the PRA has decided to maintain its
proposed approach. Firms are currently required to understand and manage their
risks under the existing Fundamental Rules and Internal Capital Adequacy
Assessment Process (ICAAP) Parts of the PRA Rulebook, so the PRA expects firms
to already have a good understanding of how to monitor counterparties. The PRA
has also decided not to provide further guidance at this time on the proposed
requirement to increase risk weights in cases where a firm’s due diligence indicates
that an exposure has higher credit risk than the external credit rating would imply,
but may consider providing such guidance in the future if evidence emerges of
inconsistent application between firms.

2.31 Six respondents also argued that Small Domestic Deposit Takers (SDDTs)
should be excluded from the due diligence requirements and four respondents
argued smaller firms were not able to better assess credit risk than their nominated
ECAI. The SA for SDDTs is outside the scope of this near-final PS. However, as set
out in CP7/24 – The Strong and Simple Framework: The simplified capital
regime for Small Domestic Deposit Takers (SDDTs), the PRA is proposing to
exempt SDDTs from due diligence requirements under the regime that applies to
SDDTs.

Other issues relating to due diligence

2.32 Other substantive responses to this section of CP16/22 focused on the

following issues:

• Due diligence requirements for MDBs: one respondent requested that the
PRA consider excluding MDBs that receive a 0% risk weight from due
Bank of England | Prudential Regulation Authority Page 30

diligence requirements, consistent with the exemption for exposures to PSEs,

central banks and central governments. Having considered this response, the
PRA has decided to amend its draft rules to exempt exposures to these MDBs
from the proposed due diligence requirements. The PRA has also decided to
amend its draft rules to exempt exposures to international organisations
named in Article 118 of the near-final Credit Risk: Standardised Approach
(CRR) Part from the proposed due diligence requirements. These
amendments will provide consistency between counterparties that share
similar risk profiles and result in more proportionate requirements. The PRA
still expects firms to monitor their counterparties in order to understand and
manage their risks.
• Due diligence requirements for exposures subject to SA for firms with
IRB permissions: three respondents requested that the PRA clarify whether
existing IRB risk management processes could be used to conduct due
diligence on exposures risk weighted under the SA through permanent partial
use or roll-out. The PRA clarifies that, under its near-final rules, for all
exposures to which the SA is applied, due diligence processes should be
used that meet the requirements set out in Article 110A of the near-final Credit
Risk: Standardised Approach (CRR) Part. Where a firm applies a common
risk management approach to a portfolio consisting of exposures, some of
which are subject to the SA and some of which are subject to the IRB
approach, the PRA considers it likely that this approach would meet the due
diligence requirement to monitor counterparties for exposures on the SA.
However, firms with IRB permissions will still be required to perform additional
due diligence for exposures on the SA to assess whether an externally-rated
exposure has a higher credit risk than the external credit rating would imply.
The PRA considers that it would be inconsistent with its secondary objective
to set different requirements for firms with IRB permissions compared with
firms only using the SA in respect of exposures to which the SA is applied.
• Due diligence requirements when calculating the output floor: one
respondent requested that the PRA clarify that existing IRB processes can be
used to meet due diligence requirements for the purpose of calculating the
output floor. For the purpose of calculating the output floor, the PRA considers
that firms with IRB permissions will generally meet the monitoring
counterparties due diligence requirements for exposures risk-weighted under
the IRB approach as a result of their application of IRB rules. They will also,
for exposures subject to the IRB approach, be able to use approved IRB
Bank of England | Prudential Regulation Authority Page 31

models to carry out the assessment of whether an ECAI’s credit rating results
in an appropriate SA risk weight for the purpose of calculating the output floor.

PRA objectives and ‘have regards’ analysis

2.33 The near-final policy on the use of external credit ratings and due diligence
requirements under the SA approach is materially aligned with the proposals in
CP16/22 and the PRA therefore considers its analysis of its objectives and ‘have
regards’ in CP16/22 remains appropriate.

Exposure values for off-balance sheet items

2.34 The PRA proposed a number of changes relating to off-balance sheet items,
including:

• the introduction of a new definition of ‘commitment’; and

• a change to the applicable CF for some issued off-balance sheet items and
commitments.

2.35 The applicable CF will depend on the approach used to calculate RWAs for
credit risk. The PRA’s decisions in this section are relevant to firms using the SA, the
foundation IRB (FIRB) approach and the slotting approach, as well as the advanced
IRB (AIRB) approach where exposure at default (EAD) modelling will be prohibited
(see Chapter 3 – Credit risk – internal ratings based approach, EAD estimation).
Where EAD can be modelled, the CFs set out in this section will also affect the EAD
input floors.

2.36 The PRA received 31 responses to this section of CP16/22. The substantive
issues raised by respondents are set out below.

Definition of ‘commitment’ for off-balance sheet items

2.37 The PRA proposed to define a commitment as ‘any off-balance sheet

contractual arrangement that has been offered by the institution and accepted by the
Bank of England | Prudential Regulation Authority Page 32

obligor, including to extend credit, purchase assets or issue off-balance sheet items
(but which is not itself an issued off-balance sheet item)’.20

2.38 The PRA received 14 responses on the proposed definition and related
exemptions to it for certain contractual arrangements:

• one respondents supported the proposed definition of commitment;

• four respondents requested that the PRA clarify the proposed treatment of
unadvised limits within the definition of commitment. Of these, three argued
that the proposed definition of ‘conversion factor’ set out in HMT’s
consultation21 should align with the proposed definition of commitment;
• six respondents argued that the PRA should exempt certain arrangements to
corporates and SMEs from the definition of commitment, noting that this
would align with a national discretion in the Basel 3.1 standards;22
• one respondent requested that, if the PRA did not exercise the national
discretion, the PRA should consider only applying the definition of
commitment and applicable conversion factors to exposures that were
originated post the Basel 3.1 implementation date;
• one respondent argued that firms should be able to delay the point at which
they are subject to capital requirements for facilities that remain within the
control of the firm for each drawing, and three respondents argued that the
PRA should permit firms to delay the recognition of capitalisation for facilities
that are subject to mandatory regulatory approvals, for example, in merger
and acquisition (M&A) transactions, due to the need for approval from
competition regulators;
• two respondents argued for Bankers Association for Finance and Trade
Master Risk Participation Agreements (MRPAs) to be exempted from the
definition of commitment; and
• six respondents suggested that there should be a consistent definition of
commitment for the SA and the IRB approach.

2.39 Having considered the responses, the PRA has decided to maintain its
proposed definition of commitment. However, it has clarified in its near-final

20 This includes but is not limited to any such arrangement that may be: (1) unconditionally cancelled
by the institution at any time without prior notice to the obligor; or (2) cancelled by the institution if the
obligor fails to meet conditions set out in the relevant agreement, including conditions that must be
met by the obligor prior to any initial or subsequent drawdown under the arrangement.
21 In November 2022, HMT consulted on the legislative changes necessary to facilitate the PRA's

implementation of the Basel 3.1 standards.

22 Basel CRE 20.94, footnote 43. CRE20 - Standardised approach: individual exposures (bis.org).
Bank of England | Prudential Regulation Authority Page 33

amendments to SS10/13 that firms are only expected to apply CFs to advised limits
that have been contractually agreed between the firm and the obligor when
calculating capital requirements for commitments under the SA. The PRA notes that
HMT has stated it will update the definition of CF, if it is to remain in legislation at
the point the PRA’s final rules take effect (such that the amended definition also
takes effect at this point).23 This would align with the PRA’s near-final amendments
to SS10/13, and would be consistent across the SA and the IRB approach.

2.40 As part of its decision to maintain the proposed definition of commitment, the
PRA has decided to maintain its proposal not to exercise the national discretion in
the Basel 3.1 standards to exempt certain arrangements in relation to corporates and
SMEs. The PRA acknowledges that such arrangements may differ from other types
of unconditionally cancellable commitments (UCCs) due to the need for a further
credit assessment before the obligor can execute a drawdown. However, the PRA
did not receive any quantitative evidence that such arrangements have a different
risk profile from other unconditionally cancellable commitments and considers that
applying zero capital requirements for such arrangements would be inconsistent with
their risk. Firms are unable to perfectly predict the likelihood of obligor default when
further credit checks are undertaken so there is a non-zero risk that an obligor
passes such checks before defaulting after the commitment has been drawn down.
Firms may also have an incentive to extend credit, regardless of the obligor’s
creditworthiness, for reputational or business reasons.

2.41 The PRA has decided not to exempt any exposures from, or introduce any
transitional arrangements in relation to, the proposed definition of commitment. As
set out above, the PRA considers that applying zero capital requirements for such
arrangements would be inconsistent with their risk, and therefore, considers that the
definition of commitment should be implemented on 1 January 2026.

2.42 The PRA has also decided not to delay the point of recognition of capitalisation
for facilities that are subject to mandatory regulatory approvals or exempt MRPAs
from the definition of commitment because there is a non-zero risk of such
commitments moving on-balance sheet.

23As part of work to complete revocation of the rest of the CRR, the PRA is working with HMT to
assess which definitions from the CRR will need to remain in legislation and which definitions should
be revoked to be replaced by PRA rules, and to determine the timetable to complete this work.
Bank of England | Prudential Regulation Authority Page 34

Conversion factors for commitments

Conversion factors for UCCs

2.43 The PRA proposed to align with the Basel 3.1 standards and increase the CF
for UCCs from 0% under the current requirements to 10%, reflecting the non-zero
risk that these commitments will move onto the balance sheet.

2.44 One respondent did not support the PRA’s proposal, arguing that the legal
ability to cancel such commitments at any time and without notice warrants the
application of a 0% CF.

2.45 Ten respondents argued that the PRA should introduce transitional
arrangements to phase in the increase in the CF, with one respondent suggesting a
five-year transitional period and eight suggesting a longer-term transitional period
aligned with that which is expected to be introduced in the EU. Most respondents
argued that not introducing transitional arrangements would harm the UK’s relative
standing.

2.46 Having considered the responses, the PRA has decided to maintain its proposal
to introduce a 10% CF for UCCs because the available evidence suggests that
retaining the existing 0% CF would be inconsistent with the risk of such
arrangements and could result in imprudent outcomes. Even though a commitment
is unconditionally cancellable, firms sometimes fail to cancel a commitment and
allow obligors to continue to draw down on existing facilities for a variety of reasons,
including reputational or business reasons, which in turn prevents UCCs from being
riskless. This is in line with internal analysis conducted by the BCBS during its
development of the Basel 3.1 standards, and with the PRA’s assessment that there
is little empirical support for application of 0% CFs.

2.47 The PRA has also decided to maintain its proposal not to introduce a
transitional period for the introduction of the 10% CF for UCCs. The PRA
acknowledges that this may have a small negative impact on international
competitiveness for a limited period relative to the EU’s expected approach.
However, the PRA considers that, in order to advance its primary objective, it is
necessary to end the practice of zero capital requirements for UCCs without undue
delay.

Conversion factors for ‘other commitments’

Bank of England | Prudential Regulation Authority Page 35

2.48 The PRA proposed to set a 50% CF for ‘other commitments’. It considered that
the 40% CF in the Basel 3.1 standards was likely to be an under-estimation of the
risk of these commitments moving on balance sheet based on evidence set out in
the BCBS’s 2014 Consultation Paper and information available to it relating to
realised conversion rates for UK mortgage offers, which would typically be allocated
to the ‘other commitments’ category before the loan is drawn down.24

2.49 The PRA received a significant number of responses:

• three respondents opposed the proposed CF and suggested that the PRA
should align with other jurisdictions and the Basel 3.1 standards. Another four
respondents highlighted competitiveness concerns with the proposal. One
respondent argued that the increase in capital requirements, relative to the
CRR, for ‘other commitments’ that have a maturity up to and including one
year would be disproportionate to the risk;
• ten respondents did not oppose assigning a CF of 50% for UK residential
mortgage commitments; however, these respondents opposed assigning a
CF of 50% for non-UK residential mortgage commitments and wholesale
commitments. Two respondents argued that assigning a CF of 50% for UK
residential mortgage commitments and a CF of 40% for non-UK residential
mortgage commitments and wholesale commitments would be a more risk-
sensitive approach that would not be difficult to operationalise; and
• one respondent opposed the proposal to not consider maturity in the
determination of the CF.

2.50 Having considered the responses, including empirical evidence shared by

respondents during the consultation period, the PRA has decided to amend its
proposal. The near-final rules apply a 50% CF only to UK residential mortgage
commitments. A 40% CF will apply to the remaining types of ‘other commitments’.
The PRA considers that a 50% CF for UK residential mortgage commitments is
justified based on data from UK firms. However, the evidence for other types of
‘other commitments’ is more nuanced, making it appropriate to apply the lower 40%
CF prescribed in the Basel 3.1 standards.

24The BCBS analysis is referenced in the BCBS second consultative document standards:
Revisions to the Standardised Approach for credit risk under section 1.7: Off-balance sheet
exposures.
Bank of England | Prudential Regulation Authority Page 36

Other issues relating to commitments

2.51 Other substantive responses to this section of CP16/22 raised a range of

issues:

• Commitments with certain drawdown: four respondents requested that the

PRA clarify the concept and scope of ‘other commitments with certain
drawdown’. The PRA has amended its draft rules to require that a 100% CF is
applied to other commitments with similar economic substance to the types of
commitments otherwise listed as receiving a 100% CF in its near-final rules.
However, the PRA does not consider, in general, that real estate exposures
would be classified as having similar economic substance to the types of
commitments listed as receiving a 100% CF under its near-final rules.
• Commitment to issue off-balance sheet items: the PRA proposed that,
where a commitment is made to issue an off-balance sheet item, the lower of
the CF applicable to the commitment and the CF applicable to the issued off-
balance sheet item would apply. Three respondents argued that this approach
would not correctly reflect the interaction between the probability of the off-
balance sheet item being issued and the probability of it then moving on-
balance sheet. The PRA has decided to maintain its proposal. Attempting to
capture the probability of the off-balance sheet item being issued and then the
probability of it moving on-balance sheet in a more risk-sensitive way would
be challenging in practice and inconsistent with the degree of risk sensitivity
envisaged by the Basel 3.1 standards under the SA.
• Merchant acquiring activity: one respondent argued that the appropriate CF
for contingent liabilities arising from merchant acquiring activity should be
20%. As noted above, the PRA has amended its draft rules such that ‘other
commitments’ receive a 40% CF, and the PRA has decided not to make an
exception for merchant acquiring activity. The PRA considers that a 40% CF
more appropriately reflects the risk of such commitments than the 50% CF
proposed in CP16/22 and that respondents did not provide persuasive
evidence that a 20% CF would adequately reflect economic downturn
conditions. This is aligned with the Basel 3.1 standards and the approach
expected to be taken by other major jurisdictions.
• Scope of a commitment: one respondent requested that the PRA clarify
whether entire facility amounts will be subject to a CF, rather than just the
available or pledged amount. The PRA considers that, under its near-final
Bank of England | Prudential Regulation Authority Page 37

rules, the CFs will apply to the full advised limit contractually offered by the
institution and accepted by the obligor.
• Syndicated commitments: one respondent argued that the PRA should
provide additional clarity on the treatment of syndicated commitments. The
PRA considers its draft rules are clear and has decided not to make any
amendments in this respect. The amount of such commitments will be the full
amount that is contractually agreed between counterparties. The SA balances
risk sensitivity with simplicity and proportionality and the PRA did not receive
persuasive evidence to justify a bespoke treatment for syndicated
commitments.
• Transitional arrangements: one respondent argued that the PRA should
introduce transitional arrangements to smooth the increase in capital
requirements resulting from the introduction of the 50% CF for UK mortgage
commitments. The PRA does not expect that the stock of existing exposures
that will be impacted by this change is significant, and firms will have time to
adjust to the impact of this change on the flow of new lending. The PRA
considers that requiring the exposure value to be calculated in a prudent
manner from the date of implementation is proportionate given the expected
impact on capital requirements, and that it would not be appropriate to
introduce a transitional period in this circumstance.

Issued off-balance sheet items

Other transaction-related contingent items

2.52 The PRA proposed to align with the Basel 3.1 standards and assign a 50% CF
to other ‘transaction-related contingent items’, which includes guarantees,
warranties, and standby letters of credit that do not have the characteristics of credit
substitutes.

2.53 In addition, the PRA proposed to maintain the existing 20% CF for short-term
self-liquidating trade letters of credit (with a maturity of less than one year) and clarify
that a 50% CF would therefore only apply to self-liquidating trade letters of credit with
a maturity of greater than one year.

2.54 The PRA received ten responses that opposed the proposal to assign a 50%
CF to transaction-related contingent items. They argued that a 50% CF was not an
accurate reflection of the risk for such items and that empirical evidence provided by
Bank of England | Prudential Regulation Authority Page 38

the International Chamber of Commerce and Global Credit Data demonstrated that a
20% CF was more appropriate.

2.55 One respondent supported the proposal to maintain a 20% CF for short-term
self-liquidating trade letters of credit with a maturity of less than one year. However,
three respondents did not support the application of different CFs to self-liquidating
trade letters of credits based on the maturity of the exposure and suggested that a
20% CF should be assigned irrespective of maturity. These respondents argued that
if the PRA decided to maintain its proposal for exposures subject to the SA, it should
introduce a 20% CF for all exposures subject to the FIRB approach because maturity
is already explicitly captured in the IRB risk weight formula.

2.56 Having considered the responses, the PRA has amended its draft rules such
that a 20% CF will be assigned to all ‘other transaction-related contingent items’ that
do not have the character of credit substitutes (including trade letters of credit). The
PRA agrees with respondents that the empirical evidence provided by the
International Chamber of Commerce and Global Credit Data sufficiently addresses
the PRA’s previous concerns that a 20% CF may not fully reflect the probability of a
‘trigger event’ occurring or the behaviour in downturn conditions.25 A CF of 20%
therefore advances the PRA’s primary objective in a more proportionate manner.

2.57 The PRA notes that the effect of this change will be to reduce the existing 50%
SA CF for certain ‘other transaction-related contingent items’ (such as for shipping
guarantees, custom and tax bonds) under the CRR, while retaining the existing 20%
SA CF in other cases (such as for warranties and performance bonds). The PRA
considers that this approach is prudentially justified based on the evidence available
to it, and notes that it may facilitate international competitiveness depending on the
approach taken in other jurisdictions. A CF of 20% is lower than the 50% CF in the
Basel 3.1 standards, but the PRA considers this to be warranted based on the data
provided by firms during the consultation period.

25 Trigger events occur when a counterparty fails to perform a non-financial obligation. Trigger events
differ from default events as trigger events relate to the underlying transaction (between the
counterparty and third party) rather than whether the counterparty has defaulted or not. When a
trigger event occurs, it enables the third-party beneficiary to make a claim which the firm needs to
pay, which means the exposure comes on-balance sheet.
Bank of England | Prudential Regulation Authority Page 39

Other issues relating to issued off-balance sheet items

2.58 Other substantive responses to this section of CP16/22 raised two technical
issues:

• Conversion factor tables: one respondent suggested that CFs for the SA
and the FIRB approach should be set out in separate tables. The PRA has not
amended its draft rules in this respect as the applicable CFs are the same for
the SA and the FIRB approach.
• Definition of trade finance: two respondents argued that the PRA should
complement the list of specified ‘transaction-related contingent items’ with a
broader definition of ‘trade finance’ related items which makes clear that items
relating to the trade of both goods and services are included. The PRA
considers that the list of ‘transaction-related contingent items’ is sufficiently
exhaustive and notes that the near-final rules will not require the specified
items to be connected to the exchange of goods (as opposed to services).
The PRA has therefore decided not to refer to ‘trade finance’ in its near-final
rules.

PRA objectives analysis

2.59 With the exception of the changes to the CF calibration for 'other commitments'
and 'transaction-related contingent items', incorporating the amendments and
clarifications described above, the PRA considers that its near-final rules and near-
final amendments to SS10/13 remain materially aligned with the proposals in
CP16/22 and therefore the PRA considers its analysis of its objectives and have
regards for those areas in CP16/22 remains appropriate.

2.60 The PRA's decision to assign a CF of 20% for 'transaction-related contingent

items' will result in a CF that is either the same or lower than the current CF applied
under the CRR depending on the item. Having analysed the empirical evidence
provided by respondents, the PRA considers this decision will result in risk sensitive
CFs and so will advance its primary objective. Maintaining the proposed CFs would
have resulted in capital requirements that are overly conservative, given the
evidence available to the PRA.

2.61 The PRA also considers that its decision to align with the Basel 3.1 standards
for the CF applied to ‘other commitments’ (excluding UK residential mortgage
Bank of England | Prudential Regulation Authority Page 40

commitments) will result in the appropriate capitalisation for these off-balance sheet
risks, consistent with its primary objective.

‘Have regards’ analysis

2.62 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its 'have
regards', as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Sustainable growth:

• The PRA's decision to assign a 20% CF for 'transaction-related contingent

items' will either maintain or reduce RWAs for these items compared to under
the CRR, while still adequately capturing risk and therefore supporting
sustainable growth.
• The impact of the proposed 40% CF for ‘other commitments’ (excluding UK
residential mortgage commitments) will vary depending on the exact nature of
the commitment, increasing the CF for some commitments and decreasing it
for others. However, the PRA still considers that the proposed treatment
should result in adequate risk capture and therefore support sustainable
growth.

2. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA's decision to apply a 20% CF for 'transaction-related contingent

items' may have some positive implications from a competitiveness
perspective, as 'transaction-related contingent items' will be assigned a lower
CF than in some other jurisdictions that have implemented, or have proposed
to implement, a 50% CF for transaction-related contingent items.
• The PRA’s decision to align with the Basel 3.1 standards and apply a 40% CF
for ‘other commitments’ with the exception of non-UK residential mortgage
commitments should support the relative standing of the UK given that these
include categories of wholesale commitments that are typically international in
Bank of England | Prudential Regulation Authority Page 41

nature. The PRA recognises that the proposal to apply a 50% CF for UK
residential mortgage commitments is somewhat higher than that set out in the
Basel 3.1 standards and the CF applied by other jurisdictions. However, the
PRA considers the potential impact on relative standing is likely to be limited
given UK mortgage lending is concentrated within domestic lenders.

3. Relevant international standards:

• The PRA considers that its amendments to the proposed CFs for ‘other
commitments’ align with the Basel 3.1 standards. While the CF for UK
residential mortgage commitments will be somewhat higher than that set out
in the Basel 3.1 standards, the Basel 3.1 standards envisage that national
supervisors may choose to set stricter requirements. The PRA considers that
this is warranted based on data specific to the UK mortgage market.
• The PRA recognises that the CF for ‘transaction-related contingent items’ is
lower than that set out in the Basel 3.1 standards but considers that there is
sufficient evidence that a 20% CF is appropriate and risk sensitive to justify
taking a different approach for this category.

4. Finance for the real economy:

• The PRA considers that the impact of the changes in CFs for 'transaction-
related contingent items' and ‘other commitments’ will vary across products
but will likely decrease RWAs for certain items compared to their treatment
under the CRR. The PRA considers that the likely decrease in RWAs
following the decisions made on the CFs for ‘transaction-related contingent
items’ and some ‘other commitments’ will result in capital requirements that
are more reflective of the risk of the exposures. This should facilitate firms’
willingness to provide these off-balance sheet items and commitments which
may be positive for economic activity.

Exposures to central governments, central banks, regional

governments, local authorities, PSEs, and MDBs
2.63 The PRA proposed to broadly retain the existing risk weight treatment for
exposures to central governments, central banks, regional governments, local
authorities, PSEs and MDBs, which it considered to be broadly aligned with the
Basel 3.1 standards.
Bank of England | Prudential Regulation Authority Page 42

2.64 The PRA received eight responses to this section in CP16/22. The substantive
issues raised by respondents are set out below.

Exposures to public sector entities

2.65 The PRA proposed that firms would be required to apply risk weights to
exposures to PSEs that correspond to their external credit rating, or to apply a 100%
risk weight where an external credit rating is not available. The PRA proposed to not
treat any PSEs as exposures to the central government, regional governments or
local authorities of the UK. The CRR contains a provision that permits firms to apply
central government, regional government or local authority risk weights to exposures
to UK PSEs where the PRA has identified that there is no difference in risk.
However, given the PRA had not previously identified any UK PSEs meeting the
criteria, the PRA did not consider that its proposals reflected a substantive policy
change.

2.66 Seven respondents argued that exposures to certain PSEs should receive the
same risk weight treatment as exposures to their central government and that this
would align with a national discretion in the Basel 3.1 standards. Six respondents
argued that the PRA’s proposal would put the UK at a competitive disadvantage
relative to jurisdictions who exercise the Basel national discretion. One respondent
argued that the PRA should designate a global list of PSEs that are eligible for the
same risk weight treatment as the relevant central government. Two respondents
requested that the PRA treat export credit agencies (ECAs) the same as the relevant
central government where there is no difference in risk between the central
government and the ECA. Two respondents acknowledged that firms could apply the
risk weight of the central government to PSEs under the credit risk mitigation (CRM)
framework but argued this would be a complex and operationally costly approach.

2.67 Having considered the responses, the PRA has decided to maintain its proposal
that firms would not be permitted to apply central government risk weights to any
PSE exposures. The PRA considers that PSEs (both in the UK and internationally)
are typically riskier obligors than central governments, meaning applying the central
government risk weight would be imprudent. The PRA did not receive persuasive
evidence to support respondents’ claims in relation to any category of PSEs or any
PSE exposures.

2.68 As noted by respondents, where an exposure to a PSE is subject to a

guarantee that meets the CRM eligibility requirements, firms are permitted to
Bank of England | Prudential Regulation Authority Page 43

recognise the guarantee and reduce capital requirements through the CRM
framework.

Exposures to unrated central banks

2.69 The PRA proposed to retain the CRR treatment of central bank exposures,
where risk weights depend on the external credit rating for rated central bank
exposures and a 100% risk weight applies to unrated central bank exposures
(except for third-country exposures denominated in the obligor’s local currency,
which can be assigned a lower risk weight in certain circumstances and based partly
on an equivalence assessment of each third country’s prudential regulation
conducted by HMT).

2.70 Five respondents argued that the PRA should permit firms to use the relevant
central government’s external credit rating to risk weight unrated central bank
exposures. One respondent argued that a 100% risk weight for unrated central bank
exposures is punitive and proposed that a 0% risk weight should apply where the
central government qualifies for CQS 1. This respondent argued that central banks
can generate seigniorage revenues and have low default rates.

2.71 Having considered the responses, the PRA acknowledges the arguments made
by respondents and has decided to amend its draft rules to permit firms to apply a
risk weight to an unrated central bank exposure that corresponds to the risk weight
of the relevant central government. The PRA considers its decision to be consistent
with its primary objective because it is appropriate to treat central banks and central
governments equally due to their interdependency and similar risk profiles. The PRA
considers that this approach broadly aligns with the Basel 3.1 standards.

Exposures to multilateral development banks

2.72 Other substantive responses to this section in CP16/22 focused on the
treatment of exposures to MDBs. Four respondents argued that the PRA should set
out the criteria by which it would determine MDBs that would qualify for the 0% risk
weight. These respondents argued that firms should be permitted to apply to the
PRA to amend the list where necessary. The PRA has decided not to publish criteria
by which it would determine additional MDBs who would qualify for the 0% risk
weight, but notes that it could consult to amend its rules if it considers that it would
be appropriate to change the list in future.
Bank of England | Prudential Regulation Authority Page 44

Exposures to regional governments or local authorities

2.73 Alongside considering the responses to the proposals covered in this section,
the PRA has decided to amend its draft rules to clarify that, where a credit rating is
not available for an exposure to a regional government or local authority, and there is
not a credit rating available for the central government, the exposure will be assigned
a risk weight of 100%. The PRA considers that this will support the consistent
application of its near-final rules across firms.

PRA objectives analysis

2.74 With the exception of the change to the treatment of unrated central bank
exposures, the PRA considers that the near-final rules regarding exposures to
central governments, central banks, regional governments, local authorities, PSEs
and MDBs remain materially aligned with the proposals in CP16/22. Therefore, the
PRA considers its analysis of its objectives and have regards for those areas in
CP16/22 remains appropriate.

2.75 The PRA considers that its near-final policy on unrated central bank exposures
advances its primary objective. The approach introduces greater risk sensitivity
reflecting the fact that the credit risk of a central bank and the central government
are linked.

‘Have regards’ analysis

2.76 In developing these near-final rules, the PRA has had regard to its regulatory
principles and the matters to which it is required to have regard when proposing
changes to CRR rules. The PRA considers its analysis of its ‘have regards’, as
presented in CP16/22, remains appropriate, subject to the following updates:

1. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA considers that its decision on the risk weighting of unrated central
banks will support international competitiveness in cases where other
jurisdictions apply a 100% risk weight to unrated central banks.

2. Relevant international standards:

• The PRA considers its decision on the risk weighting of unrated central banks
broadly aligns with the Basel 3.1 standards.
Bank of England | Prudential Regulation Authority Page 45

Exposures to institutions and covered bonds

2.77 The PRA proposed to make a number of changes to the treatment of exposures
to institutions and covered bonds, including to:

• adjust the approach for rated institutions, the ‘external credit rating approach’
(ECRA);
• introduce a new approach for unrated institutions, the ‘standardised credit risk
assessment approach’ (SCRA); and
• change the risk weight treatment for eligible unrated covered bonds.

2.78 The PRA received 15 responses to its proposals for treatment of exposures to
institutions and 7 responses relating to its proposals for the treatment of exposures
to covered bonds.

Exposures to institutions
Short-term exposures
2.79 The PRA proposed to continue to permit firms to apply lower risk weights to
short-term exposures relative to long-term exposures for rated and unrated
institutions. Short-term exposures are currently defined under the CRR as having a
residual maturity of less than three months. The PRA proposed that an original
maturity of less than three months should instead be used for identifying short-term
exposures. The PRA also proposed that exposures arising from the movement of
goods across national borders with an original maturity of less than six months,
would be risk weighted as short-term exposures.

2.80 The PRA proposed to remove the specific CRR risk weight treatment for
exposures to institutions of a residual maturity of three months or less that are
denominated and funded in the national currency of the obligor.

2.81 Four respondents argued that the proposed eligibility criteria for identifying
short-term exposures were too restrictive. Seven respondents did not support the
proposal to use original maturity rather than residual maturity, arguing that the
proposed approach did not reflect the level of risk of exposures with residual maturity
of less than three months. Four respondents argued that the treatment of exposures
arising from the trade of services and the movement of goods within the UK should
be aligned with the treatment of exposures arising from the movement of goods
across national borders.
Bank of England | Prudential Regulation Authority Page 46

2.82 Having considered the responses, the PRA has decided to maintain its proposal
for the definition of short-term exposures as set out in CP16/22. The PRA’s proposal
aligns with the Basel 3.1 standards and the approach taken by other jurisdictions.
The PRA considers that the original intention of the lower risk weight for shorter-
maturity exposures in the Basel framework was to capture specific types of
exposure, rather than generally assuming a lower credit risk associated with
exposures with limited remaining maturity. This is consistent with the general
principle in the Basel 3.1 standards that risk weights under the SA are not adjusted
depending on an exposure’s residual maturity.

2.83 The PRA has decided however to amend its draft rules such that exposures
arising from the movement of goods within the UK are treated in the same way as
exposures arising from the movement of goods across national borders. The PRA
recognises the issues raised by respondents and considers that a different treatment
for the movement of goods within the UK is not justified on a risk basis.

2.84 Regarding the proposed treatment of exposures arising from the trade of
services, the PRA has decided not to amend its draft rules and will not permit them
to be risk weighted in the same way as exposures arising from the movement of
goods. The delivery of services is different in nature to the movement of goods and a
very broad range of exposures could be deemed to arise from the delivery of
services. The PRA did not receive persuasive evidence that the risk weight treatment
for short-term exposures should be extended and notes its approach is aligned with
international standards and the approach of other jurisdictions. Exposures to
institutions (including those arising from the trade of services) will continue to be risk-
weighted as short-term exposures if they have an original maturity of less than three
months.

Unrated institutions
2.85 The PRA proposed to introduce a new approach (SCRA) for exposures to
institutions where no external credit rating is available. Under this approach,
exposures to institutions would be categorised into one of three grades (A, B, or C)
and assigned an associated risk weight, depending on the institution’s ability to meet
or exceed published minimum regulatory requirements, and the firm’s internal
assessment of the institution’s credit risk. The proposed treatment for exposures to
unrated institutions would remove the link between the risk weighting of institutions
and the credit rating of their sovereigns.
Bank of England | Prudential Regulation Authority Page 47

2.86 Several respondents argued that the PRA should provide further clarity on the
application of the SCRA approach:

• three respondents argued that the PRA should introduce more prescriptive
criteria for determining the grade of an exposure;
• one respondent argued that the PRA should encourage non-listed SDDTs to
publish their CET1 ratio and their Tier 1 Leverage ratio data in their annual
reports and accounts to help other firms apply the SCRA approach for
exposures to them;
• one respondent argued that the PRA should designate the jurisdictions which
are considered to have implemented equivalent regulatory requirements and
buffers;
• one respondent argued that the PRA should permit firms to use third-party
sources to carry out the SCRA approach;
• one respondent requested that the PRA clarify whether firms would be
permitted to reassign institutions between categories and how often they
would be able to do so. Respondents argued that it would make it more
challenging for small institutions to raise wholesale funding if they could not
be reassigned to reflect a reduction in risk; and
• one respondent requested that the PRA clarify whether firms would need to
seek permission from the PRA to apply their assessment approach.

2.87 Having considered these responses, the PRA has decided not to amend its
draft rules in relation to the SCRA for unrated institutions for the reasons set out
below.

2.88 Regarding the level of prescription in the draft rules, the PRA considers that the
approach is sufficiently detailed to support consistent application amongst firms and
that firms should already have the capability to carry out a credit risk assessment as
part of their broader risk management processes. However, the PRA will consider
providing further clarification in future if evidence emerges of inconsistent application
across firms.

2.89 The PRA is responsible for setting Pillar 3 disclosure requirements (see the
Disclosure (CRR) Part of the PRA Rulebook). The form and content of financial
statements is mandated under the Companies Act 2006, which does not fall under
the remit of the PRA. In relation to the disclosure of non-listed SDDTs’ capital ratios,
as set out in PS15/23 – The Strong and Simple Framework: Scope Criteria,
Liquidity and Disclosure Requirements, the PRA will exclude non-listed SDDTs
Bank of England | Prudential Regulation Authority Page 48

from the requirement to disclose a Pillar 3 report. However, some SDDTs without
listed instruments may still wish to disclose (either publicly or directly to their lender)
their prudential requirements.

2.90 While third-party sources of information may be used as an input for the
application of the SCRA, the PRA considers it important that firms carry out this
assessment for their own counterparties, alongside broader due diligence processes,
rather than relying solely on third party sources.

2.91 Finally, the PRA clarifies that firms will not be required to apply for PRA
permission to apply their assessment approach. The PRA also clarifies that its near-
final rules do not restrict firms from re-categorising institutions into different grades
where appropriate.

Other issues relating to exposures to institutions

2.92 One respondent argued that the proposed retention of a specific risk weight
treatment for exposures to institutions in the form of minimum reserves required by
the Bank of England should be amended to remove outdated references to a
European Central Bank (ECB) regulation. Having considered this response, the PRA
has decided to amend its draft rules to remove this treatment. The PRA does not
consider there to be any applicable minimum reserve requirements currently set by
the Bank of England that would qualify for the treatment and notes that direct
exposures to the Bank of England that are denominated and funded in sterling will
receive a 0% risk weight in any event.

2.93 The PRA also received responses on the use of external credit ratings for
institutions. The PRA has provided feedback to these responses in the ‘External
credit ratings and due diligence’ section of this chapter.

Exposures to eligible covered bonds

2.94 The PRA proposed to introduce changes to the risk weight treatment that
applies to certain covered bonds. To be eligible for this treatment, covered bonds
would be required to meet the definition of a ‘CRR covered bond’ (CRR covered
bonds are, among other things, issued by a credit institution with its registered office
in the UK) and be secured by exposures which meet the collateral eligibility criteria
(including additional requirements for immovable property collateral).

2.95 As part of the above changes, the PRA proposed to introduce a more risk-
sensitive mapping from the issuing institutions’ risk weights to unrated covered
Bank of England | Prudential Regulation Authority Page 49

bonds risk weights. Consistent with the proposed treatment of institutions, the PRA
proposed that the risk weight for unrated eligible covered bonds issued by rated
institutions which have a credit rating corresponding to CQS 2 would be reduced
from 20% to 15%, and that the risk weight for unrated eligible covered bonds issued
by rated institutions which have a credit rating corresponding to CQS 3 would be
increased from 20% to 25%. The PRA also proposed that the new due diligence
requirements would apply to all covered bond exposures. In respect of eligible
collateral, the PRA proposed to retain the requirement that exposures to residential
and commercial mortgage loans would be required to meet the valuation
requirements in Article 208 of the Credit Risk Mitigation (CRR) Part of its draft rules
(including a requirement to revalue at default which was not required under the
CRR). The PRA did not propose changes to the maturity assessment of short-term
collateral.

2.96 Seven respondents provided comments on the proposed treatment of eligible

covered bonds:

• seven respondents argued that the eligibility criteria for covered bonds
collateralised by exposures to institutions should depend upon residual
maturity or argued all exposures to institutions that are CQS 2 (of any
maturity) should be eligible collateral;
• four respondents did not support the PRA’s proposal that the eligibility criteria
for the lower risk weight treatment should be limited to those covered bonds
which are issued by a credit institution with its registered office in the UK; and
• two respondents argued that there should not be a requirement for real estate
collateral used in eligible covered bond pools to be revalued at default, where
the issuing institution applies the SA.

2.97 Having considered the responses, the PRA has decided to make a number of
amendments to its draft rules, as set out below.

2.98 For covered bonds collateralised by exposures to institutions, the PRA has
decided that exposures to institutions which have a credit rating corresponding to
CQS 2 will be eligible covered bond collateral irrespective of maturity
(notwithstanding any other eligibility requirements). This maintains an appropriate
level of prudence and aligns with international standards.

2.99 The PRA has decided to maintain its proposal that only covered bonds which
are issued by a credit institution with its registered office in the UK should be eligible
Bank of England | Prudential Regulation Authority Page 50

covered bonds. It is important that only high-quality covered bonds qualify for lower
risk weights, and the PRA considers that regulation in the UK underpins the quality
of covered bonds issued by UK institutions.

2.100 The PRA has decided to remove its proposed requirement that real estate
collateral in eligible covered bond pools be revalued at default. This was included in
its draft rules as a result of a cross-reference to the foundation collateral method’s
real estate valuation requirements. The PRA agrees with respondents that it is not
necessary to maintain this requirement and that the amended approach aligns with
the Basel 3.1 standards. The PRA has similarly excluded real estate covered bond
collateral from the requirement for valuations to be adjusted to reflect prior charges,
under Article 229 of the near-final Credit Risk Mitigation (CRR) Part, as the existing
requirements on the use of real estate collateral in eligible covered bond pools
already reflect the risks associated with prior charges.

PRA objectives and ‘have regards’ analysis

2.101 The PRA considers that the amendments set out above do not materially
change the proposals in CP16/22 and therefore the PRA considers its analysis of its
objectives and have regards in CP16/22 remains appropriate.

Exposures to corporates and specialised lending

2.102 The PRA proposed to enhance the risk sensitivity of the SA for calculating
RWAs for rated and unrated corporate exposures. The PRA also proposed to align
with the Basel 3.1 standards by not retaining the infrastructure support factor under
the SA and introducing a specific treatment for specialised lending to align the SA
more closely with the IRB approach.

2.103 The PRA received 27 responses to this section in the CP. The substantive
issues raised are set out below.

Corporate exposures
Externally rated corporate exposures
Bank of England | Prudential Regulation Authority Page 51

2.104 The PRA proposed to continue to permit the use of external credit ratings for
determining the RWAs applied to corporate exposures. Three respondents argued
that the PRA should not allow the use of external credit ratings for the purpose of
risk-weighting corporate exposures if the approach to unrated corporate exposures is
not amended (see below). Having considered the responses, the PRA has decided
to maintain its proposal to permit the use of external credit ratings for risk-weighting
corporate exposures. The PRA considers this approach results in risk weights that
better reflect the risk for rated exposures.

2.105 To align with the Basel 3.1 standards, the PRA also proposed to increase risk
sensitivity by reducing the risk weight applicable to corporates that have a credit
rating which corresponds to CQS 3 from 100% to 75%. One respondent explicitly
supported the approach, noting that it would contribute to the increased risk
sensitivity of the prudential framework and to a better allocation of firms’ capital
requirements. The PRA has maintained the proposed approach in its near-final rules.

Unrated corporate exposures

2.106 The PRA proposed to introduce a more risk-sensitive approach relative to the
CRR and the Basel 3.1 standards for unrated (non-SME) corporate exposures, to
better reflect the underlying risk of different unrated corporate exposures. The
proposal aimed to maintain an aggregate level of RWAs which was broadly
consistent with the calibration under the Basel 3.1 standards – firms would apply one
of two possible approaches to all of their unrated corporate exposures: (i) a risk-
sensitive approach, available through a permission granted by the PRA, that would
permit firms to assign a 65% risk weight to counterparties deemed ‘investment
grade’ (IG) and a 135% risk weight to counterparties deemed ‘non-investment grade’
(non-IG); or (ii) a risk-neutral approach of a 100% risk weight applied to all unrated
corporate exposures. The PRA asked respondents to provide quantitative and
qualitative evidence to support responses, particularly in respect of how appropriate
the proposed 135% risk weight for non-IG exposures would be under the risk-
sensitive approach.

2.107 The PRA received 21 responses:

• four respondents supported the proposal to give firms the option to choose
between the two approaches. However, five respondents argued that firms
with more IG exposures would select the risk-sensitive approach which would
make them uncompetitive in non-IG lending, with firms using the risk-neutral
Bank of England | Prudential Regulation Authority Page 52

approach being uncompetitive in lending to IG corporates and therefore being

concentrated in non-IG lending;
• the PRA received thirteen responses relating to the calibration of the risk
weights assigned under the risk-sensitive approach. Seven respondents
argued the proposed calibration of the risk weight for non-IG unrated
corporates was too high. Two respondents supported the proposal to reduce
the applicable risk weight for unrated corporates deemed IG to 65%, but two
respondents argued that the proposed risk weight was too punitive for the
lowest risk exposures. Two respondents argued that the risk weight for IG
exposures should be increased and the risk weight for non-IG exposures
should be decreased to narrow the differential between IG and non-IG
exposures;
• three respondents argued that the proposed calibration of the risk weight for
non-IG unrated corporates would have a negative impact on the
competitiveness of the UK relative to jurisdictions that assign a risk weight of
100%, and could cause the UK branches of internationally domiciled banks to
become concentrated in non-IG corporate lending; and
• four respondents argued that the PRA should provide guidance on the criteria
for classifying entities as IG or non-IG. Two respondents supported the PRA’s
proposal to not fully align with the definition of IG in the Basel 3.1 standards
for jurisdictions that do not permit the use of external ratings for regulatory
purposes. Respondents were particularly supportive of the PRA’s proposal not
to implement the requirement that entities or parents be listed on a recognised
exchange.

2.108 Having considered the responses, the PRA has decided to maintain its
proposed approach. Firms will be permitted to use the risk-neutral approach or to
use the risk-sensitive approach (subject to permission from the PRA). Taking into
account the range of responses received, the PRA considers that its near-final rules
strike an appropriate balance between increasing risk sensitivity while maintaining
the simplicity and proportionality of the SA.

2.109 The PRA acknowledges that the treatment for unrated corporate exposures
may result in a reallocation of exposures between lenders, depending on the risk-
weighting approach they use. However, firms will have discretion to choose which
approach to use based on their business model, broader risk-management approach
and operational capabilities (subject to PRA permission to use the risk-sensitive
approach).
Bank of England | Prudential Regulation Authority Page 53

2.110 The implications of the two approaches for lending to different types of
corporates is nuanced, including for firms with IRB permissions who will have to
apply the output floor. The provision of finance to unrated corporates is also
dependent on factors other than capital requirements, such as business
relationships, locality, and sector expertise.

2.111 The PRA recognises the importance of ensuring that the risk-sensitive
approach is calibrated to apply prudent but proportionate risk weights to IG and non-
IG exposures, given the wide range of unrated corporate exposures held by firms.
The risk weights have been set so that they broadly align with the overall calibration
of the Basel 3.1 standards, while introducing risk sensitivity to better reflect the range
of credit risk of unrated corporate exposures. In finalising its proposals, the PRA has
been conscious that SA risk weights are calibrated with the aim of ensuring that, on
aggregate, risks are adequately capitalised across a range of exposures and so it
should not be expected that the SA is complex enough to result in risk weights
tailored to every individual exposure.

2.112 The PRA had significant engagement with industry on this topic, both before
and after the publication of CP16/22. Although several respondents argued that the
proposed risk weights were calibrated too conservatively, the PRA did not receive
persuasive evidence, either from domestic or international experience, that
supported these assertions. The data provided by respondents suggest that any
lowering of the IG or non-IG risk weights would result in risk weights that no longer
appropriately align with the with the overall calibration of the Basel 3.1 standards. As
noted above, the risk weights assigned under the SA must cover a broad range of
risk in a relatively simple and proportionate manner. This means that the risk weights
assigned to exposures to some unrated IG corporates may be higher than indicated
by comparators such as modelled risk weights or the risk weights assigned under the
SA for exposures to rated corporates, but for others the risk weights may be lower
than indicated by these comparators. The situation is similar for exposures to some
non-IG corporates, and the calibration of both IG and non-IG risk weights seeks to
ensure adequate capitalisation across a range of exposures. Overall, the PRA
considers the 65% and 135% risk weights to be broadly appropriate for unrated IG
and non-IG corporate exposures respectively.

2.113 Regarding the definition of IG, the PRA has decided to not publish further
expectations on how firms should assess if an exposure to a corporate entity shall be
deemed IG. The PRA considers that the definition of IG stated in the near-final rules
is sufficiently clear. However, the PRA notes that it could choose to set further
Bank of England | Prudential Regulation Authority Page 54

expectations or guidance if evidence of inconsistent application amongst firms

emerges.

Exposures to unrated funds and special purpose vehicles (SPVs)

2.114 A number of respondents argued that the PRA should create a tailored
approach for specific types of unrated corporate exposures to better reflect their risk.
Three respondents suggested that the PRA create a specific treatment for SPV
structures, where firms use SPVs to repackage securities to provide a return on the
underlying collateral to investors. Five respondents suggested that the PRA create a
bespoke treatment for exposures to unrated funds given the difference in the nature
of these exposures and their risk compared to other corporates.

2.115 Having considered the responses, the PRA has decided to not introduce any
bespoke treatments for funds or SPVs that repackage securities. The PRA
acknowledges that exposures to funds and SPVs that repackage securities may
have different risk characteristics compared to other corporate exposures. However,
the level of risk will vary materially - funds and SPVs are not homogenous and
different types of exposures will have different levels of credit risk. The PRA
considers that it is important to maintain the simplicity and proportionality of the SA
and notes that the Basel 3.1 standards similarly do not attempt to provide a
differentiated approach. Given these are cross-border markets, if there were to be a
different, more granular approach to risk weighting such exposures, the PRA
considers it should be an agreed, internationally consistent approach.

Asset secured lending

2.116 Other responses to this section of CP16/22 focused on one technical point
relating to asset secured lending: two respondents argued that the PRA should
reconsider its proposals on the SA risk weighting of exposures secured by non-real
estate collateral (‘asset secured lending’). They argued such exposures are lower
risk than unsecured lending given the existence of collateral.

2.117 Having considered the responses, the PRA has decided to not apply a specific
risk weight approach for non-real estate asset secured lending under the SA. Given
the potential diversity of non-financial collateral, permitting its recognition in a risk-
sensitive way would introduce a level of complexity that the PRA considers would not
be proportionate or appropriate for the SA. The PRA also notes that the Basel 3.1
standards do not permit recognition of non-financial collateral for firms using the SA,
Bank of England | Prudential Regulation Authority Page 55

with the exception of real estate collateral, which is recognised directly in risk
weights.

Specialised lending exposures and the infrastructure support factor

2.118 Aligned with the Basel 3.1 standards, the PRA proposed to introduce a new
specialised lending exposure subclass, which included specific risk weight
treatments for commodities finance, object finance and project finance, and more
closely aligned the SA with the IRB approach. As part of introducing the Basel 3.1
standards’ approaches, the PRA proposed to remove the infrastructure support
factor.

2.119 The PRA received 14 responses to this section in CP16/22. The substantive
issues raised are set out below.

Project finance and the infrastructure support factor

2.120 The PRA proposed to remove the infrastructure support factor. The
infrastructure support factor applies to project finance exposures and other corporate
exposures. The PRA has presented its feedback to the responses to its proposal to
remove the infrastructure support factor alongside feedback to the responses to its
proposed treatment of project finance exposures given significant overlap between
project finance and infrastructure lending.

2.121 For unrated project finance exposures, the PRA proposed to differentiate
between exposures to projects in the pre-operational phase versus the operational
phase, in line with the Basel 3.1 standards. The PRA proposed that an unrated
exposure in the operational phase would be risk-weighted at 100% and that an
unrated exposure in the pre-operational phase would be risk-weighted at 130%.

2.122 The PRA also proposed to introduce greater risk sensitivity through a lower
risk weight for unrated ‘high-quality’ project finance exposures that are in the
operational phase. The PRA proposed that exposures that meet the ‘high-quality’
criteria would be risk-weighted at 80%. The PRA considered the proposed high-
quality project finance approach would result in a broadly similar risk weight
adjustment as provided by the infrastructure support factor for eligible exposures. It
therefore considered that maintaining the infrastructure support factor in addition to
the 80% risk weight for high-quality project finance would result in an imprudent
Bank of England | Prudential Regulation Authority Page 56

duplication of risk weight adjustments for project finance exposures in Pillar 1 capital
requirements.

2.123 The PRA received ten responses to its proposed treatment for project finance
exposures and the proposed removal of the infrastructure support factor.
Respondents were generally supportive of the introduction of the new high-quality
project finance treatment. Six respondents opposed the removal of the infrastructure
support factor, three neither opposed nor supported the removal, and one supported
the removal. Respondents made the following arguments for retaining the
infrastructure support factor:

• six respondents argued that removing the infrastructure support factor would
negatively impact the international competitiveness of the UK;
• five respondents argued that the infrastructure support factor had increased
the amount of lending to infrastructure projects and that removing it would
increase the price of lending and decrease lending volumes;
• three respondents argued that the introduction of a new high-quality project
finance treatment would not fully offset the impact of removing the
infrastructure support factor as lending by firms is predominantly to projects in
the pre-operational phase and the high-quality risk weight only applies to
projects in the operational phase;
• four respondents argued that if the PRA removed the infrastructure support
factor, transitional arrangements should be put in place in order to limit the
impact on existing exposures;
• six respondents argued that the PRA’s proposal would impact the financing of
green infrastructure projects such as the development and operation of
renewable energy sources. One respondent requested that alternative
measures be put in place to support green and sustainable financing if the
support factor is removed; and
• one respondent requested that the proposed draft rules align with the
‘Solvency II Corporate Infrastructure Exemption’.

2.124 Having considered these responses, the PRA has decided to make material
amendments to its draft policy. It has decided to:

• amend its draft rules to maintain the proposed high-quality project finance
80% risk weight, but widen the scope of eligible entities that the counterparty
is depending on for the revenue to include central banks, and certain
international organisations and MDBs;
Bank of England | Prudential Regulation Authority Page 57

• retain its proposal to risk-weight unrated project finance exposures at 100%

where the project is in the operational phase and at 130% where the project is
in the pre-operational phase; and
• maintain its proposed removal of the infrastructure support factor in Pillar 1,
but apply a firm-specific structural adjustment to reduce Pillar 2A capital
requirements (the ‘infrastructure lending adjustment’) to ensure that the
removal of the support factor does not result in an increase in overall capital
requirements for infrastructure exposures.

2.125 Given the infrastructure support factor applies to exposures risk-weighted

under both the SA and IRB approach, the PRA has considered the treatment of
infrastructure lending under both approaches collectively. Although not part of the
SA, the PRA is making a further change to lower risk weights for firms using the IRB
slotting approach by introducing a new substantially stronger category in the slotting
approach for project finance exposures. This is covered in Chapter 3 – Credit risk –
internal ratings based approach, but is cross referenced here as it is an important
change for the overall treatment of infrastructure lending. Taken together with the
changes to the SA outlined above, the PRA considers that its near-final rules result
in an overall Pillar 1 treatment for project finance exposures that is risk based and
results in risk weights that are neither too low nor too high.

2.126 The new risk weights assigned under the SA introduce risk sensitivity in a
manner that promotes consistency of application between firms. Some firms have
not applied the infrastructure support factor to date because of the difficulty in
assessing its complex criteria. The high-quality project finance treatment is simpler to
apply than the infrastructure support factor and the PRA therefore expects this
treatment to be applied more widely by firms.

2.127 Recognising the limited evidence base for the calibration of risk weights for
lending to infrastructure, the PRA requested that respondents submit quantitative or
qualitative evidence on this topic. The PRA did not receive persuasive evidence,
based purely on the risk of the lending, to support retaining the infrastructure support
factor in Pillar 1 in addition to the proposed changes in the underlying risk weights.

2.128 The PRA examined whether the proposed risk weights for exposures to
projects in the pre-operational phase should be lower than those in the Basel 3.1
standards, given these exposures may have been eligible for the infrastructure
support factor but will be ineligible for the ‘high-quality’ project finance risk weight.
The PRA conducted a two-part analysis considering:
Bank of England | Prudential Regulation Authority Page 58

(a) the relative riskiness of project finance exposures in the pre-operational phase
with corporate exposures more generally; and

(b) the relative riskiness of project finance exposures in the pre-operational and
operational phases.

2.129 The PRA used Moody’s data on default rates and recovery rates for corporate
bonds and project finance loans to inform both parts of the analysis and considered
probability of default (PD) and loss-given default (LGD) effects separately in each
case.

2.130 In the first part of the analysis, the PRA used stressed default rate data for
corporate bonds rated Ba and B (which are subject to RWs of 100% and 150%
respectively under the SA) as a comparator for project finance exposures in the pre-
operational phase in order to analyse PD effects.26,27 Due to the limited data
available, the PRA used projects in years 1 and 2 as a proxy for pre-operational
phase projects.

Table 1: Default rates

Project Finance Corporate bonds Corporate bonds

(Years 1-2) rated Ba rated B

Peak default rate c. 7.0% 3.84% 13.12%

in early 1990s

Peak default rate c. 7.2% 1.77% 4.57%

in early 2000s

2.131 This analysis is sensitive to significant variations in peak corporate default

rates in different economic scenarios, but, given that risk weights should reflect
plausible downturn scenarios, suggests the relative riskiness of project finance
exposures that are in the pre-operational phase should sit between the risk
associated with corporate bonds rated Ba and B, which are assigned risk weights of
100% and 150% respectively under the SA. The stressed default rates for project

26Moody’s (April 2023). Default and recovery rates for project finance bank loans, 1983-2021.
27Moody's (February 2024). Annual default study: Corporate default rate to moderate in 2024 but
remain near its long-term average.
Bank of England | Prudential Regulation Authority Page 59

finance exposures are significantly higher in both periods than for Ba rated bonds
which are assigned a risk weight of 100% under the SA.

2.132 In respect of LGD effects, the PRA compared recovery rates for project
finance loans in the construction phase (which the PRA took to be a proxy for the
pre-operational phase) with recovery rates for corporate loans and bonds.

Table 2: Implied LGD from recovery rates28

Project Finance – Corporate Loans29 Senior Unsecured

Construction Bonds30
phase

Implied LGD 27.5% 16.9% 52.6%

2.133 The data show that project finance loans in the construction phase have
higher implied LGDs than corporate loans but lower implied LGDs than unsecured
corporate bonds. However, additional data for project finance distressed sales
recovery rates (which was not disaggregated by construction phase) show higher
implied LGDs. Given that the risk weights assigned to unrated corporate exposures
should reflect a mix of loans and bonds, and project finance risk weights should
reflect a mix of recoveries from retaining the assets and distressed asset sales, the
PRA considers there is insufficient evidence to support a downward adjustment of
risk weights for project finance exposures based on LGD effects.

2.134 In the second part of the analysis the PRA compared PDs for projects in years
1-2 (which the PRA took as a proxy for the pre-operational phase) with the PDs for
projects in year 5 (which the PRA took as a proxy for the operational phase).
Moody’s data suggests that projects in years 1-2 have a default rate of around 1%

28 Moody’s (2023). Default and recovery rates for project finance bank loans, 1983-2021. The implied
LGD is calculated as 100% less the average ultimate recovery rate.
29 Using data on the average recovery rates over the period 1987-2021.
30 Using data on the average recovery rates over the period 1987-2021.
Bank of England | Prudential Regulation Authority Page 60

which is around twice as high as the default rate for projects in year 5 (around 0.5%).
Using the IRB risk weight formula to infer PDs under stressed conditions, the PRA
estimated that there should be an approximate 40% uplift in the risk weight for
project finance exposures in the pre-operational phase relative to the operational
phase due to the differences in PD (the uplift would be higher still if data beyond year
5 had been considered).

2.135 In relation to LGD effects, the best available evidence shows that the average
implied LGD for construction phase projects (which the PRA took as a proxy for the
pre-operational phase) is approximately 43% higher than for operational phase
projects (implying a 43% uplift in risk weights).31 Combining the PD and LGD effects,
the available evidence suggests that pre-operational phase risk weights should be
approximately 100% higher than operational phase risk weights. In comparison, the
130% risk weight the PRA has decided to introduce for project finance exposures in
the pre-operational phase is only 30% higher than the 100% risk weight assigned to
project finance exposures in the operational phase and only 63% higher than the
80% high-quality project finance risk weight for operational phase exposures.

2.136 There is a significant degree of uncertainty in both pieces of analysis. The

uncertainty is consistent with the lack of data available publicly and lack of data
provided by firms during the consultation period. However, taken together, the PRA
considers that they indicate that the 130% risk weight in the Basel 3.1 standards for
project finance exposures in the pre-operational phase is broadly appropriate and
that introducing a lower Pillar 1 risk weight for these exposures (including for ‘high-
quality’ projects without increasing the risk weight for projects that did not meet this
criteria) would not be consistent with the underlying risk.

2.137 The PRA has however amended its draft rules to improve risk sensitivity
where this can be done in a manner that is consistent with its primary objective. In
particular, for the purpose of identifying high-quality project finance exposures, the
PRA will widen the list of eligible main entities that the counterparty’s revenue is
dependent on to include international organisations that are prescribed a risk weight
of 0%, MDBs that are prescribed a risk weight of 0%, and central banks with a risk
weight of 80% or lower. The PRA considers that it is risk sensitive to treat these
counterparties in a similar manner to the eligible counterparties included in the
PRA’s original proposals, given they lead to the exposure having a similar level of

31 Moody’s (2023). Default and recovery rates for project finance bank loans, 1983-2021.
Bank of England | Prudential Regulation Authority Page 61

risk. This change further aligns the high-quality project finance counterparty eligibility
criteria with the criteria for the infrastructure support factor under the existing CRR.

2.138 The PRA continues to consider that the infrastructure support factor should be
removed from Pillar 1 capital requirements based purely on its assessment of the
risk of eligible exposures. The PRA also considers the materiality of the
infrastructure support factor to be limited as only ten firms are currently applying the
infrastructure support factor (across the SA and IRB approaches). Given the limited
data available, and consistent with the lack of data provided by firms in response to
the consultation, it is also difficult to assess how the existing stock of loans currently
benefitting from the infrastructure support factor will be classified within the corporate
exposure class. Taking into account the above points, and the amendments to the
draft rules described above (including the important changes set out in Chapter 3 –
Credit risk – internal ratings based approach which will reduce risk weights for
certain project finance exposures under the slotting approach), the PRA considers
that its near-final rules are unlikely to have a material impact on Pillar 1 capital
requirements for infrastructure lending.

2.139 However, the PRA recognises the concerns raised by respondents on the
potential impact on UK competitiveness and growth of even limited increases in
capital requirements on infrastructure lending. To minimise any potential disruption
to infrastructure lending and therefore growth resulting from the removal of the
infrastructure support factor, the PRA will apply the infrastructure lending adjustment.
This will ensure that the removal of the infrastructure support factor under Pillar 1
does not result in an increase in overall capital requirements for infrastructure
exposures.

2.140 The PRA considers that the infrastructure lending adjustment, which will be
applied where firms choose to submit the necessary data to the PRA, strikes an
appropriate balance in delivering a prudent but proportionate approach, supporting
UK competitiveness and growth. It will ensure that the Pillar 1 risk weights assigned
to infrastructure exposures appropriately reflect their risk, supporting the PRA’s
primary objective. The removal of the infrastructure support factor from Pillar 1
capital requirements also aligns with international standards. The infrastructure
lending adjustment will minimise any potential disruption to infrastructure lending as
there will be no increase in overall capital requirements for infrastructure exposures.
This will support growth without conflicting with the PRA’s primary objective or
undermining economic growth in the medium to long-term.
Bank of England | Prudential Regulation Authority Page 62

2.141 The PRA considers that the infrastructure lending adjustment, when taken
alongside the broader package of changes being introduced, will result in an overall
level of firm capitalisation that is consistent with its primary objective. The PRA
considers that the package will therefore support firms’ ability to lend through the
economic cycle and support UK competitiveness and growth.

2.142 The PRA will invite firms in due course to provide the necessary data to inform
the calibration of the infrastructure lending adjustment as part of an off-cycle review
of firm-specific Pillar 2 capital requirements (as set out in PS17/23 and see Chapter
6 – Pillar 2 for further information).32 Given the infrastructure lending adjustment will
minimise any disruption to infrastructure lending from the removal of the
infrastructure support factor, the PRA has decided there is no need to amend its
draft rules to introduce any transitional arrangements for the removal of the
infrastructure support factor from Pillar 1 capital requirements.

Project finance exposures with government and MDB support

2.143 Other substantive responses to this section of CP16/22 focused on the

recognition of government and MDBs’ support for projects.

2.144 One respondent argued that it should be easier for projects with support from
governments and MDBs to qualify for lower regulatory capital requirements. The
PRA considers that the scope of the proposed criteria for high-quality project finance
exposures is appropriate. Additionally, the CRM framework provides a way for firms
to recognise CRM-eligible guarantees to lower capital requirements for these
exposures where this is justified by the level of credit risk.

32As outlined in PS17/23, Interim Capital regime (ICR) firms and ICR consolidation entities would not
be subject to this Basel 3.1 Pillar 2 off-cycle review. Please refer to Chapter 8 of CP7/24 for specific
proposals for ICR firms.
Bank of England | Prudential Regulation Authority Page 63

Object finance

2.145 The PRA proposed that object finance exposures would be assigned a risk
weight of 100%, reflecting the broad universe of underlying assets with different risk
profiles that fall in this asset class.

2.146 Five respondents argued that firms should be permitted to apply lower risk
weights to ‘high-quality’ object finance exposures. Four of these respondents argued
that the PRA should provide guidance on the criteria for an object finance exposure
to be considered high-quality. Three respondents argued that available data on
shipping and aviation finance supported a lower risk weight for associated object
finance exposures.

2.147 Having considered the responses, the PRA has decided to maintain its
proposed treatment for object finance exposures. The PRA did not receive
persuasive evidence that supported firms’ assertions that a lower risk weight for
certain object finance exposures was appropriate. As recognised by respondents,
object finance collateral is idiosyncratic in nature and generally exhibits poor
resilience to stress. The proposed risk weight applicable to object finance exposures
reflects the full range of potential exposures and is calibrated to downturn scenarios.

Definition of specialised lending exposure

2.148 The PRA proposed to introduce a definition of specialised lending exposure

that would capture exposures that met one of several stated criteria. Following the
PRA’s review of responses and the PRA’s decisions relating to the IRB approach
(see Chapter 3 – Credit risk – internal ratings based approach, IRB exposure classes
and sub-classes), the PRA has decided to align the definition of specialised lending
in the SA with the definition used in the IRB approach for project finance, object
finance and commodities finance, such that all (rather than one) of the stated criteria
must be met for an exposure to be classed as a specialised lending exposure. The
PRA considers that there is strong merit in applying a consistent definition across the
SA and IRB approach.

PRA objectives analysis

2.149 With the exception of the eligibility criteria for the high-quality project finance
risk weight, the PRA’s near-final rules remain materially aligned with the proposals in
CP16/22 and therefore the PRA considers its analysis of its objectives and have
regards for those areas in CP16/22 remains appropriate.
Bank of England | Prudential Regulation Authority Page 64

2.150 The PRA considers that widening the eligibility criteria for exposures eligible
for the lower high-quality project finance risk weight advances its primary objective in
a proportionate and risk sensitive manner.

2.151 Furthermore, the PRA considers that its decision to proceed with the removal
of the infrastructure support factor and to apply the infrastructure lending adjustment
will advance its primary objective in a proportionate manner. The PRA’s decision will
ensure that Pillar 1 capital requirements are prudent and risk-sensitive, minimise any
disruption to infrastructure lending and thereby support UK growth, and maintain an
appropriate overall level of capitalisation.

2.152 The PRA considers that its decision to apply the infrastructure lending
adjustment is consistent with its secondary competition objective given it will be
available to all firms with eligible exposures, regardless of the credit risk approach
used.

‘Have regards’ analysis

2.153 In developing these near-final rules, the PRA has had regard to its framework
regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Relevant international standards:

• The PRA considers that although the wider eligibility criteria for high-quality
project finance exposures are not fully aligned with the explicit criteria in the
Basel 3.1 standards, they are consistent with the Basel 3.1 standards list of
other eligible main entities that the counterparty’s revenue is dependent on,
as the entities in question would be viewed as low risk elsewhere in the SA
framework.

2. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA considers that the wider eligibility for lower risk weights for certain
infrastructure exposures will support the competitiveness of UK firms relative
to the CP proposals and further mitigate any perceived negative impact that
the removal of the infrastructure support factor might have on the relative
Bank of England | Prudential Regulation Authority Page 65

standing of the UK. The impact should also be seen in combination with the
changes set out in Chapter 3 – Credit risk – internal ratings based approach
which will reduce risk weights for certain project finance exposures under the
slotting approach.
• The PRA’s decision to apply the infrastructure lending adjustment will also
support the competitiveness of UK firms by striking an appropriate balance
between delivering prudent Pillar 1 capital requirements that align with
international standards and maintaining an appropriate overall level of
capitalisation.

3. Finance for the real economy:

• The PRA considers that the near-final package of Pillar 1 capital requirements
is unlikely to have a material impact on the availability and cost of
infrastructure lending. However, the PRA considers that its decision to
implement the infrastructure lending adjustment will minimise any potential
disruption to infrastructure lending, and therefore the impact on growth, from
the removal of the infrastructure support factor.

Exposures to individuals and small and medium-sized

enterprises
2.154 Aligned with the Basel 3.1 standards, when capitalising lending to individuals
and small businesses, the PRA proposed to:

• remove the SME support factor but change risk weights for exposures to
SMEs;
• change the definition and treatment of ‘regulatory retail’ exposures (excluding
real estate);
• introduce a new treatment for ‘retail’ exposures with currency mismatch; and
• maintain the existing requirement that exposures to SMEs that are secured by
commercial real estate receive a risk weight that is no lower than 100%.

2.155 The PRA received 40 responses to its proposals for exposures to SMEs and
11 responses to its proposals for retail exposures, including lending to individuals.
The main issues raised by respondents are set out below.
Bank of England | Prudential Regulation Authority Page 66

Exposures to small and medium-sized enterprises

2.156 The PRA proposed changes to the treatment of exposures to SMEs, reflecting
the Basel 3.1 standards, including the introduction of a new ‘corporate SME’
exposure sub-class. The PRA proposed to retain the existing lower CRR risk weight
of 75% for retail SME exposures, introduce a new lower risk weight of 85% for
unrated corporate SME exposures, and introduce a lower risk weight treatment for
‘transactor’ regulatory retail exposures to SMEs of 45%. This was alongside changes
proposed to the risk weight treatment for certain exposures secured by real estate,
which will also apply to exposures to SMEs secured by real estate (but the PRA
proposed to maintain the existing requirement that risk weights for exposures
secured by commercial real estate shall be no lower than 100%).

2.157 Given the reductions in SME risk weights in the Basel 3.1 standards, relative
to the risk weights for larger corporates, the PRA also proposed to remove the
existing SME support factor as retaining it would result in an unwarranted ‘doubling-
up’ of lower risk weight treatments in Pillar 1. The PRA proposed to base the
eligibility for SME risk weights on the CRR definition of SME.

2.158 Respondents were generally supportive of lower risk weights for SMEs,
relative to larger corporates, though ten respondents argued that the lower risk
weights did not go far enough in offsetting the proposed removal of the SME support
factor. Eighteen respondents argued that risk weights for SME exposures secured by
real estate should be lower than for unsecured SME exposures, which was not the
case under the PRA’s proposed risk weight treatment for commercial real estate
(see 'Real estate exposures’ section of this chapter for further detail).

2.159 The PRA received 40 responses to its proposal to remove the SME support
factor. The most common arguments against the proposal were that its removal:

• would reduce lending to SMEs and increase the lending rates which SMEs
pay to borrow, because changes in the cost of capital would be passed on to
obligors;
• was not justified on prudential grounds, due to a lack of evidence that the
SME support factor leads to SME exposures being undercapitalised in a
stress; and
• would disproportionately affect smaller banks and building societies (including
those who are seeking to grow and compete with larger banks) who are an
important source of finance for SMEs.
Bank of England | Prudential Regulation Authority Page 67

2.160 These respondents argued that the PRA should retain the SME support factor.
However, if the PRA proceeded with the proposal to remove it, 13 requested that it is
phased out gradually, or that it is retained for exposures existing at implementation
date (until final repayment of the exposures). Two respondents suggested removing
the SME support factor and making compensatory changes to Pillar 2A as necessary
(to address specific risks on a firm-by-firm basis) or alternatively retaining the SME
support factor but offsetting some of its effect in Pillar 2A calculations.

2.161 Seven respondents noted the current definition of SME was difficult to apply
consistently, given the complexity of assessing linked and parent firms. They
requested the PRA aligns with the definition in the Basel 3.1 standards.

2.162 Having considered these responses, the PRA has decided to make significant
changes across a range of areas to its draft policy. It will:

• maintain its proposed removal of the SME support factor in Pillar 1, but apply
a firm-specific structural adjustment under Pillar 2A (the ‘SME lending
adjustment’) to ensure that the removal of the support factor does not result in
an increase in overall capital requirements for SME exposures;
• maintain its proposed unrated corporate SME risk weight of 85%, which is a
reduction from the 100% risk weight which currently applies to unrated
corporate SME exposures under the CRR, aligning with the Basel 3.1
standards;
• maintain its proposed retail SME risk weight of 75% applicable to exposures
to SMEs which meet the requirements to be treated as regulatory retail
exposures, and its proposed 45% risk weight for ‘transactor’ exposures to
retail SMEs;
• amend its draft rules to remove the 100% risk weight floor for exposures to
SMEs secured by commercial real estate, where repayment is not ‘materially
dependent on cashflows from the property’ and where the exposure meets the
‘regulatory real estate’ definition. This will result in significantly lower risk
weights for certain SME exposures secured by commercial real estate than
under the existing CRR treatment and the CP16/22 proposals for lending
secured on an SME’s own commercial premises (see the 'Real estate
exposures’ section of this chapter for further detail); and
• amend the draft rules to include a new simplified and expanded definition of
SME to align with the Basel 3.1 standards and permit more exposures to
benefit from the lower SME risk weights.
Bank of England | Prudential Regulation Authority Page 68

2.163 The PRA has decided to make the above changes to its proposals where
respondents provided new evidence or highlighted implications that had not
previously been considered in the PRA’s analysis. In light of the significant feedback
related to the proposed removal of the SME support factor, the PRA has reviewed
the appropriateness of the risk weighting of SME exposures in the round, including
the proposed underlying risk weights, the treatment of secured versus unsecured
SME exposures, and the definition of SME. The package of measures in Pillar 1
relevant to SME exposures has been assessed as a whole.

2.164 The PRA aims to adopt risk weights that are not too low to adequately capture
the riskiness of a given class or sub-class of exposures but are also not higher than
required to be commensurate with that risk. On the basis of the available evidence,
the PRA considers that its near-final rules will capitalise SME exposures under Pillar
1 at broadly the right level and advance its primary objective. To inform its analysis,
the PRA considered the riskiness of corporate and retail SMEs relative to larger
(non-SME) corporate exposures in terms of idiosyncratic and systemic risk. Unrated
corporate exposures are assigned a 100% risk weight under the risk-neutral
approach and provide a natural benchmark against which to compare against.

2.165 There are two main factors to weigh up when comparing the appropriate risk
weighting of lending to smaller corporates with lending to larger corporates. First, if
lending to smaller corporates would typically be riskier than lending to larger
corporates due to the risks specific to the individual corporate such as the
corporate’s individual business model (higher idiosyncratic risk). Second, if lending to
small corporates would be less risky because the performance of such exposures is
less correlated with the economic cycle (lower systemic risk). Then the combined
effect of these two factors (idiosyncratic and systemic risk) can be assessed.

2.166 For idiosyncratic risk, the PRA considered the following portfolio level data
from the annual cyclical scenario (ACS) on corporate and retail SME exposures for
firms with IRB permissions:33

33 The data represent the outputs of approved models under a prescribed ‘stress scenario’ rather than
being empirically observed from an actual period of economic stress. The data reflect the makeup of
IRB firms’ lending books (which may differ from firms applying the Standardised Approach). ‘%
secured’ describes the proportion of exposures to that obligor type which had any collateral pledged
(including real estate and other forms of collateral).
Bank of England | Prudential Regulation Authority Page 69

Table 3: Average probability of default (PD) and loss given default (LGD) for
different obligor types

Average PD Average LGD % secured

Mid-to-large 0.94% 39.45% 40.45%

corporate

Corporate SME 1.73% 31.87% 85.77%

Retail SME 2.65% 43.47% 34.64%

2.167 The data show that corporate SMEs have higher idiosyncratic default risk (PD)
than non-SME corporates but have a lower average LGD. The lower LGDs are likely
driven by firms seeking collateral more often when lending to smaller businesses
compared to larger ones. Although the average PD is higher for corporate SMEs,
analysis of these data using the relevant IRB formulae set out in the Basel 3.1
standards suggests that the effect of the higher PD and lower LGD for corporate
SMEs (relative to non-SME corporates) broadly balance out when considering
potential losses. For retail SMEs, the data indicate that these have higher
idiosyncratic risk than non-SME corporates in respect of both PD and LGD.

2.168 The PRA has examined several sources of evidence to understand the
systemic risk of lending to SMEs – ie whether the risk of SME lending is materially
correlated with the economic cycle (as opposed to the risks inherent to a particular
firm such as its own particular strengths and weakness). The PRA considered the
asset value correlation (AVC) parameters used in the IRB formulae set out in the
Basel 3.1 standards (see the ‘Calculation of RWAs and EL’ section of Chapter 3 –
Bank of England | Prudential Regulation Authority Page 70

Credit risk – internal ratings based approach). These parameters indicate that both
corporate and retail SME exposures have lower systemic risk than non-SME
corporate exposures. For corporate SMEs, the AVC parameter is reduced by
between 0 and 4 percentage points depending on size, and for retail SMEs, the AVC
parameter is reduced by approximately 7.4 percentage points on average.

2.169 There is limited empirical data to validate these IRB parameters for lending to
UK SMEs (although long-run data on business failure rates in the UK indicate that
SME lending risk has increased in past downturns). Some academic studies into the
systemic risk of SME lending in other jurisdictions find that the risk of SME lending is
materially correlated with the economic cycle (relative to wider corporate lending),
but several do not, and the results are likely to reflect factors related to the relevant
jurisdictions. Therefore, while some of these studies may suggest the AVC
parameters in the IRB formulae are insufficiently conservative, the PRA considers
them to be the most appropriate benchmark available given they reflect the
international consensus.

2.170 The PRA then analysed the reduction in risk weights that would be consistent
with these differences in both idiosyncratic and systemic risk. The PRA’s analysis
shows the following, when comparing to the 100% SA risk weight for unrated
corporates:

• for corporate SMEs, a risk weight of approximately 88% would be consistent

with the differences in idiosyncratic and systemic risk. This is broadly in line
with the 85% calibration in the Basel 3.1 standards; and
• for retail SMEs, a risk weight of approximately 89% would be consistent with
the differences in idiosyncratic and systemic risk. This is higher than the 75%
calibration in the Basel 3.1 standards.

2.171 This analysis indicates that the effective discount (relative to the 100% risk
weight for unrated corporates) incorporated in the risk weight for corporate SMEs
under the Basel 3.1 standards is broadly appropriate. Meanwhile, the analysis
indicates the effective discount incorporated in the risk weight for retail SMEs under
the Basel 3.1 standards may be too high. However, this is a single piece of analysis,
and the PRA does not consider that it, in itself, justifies deviating from the
international consensus set out in the Basel 3.1 standards. But it supports the view
that reducing risk weights in Pillar 1 for corporate or retail SMEs further than the
Basel 3.1 standards already have would be inconsistent with an assessment purely
based on the risk.
Bank of England | Prudential Regulation Authority Page 71

2.172 The PRA continues to consider that the SME support factor should be
removed from Pillar 1 capital requirements based on its assessment of the risk of
eligible exposures. This will also be consistent with Basel 3.1 standards. The PRA
considers that the net effect of the near-final Pillar 1 package for SME exposures is
unlikely to have a material impact on the availability and cost of SME lending. While
the internationally published evidence is mixed, overall it indicates that the SME
support factor has not had a significant impact on SME lending. The PRA considers,
based on this evidence, that the SME support factor has not significantly increased
the provision of financing to SMEs and so removing it will not significantly reduce
lending to SMEs.

2.173 The PRA’s estimate of the overall impact of its near-final package for SME
exposures (across both the SA and the IRB approach and including the changes to
commercial real estate set out in the ‘Real estate exposures’ section of this chapter)
is an eight percentage point increase in average Pillar 1 risk weights – from 56% to
64%.

2.174 The PRA has estimated the impact of the overall package on SME lending
pricing using two approaches. The first uses data from a Bank of International
Settlements repository of 83 empirical studies assessing the impact of previous
changes in minimum regulatory capital requirements on lending pricing. The second
uses the PRA’s own calculations, based on a model of how changes in capital
requirements translate into changes in lending pricing. Taking an average across
these two approaches would suggest that the change in risk weights for SME lending
could lead to an increase in pricing of 0.14 percentage points (without reflecting the
introduction of the new transactor exposure sub-class, which will permit a subset of
exposures to qualify for a new, lower risk weight which in turn should reduce the
overall pricing impact).

2.175 These estimates are uncertain, reflecting the many factors which influence the
pricing and availability of lending of which the capital framework is only one. It is
challenging to accurately estimate the impact of changes in capital requirements on
pricing, including because there is a significant discretionary element to firms’
lending decisions which differs across firms and products, and which may change
over time. The extent to which changes in capital requirements for specific types of
exposure are passed on by firms to obligors is dependent on several factors,
including firm strategy, market dynamics and the level of competition between firms.
There is also uncertainty around these estimates due to the limited data available to
Bank of England | Prudential Regulation Authority Page 72

assess how the existing stock of loans will be classified within the new classes and
sub-classes of exposures.

2.176 Although the near-final package is expected to result in a limited increase to

Pillar 1 capital requirements for finance to SMEs, the PRA considers this necessary
for both the safety and soundness of firms and the provision of finance to SMEs
through the economic cycle. Capital requirements should be calibrated appropriately,
including for downturn conditions. This means they should not be too high, but they
should not be too low either. The failure of Silicon Valley Bank in the US
demonstrated how depositors and investors can focus on lender resilience during
stress, and how bank failures in such circumstances can leave SME customers
without access to finance. This is particularly important given the reliance of SMEs
on bank lending relative to other forms of finance.

2.177 However, the PRA recognises concerns raised by respondents on the

potential impact on UK competitiveness and growth of even limited increases in
capital requirements on SME lending. To minimise any potential disruption to SME
lending and therefore growth resulting from the removal of the SME support factor,
the PRA will apply the SME lending adjustment to ensure that the removal of the
SME support factor under Pillar 1 does not result in an increase in overall capital
requirements for SME lending. The PRA considers that its near-final policy strikes an
appropriate balance in delivering a prudent but proportionate approach.

2.178 The PRA considers that the SME lending adjustment, which will be applied
where firms choose to submit the necessary data to the PRA, will minimise any
potential disruption to SME lending and growth resulting from the removal of the
SME support factor, without conflicting with the PRA’s primary objective or
undermining economic growth in the medium to long-term. When taken alongside
the broader package of changes being introduced, the approach will result in an
overall level of firm capitalisation that is consistent with its primary objective and
supports firms’ ability to lend through the economic cycle.

2.179 The PRA will invite firms in due course to provide the necessary data to inform
the calibration of the SME lending adjustment as part of an off-cycle review of firm-
specific Pillar 2 capital requirements (as set out in PS17/23 and see Chapter 6 –
Pillar 2 for further information).34 Given the SME lending adjustment will minimise

34As outlined in PS17/23, Interim Capital regime (ICR) firms and ICR consolidation entities would not
be subject to this Basel 3.1 Pillar 2 off-cycle review. Please refer to Chapter 8 of CP7/24 for specific
proposals for ICR firms.
Bank of England | Prudential Regulation Authority Page 73

any disruption to SME lending from the removal of the SME support factor, the PRA
has decided there is no need to amend its draft rules to introduce any transitional
arrangements for the removal of the SME support factor from Pillar 1 capital
requirements.

2.180 In addition to the above changes, the PRA is introducing a revised SME
definition. The new definition will require firms to assess the turnover of entities on
the basis of the approach to accounting consolidation taken in the obligor’s
jurisdiction. This will enable firms to assess SME status more easily and eliminate
the requirement for firms to undertake a bespoke assessment of linked firms beyond
those linkages that are captured through accounting consolidation. This will lower the
operational burden, improve consistency and comparability across firms, and
increase the number of exposures which qualify as SMEs.

Treatment of regulatory retail exposures

Criteria for identifying regulatory retail exposures

2.181 The PRA proposed to update the criteria for identifying regulatory retail
exposures and introduce three qualifying elements relating to the product type,
exposure value and granularity of the exposure. In particular, the PRA proposed that
the value of the exposure (either individually or when aggregated with all other retail
exposures and including undrawn commitments and off-balance sheet items) to a
single obligor or group of connected clients should not exceed £0.88 million, to align
with the Basel 3.1 standards.

2.182 One respondent requested that the PRA clarify how firms would be required to
calculate the aggregate exposure for the purpose of applying the exposure value
criterion. The PRA also identified an unintended circular reference where the
calculation of the exposure value criterion would have depended on whether an SME
exposure met that criterion (as an exposure to an SME would only have been treated
as a retail exposure if it had satisfied the criteria for regulatory retail exposures).

2.183 The PRA has decided to amend its draft rules to materially align with the
current treatment under the CRR, such that the value criterion is based on the total
amount owed to the firm, excluding all residential real estate exposures. The PRA
notes that this has the following effects:
Bank of England | Prudential Regulation Authority Page 74

• undrawn commitments will be excluded from the value criterion calculation;

and
• only residential real estate exposures will be excluded from the value criterion
calculation (as opposed to all exposures which do not meet the definition of a
retail exposure, including all real estate exposures, as proposed in CP16/22).

2.184 While this does not fully align with the Basel 3.1 standards, the PRA considers
the approach to be appropriately prudent when considered alongside the other
criteria for classifying retail exposures. The PRA further considers that its decision
advances its secondary competition objective by more closely aligning the treatment
between exposures subject to the SA and the IRB approach. It is also a more
appropriate and prudent criterion for determining if commercial real estate exposures
to SMEs should receive a 75% counterparty risk weight, than a criterion based solely
on a firm’s aggregate retail exposures to the obligor (see the ‘Real estate exposures’
section of this chapter).

2.185 Other substantive responses to this section of CP16/22 focused on two issues:

• Off-balance sheet items: one respondent argued that the proposal to include
commitments to issue off-balance sheet items to SMEs in the product
criterion, but to exclude off-balance sheet items that have been issued to
SMEs, is inconsistent. The respondent argued that issued off-balance sheet
items should also be included in the product criterion. The PRA agrees the
proposed treatment was inconsistent. However, it considers most off-balance
sheet items and commitments to purchase such items are not retail in nature,
so has decided to amend its draft rules to also exclude commitments to issue
off-balance sheet items from the definition of regulatory retail exposures.
• Asset-backed lending: one respondent requested that the PRA clarify how
firms would be required to classify their asset-backed lending portfolio,
identifying that if a product was offered to a natural person, it would appear to
not meet the regulatory retail definition as it would not be one of a range of
similar exposures. The PRA confirms that, if an asset-backed exposure to a
natural person is not one of a range of similar exposures, the exposure would
not meet the criteria to be categorised as a regulatory retail exposure.

Transactors, non-transactors and other retail exposures

2.186 The PRA proposed to add granularity within the ‘retail’ exposure class, by
breaking it down into three sub-exposure classes for the purpose of determining the
Bank of England | Prudential Regulation Authority Page 75

appropriate risk weight: regulatory retail exposures that are ‘transactor exposures’35
subject to a 45% risk weight; regulatory retail exposures that are ‘non-transactor
exposures’ subject to a 75% risk weight; and ‘other retail’ exposures subject to a
100% risk weight.

2.187 Respondents broadly supported of the introduction of the new, lower risk
weight for transactor exposures, although one argued that the definition of retail
exposures had been complicated by the introduction of the transactor category. Six
respondents requested the PRA introduce a materiality threshold to assess whether
exposures meet the conditions to qualify as a ‘transactor exposure’ to introduce
proportionality.

2.188 Having considered the responses, the PRA has decided to maintain its
proposal to introduce a specific risk weight treatment for ‘transactor exposures’. The
PRA considers its decision to introduce the ‘transactor exposures’ category improves
the risk sensitivity of retail risk weights and aligns with the Basel 3.1 standards.
However, the PRA has clarified in its near-final amendments to SS10/13, that, where
an exposure has breached the transactor conditions due to certain technical events,
the exposure should still be classified as a ‘transactor exposure’ as such technical
events do not affect the risk of such exposures. A broader materiality threshold (for
example based on interest or charges applied to the obligor) would be inappropriate
given late payments or drawdown of overdrafts affect the credit risk of such
exposures, regardless of the length of the delay or period of drawdown.

Exposures with a currency mismatch

2.189 The PRA proposed to introduce a risk weight multiplier of 1.5x for unhedged
foreign exchange retail and residential real estate exposures to individuals, subject
to a maximum risk weight of 150%. The multiplier would be applied to exposures
where a mismatch is identified (at origination and throughout the loan term) between
the currency of the loan and that of the obligor’s main source of income.

35 The PRA proposed that ‘transactor exposures’ refers to regulatory retail exposures that are to: (i)
obligors in relation to revolving facilities such as credit cards and charge cards where the balance has
been repaid in full at each scheduled repayment date for the previous 12 months; and (ii) obligors in
relation to overdraft facilities if there have been no drawdowns over the previous 12 months.
Bank of England | Prudential Regulation Authority Page 76

2.190 The PRA also proposed an ‘alternative approach’ to identifying currency

mismatches where information about an obligor’s main source of income cannot be
verified for lending prior to Basel 3.1 implementation. The PRA proposed that firms
applying the ‘alternative approach’ would instead use, as a proxy, any currency
mismatch between the currency of the exposure and the domestic currency of the
country of residence of the obligor.

2.191 Three respondents argued that the PRA should limit the scope of the
mismatch multiplier to regulatory residential real estate exposures, and retail
exposures to individuals in the form of instalment loans or non-revolving loans with
pre-specified schedules of repayment, in line with some other international
jurisdictions. Five respondents requested that asset-based lending to high-net-worth
individuals should be excluded from the currency mismatch treatment, arguing that
for this type of lending, the collateral reduces the risks associated with currency
mismatch, and that the source of income of an obligor was not a part of the
underwriting criteria. Therefore, they argued that applying the proposed
requirements to identify if a currency mismatch exists for such exposures would
represent a disproportionate burden.

2.192 Having considered the responses, the PRA has decided to maintain its
proposal that the currency mismatch multiplier should apply to all residential real
estate exposures and retail exposures to individuals. The PRA did not receive
persuasive evidence that foreign exchange risks were reduced for specific types of
retail lending. This also aligns with the Basel 3.1 standards. Consistent with this
decision, the PRA has decided to amend its draft rules to include ‘other real estate
exposures’ within the scope of the currency mismatch multiplier treatment to correct
a drafting error. However, the PRA notes that its proposed definition of loan
instalment amount may not be clear when assessing if revolving facilities are
hedged. Therefore, the PRA has decided to amend its draft rules to clarify that firms
should use the minimum instalment required under the revolving exposure contract,
and that for partially drawn revolving facilities, firms should consider the facility as
fully drawn when calculating loan instalments.

2.193 Having considered the responses, the PRA has decided not to change the
scope of the currency mismatch multiplier by exempting asset-based lending to high-
net-worth individuals. However, recognising the risk mitigation that assets held as
collateral provide, the PRA has decided to amend its draft rules to permit certain
assets to be considered as a hedge when determining if loans are subject to the
currency mismatch multiplier. This treatment will be limited to pledged assets that
Bank of England | Prudential Regulation Authority Page 77

are eligible collateral under the CRM financial collateral comprehensive method and
will be subject to the application of relevant haircuts.

Other issues relating to the currency mismatch multiplier

2.194 Other substantive responses to this section of CP16/22 focused on the

following issues:

• Financial hedges: three respondents requested that the PRA clarify what
constitutes a ‘financial hedge’ for the purposes of identifying when to apply the
currency mismatch multiplier. Having considered the responses, the PRA has
decided to not provide further clarification on the definition of a financial
hedge. Firms are already required to consider what constitutes a financial
hedge in other contexts, so providing additional detail for this aspect could
lead to increased burdens on firms if it is inconsistent with their existing
approaches.
• Assessing an obligor’s source of income: four respondents noted that the
PRA’s draft rules specify that firms should consider a currency mismatch
between an obligors ‘source of income’ and the loan, while CP16/22 referred
to an obligor’s ‘main source of income’. These respondents argued that the
latter would be more appropriate. The PRA has decided to maintain its draft
rules but has clarified in its near-final amendments to SS10/13 how it expects
firms to apply them. Firms should evaluate foreign exchange risk between an
obligors’ main source of income and a loan where this source of income
constitutes a substantial proportion of the loan instalments. Where this is not
the case, firms should consider other income sources to ensure that they
have correctly identified material foreign exchange risks. This addresses the
inconsistency highlighted by respondents and ensures firms are identifying
foreign exchange risk in a proportionate manner.
• Non-natural persons: one respondent argued that the treatment of currency
mismatch for real estate exposures was inconsistent between natural persons
and non-natural persons with the characteristics of an individual obligor.
Having considered the response, the PRA has decided to amend its draft
rules to specify that real estate exposures to SPVs with an individual
guarantor must be treated as an exposure to a natural person for the purpose
of applying the currency mismatch multiplier to residential real estate
exposures. The PRA agrees with the respondent that this provides
consistency between obligors who share similar characteristics and prevents
arbitrage opportunities.
Bank of England | Prudential Regulation Authority Page 78

• Assessment of currency mismatch post-origination: three respondents

requested clarification on the assessment of a currency mismatch post-
origination, arguing it should be the obligor’s responsibility to make firms
aware of any material change in circumstances. Having considered the
responses, the PRA has clarified in its near-final amendments to SS10/13 the
circumstances where firms should re-assess currency mismatch.
• Alternative approach (ongoing application): three respondents argued that
the PRA should expand the alternative approach to apply to all exposures on
an ongoing basis. The PRA does not consider it appropriate to permit the
alternative approach to be used in respect of exposures originated on or after
1 January 2026. Firms should have adequate processes in place by this time
to obtain the necessary information from obligors at origination.
• Alternative approach (country of employer): three respondents argued that
the PRA should permit the country of employer to be used as a proxy for
assessing an obligor’s income under the alternative approach. Having
considered the responses, the PRA has decided to widen the scope of the
alternative approach to permit firms to use country of employment as a proxy.
The PRA considers this to be a reasonable alternative to country of residence
for identifying a currency mismatch under the alternative approach.

PRA objectives

2.195 With the exception of the introduction of a new SME definition, the PRA
considers that its analysis of its objectives presented in CP16/22 remains
appropriate.

2.196 The PRA considers that the new definition of SME in its near-final rules will
advance its primary objective by improving the consistency of application by firms
and therefore the comparability of risk weights across firms. In respect of the PRA’s
secondary objective, the PRA considers that the revised definition of SME should be
easier for all firms to apply, and therefore support smaller firms being able to
compete with larger firms when seeking SME business.

2.197 Furthermore, the PRA considers that its decision to proceed with the removal
of the SME support factor and to apply the SME lending adjustment to ensure this
does not result in an increase in overall capital requirements will advance its primary
Bank of England | Prudential Regulation Authority Page 79

objective in a more proportionate manner. The PRA’s decision will ensure that Pillar
1 capital requirements are prudent and risk-sensitive, minimise any disruption to
SME lending and therefore growth, and maintain an appropriate overall level of
capitalisation.

2.198 The PRA considers that its decision to apply the SME lending adjustment is
consistent with its secondary competition objective given it will be available to all
firms with eligible exposures, regardless of the credit risk approach used.

‘Have regards’ analysis

2.199 In developing these near-final rules, the PRA has had regard to its framework
of regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in chapter 3 of CP16/22, remains appropriate, subject to the
following updates:

1. Relevant international standards:

• The PRA’s new definition of SME is consistent with international standards.

2. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA considers that the package of near-final rules for exposures to
SMEs will support the relative standing of the UK as a place to operate by
lowering capital requirements for exposures to SMEs relative to non-SME
corporates where it is prudentially justified to do so.
• The PRA’s decision to apply the SME lending adjustment will also support the
competitiveness of UK firms by striking an appropriate balance between
delivering prudent Pillar 1 capital requirements that align with international
standards and maintaining an appropriate overall level of capitalisation.
• The PRA considers that its decisions to revise the treatment of SME lending
secured by commercial real estate (covered in the ‘Real estate exposures
section of this chapter), and to introduce a new expanded definition of SME,
will support the competitiveness of UK firms relative to the CP proposals and
Bank of England | Prudential Regulation Authority Page 80

further mitigate any perceived negative impact that the removal of the SME
support factor might have on the relative standing of the UK.

3. Finance for the real economy:

• The PRA considers that the near-final package for Pillar 1 capital
requirements is likely to support growth, with little effect on the availability and
cost of SME lending. However, the PRA considers its decision to apply the
SME lending adjustment should address concerns raised by respondents on
the potential impact of even limited increases in capital requirements on SME
lending. The SME lending adjustment will support growth and minimise
potential disruption and any impact on the provision of SME lending, and
therefore the impact on growth, from the removal of the SME support factor.

4. Proportionality:

• The PRA considers that the definition of SME is more proportionate for firms
to apply and will require fewer resources to operationalise relative to the
current definition.
• The PRA considers that its decision to permit transactor exposures to retain
their status if the threshold is breached due to a technical event, to be
proportionate. It ensures risk weights do not increase due to technical events
that do not affect the risk of the exposure. Similarly, the PRA considers its
decision to permit firms to use the least burdensome loan instalment amount
when assessing if a revolving exposure is hedged, and the introduction of new
proxy measures under the alternative approach, lowers the operational costs
of implementing the currency mismatch multiplier.

5. Different business models:

• The PRA considers its decision to permit assets to be considered as a hedge

when assessing currency mismatch should result in an application of a
currency mismatch multiplier that better reflects the risks of exposures for
firms specialising in asset-based lending and lending to high-net-worth
individuals.
Bank of England | Prudential Regulation Authority Page 81

Real estate exposures

2.200 The PRA proposed changes to the treatment of exposures secured on
immovable property, including:

• a more structured and granular exposure allocation and greater risk sensitivity
of the treatment for real estate, including introducing a new treatment for
exposures that are materially dependent on cash flows from property;
• new requirements for determining the value of the property, including a
requirement that the value of the property should be the value at origination;
and
• a specific treatment for ‘land acquisition, development and construction
exposures’ (ADC) exposures.

2.201 The PRA received 58 responses to this section in CP16/22. The substantive
issues raised by respondents are set out below.

Definition of residential real estate and commercial real estate

2.202 The PRA proposed to introduce a definition for residential real estate that the
property predominantly has, or will have, the nature of a dwelling. The PRA
proposed to include a list of property types that were excluded from the definition for
residential real estate as the PRA considered the use of such property was not
consistent with residential real estate. The list included care homes, purpose-built
student accommodation, and property that was predominantly used for holiday lets.

2.203 Respondents generally argued that the proposed exclusion of holiday lets from
the residential real estate definition was not reflective of the risk, as such exposures
may be more akin to buy-to-let residential property, with nine respondents arguing
that holiday lets should be considered residential property when the nature of the
dwelling is like standard residential housing.

2.204 Two respondents requested that the PRA clarify the treatment of purpose-built
student accommodation, and one respondent did not support the proposed exclusion
of purpose-built student accommodation from the definition of residential real estate.

2.205 Having considered the responses, the PRA has decided to amend its draft
rules to remove the provisions excluding specific types of property from the definition
of residential real estate. While the feedback mainly pertained to holiday lets and
Bank of England | Prudential Regulation Authority Page 82

purpose-built student accommodation, the PRA considers that the feedback is also
applicable, in principle, to care homes. In the PRA’s near-final amendments to
SS10/13, the PRA has introduced expectations that firms should treat property as
residential real estate only where it could be used as a standard residential dwelling.
In particular, the PRA has clarified that it considers it unlikely that holiday lets, care
homes and purpose-built student accommodation would meet the definition of
residential real estate unless the property is capable of being resold as a standard
residential dwelling in the event of the obligor’s default.

2.206 The PRA has also decided to make further amendments to the definition of
real estate exposures to align with the approach to ADC exposures set out below.

Other issues relating to the definition of residential real estate and

commercial real estate
2.207 Other substantive responses to this section of CP16/22 focused on mixed-use
properties. Two respondents requested that the PRA clarify its proposed treatment of
mixed-use properties (ie where a single property is used for residential and
commercial purposes).

2.208 Having considered the responses, the PRA has decided to retain the proposed
predominant nature test for defining whether a property is residential real estate for
operational simplicity. The PRA has decided to set a further expectation in its near-
final amendments to SS10/13 that firms should have a clear documented policy for
determining the predominant nature of a property for the purpose of applying the
definition of residential real estate.

2.209 Where an exposure is secured by multiple properties, the PRA has clarified in
its near-final amendments to SS10/13 that firms must assess the predominant nature
of each property separately to determine if it is residential or commercial real estate.
The approach to exposures that are secured by both residential and commercial real
estate is set out below.

Requirements for ‘regulatory real estate’

2.210 The PRA proposed to introduce criteria for a loan to be classified as a

‘regulatory real estate exposure’ which are aligned with the Basel 3.1 standards, as it
considered these to be proportionate and prudent. This included a proposed
requirement that the exposure is secured on a finished property. In cases where the
Bank of England | Prudential Regulation Authority Page 83

requirements are not met, the PRA proposed that the exposures would be classified
as ‘other real estate’ and receive a higher risk weight, given the elevated risks
associated with collateral that does not fully meet the regulatory real estate
requirements. The PRA acknowledged that the proposed approach may affect self-
build mortgage loans, as these would not meet the ‘finished property’ requirement
during the construction phase, but considered, based on the evidence it had, that the
greater risk of these exposures justified a higher risk weight.

2.211 The PRA received a significant number of responses to its proposal not to
exempt self-build mortgage loans from the ‘finished property’ requirement. Seven
respondents argued that the applicable risk weights for ‘other residential real estate’
would be too high for self-build property mortgages given what they considered to be
their low-risk nature and the existing risk management practices of firms. Six
respondents also noted that providing such an exemption would align with the Basel
3.1 standards, which allow discretion for national authorities to exempt self-build
mortgage loans from the ‘finished property’ requirement. A number of respondents
provided empirical data to support their arguments.

2.212 Having considered the responses and the data provided, the PRA agrees that
classifying self-build mortgage loans as ‘other residential real estate’ could result in
risk weights that are not proportionate to the level of risk associated with these
exposures. The PRA has therefore amended its draft rules to exempt self-build
mortgage loans from the ‘finished property’ requirement. If all other requirements are
met, loans secured by unfinished self-build properties will be classed as ‘regulatory
real estate exposures’, and use of the loan-splitting approach to risk weight these
exposures will therefore be permitted. Specifically, the PRA has decided to exempt
exposures from the ‘finished property’ requirement where the exposure is: (i)
secured by property that has been acquired or held for development and
construction purposes; (ii) the property does or will not have more than four
residential housing units; and (iii) the property will be the obligor’s primary residence.

2.213 The valuation and market liquidity of unfinished self-build properties is subject
to substantial uncertainty compared with finished properties, particularly in a
downturn. To account for this, the PRA has decided to require that, for the purposes
of determining the value of an unfinished self-build property for the purpose of risk-
weighting the exposure, firms must use the higher of the most recent valuation with a
20% haircut applied, or the land value. The PRA considers that these changes in
aggregate address respondents’ concerns and advance the PRA’s primary objective
in a proportionate manner.
Bank of England | Prudential Regulation Authority Page 84

Other issues relating to the requirements for regulatory real estate

2.214 Other substantive responses to this section of CP16/22 focused on the issues
set out below.

Regulatory real estate criteria – value of the property must not materially
depend on the performance of the obligor

2.215 The PRA proposed that the value of the property must not materially depend
on the performance of the obligor. The PRA has decided to amend its draft rules to
clarify that a real estate exposure must meet this requirement in order to be
classified as a regulatory real estate exposure, as opposed to this being a
requirement on how a valuation is obtained. This more closely aligns with the Basel
3.1 standards.

Regulatory real estate criteria – second charges

2.216 One respondent requested that the PRA clarify whether a loan secured by a
second charge mortgage can be deemed a ‘regulatory real estate exposure’. Three
respondents argued that the PRA should include the additional clarification provided
in the Basel 3.1 standards regarding the situation where there is an intermediate
charge held by another lender.

2.217 Having considered these responses, the PRA clarifies that an exposure
secured by a second charge on a property may be treated as a ‘regulatory real
estate exposure’ if certain requirements are met (including where there is an
intermediate charge held by another lender). The PRA has decided to amend its
draft rules to more clearly reflect this approach.

Insurance against damage

2.218 One respondent argued that the PRA should retain the CRR requirement that
firms must monitor that immovable property is adequately insured against the risk of
damage. Having considered this response, the PRA agrees that this would promote
safety and soundness so it has amended its draft rules to introduce a requirement
that firms must have procedures in place to monitor that the immovable property is
adequately insured against the risk of damage in order for the exposure to be
classified as a ‘regulatory real estate exposure’.

Monoline insurance
Bank of England | Prudential Regulation Authority Page 85

2.219 Three respondents considered that the PRA should recognise monoline-
insured loans as meeting the regulatory real estate requirement for charges over the
property, where the specific requirements in the Basel 3.1 standards are met.36

2.220 Having considered the responses, the PRA has decided not to recognise
monoline-insured loans as meeting the regulatory real estate requirement for being
secured by appropriate charges over the property. The PRA considers that there
was insufficient evidence provided in responses to justify implementing a bespoke
treatment for such exposures and notes a firm may be able to use eligible credit risk
mitigation techniques to reflect the credit insurance.

Underwriting standards

2.221 Two respondents requested that the PRA provide further guidance on good
underwriting practice. The PRA notes that buy-to-let exposures are already subject
to specific expectations set out in SS13/16 and does not consider that further
guidance or requirements for underwriting standards are necessary at this stage.

Valuation of real estate collateral

2.222 In CP16/22, the PRA proposed that the value for residential and commercial
property should be the value at origination, which the PRA considered to be the
valuation obtained by a firm when it issues a new mortgage loan for the purchase of
the property, or when a firm issues a new mortgage loan to an existing or new
obligor for the property securing the loan. The PRA proposed to permit some
exceptions for firms to use updated valuations, in particular to require a new
valuation of the property when: (i) an event occurs that results in a likely permanent
reduction in the property’s value; (ii) there is a significant decrease in the market

36 CRE20.71(3), footnote 29: In certain jurisdictions, the majority of bank loans to individuals for the
purchase of residential property are not provided as mortgages in legal form. Instead, they are
typically provided as loans that are guaranteed by a highly rated monoline guarantor that is required
to repay the bank in full if the obligor defaults, and where the bank has legal right to take a mortgage
on the property in the event that the guarantor fails. These loans may be treated as residential real
estate exposures (rather than guaranteed loans) if the following additional conditions are met: (a) the
obligor shall be contractually committed not to grant any mortgage lien without the consent of the
bank that granted the loan; (b) the guarantor shall be either a bank or a financial institution subject to
capital requirements comparable to those applied to banks or an insurance undertaking; (c) the
guarantor shall establish a fully-funded mutual guarantee fund or equivalent protection for insurance
undertakings to absorb credit risk losses, whose calibration shall be periodically reviewed by its
supervisors and subject to periodic stress testing; and (d) the bank shall be contractually and legally
allowed to take a mortgage on the property in the event that the guarantor fails.
Bank of England | Prudential Regulation Authority Page 86

value of the property as a result of a broader decrease in market prices; or (iii)

modifications are made to property that unequivocally increase its value.

2.223 The PRA also proposed that the valuation of a property would need to be
appraised using prudently conservative valuation criteria, and that this valuation
would need to be undertaken by a suitably qualified valuer who was independent
from the institution’s mortgage acquisition, loan processing and loan decision
process.

2.224 The PRA considered that the proposed approach achieved a balance between
ensuring accurate valuations while mitigating the risk of excessive cyclicality in
values that could flow through to risk weights.

2.225 The PRA received 47 responses. The material issues raised were:

• Use of value at origination: some respondents explicitly supported parts of

the proposals on valuing real estate collateral. In particular, three respondents
supported permitting revaluations to be performed at the point a loan is
refinanced and two respondents agreed with the proposal that the value
should reflect the value at origination. However, 29 respondents did not
support using value at origination. These respondents argued that it was not
risk sensitive as it would not reflect the current market value, that it would be
unsuitable for specific products with longer term fixed periods, and it would
create inconsistency between firms using the SA and those using the IRB
approach. Respondents also raised concerns over the operational complexity
of maintaining two values for a property: one for risk management purposes
reflecting current market value and a separate origination value for capital
requirement purposes.
• Revaluation events: ten respondents requested that the PRA clarify what
constitutes a revaluation event and to publish a non-exhaustive list of
examples of valid revaluation events.
• Revaluation due to a broader decrease in market prices: ten respondents
requested that the PRA clarify the proposed requirement to update the value
of the property where there has been a significant decrease in its market
value as a result of a broader decrease in market prices. Respondents
suggested the PRA issue guidance on how to comply with the requirement,
including the triggers that should be used to indicate a significant decrease in
the market value of the property and when there had been a broader
decrease in market prices. Eight respondents argued that if the value of the
Bank of England | Prudential Regulation Authority Page 87

property was revised downwards due to a broader decrease in market prices,

firms should be permitted to reflect subsequent price increases up to the
previously recognised property value.
• Valuation of existing exposures: two respondents agreed with the PRA’s
proposal to permit firms to use the valuation obtained at the most recent
revaluation event for exposures incurred prior to implementation date, where it
is not reasonably practicable to use the origination value of the property.
However, two respondents argued that it could lead to inconsistent
approaches across firms, with some arguing it is unclear what is meant by the
term ‘reasonably practical’ and one arguing that the requirement to use the
origination value should only be applied to new exposures.
• Prudent valuation criteria: 15 responses related to the proposed
requirement that the valuation must be adjusted to consider the potential for
the current market price to be significantly above the value that would be
sustainable over the life of the loan. Respondents requested that the PRA
clarify the proposed requirement, and some argued that the PRA should not
introduce the requirement due to the complexity of adjusting valuations at
individual property level. Two respondents supported the proposed
implementation of a prudent valuation approach.
• Use of automated valuation models (AVMs): 19 respondents argued that
the PRA should explicitly permit AVMs to be used for property valuations,
noting the trend towards increased levels of automation across the industry.

Value at origination

2.226 Having considered the responses, the PRA has decided to maintain the
proposed requirement that the value of the property should be the value at
origination but has made several important amendments to its draft rules.

2.227 The PRA continues to consider that using the value at origination strikes a
good balance between ensuring an accurate valuation is used while mitigating
potential cyclicality in values that could lead to excessive cyclicality in risk weights.
However, the PRA acknowledges that, without compromising the advancement of its
primary objective, changes are appropriate in order to make the valuation approach
more product agnostic and make aspects of the approach easier for firms to
operationalise.

2.228 The PRA has amended its draft rules to introduce a revaluation ‘backstop’ that
will require firms to obtain an updated valuation every five years after the most
Bank of England | Prudential Regulation Authority Page 88

recent valuation has been obtained. This addresses respondents’ concerns that
using value at origination could impact firm and obligor incentives and behaviours in
relation to the length of fixed-rate products and therefore not be product agnostic.
The PRA has amended its draft rules to introduce two exceptions to this
requirement:

• where the amount of the loan is more than £2.6 million or 5% of the own funds
of the firm, the firm must obtain an updated value of the property every three
years. This reflects the greater risk of loss in the event of a default for such
exposures if they are inaccurately valued and is consistent with the existing
requirement for the valuation of such immovable property collateral; and
• where the most recent valuation has been obtained due to a broader
decrease in market prices (see below), a firm may either: (i) obtain an updated
valuation either three or five years (as applicable) after this revaluation; or (ii)
obtain an updated valuation either three or five years (as applicable) after the
most recent origination event that occurred prior to this most recent valuation.

Revaluation due to a broader decrease in market prices

2.229 The PRA acknowledges the concerns raised by respondents relating to a lack
of clarity on the trigger for firms to obtain an updated valuation where there has been
a significant decrease in the market value of a property due to a broader decrease in
market prices. The PRA has decided to amend its draft rules to retain the existing
requirement that firms shall continue to monitor the market value of the property on a
frequent basis and carry out more frequent monitoring where the market is subject to
significant changes in conditions. In addition, the PRA has decided to amend its draft
rules to only require that firms obtain an updated valuation if the firm estimates that
the market value of the property has fallen more than 10% from the recorded value
of the property at the last valuation event. The PRA considers that this simpler
approach should promote the consistent application of its rules across firms.

Valuation of existing exposures

2.230 The PRA has maintained its proposed policy for assessing origination
valuation for exposures incurred prior to 1 January 2026. The PRA clarifies that the
most recent available origination value, whether at the point of purchase of the
property or a valuation at another origination event (including when an obligor
remortgages) must be used. The PRA notes that the revaluation ‘backstop’ will mean
firms will be required to update existing valuations that are older than five years (or
Bank of England | Prudential Regulation Authority Page 89

three years if the exception above applies) on 1 January 2026. The PRA considers
that most regulatory real estate exposures will have relatively recent origination
values, with limited scope for inconsistent approaches between firms.

Prudent valuation criteria

2.231 The PRA agrees with respondents that the proposed requirement to adjust a
valuation to reflect the value of the property that would be sustainable over the life of
the loan could be complex for firms to operationalise and may lead to inconsistent
approaches. Having considered the responses, the PRA has amended its draft rules
to remove this requirement.

Use of automated valuation models

2.232 In response to comments related to the use of automated valuation models

(AVMs), the PRA clarifies that it did not intend to propose that only physical
valuations by a qualified surveyor would be permitted and has amended the draft
rules to state that firms can use robust statistical valuation methods. This may
include the use of AVMs or indices, where it is prudent to do so.

Definition of real estate where repayment is materially dependent on

the cash flows generated by the property

2.233 The PRA proposed to implement criteria for determining whether repayment of
the loan was ‘materially dependent on the cash flows generated by the property’ that
were aligned with the Basel 3.1 standards, and proposed guidance in its draft
amendments to SS10/13 to support consistent implementation across firms. It
proposed that a real estate exposure would be considered materially dependent on
the cash flows generated by the property where payment of the mortgage loan over
a representative period (or the prospects of recovery in the event of default)
materially depends on the cash flows generated by the property securing that
exposure, rather than on the capacity of the obligor to pay the mortgage loan from
the other sources.

2.234 In addition to the general criteria, the PRA proposed that houses in multiple
occupation (HMOs) would automatically be treated as materially dependent on the
cash flows generated by the property. The PRA also proposed exceptions to the
Bank of England | Prudential Regulation Authority Page 90

definition of materially dependent on the cash flows generated by the property.

These included exposures secured by a property that was the obligor’s primary
residence and social housing exposures.37

2.235 The PRA proposed to permit an exposure to an individual who has no more
than three mortgaged residential properties in total, regardless of the firm that
provided the loan on the other properties, to be exempt from being classified as
materially dependent on the cash flows generated by the property (the ‘three
property limit’). For the purposes of the three-property limit, the PRA proposed that:

• properties of an individual would include properties held through structures

where the individual was the ultimate beneficial owner; and
• the three-property limit would not include the individual’s primary residence
unless the individual depends on cash flows generated by their property
portfolio to meet the mortgage payments on that primary residence.

2.236 The PRA proposed that if the three-property limit was exceeded by an
individual, all residential real estate exposures to that individual would be treated as
being materially dependent on the cash flows generated by the property (except for
the obligor’s primary residence unless that property itself counts towards the three-
property limit).

General criteria for loans to be materially dependent on the cash flows

generated by the property

2.237 Apart from responses on the application of the three-property limit, which are
covered in the following subsection, the PRA received responses on the following
points:

• General criteria for loans to be materially dependent on the cash flows

generated by the property: nine respondents raised concerns relating to
the general criteria for determining whether the exposure was materially
dependent on the cash flows generated by the property. Respondents
argued it would be operationally challenging to obtain data to assess
whether the repayment of the loan was materially dependent on the cash
flows generated by the property over a representative period of sufficient

37A public housing company or not-for-profit association regulated in the UK that exists to serve
social purposes and to offer tenants long-term housing.
Bank of England | Prudential Regulation Authority Page 91

length to include a mix of good and bad years, and argued that the proposed
requirement was not sufficiently clear.
• High-net-worth individuals: one respondent argued that the PRA should
exempt exposures to high-net-worth individuals from being determined as
materially dependent on the cash flows generated by the property and
provide guidance on how to account for individuals who own more than three
properties but generate no rental income.
• Houses in multiple occupation: six respondents commented on the
proposed treatment of HMOs. Respondents challenged the automatic
inclusion of HMOs in the definition of materially dependent on the cash flows
generated by the property and some requested that the PRA clarify the
interaction of this proposed requirement with the three-property limit.
• Housing associations or cooperatives of individuals: two respondents
argued that the PRA should exempt exposures secured by residential real
estate property to associations or cooperative of individuals from the
definition of materially dependent on the cash flows generated by the
property, which would align with the Basel 3.1 standards.

2.238 Having considered the responses, the PRA has amended its draft rules to
simplify and clarify the definition of materially dependent on the cash flows generated
by the property. Reflecting this approach, the PRA has also removed the related
expectations from its draft amendments to SS10/13.

2.239 The PRA has amended its draft rules to remove the general requirement to
assess whether the payment of the mortgage loan over a representative period (or
the prospects of recovery in the event of default) materially depends on the cash
flows generated by the property securing that exposure, rather than on the capacity
of the obligor to pay the mortgage loan from other sources.

2.240 For a residential real estate exposure, the PRA has amended its draft rules to
require that the exposure must be treated as materially dependent on the cash flows
generated by the property unless one of the following criteria is met:

• the exposure is secured by a single property that is the obligor’s primary

residence;
• the exposure is to an individual or, in certain cases, to a special purpose entity
where an individual is a guarantor, and does not exceed the three-property
limit, assessed at a loan origination event (including refinancing);
Bank of England | Prudential Regulation Authority Page 92

• the exposure is to a public housing company or not-for-profit association

regulated in the UK that exists to serve social purposes and to offer tenants
long-term housing; or
• the exposure is to an association or a cooperative of individuals that exist with
the sole purpose of granting its members the use of a primary residence in the
property securing the loans.

2.241 These amendments will make it operationally easier for firms to assess
whether exposures are materially dependent on the cash flows generated by the
property, and should result in more consistent application of the near-final rules
across firms, while advancing the PRA’s primary objective. The PRA acknowledges
that the change may result in some exposures meeting the definition of materially
dependent on the cash flows generated by the property which would not have met
the definition proposed in CP16/22. However, the PRA considers that a simpler
framework, which addresses respondents’ concerns relating to operational
complexity, is a proportionate response and will result in a prudent framework that
will improve the consistency and comparability of real estate RWAs. The PRA did not
receive persuasive evidence that a narrower or more risk-sensitive definition of
whether exposures are materially dependent on the cash flows generated by the
property (including an exemption for high-net-worth individuals) would achieve this.

2.242 The PRA considers that its decision to permit certain exposures to special
purpose entities to be treated as not being materially dependent on cash flows from
the property should result in exposures of similar economic substance but different
legal form being treated in a similar manner that better reflects the risk of the
exposures.

2.243 The PRA has also decided to remove the explicit inclusion of HMOs from the
materially dependent on the cash flows generated by the property definition. As a
result, firms will be required to assess HMOs in the same way as other residential
real estate exposures.

2.244 The PRA considers that it is appropriate to exempt exposures to housing

associations or cooperatives from being determined as materially dependent on the
cash flows generated by the property, given the similar nature of these exposures to
social housing exposures (as reflected in the Basel 3.1 standards). Consistent with
this judgement, the PRA has decided to implement a minimum counterparty risk
weight of 75% for these exposures in a similar manner to the risk weighting of social
housing exposures (see below).
Bank of England | Prudential Regulation Authority Page 93

2.245 For commercial real estate exposures, the PRA has also decided to amend its
draft rules to require that an exposure is treated as materially dependent on the cash
flows generated by the property unless each commercial real estate property that the
exposure is secured on is predominantly used by the obligor for its own business
purposes (eg where it is used as an office or a production facility by the business,
rather than being leased out to generate income). For commercial real estate
exposures, the PRA considers it appropriate that firms should update their
assessments of the use of the property at least annually.

Calibration and monitoring of the three-property limit

2.246 The PRA received eighteen responses which argued that the proposed
requirement to monitor the three-property limit for an individual obligor across
lenders on a continuous basis would be operationally complex and place a high
burden on firms. Some requested that the PRA clarify its proposed requirements for
ongoing monitoring. Sixteen respondents did not support the proposed calibration of
the three-property limit, and some argued that the limit should be increased to reflect
the relative risk of larger professional landlords compared to those with smaller
portfolios. Some requested that the PRA clarify the proposed treatment of properties
held through corporate structures (eg special purpose entities) and whether these
exposures would be in scope of the three-property limit.

2.247 The PRA continues to consider that individual obligors who have no more than
three mortgaged residential properties (excluding their primary residence) typically
represent a lower risk than obligors with more mortgaged properties. The exception
from treatment as materially dependent on cashflows for exposures to individual
obligors with no more than three residential properties (the ‘three property limit’) is
prudent and proportionate and advances the PRA’s primary objective, given the
increased risk associated with larger property portfolios.

2.248 However, based on the responses received, the PRA has decided to amend
its draft rules on how firms calculate the three-property limit for exposures to
individuals and exposures to special purpose entities. For exposures to individuals,
the number of properties will be the sum of:

• properties used as security for a residential real estate exposure to the

individual; and
Bank of England | Prudential Regulation Authority Page 94

• properties used as security for a residential real estate exposure to a special

purpose entity where the individual is a guarantor, and the individual receives
the economic benefit from the residential real estate.

2.249 In counting the number of properties:

• the obligor’s primary residence will not be considered in any circumstances;

• properties that act as security for residential real estate exposures will be
counted regardless of the lender; and
• firms must consider a single housing unit that is a separate part within a multi-
unit property as one property.

2.250 The PRA will only require firms to update their assessment of material
dependence on cashflows from the property (including assessing the number of
properties mortgaged by the obligor where relevant) when a new or replacement
mortgage is issued. When the three-property limit is exceeded, all residential real
estate exposures to that individual or entity must be treated as being materially
dependent on the cash flows generated by the property (unless they are secured by
the obligor’s primary residence).

2.251 These amendments to the calculation of the three-property limit will result in a
simpler and more proportionate approach. The PRA considers that properties used
as security for a residential real estate exposure to other lenders to be relevant in
determining the risk, and only considering exposures to a single firm could therefore
lead to imprudent outcomes.

Risk-weighting of real estate sub-classes

Treatment of ‘regulatory residential real estate’ exposures that are not
materially dependent on the cash flows generated by the property

2.252 The PRA proposed to introduce more risk-sensitive risk weights for regulatory
residential real estate exposures. For regulatory residential real estate exposures
that are not materially dependent on the cash flows generated by the property, the
PRA proposed to specify that the risk weight treatment would be the loan splitting
approach as set out in the Basel 3.1 standards. The loan splitting approach assigns
Bank of England | Prudential Regulation Authority Page 95

a 20% risk weight to the part of the exposure value up to 55% of the property value
and the risk weight of the counterparty38 to any residual part of the exposure.

2.253 For second charge mortgage loans, the PRA proposed that, where there are
charges on the property not held by the firm, the loan splitting approach should be
adjusted, such that the amount of exposure that would be assigned a 20% risk
weight would be reduced to reflect other charges on the property and appropriately
reflect the risk of the firm’s exposures.

2.254 Two respondents supported the proposed risk weights, and four respondents
supported the increased risk sensitivity in the proposed treatment for regulatory
residential real estate more generally. However, four respondents did not support the
proposed calibration of the risk weight treatment.

2.255 Three respondents argued that the proposed treatment for second charge
mortgage loans under the loan splitting approach for regulatory residential real
estate exposures that are not materially dependent on the cash flows generated by
the property was overly punitive. The respondents argued that the loan splitting
approach would result in increased risk weights for second charge mortgage loans
that are not justified by the risk, and risk weights that would be broadly similar to
unsecured exposures which they consider too conservative. The respondents
argued that the whole loan approach available in the Basel 3.1 standards for
regulatory residential real estate exposures that are not materially dependent on the
cash flows generated by the property should be available for second charge
mortgage loans.

2.256 Having considered the responses, the PRA has decided to maintain its
proposed risk weight treatment for regulatory residential real estate exposures that
are not materially dependent on the cash flows generated by the property. However,
the PRA has adjusted the counterparty risk weights that apply to exposures to SMEs
(see the section on the treatment of regulatory commercial real estate below). The
PRA notes that its proposal will significantly increase risk sensitivity compared to the
CRR treatment and considers that this is one of the most important developments in
the SA. The PRA did not receive persuasive evidence to support respondents’
assertions that the calibration in the Basel 3.1 standards was overly conservative.

38The proposed relevant counterparty risk weights were: (a) for exposures to individuals, 75%; (b) for
exposures to SMEs, 85%; and (c) for exposures to other counterparties, the risk weight that would be
assigned to an unsecured exposure to that counterparty (subject to a minimum risk weight of 75% for
social housing exposures).
Bank of England | Prudential Regulation Authority Page 96

The package is prudent and reflects the risk of exposures, while facilitating effective
competition by significantly reducing the gap between SA risk weights and risk
weights calculated under the IRB approach. It is also in line with international
standards.

2.257 The PRA has also decided to maintain its proposed risk weight treatment for
second charge mortgage loans. The PRA considers that the loan splitting approach
captures the risks associated with second charge mortgage loans, whereas other
approaches (including the ‘whole loan’ approach) would not. Second charge
mortgage loans are generally riskier than first charge mortgage loans. Even if
recoveries are maximised, the second charge holder does not receive any
recoveries until the first charge holder is fully paid meaning the LGD on the second
charge will typically be higher. In a downturn, falls in the value of the property may
result in the second charge holder being reliant on unsecured recoveries. The loan
splitting approach reflects these dynamics and ensures total capital requirements
remain unchanged if a single mortgage loan is split into two sequential charges. It
would not be prudent for capital requirements to reduce in these circumstances.

Treatment of ‘regulatory residential real estate’ exposures that are materially

dependent on the cash flows generated by the property

2.258 For regulatory residential real estate exposures that are materially dependent
on the cash flows generated by the property, the PRA proposed to require firms to
risk-weight the whole loan amount of such exposures using the relevant risk weight
determined by the loan to value (LTV) of the exposures, ranging between 30% and
105% (the ‘whole loan’ approach). This would result in higher risk weights for these
exposures than for regulatory residential real estate exposures that are not materially
dependent on the cash flows generated by the property. In cases where the firm has
a junior charge and there are senior charges not held by the firm, the PRA proposed
that firms should multiply the applicable risk weight by 1.25 (unless the LTV is less
than or equal to 50%).

2.259 Five respondents did not support the proposed increased risk weights for
regulatory residential real estate exposures that are materially dependent on the
cash flows generated by the property relative to exposures that are not materially
dependent on the cash flows generated by the property. Five respondents did not
support the proposed increased risk-weights for higher-LTV exposures that are
materially dependent on the cash flows generated by the property relative to the
Bank of England | Prudential Regulation Authority Page 97

current treatment. Two respondents argued that there should be further risk
sensitivity in the final treatment.

2.260 One respondent supported the proposed requirement to use the whole loan
approach for regulatory residential real estate exposures that are materially
dependent on the cash flows generated by the property. However, two respondents
argued that the whole loan approach would introduce operational complexity as firms
may be required to use two different risk weight calculation methods across
regulatory real estate portfolios.

2.261 Having considered the responses, the PRA has decided to maintain the
requirement for firms to assign higher risk weights to regulatory residential real
exposures that are materially dependent on the cash flows generated by the property
and also to maintain the proposed approach to assign a risk weight to the whole
exposure based on the LTV. The PRA did not receive persuasive evidence to
support respondents’ assertions that the level of risk was the same as for residential
real estate exposures that are not materially dependent on the cash flows generated
by the property, particularly in a downturn. The PRA continues to consider that
exposures which are materially dependent on the cash flows generated by the
property are generally higher risk than exposures that are not materially dependent
on the cash flows generated by the property.

2.262 However, the PRA agrees that the risk weight treatment could be made more
risk sensitive. The PRA has amended its draft rules to introduce greater risk
sensitivity in the treatment for exposures that fall in the range 60% < LTV ≤ 80%,
assigning a 40% risk weight for exposures that fall in the range 60% < LTV ≤ 70%
and a 50% risk weight for exposures that fall in the range 70% < LTV ≤ 80% (in
CP16/22 the PRA proposed to assign a 45% risk weight for all exposures that fall in
the range 60% < LTV ≤ 80%).

Other issues relating to the treatment of regulatory residential real estate

2.263 Other substantive responses to this section of CP16/22 focused on the

following issues:

• Social housing exposures: two respondents did not support the minimum
counterparty risk weight of 75% for social housing exposures and noted that it
could result in secured exposures attracting a higher risk weight than
unsecured exposures to the same counterparty. The PRA has decided to
Bank of England | Prudential Regulation Authority Page 98

maintain the proposed minimum counterparty risk weight of 75% for social
housing exposures. The PRA considers that this approach is risk-sensitive
and proportionate. Social housing exposures will not be considered to be
materially dependent on the cash flows generated by the property and will
therefore not be subject to the higher risk weights under the whole loan
approach, despite the obligor’s ability to repay the loan, at least in part, being
reliant on the performance of the individual tenants. The PRA considers that
this risk should instead be reflected in the application of the retail counterparty
risk weights under the loan splitting approach. As set out above, the PRA has
decided to amend its draft rules to introduce a similar treatment for exposures
to housing associations and cooperatives.
• Social housing exposures: one respondent argued that only drawn
commitments should be considered for determining the applicable risk weight
under the loan splitting approach. The PRA has decided to maintain the
proposed requirement that undrawn balances must be considered for
determining the risk weight. It considers this to be a more risk-sensitive
approach which reflects the non-zero chance of such off-balance sheet items
moving on to the balance sheet.
• Loan splitting approach calculation: one respondent suggested that the
PRA should include the examples of the loan splitting approach calculation set
out in the Basel 3.1 standards in a supervisory statement. The PRA has
provided further examples of the loan splitting approach calculation in its near-
final amendments to SS10/13.

Treatment of ‘regulatory commercial real estate’

2.264 For commercial real estate exposures, the PRA proposed that risk weights
should be no lower than 100% given the default experience of this asset class in
stressed environments and broader factors such as market price stability.

2.265 For regulatory commercial real estate exposures that are not materially
dependent on the cash flows generated by the property, the PRA proposed that firms
would be required to risk weight the exposure by assigning the risk weight of the
counterparty or 60% (whichever is lower) to the part of the exposure up to 55% of
the property value, and apply the risk weight of the counterparty to the residual part
of the exposure. If the resultant risk weight was lower than 100%, a risk weight of
100% would be applied to the exposure.
Bank of England | Prudential Regulation Authority Page 99

2.266 For regulatory commercial real estate exposures that are materially dependent
on the cash flows generated by the property, the PRA proposed to require firms to
apply a 100% risk weight, unless the LTV of the exposure was greater than 80%, in
which case the risk weight would be 110%.

2.267 Eighteen respondents did not support the PRA’s proposal that risk weights
should be no lower than 100% for regulatory commercial real estate exposures,
particularly for exposures which are not materially dependent on the cash flows
generated by the property. Respondents argued that a 100% risk weight was overly
conservative for these exposures and that this would result in a lack of risk sensitivity
which diverged from the stated objective of the Basel 3.1 standards, placing UK firms
at a disadvantage relative to international competitors. Respondents also argued that
the proposals would create perverse incentives for firms given secured commercial
real estate exposures to SMEs would receive a higher risk weight than unsecured
exposures. Some respondents requested that the PRA publish analysis to justify the
calibration of the risk weights for commercial real estate exposures.

2.268 The majority of respondents argued that the PRA should align the risk weight
treatment with the Basel 3.1 standards, while some respondents argued commercial
real estate exposures that are not materially dependent on the cash flows generated
by the property should be subject to a lower minimum risk weight.

2.269 The treatment of commercial real estate under the PRA’s near-final rules is
summarised in Table 4. Having considered the responses, the PRA acknowledges
the arguments in relation to the risk-sensitivity of the draft rules. It has amended the
draft rules to remove the 100% minimum risk weight in the cases outlined below,
distinguishing between commercial real estate exposures to SMEs and non-SMEs,
and between exposures that are materially dependent on the cash flows generated
by the property and exposures that are not materially dependent on the cash flows
generated by the property:

• for regulatory commercial real estate exposures to SMEs that are not
materially dependent on the cash flows generated by the property, firms will
be required to risk weight exposures based on the loan splitting approach.
Firms will be required to assign a risk weight of 60% to the part of the
exposure up to 55% of the property value, and apply the risk weight of the
counterparty to the residual part of the exposure; and
• for regulatory commercial real estate exposures to corporates that are non-
SMEs that are not materially dependent on the cash flows generated by the
Bank of England | Prudential Regulation Authority Page 100

property, firms will be required to apply the counterparty risk weight or 60%
(whichever is greater), unless the risk weight would be greater than if the
exposure were materially dependent on the cash flows generated by the
property, in which case the risk weight applicable to the exposure will be the
same as the risk weight for exposures materially dependent on the cash flows
generated by the property (100% or 110%, according to LTV).

2.270 Having considered the responses, the PRA has decided to maintain its
proposal in relation to regulatory commercial real estate exposures to both SMEs
and non-SMEs that are materially dependent on cash flows from the property. The
PRA has retained the minimum risk weight of 100% in its near-final rules and firms
will be required to risk weight exposures with LTV ≤ 80% at 100% and LTV > 80% at
110%.

Table 4: Near-final treatment of exposures secured by commercial real estate

SME Non-SME corporates

Regulatory and not Loan splitting approach Counterparty risk weight
materially dependent 60% risk weight up to 55% of with a 60% risk weight
on cash flows from the property value floor and capped at the
the property Apply the counterparty risk ‘materially dependent on
weight to the residual part of cashflows’ treatment as
the exposure (if any)39 set out in the row below
Regulatory and Apply a 100% risk weight floor. Apply a 100% risk weight
materially dependent LTV ≤ 80% = 100% risk weight floor.
on cash flows from
LTV > 80% = 110% risk weight LTV ≤ 80% = 100% risk
the property
weight
LTV > 80% = 110% risk
weight

Non-regulatory and Counterparty risk weight40 No collateral benefit,

not materially apply the counterparty
dependent on cash risk weight with 60% risk
flows from the weight floor
property

Non-regulatory and
materially dependent 150% risk weight 150% risk weight
on cash flows from
the property

39 The relevant counterparty risk weights are 75% for retail SMEs and 85% for corporate SMEs.
40 The relevant counterparty risk weights are 75% for retail SMEs and 85% for corporate SMEs.
Bank of England | Prudential Regulation Authority Page 101

2.271 These changes will result in a more risk-sensitive approach, reflecting the
PRA’s analysis of the differing risk mitigation provided by commercial property
collateral depending on the status of the obligor. Analysis of stress testing data for
firms with approved IRB models shows that, on average, exposures to SMEs that
are secured on collateral have both a lower PD and LGD than unsecured exposures
(see Table 5).

2.272 For exposures to non-SME corporates, the analysis shows that, on average,
the overall riskiness of secured and unsecured exposures is similar. Secured
exposures have a lower LGD but a higher PD than unsecured exposures, which
results in similar implied overall losses for secured and unsecured exposures. The
analysis does not justify giving credit for holding commercial real estate collateral in
respect of exposures to non-SME corporates. Equally, though, it does not suggest
that the riskiness of secured borrowing warrants a risk weight that is no lower than
100%. However, the PRA considers that a minimum risk weight of 60% is necessary
to ensure a minimum level of prudence, and to reduce the cliff edge in risk weights
between exposures that are materially dependent on cashflows from the property
and those that are not.

Table 5: IRB modelled PDs and LGDs for corporate SMEs and non-SME
corporates (annual cyclical scenario stress test, base case data)

Corporate SMEs Non-SME corporates

Secured Unsecured Secured Unsecured
PD 1.66% 2.01% 1.29% 0.69%
LGD 29.69% 42.65% 32.64% 43.44%

2.273 The PRA has amended its draft rules to clarify that, where a firm has a real
estate exposure to an SME that meets the PRA’s revised definition of a retail
exposure (except the requirement that it is not a real estate exposure), the
counterparty risk weight shall be 75%. The counterparty risk weight for other SMEs
will continue to be 85%. This is relevant for commercial real estate exposures but will
apply in respect of any relevant real estate exposures where the counterparty risk
weight is used to assign a risk weight to an SME exposure. This increases alignment
between the risk weight treatments of secured and unsecured exposures.

2.274 The PRA continues to consider that its proposed treatment for commercial real
estate exposures that are materially dependent on cash flows generated by the
property appropriately reflects the greater risks associated with commercial real
Bank of England | Prudential Regulation Authority Page 102

estate lending where the obligor is likely to be reliant on rental income for repayment
of the loan.

Treatment of ‘other commercial real estate’

2.275 The PRA proposed that commercial real estate exposures which do not meet
all the requirements of regulatory commercial real estate would be classed as other
commercial real estate. Other commercial real estate exposures which are not
materially dependent on the cash flows generated by the property would be risk-
weighted according to the risk weight of the counterparty, but the risk weight would
be floored at 100%. Other commercial real estate exposures which are materially
dependent on the cash flows generated by the property would be risk-weighted at
150%.

2.276 As with regulatory commercial real estate exposures, respondents argued that
secured exposures should not receive a higher risk weight than unsecured
exposures.

2.277 For consistency with the treatment of regulatory commercial real estate
exposures, the PRA has revised its draft rules regarding the treatment of other
commercial real estate exposures which are not materially dependent on the cash
flows generated by the property, distinguishing between exposures to SMEs and
non-SMEs:

• the risk weight for other commercial real estate exposures to SMEs which are
not materially dependent on the cash flows generated by the property will be
the relevant counterparty risk weight (75% for retail SMEs and 85% for
corporate SMEs); and
• the risk weight for other commercial real estate exposures to non-SME
corporates which are not materially dependent on the cash flows generated
by the property will be the risk weight of the counterparty or 60% (whichever is
greater).

2.278 The PRA has decided to maintain its proposed 150% risk weight for other
commercial real estate exposures which are materially dependent on cashflows from
the property. This is consistent with the Basel 3.1 standards.

Exposures with multiple types of property collateral

Bank of England | Prudential Regulation Authority Page 103

2.279 Other substantive responses to this section of CP16/22 focused on the

treatment of exposures with multiple types of property collateral.

2.280 Three respondents requested that the PRA clarify the proposed treatment of
exposures where the loan is secured against a mixture of residential real estate and
commercial real estate. The PRA has decided to amend its draft rules to state that a
mixed real estate exposure will be split into a residential real estate exposure and a
commercial real estate exposure. The PRA has also provided further clarification on
the approach firms are expected to take to risk-weight exposures in its near-final
amendments to SS10/13. Firms will be required to use a value-weighted allocation
approach, where the proportion of the total value of the property collateral for each
type of real estate collateral is used to weight the allocation of the loan amount (and
the respective exposure value) across real estate exposure categories.

2.281 Both the residential real estate part and the commercial real estate part of a
mixed real estate exposure must separately meet the requirements to be deemed a
regulatory real estate exposure (see above) in order for both parts to be risk-
weighted as regulatory real estate exposures. In all other cases (including if one part
meets the requirement to be regulatory real estate and the other part does not), both
parts must be risk-weighted as other real estate exposures.

Land acquisition, development and construction exposures

2.282 The PRA proposed to introduce a specific treatment for ‘land acquisition,
development and construction’ (ADC) exposures that would apply to exposures to a
corporate or special purpose entity financing land acquisition for development and
construction purposes, or financing development and construction of any residential
or commercial real estate. The PRA considered that higher risk weights for ADC
exposures reflected the higher risk of these exposures, given that the source of
repayment of the loan was a planned, but uncertain sale of the property, or
substantially uncertain cash flow. The PRA proposed to assign a risk weight of 150%
to ADC exposures, except that in cases where certain conditions were met, a loan
granted for the purpose of developing residential real estate would be assigned a
risk weight of 100%.

2.283 Four respondents argued that the PRA should consider exemptions to the
definition of ADC exposures to support decarbonisation, regeneration, and the build-
to-rent sector. One respondent raised concerns with the difference in risk weights for
Bank of England | Prudential Regulation Authority Page 104

residential development finance in the SA compared to the IRB approach. One

respondent noted that the ADC exposure class would capture exposures not
currently classified under items associated with high risk as speculative immovable
property financing. Four respondents argued that the PRA should provide guidance
to support firms’ assessment of when a 100% risk weight can be assigned to ADC
exposures, with some respondents arguing that a lack of clarity could lead to
inconsistent application by firms.

2.284 Having considered the responses, the PRA has decided to maintain its
proposed risk weight treatment for ADC exposures. The PRA considers the scope of
exposures captured remains appropriate given the risk profile of these exposures
and considers that it would not be appropriate to introduce exclusions to the
treatment. ADC exposures are generally higher risk than other real estate exposures
and unsecured corporate lending, as the repayment of ADC loans at origination of
the exposure is either dependent on the future uncertain sale of the property, or the
source of cash flows is substantially uncertain. There are various reasons for the
increased risk associated with the uncertain repayment of the loan, such as the risk
of delayed expected completion due to a deterioration in a counterparty’s financial
condition or market conditions.

2.285 The PRA has decided to substantially maintain its proposed approach for
assigning a 100% risk weight for ADC exposures to allocate exposures that meet
both the definition of regulatory real estate and the definition of ADC. However, the
PRA has decided to make amendments to its draft rules to clarify that, to be eligible,
an exposure must be subject to prudent underwriting standards, including for the
valuation of any real estate used as security for the exposure. The PRA will consider
providing further clarification in future of which ADC exposures are eligible for a
100% risk weight if evidence emerges of inconsistent application across firms.

Definition of ADC exposure

2.286 Other substantive responses to this section of CP16/22 focused on the

allocation of exposures as ADC. Two respondents requested that the PRA clarify
how firms would be required to allocate an exposure when it meets the definition of
regulatory real estate and ADC. One respondent argued that the proposed treatment
for regulatory real estate exposures would be more appropriate for the risk profile of
such exposures. The PRA has amended its draft rules to clarify that the definition of
ADC exposures relates to the purpose of the lending, and that exposures which
meet the criteria for regulatory real estate and ADC must be treated as ADC
Bank of England | Prudential Regulation Authority Page 105

exposures. This definition aligns with the Basel 3.1 standards and is prudent given
the heightened risk of ADC exposures.

PRA objectives analysis

2.287 The PRA considers that its analysis of its objectives in CP16/22 remains
appropriate, subject to the following updates to reflect changes to the proposals for
real estate.

2.288 The PRA considers that its amended proposals for the valuation of real estate
promote safety and soundness by dampening the cyclicality of property valuations,
relative to indexed approaches or other more frequent valuation approaches.
Although the amended proposals are likely to be marginally more cyclical than those
in CP16/22, the PRA considers that its amended proposals appropriately balance
risk sensitivity and cyclicality.

2.289 The PRA considers that its decision to change the approach to assessing
whether an exposure is materially dependent on cashflows from the property
promotes safety and soundness by improving the clarity of the requirements which
should result in a more consistent and comparable approach across firms. The PRA
considers that its adjustments to the risk weight applicable to residential real estate
exposures which are materially dependent on the cash flows generated by the
property in the 60% < LTV ≤ 70% and 70% < LTV ≤ 80% categories promotes safety
and soundness, because it adds further risk sensitivity to the framework.

2.290 The PRA considers that its decision to reduce risk weights for certain
commercial real estate exposures results in an overall treatment that advances its
primary objective. The proposed changes would improve risk sensitivity relative to
the existing treatment and are based on evidence of the risk of particular types of
commercial real estate exposures, including exposures which are materially
dependent on cashflows from the property which are subject to a minimum 100%
risk weight because the collateral represents the main source of repayment for the
loan.

2.291 In respect of the PRA’s secondary objective to facilitate effective competition,

the PRA’s decision to permit some self-build properties to be treated as regulatory
real estate will result in a smaller difference in risk weights between the SA and the
IRB approach for self-build loans relative to the proposals in CP16/22, thereby
facilitating effective competition. The PRA also considers that its near-final approach
Bank of England | Prudential Regulation Authority Page 106

to assessing whether an exposure is materially dependent on cashflows from the

property facilitates effective competition by promoting consistent application across
firms. The PRA’s decision to reduce risk weights for certain commercial real estate
exposures brings the average level of capital requirements under the SA for these
exposures closer to that of firms applying IRB approaches, facilitating effective
competition.

‘Have regards’ analysis

2.292 In developing these near-final rules, the PRA has had regard to its framework
of regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in chapter 3 of CP16/22, remains appropriate, subject to the
following updates:

1. Relevant international standards:

• The PRA’s decision to apply lower risk weights than those proposed under
CP16/22 and the CRR to certain commercial real estate exposures results in
a treatment that is closer to the baseline set out in the Basel 3.1 standards
than the existing treatment.

2. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA generally expects that its approach to real estate valuation will
produce outcomes that are comparable with other major jurisdictions, but
notes that the revised approach expected to be taken by the EU to valuations
is likely to produce real estate risk weights that are more cyclical than the
PRA’s approach. Lower cyclicality of risk weights is of benefit to UK firms, by
reducing volatility in capital requirements.
• The PRA’s amended approach to risk weighting commercial real estate
exposures will result in risk weights that are closer to the EU’s expected
approach, relative to the existing treatment, while some jurisdictions have
proposed more conservative risk weights than the PRA’s amended approach.
The PRA considers that its approach supports the relative standing of the UK
and the ability of UK firms to compete in a market with cross-border lending.
Bank of England | Prudential Regulation Authority Page 107

3. Different business models:

• The PRA’s decision to permit some self-build real estate exposures to be

classed as regulatory real estate exposures means that firms specialising in
self-build mortgage loans will not be affected in the way described in CP16/22.
The net effect of the PRA’s near-final rules affecting self-build mortgage loans
– treating some self-build mortgage loans as regulatory real estate and
introducing specific valuation requirements for self-build mortgage loans – will
be lower capital requirements relative to CP16/22. Relative to the current
treatment, capital requirements could increase or decrease dependent on the
specific nature of firms’ exposures.
• The PRA’s analysis in CP16/22 indicated that specialist firms with exposures
to holiday lets, purpose-built student accommodation and care homes could
be affected, because these exposures were to be explicitly excluded from
treatment as residential real estate and would have received a higher risk
weight than now, as commercial real estate. This is now less likely to be the
case because holiday lets, purpose-built student accommodation and care
homes may in some cases be able to qualify for treatment as residential real
estate under the near-final rules and near-final amendments to SS10/13.
• The PRA’s decision on the approach to assessing if residential real estate
exposures are materially dependent on the cash flows generated by the
property may have a greater impact on firms who target lending towards
portfolio landlords and high-net-worth individuals, relative to the current
treatment. The PRA’s decision – for both residential and commercial
exposures – is intended to balance risk sensitivity with promoting consistent
implementation across firms, including smaller firms who may otherwise face
disproportionate complexity in the calculation of capital requirements.

4. Sustainable growth and growth:

• The PRA’s decision to apply lower risk weights than those in the current
treatment and proposed in CP16/22 to certain commercial real estate
exposures helps to promote sustainable growth, by aligning risk weights for
specific exposures (and specific counterparties like SMEs) with their relative
risk, as reflected in data on modelled PD and LGDs.

5. Proportionality:
Bank of England | Prudential Regulation Authority Page 108

• The PRA considers that its approach to assessing whether an exposure is

materially dependent on cashflows from the property is proportionate, as a
result of the assessment being simple, objective and conducted only at
origination events. The PRA considers that this proportionate approach is
likely to result in a similar level of capitalisation in aggregate, relative to a
more complex approach such as the proposals in CP16/22. The removal of
the proposal to require real estate valuations to be adjusted to reflect the
sustainable value over the life of the loan should make the amended
approach for the valuation of real estate more proportionate than the CP16/22
proposals.

Capital instruments, defaulted exposures, and high-risk items

2.293 Aligned with the Basel 3.1 standards, the PRA proposed a number of changes
to enhance the risk sensitivity and robustness of the treatment of the SA risk weights
for: (i) equities, subordinated debt and other capital instruments; (ii) defaulted
exposures; and (iii) high-risk items.

2.294 The PRA proposed to remove the use of the IRB approach to calculate RWAs
for equity exposures, and, as a result, the proposed SA treatment would apply to all
equity exposures (subject to proposed transitional arrangements).

2.295 The PRA received 14 responses to this section of CP16/22. The substantive
issues raised by respondents are set out below.

Equities, subordinated debt and other capital instruments

2.296 The PRA proposed to apply a 400% risk weight to venture capital41 exposures
and a 250% risk weight to other equity exposures. The PRA proposed that the new
SA equity risk weights would be phased-in over a five-year period.

2.297 Two respondents did not support the proposals, arguing that the proposed
increase in the equity risk weights was not prudentially justified as equity portfolios
showed limited downside risks of losses, while offering greater potential profit than
other exposure classes. Five respondents argued the PRA should permit firms to
reduce equity risk weights to reflect diversification benefits, as is the case under the

41 The PRA proposed that these would be ‘unlisted’ equity investments held with the objective of
providing funding to newly established enterprises, including to the development of a new product and
related research for the enterprise in order to bring this product to the market, to the build-up of the
production capacity of the enterprise or to the expansion of the business of the enterprise.
Bank of England | Prudential Regulation Authority Page 109

CRR IRB simple risk weight approach. Respondents argued that diversification limits
the risk of downside losses by offsetting losses with profits on other investments.

2.298 Four respondents requested that the PRA clarify the proposed definition of
‘venture capital’ and, in particular, the PRA’s intended definition of ‘newly established
enterprises’. One respondent argued for an approach based on the age of the
business being invested in for defining exposures subject to the 400% risk weight,
arguing it would be the most practical method.

2.299 Having considered the responses, the PRA has decided to maintain its
proposal that equity exposures should either be assigned a 400% or a 250% risk
weight. Applying higher risk weights to equity exposures than to other types of
exposures reflects that equity exposures are riskier, given their position in the
creditor hierarchy and the expected low level of recoveries in default. The PRA also
considers that, in line with the Basel 3.1 standards and approaches expected to be
adopted by other jurisdictions, there is a subset of equity exposures that carry a
materially higher credit risk, and therefore require a risk weight of 400%.

2.300 The proposed risk weight calibration aligns with the Basel 3.1 standards and
with other major jurisdictions such as the EU and the US (based on their proposed
implementation). The PRA did not receive persuasive evidence from firms to support
their assertions that lower risk weights for equity exposures are justified, including
regarding the impact of diversification on the aggregate risk of equity exposures. In
particular, the diversification of equity portfolios and the level of credit risk will vary
materially across portfolios. This is difficult to capture under the SA and it is
important to maintain the simplicity and proportionality of the SA approach. The PRA
also notes that the Basel 3.1 standards similarly do not provide a diversification
benefit for equity exposures.

2.301 Having considered the responses, however, the PRA has made significant
amendments to the criteria for assigning a 400% risk weight to equity exposures.
The PRA has amended its draft rules to require firms to apply a 400% risk weight to
exposures to businesses that are less than five years old, instead of to ‘venture
capital exposures’ as proposed in CP16/22.42 The PRA has also decided to set out

42For an exposure to an undertaking (‘A’), the date of formation used to calculate the age of the
business shall be as follows:
(a) where the business was first established within A, the date A was first established;
(b) where the business was first established within a different undertaking (‘B’) and either:
Bank of England | Prudential Regulation Authority Page 110

expectations on how firms should determine the age of a business in its near-final
amendments to SS10/13. Once a business is over five years of age, a 250% risk
weight will be applied to any exposures to that business.

2.302 The PRA is taking this approach because respondents indicated that it would
be difficult to define ‘venture capital’ in a way that could be consistently implemented
by firms and because the available data,43 displayed in the chart below, shows there
is a clear correlation between the age of a business and its risk of failure. The PRA
considers that the revised criteria for applying a 400% risk weight should maintain
the right level of risk sensitivity while remaining broadly aligned with the intent of the
Basel 3.1 standards, and should address respondents’ concern by providing a
clearer definition that will reduce the likelihood of inconsistent application.

(i) the risk profile and nature of the business did not substantially change as a result of the
transfer of the business to A, the date B was first established; or
(ii) the risk profile or nature of the business substantially changed as a result of the transfer of
the business to A, the date the business was transferred to A.
43 Data included: Selection of Office of National Statistics (ONS) Business Demography Data,

Business Survivals (UK Businesses Born 2002-2017) and Bureau of Labour Statistics (BLS) Business
Employment Dynamics, Establishment Age and Survival Data (US Businesses Born 1994 – 2013).
US data has been adjusted by one year to align methodologies with ONS data. BLS defines business
death as no trading activity for 4 quarters and therefore had 100% business survival in year one.
Bank of England | Prudential Regulation Authority Page 111

Chart 1: US and UK business failure rate (a)

Business failure rate in the UK and US. Sample of data taken from a selection of years within
specified date ranges.44
(a) US data has been adjusted by one year to align methodologies with ONS data. BLS defines as
business death as no trading activity for 4 quarters and therefore had 100% business survival in year
one.

Other issues relating to equities, subordinated debt and other capital

instruments
2.303 Other substantive responses to this section of CP16/22 focused on the
following issues:

44Office of National Statistics (ONS) Business Demography Data, Business Survivals (UK Businesses
Born 2002-2017) and Bureau of Labour Statistics (BLS) Business Employment Dynamics,
Establishment Age and Survival Data (US Businesses Born 1994 – 2013).
Bank of England | Prudential Regulation Authority Page 112

• Exposures to companies where there is an ongoing business

relationship: two respondents argued that the PRA should reduce risk
weights for equity exposures to companies where the firm intends to have a
long-term business relationship. The PRA has considered the response and
has decided to maintain its proposal. The PRA did not receive persuasive
evidence to support respondents’ assertions that an ongoing business
relationship reduces credit risk.
• Exposures arising from debt/equity swaps: two respondents argued that
exposures arising from debt/equity swaps should be excluded from the 400%
risk weight, aligning with a national discretion in the Basel 3.1 standards. The
PRA has decided to not amend its draft rules. The PRA considers that
exposures arising from debt/equity swaps generally carry the same level of
risk as other equity exposures and the PRA did not receive persuasive
evidence to suggest otherwise.
• Nationally legislated programmes: four respondents argued that equity
exposures to national legislated programmes should be risk weighted at
100%, aligning with a national discretion in the Basel 3.1 standards. The PRA
has decided not to amend its draft rules. Co-investment with government
bodies does not provide a guarantee of returns, and the PRA considers that
the CRM framework enables firms to reflect guarantees where appropriate.
The PRA is not aware of any UK programmes which fall within scope of the
national discretion.
• Exposures to subsidiaries: two respondents argued that the PRA should
retain a 100% risk weight for certain subsidiary investments instead of the
proposed 250% risk weight for equity exposures, arguing that firms investing
in their subsidiaries will have detailed information to support the valuation of
subsidiary share-based capital. The PRA has decided to not amend its draft
rules because it does not consider that access to additional information in and
of itself provides a meaningful mitigation against credit risk for equity
investments.
• Capital instruments with the economic substance of debt: two
respondents argued that capital instruments with the economic substance of
debt should be risk-weighted in a similar manner to corporate loans and not
be treated as ‘equity exposures’, aligning with the national discretion in the
Basel 3.1 standards. The PRA clarifies that that capital instruments (including
equity instruments) that do not meet the criteria set out in Articles 133(1) to (2)
of the near-final Credit Risk: Standardised Approach (CRR) Part will not be
risk-weighted as equity exposures and will be assigned a 150% risk weight.
Bank of England | Prudential Regulation Authority Page 113

The PRA did not receive persuasive evidence that these instruments have the
economic substance to justify receiving the same risk weight treatment as
loans that qualify to be risk-weighted as corporate exposures.
• Other instruments with the economic substance of equities: the PRA has
decided to amend its draft rules to remove the requirement that firms must
request permission from the PRA to exclude certain instruments from being
risk-weighted as equity exposures. However, firms will still be required to be
able to demonstrate that such instruments should be treated as debt positions
according to the criteria in the PRA’s near-final rules. The PRA considers that
this will advance its objective of safety and soundness in a more proportionate
way.
• Listed equities and CIUs: one respondent requested that the PRA clarify
how firms would be required to treat listed equities held for trading purposes
and the treatment of shares held in the banking book as part of an unlisted
CIU that is a hedge fund. The PRA clarifies that firms should apply the trading
book boundary criteria45 to determine whether exposures are held under the
banking book or trading book. Firms should apply Article 133 of the near-final
Credit Risk: Standardised Approach (CRR) Part to determine the treatment of
exposures held in the banking book. For exposures to CIUs, firms should
consult Articles 132 to 132C of the near-final Credit Risk: Standardised
Approach (CRR) Part to determine the correct risk weighting approach.
Where a firm is applying the look-through approach for risk-weighting
exposures to CIUs, the firm should apply the definitions in Article 133 to the
CIU’s underlying exposures s that fall within the scope of that article.

Defaulted exposures
2.304 The PRA proposed to introduce several changes to the SA risk weights for
defaulted exposures, including restricting the flat 100% risk weight treatment to
residential real estate exposures that are not materially dependant on the cash flows
generated by the property, in line with the Basel 3.1 standards. The PRA also
proposed to clarify the criteria that are used under the SA to determine whether
exposures are treated as retail exposures for the purpose of applying the definition of
default (as set out in set out in Article 178 of the near-final Credit Risk: Internal
Ratings Based Approach (CRR) Part). In the case of such exposures, an institution

45
As set out in near final amendments to Article 104 of the Trading Book (CRR) Part of the PRA
Rulebook that are set out in Appendix 2 of PS17/23.
Bank of England | Prudential Regulation Authority Page 114

may apply the definition of default at the level of an individual credit facility rather
than in relation to the total obligations of an obligor.

2.305 Five respondents argued that the PRA should exercise a national discretion in
the Basel 3.1 standards which enables a 50% risk weight to be applied to defaulted
exposures where specific provisions are no less than 50% of the outstanding amount
of the loan. Having considered the responses, the PRA has decided not to amend its
draft rules. The PRA did not receive persuasive evidence that exercising the national
discretion would result in risk weights that, on average, better reflect the risks
associated with defaulted exposures.

2.306 Two respondents did not support the proposal to restrict the availability of the
100% risk weight to defaulted residential real estate exposures which are not
materially dependent on cashflows from the property. Having considered this
response, the PRA has decided not to amend its draft rules. The PRA considers that
the risk weight treatment for defaulted exposures appropriately reflects the higher
risks associated with commercial real estate and real estate that is materially
dependent on cash flows from the property and is consistent with the risk-weighting
of real estate exposures more broadly.

2.307 The PRA has however amended its draft rules to simplify the treatment of
defaulted exposures under the SA. All exposures that meet the definition of a ‘retail
exposure’ under the SA and all real estate exposures that would otherwise meet this
definition shall be treated as retail exposures for the purpose of applying the
definition of default.

2.308 This treatment aligns with the Basel 3.1 standards and appropriately reflects
the broader changes to the classification of retail exposures outlined in the
’Exposures to individuals and small and medium-sized enterprises’ section of this
chapter.

2.309 The PRA also proposed that the risk weights for defaulted exposures would
apply to the part of each defaulted exposure that is not covered by collateral or a
guarantee. The PRA has made minor changes to its draft rules to clarify that the size
of the uncovered part should be calculated as set out in the near-final Credit Risk:
Credit Risk Mitigation (CRR) Part.
Bank of England | Prudential Regulation Authority Page 115

High risk items

2.310 The PRA proposed to retain elements of CRR Article 128 that apply a 150%
risk weight to exposures that are associated with particularly high risk. Three
respondents argued that the updated treatment for ADC and equity exposures
rendered the high-risk exposures treatment redundant. Having considered the
responses, the PRA has decided to maintain its proposed approach. The PRA
acknowledges that broader changes to the SA framework will mean fewer exposures
will be classed as being of particularly high risk but considers that maintaining the
exposure class will preserve existing risk sensitivity in the framework.

PRA objectives analysis

2.311 With the exception of the change to the criteria for assigning a 400% risk
weight to equity exposures, the PRA considers that the objectives analysis set out in
CP16/22 remains appropriate.

2.312 The PRA considers that the decision to introduce a new age-based criteria to
determine whether an equity exposure is assigned a 400% risk weight will result in
RWAs that better reflect the risks associated with equity and other capital
instruments and should promote consistent application of the rules across firms. The
PRA therefore considers that it is consistent with both its primary and secondary
objectives.

‘Have regards’ analysis

2.313 In developing these near-final rules, the PRA has had regard to its framework
of regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in chapter 3 of CP16/22, remains appropriate, subject to the
following update:

1. Proportionality:

• The PRA continues to acknowledge that allocating equity exposures to the

different risk weight categories will result in some initial operational costs for
firms but considers this to be proportionate to the benefits that the simplified
criteria provide.
Bank of England | Prudential Regulation Authority Page 116

• Permitting equity exposures to be assigned a 250% risk weight once the

business is over 5 years of age should result in a proportionate approach as
the 400% risk weight will only apply to younger equity issuers and then
reduce as the equity gets older, which is justified by the level of credit risk.
Bank of England | Prudential Regulation Authority Page 117

3: Credit risk – internal ratings based

approach

Introduction
3.1 This chapter provides feedback to responses to chapter 4 of consultation paper
(CP) 16/22 – Implementation of the Basel 3.1 standards, which set out proposals
to implement the Basel 3.1 standards for the internal ratings based (IRB) approach
to credit risk. This chapter also sets out the Prudential Regulation Authority’s (PRA)
near-final policy on the IRB approach for credit risk following the consultation.

3.2 In CP16/22, the PRA proposed to introduce restrictions on the use of the IRB
approach for equities and low default portfolios such as exposures to banks, financial
corporates, large corporates, and sovereign exposures. Other proposals included
changes to the risk parameters used in IRB modelling, including new input floors for
probability of default (PD), loss given default (LGD) and exposure at default (EAD),
and greater specification of parameter estimation practices to reduce variability in
risk-weighted assets (RWAs) for portfolios where the IRB approach remains
available.

3.3 The PRA received 34 responses to its proposals on the IRB approach for credit
risk. Responses covered a wide range of the PRA’s proposals. Comments focused
on:

• the appropriate approaches to credit risk for different types of exposures;

• the calibration of IRB risk weight parameters;
• the proposals to remove the small and medium-sized enterprises (SME)
support factor and the infrastructure support factor;
• the PRA’s proposed timelines for firms to make modelling changes; and
• the proportionality and clarity of the PRA’s proposed requirements and
expectations.

3.4 Having considered the responses to the consultation, the PRA has decided to
amend the draft rules and draft supervisory statements (SSs) in certain areas. This
chapter describes the comments and amendments that the PRA considers are
material. As described in Chapter 1 – Overview, the PRA has also made a number of
less material amendments and clarifications to the draft rules and draft SSs, which
Bank of England | Prudential Regulation Authority Page 118

are not described in this chapter. These amendments are reflected in the near-final
PRA Rulebook: CRR Firms: (CRR) Instrument [2024] in Appendix 2 Please refer to
the document titled Comparison of Draft PRA Rulebook (CRR) Instrument [2023]
against Near-final PRA Rulebook: CRR Firms (CRR) Instrument [2024], which
contains a comparison of the near-final rules with the draft rules as set out in
CP16/22 for ease of identifying all of the changes made.

3.5 The appendices to this near-final policy statement (PS) contain the PRA’s near-
final policy, which will:

• introduce a new Credit Risk: Internal Ratings Based Approach (CRR) Part of
the PRA Rulebook (Appendix 2) to replace the CRR articles and associated
technical standards that HM Treasury (HMT) plans to revoke and a technical
standard that the PRA will revoke;
• introduce a new Credit Risk: General Provisions (CRR) Part of the PRA
Rulebook relating to general provisions for credit risk to replace CRR articles
that HMT plans to revoke;
• amend the Credit Risk Part of the PRA Rulebook and remove the existing
Standardised Approach and Internal Ratings Based Approach to Credit Risk
(CRR) Part of the PRA Rulebook;
• introduce a new SS4/24 – Credit risk internal ratings based approach
(Appendix 9);
• introduce a new SS3/24 – Credit risk definition of default (Appendix 8);
• withdraw SS11/13 – Internal Ratings Based (IRB) approaches; and
• amend SS17/13 – Credit risk mitigation (Appendix 10).

3.6 The sections below have been structured broadly along the same lines as
chapter 4 of CP16/22, covering the main areas where the PRA received comments
from respondents as follows:

• Implementation timelines
• Permission to use the IRB approach
• IRB exposure classes and sub-classes
• Restrictions on IRB modelling
• Roll-out, permanent partial use and reversion
• Calculation of RWAs and expected loss (EL)
• General requirements for use of the IRB approach
• Definition of default
Bank of England | Prudential Regulation Authority Page 119

• Input floors
• PD estimation
• LGD estimation
• EAD estimation
• Maturity
• Specialised lending

3.7 Unless specified otherwise, the near-final rules and near-final SSs are consistent
with those in CP16/22 and therefore the PRA considers its analysis of its objectives
and ‘have regards’ in CP16/22 with respect to the areas mentioned in the paragraph
above remains appropriate.

Implementation timelines
3.8 In CP16/22, the PRA set out its proposed timelines for firms to implement
changes arising from the PRA’s proposals relating to the IRB approach. The PRA
received ten responses to these proposed timelines.

3.9 Respondents requested that the PRA clarify and provides further information on
several aspects of the process and timelines for updating existing permissions, new
applications, material model changes and in-flight applications:

• three respondents requested that the PRA use its resources efficiently and
effectively when reviewing IRB model applications;
• five respondents requested that the PRA clarify its approach and timelines for
the repapering of existing permissions, new model applications and material
model change applications;
• five respondents requested that, where firms’ models are not fully compliant
with requirements on the implementation date, firms should be able to update
existing non-compliance notifications and post model adjustments (PMAs)
that are in place for the IRB roadmap;
• four respondents requested that the PRA clarify which compliance standard
would be applied to applications between publication of the near-final rules
and the implementation date;
• two respondents requested that the PRA clarify timelines for existing, non-
Basel 3.1-related model applications. One of the respondents argued that a
transitional period should be considered given the delayed implementation of
hybrid mortgage models;
Bank of England | Prudential Regulation Authority Page 120

• one respondent requested that the PRA monitor the approaches of other
jurisdictions regarding their implementation timelines for material model
changes and provide guidance to firms on how these approaches could
impact their implementation plans; and
• two respondents requested that the PRA clarify timelines for overseas model
approach (OMA) applications and whether these will be updated to align with
other regulators’ approaches to Basel 3.1 timelines.

3.10 The PRA has considered the requests for further clarity relating to
implementation timings and process and has set out further detail below.

3.11 In line with the process set out in CP16/22, the PRA expects that HMT will save
existing IRB permissions46 which the PRA will then vary using its power under
section 144G of the Financial Services and Markets Act (FSMA) 2000 where
necessary such that the saved permissions will operate in line with the following
changes that firms will be required to make with effect from 1 January 2026:

• all restrictions on the scope of IRB models (eg restrictions on modelling EAD
and mandatory use of the SA or the foundation IRB (FIRB) approach, subject
to the transition arrangement for equity exposures);
• all changes to LGD and EAD under the FIRB approach and all changes to the
maturity calculation; and
• all IRB input floors.

3.12 In addition, the PRA expects that it will use its section 144G FSMA 2000
powers to amend saved permissions for roll-out and permanent partial use (PPU)
such that the scope of the saved permissions is restricted to make them consistent
with the near-final rules. The PRA clarifies that firms will not need to apply to make
the changes referred to in the previous paragraph.

3.13 The PRA recognises that firms may wish to apply for permissions relating to the
IRB approach under the near-final rules before 1 January 2026. Examples could
include:

• applications to change roll-out plans and PPU permissions to take advantage

of additional flexibility in the near-final rules; and

46The PRA expects all permissions granted under CRR Articles 143(1), 143(2), 143(3), 148(1),
149(1), 149(2), 150(1), 162(2)(h), and 179(1) to be saved by HMT for firms implementing the Basel
3.1 standards.
Bank of England | Prudential Regulation Authority Page 121

• applications to revert portfolios to less sophisticated credit risk approaches

(eg from the IRB approach to the SA or from the AIRB approach to the FIRB
approach).

3.14 The PRA has communicated details of the application process, including when
firms would need to apply in order for there to be sufficient time for applications to be
determined before 1 January 2026. The PRA notes that firms should discuss their
intentions regarding applications with their supervisors.

3.15 As proposed in CP16/22, and in contrast to the changes described above, the
PRA will not require that IRB models themselves are fully compliant on 1 January
2026 provided that:

• firms have an appropriate remediation plan in place that has been agreed with
the PRA, including an appropriate date for the implementation of their new
models or model changes, or that they demonstrate that the effect of the non-
compliance is immaterial; and
• during this period, firms assess whether a PMA is necessary in order to cover
any shortfall in RWAs.

3.16 The PRA is aware that a number of applications relating to the IRB approach
(eg new IRB permission applications and material model change applications), may
be ‘in flight’ (not determined), when the final rules take effect on 1 January 2026. Any
such applications made under the CRR would fall away when the relevant CRR
provision is revoked. However, the PRA has set out a process whereby firms can
inform the PRA that it wishes for an application originally made under the CRR to
instead be treated as an application made under the near-final rules (once they are
finalised). The PRA may request that firms submit additional information in support of
such applications.

3.17 The PRA expects firms to engage with their supervisors regarding whether,
once the PRA has made the final rules, future applications relating to the IRB
approach should be treated as having been made under the CRR or these rules, and
whether existing applications should be treated as having been made under these
rules.

3.18 Where the PRA approves an application made, or treated as having been
made, under these rules before 1 January 2026, the approval would not take effect
until 1 January 2026. The PRA expects that it will be appropriate in the majority of
Bank of England | Prudential Regulation Authority Page 122

cases for applications relating to the IRB approach to be made or to be treated as

having been made under the near-final rules once these have been finalised.

3.19 The PRA clarifies that it plans to repaper firms’ IRB permission documentation
to reflect all changes that will take effect from 1 January 2026.

3.20 The PRA has considered the requests regarding the amendment of existing
non-compliance notifications and PMAs that are in place for the IRB roadmap and
has made no changes to its proposals because it considers that these are consistent
with the respondents’ requests.

3.21 The PRA has considered the request for further clarity on the approval standard
that will be applied to IRB applications received before the 1 January 2026
implementation date. The PRA confirms that where an application has been made
(and is treated as having been made) under the CRR, the approval standards set out
in the CRR will apply. Where an application has been made (or is treated as having
been made) under the near-final rules (once finalised), the approval standards set
out in those rules will apply, including the PRA’s material compliance approval
threshold for IRB applications.

3.22 The PRA has considered respondents’ comments regarding the approaches
taken by other regulators and OMA applications. The PRA confirms that its existing
OMA policy remains in place and firms can continue to apply to the PRA under this
policy. Firms wishing to submit OMA applications should raise any considerations
relating to their specific circumstances with their supervisor.

Permission to use the IRB approach

3.23 The PRA proposed a number of changes relating to firms’ permission to use the
IRB approach, including:

• to change the threshold for approval of IRB permission applications from ‘full
compliance’ to ‘material compliance’; and
• to change the standard for approval of IRB model change applications for
firms that already have permission to use the IRB approach such that they
may be approved where materially non-compliant if, among other things, they
reduce the overall level of non-compliance in the firm’s IRB approach.
Bank of England | Prudential Regulation Authority Page 123

3.24 The PRA received 12 responses to this section of CP16/22. The substantive
issues raised by respondents are set out below.

Standards for IRB application approval for new models and material
model changes

3.25 The PRA proposed to change the threshold for approval of IRB permission
applications and material model change applications from ‘full compliance’ to
‘material compliance’ with the PRA’s requirements. For this purpose:

• ‘material compliance’ would mean where any non-compliance is immaterial,

meaning it would result in a minimal impact on the quantitative and qualitative
aspects of the firm’s IRB approach; and
• the materiality of the non-compliance would be assessed at model level and in
aggregate to help ensure that immaterial non-compliance across multiple
models would not become material overall.

3.26 Where firms have already received permission to use the IRB approach, the
PRA proposed that firms would continue to be required to notify the PRA where they
no longer comply with any of the requirements applicable to the IRB approach.
However, the PRA proposed to retain the rule that firms would not be required to
present a remediation plan in respect of non-compliance if they can demonstrate that
the effect of the non-compliance is immaterial.

3.27 The PRA considered these proposals overall to be more proportionate than the
existing approach and would promote a more level playing field between firms with
existing IRB permissions and IRB aspirants.

3.28 The PRA received 12 responses to its proposals. All were generally supportive,
but some requested clarification on certain aspects.

3.29 Four respondents requested greater detail on the meaning of ‘immaterial non-
compliance’. The PRA has decided not to provide any additional detail at this time on
the meaning of ‘immaterial non-compliance’ given the idiosyncratic nature of
individual firms’ IRB applications. This makes it difficult to provide guidance that
would apply to firms generally. The PRA considers it appropriate to maintain
flexibility to assess materiality on a case-by-case basis in the context of the firm’s
overall compliance level.
Bank of England | Prudential Regulation Authority Page 124

3.30 One respondent requested clarification on whether materially non-compliant

IRB model change applications would be approved for firms that already have
permission to use the IRB approach where approval of the application would reduce
the overall level of non-compliance in a firm’s IRB approach, and the firm has a
remediation plan in place. The PRA clarifies that this interpretation of the proposal is
correct.

3.31 One respondent requested that the PRA revise its proposal that it would
approve material model changes that do not comply with the IRB rules provided that
the non-compliance is immaterial at the model level and in aggregate. They
requested that the PRA defines the aggregate level as covering only the models that
are related to the change being sought, rather than all models that the firm has
permission to use. Under that alternative definition, the PRA could approve
immaterially non-compliant model changes where the firm is materially non-
compliant with the IRB rules overall, provided that the non-compliance stems from
models that are not related to the change being sought. Having considered the
response, the PRA has decided to maintain its proposal. This is consistent with the
PRA’s policy intention that overall non-compliance of firms with the PRA’s IRB
requirements should not be material. The PRA considers that this is consistent with
its primary objective to promote the safety and soundness of regulated firms by
ensuring that firms with permission to use the IRB approach continue to comply, to a
material extent, with the requirements that apply to that approach.

Other issues relating to permission to use the IRB approach

3.32 Other substantive responses focused on a range of technical issues:

• Self-assessments of model changes: two respondents requested that the

PRA clarify whether the self-assessments that would accompany applications
for material model changes should be submitted by a Senior Management
Function (SMF) holder. The PRA proposed that, when firms submit
applications for permission relating to the IRB approach, or notify the PRA of
an extension or change to an IRB model, they should provide the PRA with a
self-assessment of whether they would comply with all relevant CRR articles,
PRA rules and SS expectations. For the avoidance of doubt, the PRA does
not expect this self-assessment to be made by an SMF holder. Rather, the
PRA proposed that an SMF holder should submit an annual attestation as to
whether the firm’s IRB approach complies with the CRR, PRA rules and PRA
SS expectations, and cover the implementation of an appropriate remediation
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plan where relevant – this proposed expectation has been maintained in the
near-final SS4/24 – Credit risk internal ratings based approach.
• Annual attestations by SMF holders: one respondent argued that the
PRA’s proposed expectation that an SMF holder attests to the compliance of
the firm’s modelling approaches is onerous where models and external
environments do not change year-on-year. The PRA has decided to maintain
its proposal and considers that it is a proportionate expectation. The PRA
does not expect that the burden on firms and SMF holders would be
significant where neither the model nor the external environment has changed
since the SMF holder made their last attestation.
• Documentation requirements for model change notifications: two
respondents requested that the PRA does not proceed with its proposal to
require firms to submit technical process documents and the reports of firms’
independent review or validation in support of notifications for extensions and
changes to IRB models. Those respondents argued that providing this
information would be disproportionate to the scale of change being made. The
PRA notes that firms are already asked to provide this information in the
proforma application for making such notifications to the PRA. The PRA
considers that the proposed requirement is proportionate because the
information required is only that which is relevant to the change being made.
As such, the PRA has decided to maintain its proposal.

PRA objectives and ‘have regards’ analysis

3.33 The near-final policy on permission to use the IRB approach is as proposed in
CP16/22. Therefore, the PRA considers that the objectives and ‘have regards’
analysis presented in CP16/22 remains appropriate.

IRB exposure classes and sub-classes

3.34 The PRA proposed a number of definitional changes to existing IRB exposure
classes, and to introduce new exposure sub-classes in some cases to improve the
clarity of the framework. The PRA received eight responses to this section of
CP16/22. The substantive issues raised by respondents are set out below.

Corporates exposure class

3.35 The PRA proposed to define a large corporate for the purpose of assigning
exposures to the ‘financial corporates and large corporates’ exposure sub-class as a
corporate with consolidated assets equal to or greater than £440 million, or having
Bank of England | Prudential Regulation Authority Page 126

consolidated annual sales of more than £440 million, or belonging to a group where
the annual turnover for the consolidated group is more than £440 million. For the
purpose of the PRA’s proposal, consolidated annual sales would be calculated as
the average annual amount over the last three years. The PRA considered this
proposed definition to be broadly aligned with the Basel 3.1 standards while adding
clarification on certain elements.

3.36 Two respondents requested that the PRA clarify the appropriate basis of
consolidation to be applied in its proposal that firms should assess the consolidated
annual sales and consolidated assets of the obligor. They requested that the PRA
confirms that firms would be permitted to use internal measures of these values
rather than published financial statements. The PRA has considered the responses
and has decided that firms should be required to use audited financial statements.
The PRA considers that this will lead to an appropriately robust assessment of
obligor size and achieve an appropriate degree of consistency between firms. The
PRA has also clarified in its near-final rules that firms will be required to assess the
highest level of consolidation that includes the obligor and for which audited financial
statements are available. Firms will therefore use the accounting standard that is
applicable to those statements.

3.37 One respondent identified an error in the PRA’s proposal that the definition
should depend, in part, on the obligor’s consolidated assets being more than £440
million. Having considered this response, the PRA clarifies that the appropriate test
is only that the obligor’s annual sales are greater than £440 million. As such, the
PRA has amended its near-final rules to remove the reference to consolidated
assets being more than £440 million in the definition.

3.38 Two respondents requested that the PRA revise its proposal that consolidated
annual sales are calculated as an average amount over the last three years. These
respondents argued that the PRA should alternatively permit firms to assess
consolidated annual sales as of the most recent year available and argued that this
is in line with the Basel 3.1 standards which permit either approach. Having
considered the responses, the PRA has decided to maintain its proposal. The PRA
considers it desirable for the definition to be calibrated against a three-year moving
average in order to reduce volatility in the classification of obligors over time. The
PRA has decided not to permit firms to choose whether to use a three-year moving
average or the most recent year available in order to increase the consistency of
approaches across firms and so that firms do not ‘cherry-pick’ approaches in order to
achieve lower risk weights.
Bank of England | Prudential Regulation Authority Page 127

3.39 Three respondents argued that the PRA’s proposal to redenominate the
threshold for large corporates from Euro to Sterling, in line with the PRA’s approach
to currency redenomination, would increase complexity for firms that seek model
approvals in multiple jurisdictions. The PRA has decided to maintain its proposal. It
considers that it is in line with its overall approach to currency redenomination and
would reduce complexity for firms which do not seek model approvals in multiple
jurisdictions. Further, the PRA’s near-final rules should reduce the extent to which
fluctuations in exchange rate affect the assignment of exposures to exposure sub-
classes for firms that operate predominantly in the UK.

3.40 In its near-final rules, the PRA has also amended the definition of large
corporates by referring only to the obligor’s annual revenue, rather than to annual
sales and annual turnover. The PRA does not consider these terms to have different
meanings, but it considers that using a single term will avoid any ambiguity in the
framework.

Definition of specialised lending

3.41 Five respondents commented on the PRA’s proposed definition of the
‘specialised lending’ exposure sub-class. The PRA proposed to align with the Basel
3.1 standards by including a condition that the borrowing entity has ‘little or no other
material assets or activities’ in the definition of specialised lending. Two respondents
supported this proposal in general, but all five respondents raised concerns
regarding specific aspects of the definition. Three respondents argued that the
proposed definition would lead to inconsistent classification of exposures between
firms. One respondent requested that the PRA provide guidance on the aspects of
the definition that they considered are open to different interpretations by firms. Two
respondents thought that the PRA’s proposal would not significantly impact the set of
exposures classed as specialised lending. One respondent was concerned about
potential interactions with the definition of securitisation. One respondent argued that
other characteristics are more important to the classification of exposures as
specialised lending than the ones the PRA proposed.

3.42 Having considered the responses, the PRA has decided to maintain its proposal
to align the definition of specialised lending with the Basel 3.1 standards. While the
PRA recognises that the proposed change to the definition relative to the CRR may
have limited impact, the PRA considers that it is desirable for firms to consider the
additional condition when assessing whether an exposure is specialised lending.
Indeed, the existence of other assets or activities by which the obligor may repay the
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obligation makes treating the exposure as a specialised lending exposure less

appropriate. The PRA notes that HMT has stated it will update the definition of
securitisation in the Securitisation Regulations 2024 such that it aligns with the
PRA’s near-final rules. The PRA does not consider that it is necessary to provide
further guidance on the definition of specialised lending at this time.

Definition of retail small and medium-sized enterprises

3.43 Five respondents commented on the PRA’s proposed amendments to the
criteria for SMEs to be included in the ‘retail’ exposure class. The PRA proposed that
the value of the exposure (either individually or when aggregated with all other retail
exposures) to a single obligor, excluding exposures secured by residential
immovable property, should not exceed £0.88 million to be classed as retail. The
PRA also proposed to include undrawn commitments in the threshold and
considered that this would align with the Basel 3.1 standards and reduce the
likelihood that exposures are reclassified when facilities are drawn down and repaid.

3.44 Four respondents opposed the proposal to include undrawn commitments in the
threshold arguing that it would lead to reclassification of obligors currently treated as
retail to the ‘corporates’ exposure class. One respondent requested that the
definition of retail SMEs should be based on financial turnover rather than the size of
a firm’s exposure to the obligor.

3.45 Having considered the responses, the PRA has decided to amend its draft rules
regarding the inclusion of undrawn commitments in the assessment of SMEs against
the proposed £0.88 million size threshold to align with the CRR approach. Firms
should only include the total amount owed to the institution when calculating the size
of firms’ exposures to obligors against the threshold. This is aligned with the revised
definition of retail SME under the SA as described in Chapter 2 – Credit risk –
standardised approach. While this does not fully align with the Basel 3.1 standards,
the PRA considers the approach to be appropriately prudent when considered
alongside the other criteria for classifying exposures as retail SMEs.

3.46 In response to the proposed threshold level, respondents argued that the £0.88
million threshold is outdated and should be increased, as it is based on a threshold
that has not been updated by the Basel Committee on Banking Supervision (BCBS)
since 2004. Two respondents also argued that firms should be permitted to use
either a £0.88 million or a €1 million threshold level when categorising exposures to
avoid inconsistencies within an international group. One respondent requested that
special purpose vehicles (SPVs) set up exclusively to hold buy-to-let residential
Bank of England | Prudential Regulation Authority Page 129

properties should be exempt from the £0.88 million threshold, and instead be subject
to a £3 million threshold.

3.47 Having considered the responses, the PRA has decided to maintain its
proposed threshold level for retail SMEs. The PRA considers that the £0.88 million
threshold is consistent with the Basel 3.1 standards. The PRA does not consider it
appropriate for firms to be permitted to use different currencies when calculating the
threshold level. This is consistent with the PRA’s general approach to currency
redenomination and ensures consistent (in pound sterling terms) thresholds over
time and across all PRA-regulated firms. Finally, the PRA does not consider it
appropriate to permit an additional carve-out from the threshold level for SPVs set up
to hold buy-to-let properties.

Other issues relating to IRB exposure classes and sub-classes

3.48 Other substantive responses focused on a range of technical issues:

• ‘Central governments and central banks’ exposure class: one respondent

requested that the PRA delete the proposed ‘central governments and central
banks’ exposure class given that firms would not be permitted to apply the
IRB approach to exposures to those obligors under the PRA’s proposals. The
PRA has decided to proceed with its proposal. The PRA considers it desirable
to define exposure classes for all exposures so that it is clear which
approaches firms are permitted to use. The PRA has also revised this
exposure class to include exposures to quasi-sovereigns in line with its
decision to withdraw the IRB approach for those exposures (see ‘Restrictions
on IRB modelling’).
• Alignment of the ‘qualifying revolving retail exposures’ exposure sub-
class with the SA: one respondent requested that the PRA align the
proposed ‘qualifying revolving retail exposures’ exposure sub-class with the
revolving facilities that might qualify as regulatory retail exposures in the SA.
The PRA has decided not to align these definitions. The PRA considers that
the definition of the ‘qualifying revolving retail exposures’ exposure sub-class
is appropriate given the treatments that apply to those exposures under the
IRB approach, which are aligned with the Basel 3.1 standards.
• ‘Qualifying revolving retail exposures’ exposure sub-class definition:
three respondents requested that the PRA clarify its proposal that the
‘qualifying revolving retail exposures’ exposure sub-class is defined as
exposures where, among other things, the maximum amount to a single
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individual is £90,000. They requested clarification on whether this includes

undrawn amounts and, if so, whether those amounts should be calculated
following the application of conversion factors (CFs). They requested that the
PRA clarify whether ‘maximum exposure’ means the largest aggregate
exposure to a single individual or the largest single exposure to a single
individual. The PRA confirms that ‘maximum exposure’ includes the total
notional undrawn amount and that it means the largest aggregate exposure to
a single individual. The PRA considers that this clarified definition reduces
volatility in the classification of exposures as either qualifying revolving retail
exposures or ‘other retail’ as customers draw on their credit limits. The PRA
further considers that its decision appropriately classifies exposures as
qualifying revolving retail exposures where customers have multiple facilities
and is aligned with the Basel 3.1 standards. The PRA has amended its near-
final rules to reflect these clarifications.
• ‘Equity’ exposure class: one respondent requested that units or shares in
CIUs should be a separate exposure class rather than included in the ‘equity’
exposure class as the PRA proposed. The PRA considers that this would
improve the clarity of the draft rules as it more appropriately reflects
differences between CIU exposures and equity exposures. As such, the PRA
has adopted this approach in its near-final rules. One respondent requested
that the PRA clarify why it proposed the ‘other equity’ exposure subclass
given that it had proposed elsewhere to withdraw the IRB approach for
exposures to equities. The PRA considers that it is desirable to define
exposure classes for all exposures so that it is clear which approaches firms
are permitted to use.
• Treatment of exposures to the Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac): two respondents requested that the PRA clarify the appropriate
exposure class for exposures to Fannie Mae and Freddie Mac. The PRA has
decided that it would not be appropriate to clarify the appropriate exposure
class for specific obligors. The PRA considers that the exposure class
definitions that it proposed are appropriate, and that it is desirable for firms to
consider all exposures against those definitions rather than introduce specific
treatments for individual exposures.
• Suitability of the ‘corporates’ exposure class for exposures not falling
into any other class: one respondent argued that the PRA’s proposed
‘corporates’ exposure class is defined too broadly by including any exposure
which does not fall into any other class. The PRA has decided not to make
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any changes to this exposure class because it considers that it captures

sufficiently similar exposures and that it is appropriately divided into exposure
sub-classes.

PRA objectives analysis and ‘have regards’ analysis

3.49 The PRA considers that its revision to its proposals regarding the criteria for
SMEs to be treated as retail will mean that more SME obligors will be treated as
retail than under the CP16/22 proposals. The PRA considers that while the revised
criteria are less conservative than the CP16/22 proposal, the definition of retail SMEs
remains consistent with its primary objective when considered in the round. The PRA
considers that its ‘have regards’ and objectives analysis in CP16/22 remains
appropriate given this revision.

3.50 Aside from this, the PRA considers that its near-final rules on IRB exposure
classes and sub-classes, incorporating the minor changes and clarifications
described in this section, are materially aligned with those proposed in CP16/22.
Therefore, the PRA considers its analysis of its objectives and ‘have regards’ in
CP16/22 remains appropriate.

Restrictions on IRB modelling

3.51 The PRA proposed to implement a number of restrictions on IRB modelling,
including:

• to remove the IRB approach for exposures to central governments and central
banks;
• to remove the AIRB approach for exposures to institutions (including quasi-
sovereigns), large corporates and financial corporates; and
• to remove the IRB approach for equity exposures.

3.52 The PRA received ten responses to this section in CP16/22. The substantive
issues raised by respondents are set out below.

Removal of the IRB approach for exposures to central governments,

central banks and quasi-sovereigns
3.53 The PRA proposed to prohibit the modelling of central government and central
bank exposures under the IRB approach and to require these exposures to be risk-
weighted under the SA. The PRA proposed this because it considered that firms face
Bank of England | Prudential Regulation Authority Page 132

considerable challenges when modelling these exposures, including a lack of default

data. The PRA also considered that firms have an insufficient comparative
advantage relative to the regulator in assessing the risk of these exposures.

3.54 In contrast, the PRA proposed to define quasi-sovereign exposures as an

exposure sub-class within the ‘institutions’ exposure class and to continue to permit
firms to model these exposures under the FIRB approach. The PRA considered that
firms may have an information advantage over the regulator in relation to assessing
the risk of these exposures.

3.55 Three respondents raised concerns about modelability of quasi-sovereign

exposures on the basis that they can be just as challenging to model as central
government exposures. They argued that these exposures are often guaranteed by
or inextricably linked with central governments. One of those respondents argued
that the PRA should require exposures to quasi-sovereigns to be risk-weighted
under the SA. Two respondents suggested retaining the option to use either the SA
or the FIRB approach to determine the risk weights of these exposures. On the basis
that the IRB approach would continue to be permitted in respect of quasi-sovereign
exposures, one respondent requested that the PRA clarify that quasi-sovereign
modelling approaches where central government ratings are material risk drivers
would be acceptable. Two respondents argued that estimates of the credit risk of
central government exposures are an essential input to firms’ estimates of the credit
risk of quasi-sovereign exposures and therefore that the PRA’s proposal that
exposures to central governments should not be modelled, but exposures to quasi-
sovereigns should, is not workable in practice.

3.56 Having considered these responses, the PRA acknowledges the arguments of
respondents that modelling quasi-sovereign exposures presents similar challenges
to modelling central government exposures, and is often based heavily on firms’
central government models. Therefore, the PRA has amended the draft rules to
prohibit modelling of quasi-sovereign exposures and to require that all quasi-
sovereign exposures should be risk-weighted under the SA.

3.57 The PRA accepts that this decision could mean that some firms who would
have been able to develop a robust modelling approach for quasi-sovereigns would
not be permitted to adopt it. However, given the responses it received, the PRA does
not consider this a likely outcome and therefore considers that prohibiting modelling
for these exposures is a proportionate and appropriately prudent decision. The PRA
considers that this approach advances its primary objective by restricting the use of
Bank of England | Prudential Regulation Authority Page 133

modelling to calculate capital requirements where this cannot be done in a robust

and consistent manner. It will also ensure a level playing field between firms for risk-
weighting quasi-sovereign exposures.

3.58 The PRA notes that the impact of this decision on capital requirements will be
mixed as it will depend on the differences in risk weights between the SA and those
produced by firms’ IRB models. The PRA is concerned that SA risk weights for
exposures to central governments, central banks and quasi-sovereigns can
potentially result in an underestimation of RWAs. The PRA therefore intends to
consult in the future, as part of the wider Pillar 2 review discussed in Chapter 6 –
Pillar 2, on a potential Pillar 2 methodology to help ensure the adequate
capitalisation of these exposures.

3.59 One respondent raised concerns about the PRA’s proposed withdrawal of the
IRB approach for exposures to central governments and central banks given their
use to generate the ‘sovereign ceiling’ for exposures to institutions and corporates.
The respondent argued that the use of an external rating to generate the sovereign
ceiling would be inconsistent with the principle that firms should undertake their own
assessments. The PRA clarifies that using an external central government rating as
an input into a firm’s institution and corporate rating systems is permissible in
principle.

Removal of the advanced IRB approach for exposures to institutions, large

corporates and financial corporates
3.60 The PRA proposed to withdraw the AIRB approach for exposures to institutions,
large corporates and financial corporates on the basis that firms face challenges
developing robust modelling approaches for estimating LGD and EAD for these
exposures. The PRA proposed to define large corporates as those which, among
other things, have consolidated annual sales of at least £440 million, as noted in ‘IRB
exposure classes and sub-classes’, above. This is aligned with the Basel 3.1
standards.

3.61 One respondent argued that the PRA’s proposed threshold would mean that
nearly all clients to whom firms provide revolving credit facilities would be defined as
large corporates, and therefore firms would no longer be permitted to apply the AIRB
approach to those exposures. They argued that FIRB CFs are higher than the CFs
that they typically estimate for exposures to revolving credit facilities and that their
Bank of England | Prudential Regulation Authority Page 134

RWAs for these exposures would increase, reducing their capacity to lend to those
customers.

3.62 Having considered this response, the PRA has decided to maintain its proposal.
The PRA considers that firms face considerable challenges developing robust
modelling approaches for estimating the LGDs and EADs for exposures to large
corporates. The PRA observes that firms’ estimated CFs for revolving credit facilities
vary significantly based on firms’ processes and modelling approaches, so the
impact of the PRA’s near-final policy will vary. However, as noted in Chapter 2 –
Credit risk – standardised approach, the PRA has decided to reduce its CF for ‘other
commitments’, except those relating to UK residential real estate, from 50% to 40%.
The PRA considers that this reduction will limit any impact of its proposals while
continuing to advance its primary objective and remaining aligned with the Basel 3.1
standards.

PRA objectives analysis

3.63 The PRA considers that its decision to prohibit the modelling of quasi-sovereign
exposures advances its primary objective because it ensures that firms are only
permitted to model exposures where they can do so in a robust manner.

3.64 The PRA considers that its decision to prohibit modelling of quasi-sovereign
exposures will also advance its secondary objective to facilitate effective competition
as all firms will be required to risk weight these exposures under the SA, resulting in
less variation in risk weights across firms.

‘Have regards’ analysis

3.65 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA considers that its decision to withdraw the IRB approach for
exposures to quasi-sovereigns will not materially impact the competitiveness
of the UK. The PRA considers that its decision will likely result in lower RWAs
Bank of England | Prudential Regulation Authority Page 135

for some exposures and higher RWAs for other exposures relative to those
jurisdictions that continue to permit the IRB approach. Where other
jurisdictions permit firms to permanently apply the SA to these exposures, this
impact will be reduced.

2. Relevant international standards:

• The PRA notes that the Basel 3.1 standards grant discretion to regulators on
the extent to which they implement modelled approaches. The PRA does not
therefore consider that withdrawing the IRB approach for quasi-sovereign
exposures impacts the UK’s alignment with the Basel 3.1 standards.

Roll-out, permanent partial use, and reversion

3.66 The PRA proposed to introduce a number of roll-out classes and to introduce
revised rules relating to the permanent partial use of the SA for firms with permission
to use the IRB approach. The PRA’s proposals were intended to reduce barriers to
entry for smaller firms adopting the IRB approach while limiting the opportunity to
‘cherry-pick’ approaches in order to reduce RWAs without a corresponding reduction
in risk. The PRA also proposed to restate the existing criteria for firms to receive
permission to revert to less sophisticated approaches in its rules and supplement
them with expectations that it would consider one-off costs arising from implementing
the requirements proposed in CP16/22 as a relevant factor when it considers
whether those criteria are met.

3.67 The PRA received 13 responses to this section in the CP. The substantive
issues raised by respondents are set out below.

Permanent partial use of the standardised approach

3.68 The PRA proposed that firms would be required to roll out the IRB approach to
all exposures unless the PRA has granted the firm permission to permanently apply
the SA. The PRA would grant a firm permission to permanently apply the SA either
for all exposures in a roll-out class or for some exposures in a roll-out class.

3.69 For permanently applying the SA for all exposures in a roll-out class, the PRA
would grant permission where:

• the application of the SA does not result in significantly lower capital

requirements than if the IRB approach were used;
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• the firm cannot reasonably model the exposures; or

• the exposures are immaterial (less than 5% of total group credit risk RWAs).

3.70 For permanently applying the SA to some exposures in a roll-out class, the PRA
would grant permission provided that the SA was not permanently applied to more
than 50% of exposures within a roll-out class, and where:

• the firm cannot reasonably model the exposures; or

• the exposures are immaterial (less than 5% of total group credit risk RWAs for
that roll-out class).

3.71 The PRA’s proposal to include modelability as a criterion for these permissions
was new. The PRA therefore proposed a lower materiality threshold for exposures
within a roll-out class of 5% of total group credit risk RWAs for that roll-out class,
relative to the existing expectations, in order to ensure that firms apply the SA only in
exceptional circumstances given that some additional exposures would be subject to
the SA for reasons other than immateriality.

3.72 Five respondents argued that a 5% materiality threshold would be too low for
roll-out of the SA within a roll-out class. They argued that it would require some firms
to develop new IRB models for portfolios that are currently on the SA, but which they
consider to be immaterial.

3.73 Having considered these responses, the PRA acknowledges the issue raised
by firms. The PRA has therefore decided to amend its draft rules and redefine the
5% materiality threshold as a cumulative threshold to be applied across all roll-out
classes for which firms have permission to use the IRB approach, rather than being
restricted to 5% of credit risk RWAs for each roll-out class. This means the total
exposures classed as immaterial under this exemption will be limited to 5% of credit
risk RWAs for all of the roll-out classes for which the firm has permission to use the
IRB approach.

3.74 The PRA considers that this will reduce the operational burden raised by
respondents because firms will have more flexibility regarding which portfolios to roll
out the IRB approach to, relative to the proposed approach. For example, under the
PRA’s proposal, a firm could have two portfolios of the same size in different roll-out
classes where one of the portfolios would be deemed immaterial and the other not,
as a result of the size of the roll-out classes that those portfolios are in. The PRA’s
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revised policy will put both of these portfolios on an equal footing, irrespective of the
size of the roll-out classes they are in.

3.75 The PRA considered whether increasing the materiality threshold within a roll-
out class would be an appropriate alternative method of addressing respondents’
concerns. However, it considered that this approach would not address the fact that
the size of portfolios that have to be rolled out would vary depending on the size of
the roll-out classes they are in. The PRA was also concerned that setting a higher
materiality threshold within roll-out classes may increase opportunities for ‘cherry
picking’ of credit risk approaches to an undesirable extent. The PRA therefore
considers that its decision to redefine the materiality threshold as a cumulative
threshold across all roll-out classes for which a firm has permission to use the IRB
approach addresses respondents’ concerns in a manner that is proportionate and in
line with its primary objective.

Reversion to less sophisticated credit risk approaches

3.76 The PRA proposed to retain the requirement that firms must obtain permission
from the PRA before reverting to less sophisticated approaches (either from the IRB
approach to the SA or from the AIRB approach to the FIRB approach). The PRA
proposed to retain the following criteria for granting that permission:

• that the reversion was not proposed in order to reduce capital requirements;
• that it is necessary on the basis of the nature and complexity of the firm’s total
exposures of that type; and
• that it would not have a material adverse impact on the solvency of the firm or
its ability to manage risk effectively.

3.77 One respondent requested that the PRA revise the proposed criteria. They
requested that the primary criterion is whether the firm can reasonably model the
exposures in question. They requested that the PRA make the same change to its
proposed criteria for using the SA under permanent partial use in order to be
consistent.

3.78 Having considered this response, the PRA has decided to maintain its
proposals because it considers the criteria are important to ensure firms do not
switch between credit risk approaches in order to optimise capital requirements over
time, or where doing so would have a detrimental effect on solvency or risk
management capability. The PRA notes that a firm’s ability to model exposures is a
Bank of England | Prudential Regulation Authority Page 138

relevant factor when considering whether reversion is necessary on the basis of the
nature and complexity of the firm’s total exposures of that type.

Other issues relating to roll-out, permanent partial use, and reversion

3.79 Other substantive responses focused on a range of technical issues:

• Permanent partial use of SA by roll-out class: one respondent commented

on the PRA’s proposal that firms would be permitted to permanently apply the
SA for a roll-out class where the exposures in question are immaterial, where
an ‘immaterial’ roll-out class was defined as one where total SA RWAs do not
exceed 5% of total group credit risk RWAs. The respondent argued that the
PRA’s proposal would lead to disproportionate effort for firms to monitor their
portfolios and manage exposures to remain below the 5% threshold. The
respondent requested that the PRA introduce a lower threshold at which firms
would be required to notify the PRA and a higher threshold that would
represent a breach of the PRA’s requirements. The PRA notes that, under its
near-final rules, remediation plans presented to the PRA following a breach of
the materiality threshold could include reducing the exposures in question or
applying to the PRA to include the exposures in the firm’s roll-out plan. The
PRA has therefore decided not to make any changes to the CP16/22
proposals as it does not consider that the respondent’s request would achieve
a material additional benefit for firms.
• Corporates roll-out class: one respondent requested that the corporates
roll-out class should be split in two, with one roll-out class for non-specialised
lending exposures to large corporates and financial corporates, and another
roll-out class for non-specialised lending exposures to all other corporates.
The respondent argued this was necessary because firms would not be
permitted to apply the AIRB approach to exposures to large corporates and
financial corporates under the PRA’s proposals. The PRA considers that this
distinction is not necessary because the PRA’s near-final rules do not
distinguish between exposures on the FIRB approach and the AIRB approach
for the purpose of rolling out the IRB approach to and within roll-out classes.
Exposures subject to both the FIRB and AIRB approaches would therefore
count towards a firm’s compliance with the requirement that the firm rolls out
the IRB approach to exposures in accordance with the PRA’s near-final rules.
As such, the PRA has decided that non-specialised lending exposures to
large corporates and financial corporates should be in the same roll-out class
as those to all other corporates.
Bank of England | Prudential Regulation Authority Page 139

• Qualifying revolving retail exposures roll-out class: one respondent

requested that the PRA revise its proposed requirement for firms to assess
the immateriality of qualifying revolving retail exposures with reference to the
RWAs of those exposures under the SA for the purpose of the PRA’s
proposed roll-out rules. The respondent argued that this approach would be
burdensome because firms are not required to distinguish between exposures
which are qualifying revolving retail exposures and those which are not under
the SA. The PRA considers the definition of qualifying revolving retail
exposures to be relatively simple to apply and that it is reasonable, and
consistent with its primary objective, to require firms with IRB permissions to
assess the materiality of exposures subject to the SA to avoid ‘cherry picking’
of credit risk approaches. The PRA has therefore decided to maintain its
proposal.
• Clarity of near-final rules: one respondent commented that the PRA’s draft
rules regarding the conditions for granting permission for a firm to
permanently apply the SA for a roll-out class and within a roll-out class were
unclear. Having considered the respondent’s feedback, the PRA has
amended its draft rules on PPU conditions to make them clearer. To do this,
the PRA has made several significant structural changes to the draft PPU
requirements by moving all requirements and conditions into one article. The
PRA considers that this will make the requirements easier to follow. The PRA
has also set out more clearly the different circumstances in which firms might
be permitted to permanently apply the SA and the interaction between the
PRA’s near-final rules regarding roll-out, permanent partial use of the SA, and
sequential roll-out plans. The PRA considers that these changes will enhance
firms’ ability to implement the PPU requirements.

PRA objectives analysis

3.80 The PRA considers that its near-final policy on permanent partial use of the SA
within a roll-out class, including the amendment to apply the 5% materiality threshold
as a cumulative threshold to be applied across all roll-out classes for which firms
have permission to use the IRB approach, is materially aligned with its proposals in
CP16/22 from the perspective of the PRA objectives. Therefore, the PRA considers
analysis of its objectives in CP16/22 remains appropriate.
Bank of England | Prudential Regulation Authority Page 140

‘Have regards’ analysis

3.81 In developing the near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
update:

1. Proportionality:

• The PRA considers that its approach to permanent partial use of the SA within
roll-out classes will reduce the operational burden for firms as they will have
greater flexibility as to which portfolios they roll out the IRB approach to. This
increases the proportionality of its approach.

Calculation of risk-weighted assets and expected loss

3.82 The PRA proposed to make a number of changes to the calculation of RWAs
and EL, including to:

• remove the 1.06 scaling factor;

• revise the obligors to which the 1.25 multiplier to the coefficient of correlation
(the ‘multiplier’) would apply;
• remove the SME support factor;
• remove the infrastructure support factor;
• clarify the approach to excesses of specific provisions over EL amounts for
defaulted exposures; and
• replace the existing expectation for calculating an ‘unrecognised exposure
adjustment’.

3.83 The PRA received 19 responses to this section in CP16/22. The substantive
issues raised by respondents are set out below.

Small and medium-sized enterprise support factor

3.84 The PRA proposed to align with the Basel 3.1 standards by removing the SME
support factor under the IRB approach. The PRA received 15 responses to the
proposal in addition to responses received in respect of the similar SME support
factor proposal for the SA, outlined in Chapter 2 – Credit risk – standardised
approach. Respondents argued that the proposal:
Bank of England | Prudential Regulation Authority Page 141

• would reduce lending to SMEs and increase the lending rates which SMEs
pay to borrow, because changes in the cost of capital would be passed on to
obligors;
• was not justified on prudential grounds, due to a lack of evidence that the
SME support factor leads to SME exposures being undercapitalised in a
stress; and
• would damage the international competitiveness of UK firms.

3.85 Respondents also argued that the rationale for removing the SME support
factor for SA exposures does not apply to the IRB approach because the PRA did
not propose to make corresponding changes to the IRB approach to offset the
impact of its removal.

3.86 Respondents argued that the PRA should instead retain the SME support
factor. Four requested that it is phased out gradually, or for it to be retained for
exposures existing at implementation date (until final repayment of the exposures).

3.87 Having considered these responses, the PRA has decided to maintain its
proposal to remove the SME support factor from Pillar 1. The PRA, acknowledging
the arguments made by firms, and the potential impact on growth and UK
competitiveness, has however decided to apply a firm-specific structural adjustment
to reduce Pillar 2A capital requirements (the ‘SME lending adjustment’) to ensure
that its removal does not result in an increase in overall capital requirements for SME
exposures (see further detail in Chapter 2 – Credit risk – standardised approach).

3.88 As set out in CP16/22, the PRA considers that IRB modelled risk weights
should be appropriately risk-sensitive without the SME support factor. They are
based on firms’ own data and therefore historic experience of lending to SMEs, and
the IRB corporate risk weight function already includes an obligor size adjustment in
the correlation parameter which reduces capital requirements for exposures to
corporate SMEs relative to larger corporates. Additionally, exposures to SMEs in the
IRB ‘retail’ exposure class are risk-weighted using the retail IRB risk weight function
which produces lower risk weights for retail SME exposures than for equivalent
corporate exposures. The PRA did not receive quantitative or qualitative evidence
that persuasively challenged its view that the SME support factor should be removed
based on a consideration of the risk alone. Therefore, the PRA continues to consider
that the SME support factor should not be kept in Pillar 1 capital requirements.
Bank of England | Prudential Regulation Authority Page 142

3.89 While the PRA has concluded that, in the context of wider changes to the SME
package, the SME support factor should be removed under Pillar 1, it acknowledges
respondents’ concerns on the potential impact of even limited changes in capital
requirements for some firms with certain types of SME exposures. To minimise any
potential disruption to SME lending and therefore growth resulting from the removal
of the SME support factor, the PRA will apply the SME lending adjustment to ensure
that the removal of the SME support factor under Pillar 1 does not result in an
increase in overall capital requirements for SME lending. The PRA will apply the
SME lending adjustment where firms choose to submit the necessary data to the
PRA. The PRA considers that this strikes an appropriate balance in delivering a
prudent but proportionate approach. Further information on the SME lending
adjustment is set out in Chapter 2 – Credit Risk – standardised approach.

3.90 In addition to the SME lending adjustment, the PRA has included a revised
definition of SME in the near-final rules. The new definition will require firms to
assess the turnover of entities on the basis of the approach to accounting
consolidation in the obligor’s jurisdiction. This will result in more exposures being
eligible for treatment as SMEs and enable firms to assess whether obligors meet the
definition of SME more easily, eliminating the requirement for firms to undertake a
bespoke assessment of linked firms beyond that which is captured by accounting
consolidation. This PRA has decided also to make this change for the SA, as set out
in Chapter 2 – Credit risk – standardised approach.

Infrastructure support factor

3.91 The PRA proposed to align with the Basel 3.1 standards by removing the
infrastructure support factor under both the SA and the IRB approach. The PRA
received ten responses to its proposal, of which six respondents opposed the
removal, three neither opposed nor supported the removal, and one supported the
removal. Respondents made the following arguments which are relevant to the IRB
approach:

• six respondents argued that removing the infrastructure support factor would
negatively impact the international competitiveness of the UK;
• five respondents argued that the infrastructure support factor has increased
the amount of lending to infrastructure projects and that removing it would
increase the price of lending and decrease lending volumes;
Bank of England | Prudential Regulation Authority Page 143

• four respondents requested that if the PRA does not maintain the
infrastructure support factor, legacy instruments or transitional arrangements
should be put in place in order to limit the impact on existing exposures;
• six respondents argued that the PRA’s proposal would impact the financing of
green infrastructure projects such as the development and operation of
renewable energy sources. One respondent requested that alternative
measures be put in place to support green and sustainable financing; and
• one respondent requested that the proposed draft rules align with the
‘Solvency II Corporate Infrastructure Exemption’.

3.92 Having considered these responses, the PRA has decided to make material
amendments to its draft policy. It has decided to maintain its proposal to remove the
infrastructure support factor under the IRB approach but to apply a firm-specific
structural adjustment to reduce Pillar 2A capital requirements (the ‘infrastructure
lending adjustment’). It has also decided to introduce a new substantially stronger
category in the slotting approach for project finance, which will reduce risk weights
relative to the PRA’s proposals (see ‘Specialised lending’).

3.93 As set out above for the SME support factor, the PRA considers that modelled
risk weights reflect firm data and should be risk-sensitive and reflect an appropriate
level of risk without a support factor. That is the basis on which model approval is
given. The PRA did not receive persuasive evidence that modelled risk weights for
infrastructure exposures would be inappropriately high in the absence of the
infrastructure support factor and does not consider there to be prudential justification
for maintaining the infrastructure support factor. The removal of the infrastructure
support factor from Pillar 1 capital requirements also aligns with international
standards.

3.94 For exposures subject to the slotting approach, the PRA considers, based on
evidence provided by respondents and supervisory data available to the PRA, that a
more risk-sensitive treatment of project finance is warranted (see ‘Specialised
lending’). The PRA considers that this is an important change that will reduce the
Pillar 1 impact of removing the infrastructure support factor while ensuring that the
criteria for assigning exposures to the slotting categories will result in appropriate risk
weights.

3.95 The PRA acknowledges the role that some infrastructure projects could have in
supporting the transition to net zero. However, as set out in the 2021 Climate
Adaptation Report, the capital framework is not the right tool to address the causes
Bank of England | Prudential Regulation Authority Page 144

of climate change. Capital requirements should consider the prudential risks

associated with such exposures, and current measures of ‘greenness’ are not
necessarily reflective of financial risk.

3.96 However, the PRA recognises concerns raised by respondents on the potential
impact on growth and UK competitiveness of even limited increases in capital
requirements on infrastructure lending due to the removal of the infrastructure
support factor. To support growth, competitiveness and minimise any potential
disruption to infrastructure lending resulting from the removal of the infrastructure
support factor, the PRA will therefore apply the infrastructure lending adjustment to
ensure that the removal of the infrastructure support factor under Pillar 1 does not
result in an increase in overall capital requirements for infrastructure exposures. The
PRA will apply the infrastructure lending adjustment where firms choose to submit
the necessary data to the PRA. The PRA considers that this strikes an appropriate
balance in delivering a prudent but proportionate approach. Further information on
the optional infrastructure lending adjustment is set out in Chapter 2 – Credit Risk –
standardised approach.

Unrecognised exposure adjustment

3.97 The PRA currently expects that firms using the AIRB approach should calculate
RWAs on a portfolio basis to reflect products or relationships that are not intended to
result in a credit exposure, but where there is an EAD nonetheless. This expectation
applies where such amounts are material. An example of these products are current
accounts without an overdraft facility that are nonetheless permitted to be
overdrawn.

3.98 In CP16/22, the PRA proposed to replace and expand the existing expectation
for calculating an ‘unrecognised exposure adjustment’. The PRA proposed that firms
using the FIRB approach or the AIRB approach would be required to calculate an
unrecognised exposure adjustment for exposures that would not otherwise be
captured by the EAD framework because either: (a) they were not intended to result
in credit exposures; or (b) they are not classified as off-balance sheet items. Point (a)
reflects the expectation that currently applies to firms using the AIRB approach. Point
(b) was new for all firms.

3.99 The PRA received seven responses to its proposals. They argued that the
proposals would create a deviation between the definitions of commitment used in
the IRB approach and the SA. They argued that this would create operational
complexity and would put firms that apply the IRB approach at a competitive
Bank of England | Prudential Regulation Authority Page 145

disadvantage. They argued that it was not clear what exposures the PRA intended to
capture under ‘credit facilities that would not otherwise be captured as off-balance
items’ and that it was not clear how to assess the full range of risks that would lead
to these credit facilities being captured. One respondent argued that this lack of
clarity made the adjustment complex and that it therefore could be implemented
inconsistently across firms.

3.100 Having considered these responses, the PRA acknowledges the arguments
raised by respondents on the operational burden and complexity of the proposals. It
has therefore decided not to implement the CP16/22 proposals relating to the
unrecognised exposure adjustment (other than to restate the existing expectation
into rules). This means that firms will only be required to assess whether to apply an
unrecognised exposure adjustment to non-credit facilities for exposures that would
be subject to the AIRB approach only if they were recognised as an exposure. The
PRA considers this is a proportionate requirement given the responses received, and
that it will broadly maintain the existing level of safety and soundness achieved.

1.25 multiplier to the coefficient of correlation

3.101 The PRA proposed the following, which it considered was broadly aligned with
the Basel 3.1 standards:

• that the ‘corporates’ exposure class would be divided into exposure sub-
classes for ‘specialised lending exposures’, ‘financial corporates and large
corporates’ and ‘other general corporates’;
• that firms would not be permitted to apply the AIRB approach to exposures in
the ‘financial corporates and large corporates’ exposure sub-class;
• to retain the requirement that firms must multiply the coefficient of correlation
in the IRB risk weight function by 1.25 for exposures to large financial sector
entities and unregulated financial sector entities;
• to amend the definitions of those types of entities; and
• to introduce differentiated LGDs in the FIRB approach for exposures to
financial corporates and non-financial corporates.

3.102 The PRA received five responses relevant to these proposals:

• all five respondents requested that the 1.25 multiplier for the coefficient of
correlation should not apply to exposures to the treasury entities of non-
financial corporate groups and to certain funds;
Bank of England | Prudential Regulation Authority Page 146

• two respondents argued that the proposed withdrawal of the AIRB approach
for exposures to large corporates and financial corporates should be extended
to all funds even if they do not meet those definitions; and
• two respondents argued that firms should continue to be permitted to apply
the AIRB approach to exposures to ancillary service undertakings.

3.103 Having considered these responses, the PRA has decided to revise its
proposals. In respect of treasury entities of non-financial corporate groups, the PRA
considers that it is appropriate in some cases for firms to treat these as non-financial
corporates. For exposures to entities where the entity’s sole purpose is to provide
treasury or risk management services to its internal group, and it does not provide
financial services to third parties, the PRA considers it appropriate for firms not to
apply the 1.25 multiplier to the coefficient of correlation. Further, in that case, the
PRA considers it appropriate for the AIRB approach to remain available for these
exposures (subject to the other restrictions on the application of the AIRB approach
in the PRA’s near-final rules). The PRA has amended its draft rules accordingly.

3.104 In respect of funds and ancillary service undertakings, the PRA has decided to
maintain its proposals. The PRA considers that it is appropriate to treat these
obligors as financial corporates where they meet the definition of financial sector
entities to which the PRA’s proposals referred in CP16/22. The PRA did not receive
any evidence that the correlation of defaults with respect to the economic cycle is
any lower for these entities than for other financial corporates, or that firms do not
face the same challenges in modelling LGD and EAD for those exposures.

3.105 The PRA considers that its near-final rules, having made the changes
described above, are consistent with its primary objective as they better align the
treatment in the IRB approach to the underlying risk. The PRA further considers that
it is appropriate and proportionate to permit firms to continue to apply the AIRB
approach for exposures where firms are reasonably capable of developing compliant
modelling approaches. The PRA’s decision regarding treasury entities of non-
financial corporate groups is consistent with the international competitiveness and
growth of the UK as it will permit firms to apply lower risk weights to certain treasury
entities while still maintaining the risk sensitivity of capital requirements.

Other issues relating to the calculation of RWAs and EL

3.106 Other substantive responses focused on a range of technical issues:

Bank of England | Prudential Regulation Authority Page 147

• EL treatment for fair valued items: one respondent requested that EL for
fair valued items should be set to zero because expected gains and losses
are already reflected through firms’ earnings. The PRA did not propose any
changes to the EL treatment of fair valued items as part of CP16/22 and
considers that the matter is not impacted by the PRA’s implementation of the
Basel 3.1 standards. The PRA has therefore decided not to make any
changes to the EL treatment for fair valued items at this time.
• Excess specific provisions for defaulted exposures: one respondent
commented on the PRA’s proposal to restrict the use of excess specific
provisions for defaulted exposures to cover the EL of other exposures. The
respondent argued that this proposal would be overly conservative and should
be removed. Having considered this response, the PRA continues to consider
that its proposal would result in an appropriately prudent framework because
it would ensure that firms’ CET1 capital reflects the level of risk. The PRA has
therefore decided not to make any changes to its proposals on excess
specific provisions for defaulted exposures.

PRA objectives analysis

3.107 The PRA considers that its near-final policy relating to the calculation of RWAs
and EL, incorporating the amendments to its draft rules as described above, remains
appropriate and advances its objectives. The PRA notes the following updates to the
analysis it presented in CP16/22 to reflect its decisions:

• The revisions to its proposed policy regarding the unrecognised exposure

adjustment will mean that fewer exposures are captured by the unrecognised
exposure adjustment than under the CP16/22 proposals. However, the PRA
considers that the revised scope broadly maintains the existing level of
prudence and therefore is consistent with its primary objective.
• The revisions to the unrecognised exposure adjustment will lead to greater
alignment between the SA and the IRB approach in terms of what firms are
required to capture for their capital requirements. This will help to advance the
PRA’s secondary objective.
• The revision to permit firms not to apply the 1.25 multiplier to exposures to the
treasury entities of non-financial corporate groups will support the safety and
soundness of firms by aligning risk weights to the risk of exposures. The PRA
does not consider that this decision materially impacts its secondary objective.
• The decision to proceed with the removal of the SME support factor and
infrastructure support factor, and to implement the SME lending adjustment
Bank of England | Prudential Regulation Authority Page 148

and the infrastructure lending adjustment to ensure the removal of the support
factors does not result in an increase in overall capital requirements, will
advance its primary objective in a more proportionate manner. The PRA’s
decision will ensure that Pillar 1 capital requirements are prudent and risk-
sensitive, minimise any disruption to SME and infrastructure lending, and
maintain an appropriate overall level of capitalisation. Also, the decision to
implement the SME lending adjustment and the infrastructure lending
adjustment is consistent with its secondary objective given they will be
available to all firms with eligible exposures, regardless of the credit risk
approach used.

‘Have regards’ analysis

3.108 In developing these near-final rules, the PRA has had regard to its framework
of regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Proportionality:

• The PRA considers that its revisions to its proposal relating to the
unrecognised exposure adjustment make the adjustment materially aligned
with the existing expectation that applies to firms. The PRA considers that this
represents a proportionate requirement for firms.

2. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA’s revisions to the unrecognised exposure adjustment support the

relative standing of the UK by reducing the scope of what the adjustment
captures relative to the proposals in CP16/22. This is more in line with other
major jurisdictions who are not expected to implement similar adjustments.
• The PRA considers that its decision to permit firms to apply lower risk weights
to ‘substantially stronger’ project finance exposures (see ‘Specialised
lending’), will support the competitiveness of UK firms relative to the CP16/22
proposals and further mitigate any perceived negative impact that the removal
of the support factors might have on the relative standing of the UK. The
PRA’s decision to implement the SME lending adjustment and infrastructure
lending adjustment will also support the competitiveness of UK firms by
Bank of England | Prudential Regulation Authority Page 149

striking an appropriate balance between delivering prudent Pillar 1 capital

requirements that align with international standards and maintaining an
appropriate overall level of capitalisation.

3. Finance for the real economy:

• The PRA considers that the decision to maintain the proposed removal of the
SME and infrastructure support factors from Pillar 1 capital requirements will
have limited impact on the provision of finance for SME and infrastructure
lending. However, the SME lending adjustment and infrastructure lending
adjustment will support growth and minimise any potential disruption to the
provision of SME and infrastructure lending, and therefore the impact on
growth, from the removal of the SME and infrastructure support factors.

General requirements for use of the IRB approach

3.109 The PRA proposed enhancements to minimum data requirements for
parameter estimation, data maintenance and IRB model governance and validation.
The PRA received seven responses raising a range of technical issues regarding the
proposals. The substantive issues raised by respondents are set out below:

• Use of pooled data: two respondents requested that the PRA clarify whether
firms would be permitted to use pooled data. In addition, one respondent
requested that the PRA clarify whether the use of pooled data would be
permitted when firms make adjustments to obligor grade assignment. The
PRA notes that its draft rules and near-final rules permit the use of pooled
data for PD estimation. Regarding adjustments to obligor grade assignments,
the draft rules and near-final rules state that firms should use ‘all relevant
data’, which includes pooled data.
• Margins of conservatism to address unrepresentativeness of data: five
respondents requested that the PRA incorporate paragraph 34 of the EBA
Guidelines on PD estimation, LGD estimation and treatment of defaulted
assets into its near-final SS4/24. That paragraph notes that firms should apply
margins of conservatism to address unrepresentativeness of data. The PRA
clarifies that it considers that the principle in paragraph 34 is well-established
in the CRR, the PRA’s near-final rules and the near-final SS4/24. The PRA’s
proposal was not intended to represent any change in policy. However, for the
avoidance of doubt, the PRA has decided to incorporate that paragraph into
the near-final SS4/24.
Bank of England | Prudential Regulation Authority Page 150

• Role of IRB rating systems in internal processes: one respondent

requested that the PRA clarify its proposal that internal ratings should play an
essential role in risk management, decision-making processes, credit
approval, internal capital allocation and corporate governance functions. They
requested that the PRA clarify whether this would preclude a firm from using
rating approaches designed for decision-making and risk management
purposes as a basis for an IRB rating system. The PRA clarifies that this
would not necessarily be the case.
• Approving differences between established procedure and actual
practice: three respondents requested that the PRA clarify its proposed rule
that senior management should approve material differences between
established procedure and actual practice. They noted that it was not clear
how this differed from the proposed requirement that senior management
provides notice of any such difference to the management body or a
designated committee thereof. The PRA considers that the two proposed
rules are distinct, but it has amended its near-final rule to clarify that an
appropriate level of senior management must approve material differences
between established procedure and actual practice.
• Application of margins of conservatism (MoCs): one respondent
requested the requirement to apply a MoC due to data and modelling
limitations be disapplied for challenger banks. The PRA has considered this
request and decided that the requirement for an MoC should apply to all firms.
Ensuring appropriately robust capital requirements for all firms subject to the
IRB approach is necessary to support safety and soundness of firms.
• Threshold for estimation error: one respondent requested a materiality
threshold for the MoC that firms would be expected to apply for general
estimation error (the ‘Category C’ MoC). The PRA has decided to maintain its
proposal. The PRA considers that it is unnecessary to set a threshold
because its proposed expectations already note that firms can set the
Category C MoC to zero when the general estimation error is immaterial.
• ‘Seasoning’ effects and aging of defaults: three respondents requested
that the PRA clarify whether the seasoning assessment for LGD estimation
would be related to ‘time since default’ and not ‘time on book’ as the PRA
proposed. The PRA agrees with the respondents and has decided to amend
its expectations in the draft SS – Internal ratings based approach to that
effect.
• ‘Seasoning’ effects and margins of conservatism: three respondents
requested that the PRA clarify that an additional MoC would not be required
Bank of England | Prudential Regulation Authority Page 151

to account for seasoning effects in LGD and PD estimation if firms are able to
demonstrate that seasoning effects are already adequately captured by IRB
models. The PRA has decided to amend its draft SS – Credit risk internal
ratings based approach to clarify that there is no additional expectation for a
separate MoC to capture seasoning effects where firms’ IRB models already
capture these effects adequately.
• Key obligor and facility characteristics: one respondent requested that the
PRA clarify its proposed requirement that firms collect and store data on key
obligor and facility characteristics. They requested that the PRA clarify
whether this would include information relating to characteristics that are not
model drivers. The PRA clarifies that it did not intend to limit its proposal only
to characteristics that firms use as model drivers and that, therefore, other
information could be subject to the requirement in principle.
• Historic data: one respondent argued that the PRA’s proposal to remove a
requirement that firms need not give equal importance to historic data if more
recent data are a better predictor of loss rates or drawdowns was inconsistent
with the PRA’s proposals on the representativeness of data used to calibrate
long-run average PD estimation. The PRA does not share this view. For long-
run average PD calibration, the PRA considers that it is appropriate for firms
to use data from a long and representative time period and not place greater
emphasis on more recent data points. For other purposes, however, including
for example rank-ordering, a firm might reasonably decide to place greater
emphasis on more recent data points if it is appropriate to do so for those
purposes. As such, it has decided to maintain its proposal.

PRA objectives analysis and ‘have regards’ analysis

3.110 The near-final rules on the general requirements for use of the IRB approach,
incorporating the minor changes and clarifications described above, are materially
aligned with those proposed in CP16/22. Therefore, the PRA considers its analysis
of its objectives and ‘have regards’ in CP16/22 remains appropriate.

Definition of default
3.111 The PRA proposed to issue a new SS on the definition of default which would
replace existing material related to the definition of default in SS10/13 and SS11/13
as well as the European Banking Authority (EBA) Guidelines on the application of
the definition of default which firms are expected to comply with under those SSs.
The PRA proposed to make minor changes to existing expectations as part of
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moving them to the new SS that were either consequential or were intended to
enhance the coherence and clarity of the framework.

3.112 The PRA received six responses to this section in CP16/22. The substantive
issues raised by respondents are set out below.

• The use of a ‘months in arrears’ payment allocation scheme for

determining obligor default: three respondents requested clarification on
whether a ‘months in arrears’ payment allocation scheme is permitted when
determining if an obligor is in default. The PRA clarifies that this commonly-
used approach remains acceptable under its near-final policy and has
updated its draft SS – Credit risk definition of default (Appendix 8) to reflect
this.
• Distressed restructuring and forborne non-performing exposures: five
respondents highlighted an apparent contradiction in the draft SS – Definition
of default, relating to distressed restructuring. The PRA proposed to expect
that firms treat forborne exposures as defaulted only where the relevant
forbearance measures are likely to result in a diminished financial obligation.
In the draft SS – Credit risk definition of default, the PRA proposed to expect
that firms verify on a regular basis that all forborne exposures are treated as
defaulted. Having considered these responses, the PRA agrees that setting
both expectations would be unclear. It has decided to remove the latter
expectation because distressed restructurings that do not result in a materially
diminished financial obligation need not necessarily be classified as being in
default.
• The definition of credit agreements and informal arrangements: one
respondent requested clarification on the PRA’s proposed expectations
relating to credit agreements that explicitly allow the obligor to change the
schedule, suspend or postpone payments. The respondent requested that the
PRA clarify whether this expectation also applies to informal concessionary
arrangements. The PRA clarifies that its near-final expectation only applies
where a credit arrangement explicitly allows the obligor to change the
schedule, suspend, or postpone the payments under certain conditions, and
the obligor acts within the rights granted in the contract.
• Forbearance measures and distressed restructuring: three respondents
argued that a reference to Article 47b of the CRR on forbearance measures in
the PRA’s draft rules relating to the definition of default is ambiguous,
undesirable, and burdensome to implement. Article 47b lists a number of
Bank of England | Prudential Regulation Authority Page 153

forbearance measures. The PRA proposed that firms would be required to

consider these forbearance measures when assessing whether a distressed
restructuring has occurred. The PRA notes that it currently expects that a
distressed restructuring should be considered to have occurred when those
forbearance measures have occurred as set out in paragraph 49 of the EBA
Guidelines on the Definition of Default, and that its proposal is consistent with
this existing expectation. The PRA has decided to maintain the substance of
its proposal because it considers that these forbearance measures indicate
that a distressed restructuring has occurred, and it does not consider that they
create any additional burden on firms. The PRA has however decided to
specify the forbearance criteria in its near-final SS rather than referring to
them in its near final rules to make its regulatory framework easier to
navigate.
• Materiality threshold for non-retail exposures past due: four respondents
noted an error in the PRA’s proposed rule regarding the materiality of non-
retail exposures past due. The PRA proposed that the materiality threshold for
these exposures would be £440 million. The PRA notes that the correct
threshold is £440. The PRA has amended the draft rule accordingly.

PRA objectives and ‘have regards’ analysis

3.113 The near-final rules on the definition of default, incorporating the minor
changes and clarifications described above, are materially aligned with those
proposed in CP16/22. Therefore, the PRA considers its analysis of its objectives and
‘have regards’ in CP16/22 remains appropriate.

Input floors
3.114 The PRA proposed to introduce a number of PD, LGD and EAD input floors to
act as a backstop for improving comparability, reducing unwanted variability, and
reducing the cyclicality of modelled RWAs.

3.115 The PRA received 12 responses to this section in CP16/22. The substantive
issues raised by respondents are set out below.

Probability of default input floors

3.116 The PRA proposed to introduce a 0.1% PD input floor for UK retail residential
mortgage exposures. This proposal was more conservative than the 0.05% PD input
floor for all retail residential mortgage exposures in the Basel 3.1 standards. This
Bank of England | Prudential Regulation Authority Page 154

reflects the PRA’s longstanding concern that some IRB UK retail residential
mortgage risk weights have been falling over recent years, may be too low, and may
not fully reflect the potential for losses in unlikely, but plausible, tail scenarios. The
PRA considered that the application of the floor would help backstop against model
risk and uncertainty in PD models caused by a lack of historical default data for low-
risk exposures (ie low-loan to value mortgage loans). In addition, the input floor
would limit the extent to which a fall in default rates in benign economic conditions
translates to excessively low risk weights.

3.117 The responses received focused on the potential costs to firms. Five
respondents argued that a 0.1% PD input floor would be too conservative and would
be inconsistent with approaches taken in other jurisdictions. These respondents
requested that the PRA align with the Basel 3.1 standards. Two respondents argued
that the proposed input floor is not needed because other measures are sufficient to
address issues with declining residential mortgage risk weights. One respondent
argued that the proposed input floor is not needed because introducing stricter
requirements than the Basel 3.1 standards would imply that the UK retail residential
mortgage market is riskier than those in other jurisdictions. One respondent argued
that the input floor should be inserted into the SS rather than created as a rule.

3.118 Having considered these responses, the PRA has decided to retain the
proposed 0.1% PD input floor for UK retail residential mortgage exposures. The PRA
did not receive any persuasive evidence that the proposed input floor is
inappropriately calibrated. The PRA considers that its near-final rule best advances
safety and soundness by ensuring an appropriate level of conservatism for the
estimation of the PD for UK mortgage exposures, while maintaining risk sensitivity in
firms’ models. The PRA has decided to retain the PD input floor in its near-final rules
to ensure consistent application across firms. The PRA considers that the 0.1% input
floor will also advance the PRA’s secondary objective by acting as an additional
safeguard against an excessive gap between IRB and SA risk weights for the lowest-
risk mortgage exposures.

Other issues relating to input floors

3.119 Other substantive responses focused on a range of technical issues:

• LGD input floors for unsecured retail exposures with recourse to a

broker: one respondent requested that the PRA revise its proposed 30%
LGD input floor for certain unsecured retail exposures with recourse to a
Bank of England | Prudential Regulation Authority Page 155

broker. They argued that the floor would be inappropriately high in that case.
The PRA has decided to maintain its proposal on the basis that 30%
represents an appropriate backstop for unsecured retail LGD models that
broadly reflects the risk of this category of exposure and is in line with the
Basel 3.1 standards. The PRA considers that it would be excessively complex
to introduce different floors on a granular product basis.
• LGD input floors for retail exposures secured by residential immovable
property: one respondent requested that the PRA clarify whether its
proposed 5% LGD input floor for retail residential mortgage exposures would
apply to all exposures in the ‘retail exposures secured by residential
immovable property’ exposure sub-class. The PRA clarifies that this is the
case. The PRA has updated the draft rule accordingly.
• Interaction of PD floors with 1.25 asset value co-efficient of correlation
multiplier: one respondent requested that the PRA disapply the 1.25
multiplier for obligors whose estimated PDs fall below the proposed 0.05% PD
floor to avoid having a double impact on highly-rated exposures. The PRA has
decided to maintain its proposals. The PRA notes that the 1.25 multiplier is
intended to capture the systemic risk associated with exposures to ‘large
financial sector entities’ and ‘unregulated financial sector entities’ while the PD
floor is intended to address model risk uncertainty and to limit the extent to
which a fall in default rates translates to excessively low risk weights. The
PRA therefore considers that having both requirements is important to
advance its primary objective.
• PD input floors for qualifying revolving retail exposures: five respondents
requested that the PRA correct errors in CP16/22 and draft rules on the value
of PD input floors for qualifying revolving retail exposures. In CP16/22, the
PRA proposed that the PD input floor for qualifying revolving retail exposures
which are transactors would be 0.1%. The PRA has corrected this error and
has specified PD input floors of 0.05% for qualifying revolving retail exposures
which are transactors and 0.1% for those which are revolvers.
• Complexity of input floors: two respondents argued that the PRA’s
proposed input floors would introduce unnecessary complexity given other
proposed backstops such as portfolio-level output floors and the output floor
adjustment. One of those respondents argued that the PRA’s proposal not to
align with the Basel 3.1 standards in all cases adds to the complexity of the
framework. The PRA continues to consider that its proposed approach to
input floors is necessary to ensure an appropriate backstop against modelling
risk. As such, the PRA has decided to maintain its proposals.
Bank of England | Prudential Regulation Authority Page 156

PRA objectives and ‘have regards’ analysis

3.120 The near-final rules on input floors, incorporating the minor changes and
clarifications described above, are materially aligned with those proposed in
CP16/22. Therefore, the PRA considers its analysis of its objectives and ‘have
regards’ in CP16/22 remains appropriate.

Probability of default estimation

3.121 The PRA proposed to make a number of changes to existing approaches
relating to PD estimation, including:

• prohibiting the use of continuous rating scales; and

• prohibiting the use of adjustments to the assignment of obligor grades to
recognise support that is not in writing.

3.122 The PRA received seven responses to this section in CP16/22. The
substantive issues raised by respondents are set out below.

Use of continuous rating scales

3.123 The PRA proposed to prohibit the use of continuous rating scales in PD
models and to require firms to use discrete rating scales instead. The PRA
considered that this proposal was aligned with the Basel 3.1 standards. The PRA
observed that, for PD estimation, continuous rating scales are used relatively
infrequently by firms and that they typically result in lower RWAs than discrete rating
scales in a manner that is not always justified.

3.124 The PRA received five responses requesting that the PRA continue to permit
the use of continuous rating scales in PD estimation. Three respondents argued that
firms should only be required to use discrete rating scales for residential mortgage
lending and that the PRA should continue to permit firms to use continuous rating
scales for all other exposures. Two respondents argued that the use of discrete
rating scales could lead to a material loss of risk sensitivity and that the perceived
risk of RWA underestimation is addressed by other measures such as the PD input
floor. One respondent argued that firms can achieve robust risk differentiation for low
PD exposures using continuous rating scales.

3.125 Having considered these responses, the PRA has decided to maintain its
proposal to prohibit the use of continuous rating scales. The PRA continues to
Bank of England | Prudential Regulation Authority Page 157

consider that the increase in risk differentiation that can be achieved with continuous
rating scales is not sufficient to justify the lower risk weights that they generate. The
PRA did not receive any persuasive evidence to the contrary.

Obligor grade adjustments

3.126 The PRA proposed that adjustments to obligor grade assignments to reflect
support arrangements would only be permitted where the support is in writing. The
PRA considered the proposed approach to be broadly aligned with the Basel 3.1
standards. The PRA considered that undocumented support arrangements can be
unclear and not robust, that it is difficult for firms to demonstrate a reduction in
default risk from these arrangements, and that it is difficult for supervisors to
challenge whether these arrangements are appropriately reflected in IRB models.

3.127 Respondents did not support the PRA’s proposals and argued that the PRA
should continue to permit firms to make adjustments to obligor grade assignments
where there is undocumented support. Two respondents raised concerns regarding
international competitiveness since some other jurisdictions do not require that
parental support is documented. One respondent requested that the PRA clarify the
meaning of ‘documented’ to ensure consistency among firms. One respondent
submitted data showing that obligors with undocumented support have lower
observed default rates than those without any support arrangements in place but
higher default rates than those with documented support in place.

3.128 Having considered these responses, including the data and impact analysis
demonstrating the historical effect of undocumented support arrangements, the PRA
has decided to amend its proposal and permit undocumented support being reflected
in adjustments to obligor grade assignments. The data provided to the PRA were
particularly valuable in adjusting the PRA’s proposals. The PRA has decided instead
to introduce risk management expectations in its near-final SS4/24, to ensure a
robust and broadly consistent method of support recognition across firms. The PRA
considers that this will be a more proportionate way to address the prudential risk
previously identified and that it will also support the competitiveness of UK firms in
third country markets.

Other issues relating to PD estimation

3.129 Other substantive responses focused on a range of technical issues:

Bank of England | Prudential Regulation Authority Page 158

• Notched grading: two respondents requested that the PRA clarify whether its
proposal to prohibit the recognition of undocumented support for the
assignment of obligors to rating grades means that using notched grading
approaches, where firms notch down from the parent rating or notch up from
the subsidiary rating, would also be prohibited. Noting the PRA’s decision to
not maintain its proposal to prohibit the recognition of undocumented support
for the assignment of obligors to rating grades, the PRA nevertheless clarifies
that notched grading approaches are acceptable in principle. As part of the
risk management expectations relating to the recognition of undocumented
support, the PRA has introduced an expectation that firms should produce a
standalone rating for obligors subject to a notched approach.
• Mix of good and bad periods (macroeconomic data): five respondents
requested that the PRA clarify whether the use of macroeconomic data is
permitted to meet the requirement that the data firms use for parameter
estimation is representative of a mix of good and bad periods. The PRA
considers that its draft rules are clear that internal, external, and pooled data
can all be used and notes that firms can use a combination of these data
types to meet minimum data requirements (eg by using external industry-level
data to backcast internal default rates). The PRA therefore considers that no
further clarification is necessary.
• Mix of good and bad periods (risk quantification and rank-ordering): one
respondent requested that the PRA clarify its proposed requirement that firms
should estimate PDs from long-run averages of one-year default rates over a
representative mix of good and bad periods. They requested that the PRA
clarify whether this requirement would apply just to risk quantification or
whether it would apply also to rank-ordering. The PRA clarifies that it
proposed the former, which is aligned with the Basel 3.1 standards. The PRA
considers that its near-final rules are sufficiently clear on this point.
• Guidance on representative periods for UK portfolios: two respondents
requested that the PRA specify the years that constitute good and bad
periods for UK portfolios. The PRA has decided not to specify those periods.
The PRA considers that it is important for firms to be required to identify
periods that are representative for their own exposures.
• Count-weighted long-run average PD calculation and default rate
calculation: three respondents requested that the PRA clarify its proposed
rules regarding calculating the one-year observed default rate and long-run
average default rate. The respondents argued that the PRA’s draft rules
conflated the calculation of a one-year default rate with the calculation of long-
Bank of England | Prudential Regulation Authority Page 159

run average default rates. To address any lack of clarity, the PRA has decided
to not include the relevant text in its near-final rules as it considers that these
concepts are covered elsewhere. The one-year default rate is defined in the
CRR Article 4(1)(78) and the long-run average default rate is covered by
paragraph 11.15 of the near-final SS4/24.
• Long-run average PDs for low default portfolios: one respondent argued
that the PRA’s proposed requirement for the calculation of count-weighted
average PDs would not be feasible for low default portfolios. The PRA does
not share this view. The PRA considers that it is appropriate to require firms to
calculate long-run average PDs for these portfolios in the same way as for
other portfolios. The PRA considers that it is appropriate to expect firms to
apply statistical techniques when calculating PDs for low default portfolios in
line with its near-final SS4/24.
• Use of continuous rating scales in the calculation of the long-run
average (LRA) default rate: one respondent requested clarification on how
firms should calculate LRA PD for unsecured retail exposures as these PDs
are typically estimated on a continuous rating scale. The PRA considers that it
is not necessary to provide further guidance in this area because it considers
its rules are clear, and because it considers that calculating LRA PD for
discrete rating systems is a relatively well-established practice among firms.
• ‘Point in time (PiT) plus buffer’ methodology: four respondents requested
clarification on whether the use of ‘point in time plus buffer’ methodology
would be permitted, assuming the PRA prohibits the use of continuous rating
scales as proposed. The PRA confirms that it has not changed its approach to
rating and calibration philosophy from that set out in PS11/20. The PRA
continues to consider that for retail exposures other than residential
mortgages, firms may choose to develop models that use dynamic
recalibration in conjunction with a suitable buffer to achieve a point-in-time
approach.

PRA objectives analysis

3.130 The PRA considers that its near-final policy relating to undocumented support
arrangements is consistent with its primary objective. The PRA considers that the
evidence it received in response to CP16/22 demonstrates that it can be appropriate
for firms to reflect these arrangements in underlying risk weights. The PRA’s new
risk management expectations will require that firms make a comprehensive
assessment of support arrangements before recognising them in an IRB model. This
Bank of England | Prudential Regulation Authority Page 160

advances safety and soundness without imposing a disproportionate impact on

firms, including with respect to their international competitiveness.

3.131 The PRA recognises that firms that apply the IRB approach are permitted to
recognise a broader range of third-party support in capital requirements than firms
that apply the SA. Therefore, in addition to advancing the PRA’s primary objective,
the PRA’s proposal in CP16/22 was intended to advance its secondary objective by
aligning more closely the situations in which firms using different credit risk weighting
approaches are permitted to recognise third party support. Notwithstanding this, and
on the basis of the responses received, the PRA considers that its near-final policy
facilitates effective competition by only recognising the impact of undocumented
support where it is robust, based on the safeguards set out in the PRA’s rules and
expectations for the IRB approach.

3.132 For all other aspects of PD estimation, the PRA considers its analysis of its
objectives as presented in CP16/22 remains appropriate.

‘Have regards’ analysis

3.133 In developing these near-final rules, the PRA has had regard to its framework
of regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA considers that its decision to permit the recognition of

undocumented support arrangements supports the international
competitiveness ‘have regard’ by more closely aligning the UK approach with
that of other jurisdictions.

2. Proportionality:

• The PRA considers its decision to permit firms to make adjustments to obligor
grades to reflect undocumented support, but to apply additional supervisory
expectations to ensure it is robust, is proportionate. It ensures that the burden
imposed on firms is proportionate to the risks of reflecting the benefit of
insufficiently robust arrangements.
Bank of England | Prudential Regulation Authority Page 161

Loss given default estimation

3.134 The PRA proposed to make a number of changes to existing approaches
relating to LGD estimation, including to:

• reduce the applicable LGD under the FIRB approach for unsecured
exposures to corporates that are senior claims from 45% to 40%;
• clarify the eligibility of collateral in the LGD modelling collateral method and
introduce an alternative methodology;
• clarify the eligibility requirements for recognising unfunded credit protection
(UFCP) in the LGD adjustment method;
• clarify the applicable LGD when applying the parameter substitution method;
and
• remove the wholesale LGD framework.

3.135 The PRA received seven responses to this section in CP16/22. The
substantive issues raised by respondents are set out below.

Loss given default modelling collateral method for firms using the AIRB
approach
3.136 The PRA proposed that firms applying the LGD modelling collateral method
would be required to exclude recoveries from ineligible and disregarded eligible
collateral when calculating unsecured LGD. The PRA also proposed that firms
record the source of recoveries. The rationale behind its proposal was that if
cashflows from ineligible and disregarded eligible collateral were included in LGD
estimates, it would effectively negate the classification of the collateral as ineligible
or disregarded, and consequently bias LGD estimates.

3.137 Three respondents argued that exclusion of cash flows associated with
ineligible and disregarded collateral would bias the real recovery amount and hence
increase LGD estimates. Respondents argued that, while these recoveries come
from ineligible collateral, they are still realised and not reflecting them in LGD
estimates would be overly conservative. The PRA did not receive responses on the
proposed requirement to record the source of recoveries.

3.138 Having considered these responses, the PRA has decided to broadly retain
the proposals in CP16/22. The PRA considers that recoveries from ineligible
collateral are less certain and there is prudential risk in permitting recoveries from
Bank of England | Prudential Regulation Authority Page 162

them to be reflected in LGD and RWA calculations. However, the PRA also notes
that firms may not always be able to identify the source of recoveries. The PRA has
therefore decided to proceed with its proposal to require firms to exclude recoveries
from ineligible and disregarded collateral when calculating unsecured LGD. The PRA
has also decided to introduce a new expectation that firms’ policies on the treatment
and allocation of unidentified cash flows should consider whether cash flows are
classified as arising from recognised collateral or unfunded credit protection,
unrecognised collateral or unfunded credit protection, or from other sources, and
should do this in a way that results in LGDs being estimated in a conservative
manner.

Proposed introduction of an alternative methodology

3.139 The PRA proposed to require the use of an alternative methodology if a firm is
using the LGD modelling collateral method to recognise the effect of collateral and
does not have sufficient data to model the effects of the collateral in a particular
jurisdiction. The PRA proposed to set an expectation that the data would be
considered insufficient where the firm has fewer than 20 relevant data points for any
non-financial collateral that the firm wishes to recognise in its LGD models.

3.140 Three respondents commented on the PRA’s proposal. Respondents noted

that the expectation was omitted from the draft SS - Credit risk internal ratings based
approach, in error. The PRA has corrected this omission in the near-final SS4/24.
The near-final SS4/24 also includes expectations regarding whether recoveries in a
different jurisdictions are relevant for the purpose of the 20 relevant data points. The
PRA has made minor drafting amendments to improve the clarity of its near-final
rules relating to the cases where the alternative methodology applies.

Other issues relating to LGD estimation

3.141 Other substantive responses focused on a range of technical issues:

• Probability of possession given default (PPGD) reference points: two

respondents requested changes to the PRA’s expectations relating to the
reference points that it considers are appropriate when estimating the PPGD
of UK residential mortgage exposures where firms have limited data. The
PRA did not propose any changes to these reference points as part of
CP16/22 and considers that their suitability is not impacted by the PRA’s
Bank of England | Prudential Regulation Authority Page 163

implementation of the Basel 3.1 standards. The PRA has therefore decided
not to make any changes to these reference points at this time.
• Assuming zero costs and recoveries for incomplete workouts: three
respondents requested clarification on whether firms are permitted to assume
zero costs and recoveries for incomplete workouts when estimating Best
Estimate of Expected Loss (BEEL). The PRA clarifies that an assumption of
zero costs and recoveries should not be used when estimating BEEL because
conservatism should not be used in the calculation of BEEL, and the inclusion
of this assumption would add an element of conservatism.
• Recovery periods for incomplete workouts: three respondents requested
that the PRA clarify whether its proposed retention of an existing expectation
that firms should not estimate costs and recoveries for incomplete workouts
after the maximum period of the recovery process for the purpose of long-run
average LGD estimation is consistent with the statements it made at the IRB
mortgages roundtable that it held on 5 October 2020. The PRA understands
that this comment relates to an observation made by the PRA that firms may
make a conservative assumption in PPGD modelling that all exposures
unresolved at the end of the outcome period enter possession. The PRA
therefore considers that there is no inconsistency between its proposals and
the material discussed at the mortgage roundtable.
• Long-run average LGD estimation: one respondent requested that the PRA
permits calibration at the calibration segment level for discrete LGD model
estimates when only a portfolio level calibration target is available. The PRA
agrees that this is an appropriate approach and has amended its draft SS –
Credit risk internal ratings based approach, accordingly.
• Recognising collateral: one respondent requested clarification on the PRA’s
draft rule that firms using the LGD modelling collateral method to recognise
collateral must have internal requirements that are generally consistent with
those of the foundation collateral method. The PRA did not propose any
substantive changes to this requirement as part of CP16/22 and considers
that its operation is not materially impacted by the PRA’s implementation of
the Basel 3.1 standards. The PRA has therefore decided not to provide further
clarification of this requirement.
• Separation of general expectations and model development
expectations: two respondents highlighted that the chapter on model
development in the draft SS – Credit risk internal ratings based approach,
includes expectations that should apply to both model development and
model calibration. The PRA has adjusted the section headings in its near-final
Bank of England | Prudential Regulation Authority Page 164

SS to clarify this point. The PRA considers that this adjustment in the naming
of sections will provide further clarity to users navigating the near-final SS.
• The use of house price indices as an economic indicator: one respondent
requested clarification on the PRA’s proposal to retain requirements regarding
the inclusion of house price indices as a relevant economic indicator when
estimating LGD and EAD. The PRA has decided not to provide further
clarification in its near-final rules as it considers that they are sufficiently clear.
• Appropriate discounting rate for cashflows in downturn LGD
calculation: one respondent noted an apparent error in the PRA’s proposed
expectations. The PRA proposed that, when estimating downturn LGD, firms
would be expected to apply a discounting rate of at least the higher of 9% and
the Sterling Overnight Index Average (SONIA) plus 5%. The PRA agrees that
this was an error and has corrected it and clarified that, for the purpose of
downturn LGD, the PRA expects firms to use a discount rate of at least 9%.
• Supervisory LGD for covered bonds: one respondent requested that the
PRA extend the application of the 11.25% supervisory LGD that it proposed
for certain covered bonds issued in the UK to covered bonds issued outside
the UK. The PRA has decided to maintain its proposal. The PRA considers
that this approach means that only high-quality covered bonds are eligible for
the lower LGD, which is important for safety and soundness and is consistent
with the approach described in Chapter 2 – Credit risk – standardised
approach.
• Treatment of funded credit protection securing unfunded credit
protection: as set out in Chapter 4 – Credit risk mitigation, the PRA has
decided to specify in its near-final rules the treatment of funded credit
protection securing unfunded credit protection obligations. As a result, the
PRA has made minor amendments to the draft IRB rules to address how firms
applying the AIRB approach may treat this type of credit risk mitigation in their
LGD models. The PRA has also introduced some expectations on this
situation in its near-final SS4/24. The PRA considers that these changes
improve the clarity, and will support a consistent implementation, of its policy.

PRA objectives and ‘have regards’ analysis

3.142 The near-final rules on LGD estimation, incorporating the minor changes and
clarifications described above, are materially aligned with those proposed in
CP16/22. Therefore, the PRA considers its analysis of its objectives and ‘have
regards’ in C16/22 remains appropriate.
Bank of England | Prudential Regulation Authority Page 165

Exposure at default estimation

3.143 The PRA proposed to make a number of changes relating to EAD estimation,
including to:

• align the CFs in the FIRB approach with the proposed revised CFs that would
apply under the SA;
• restrict the scope of EAD modelling to revolving commitments in the form of
revolving loan facilities only;
• prohibit modelling of EAD under the slotting approach;
• require that firms use a 12-month fixed-horizon approach for EAD modelling;
• permit firms to recognise post-default additional drawings in either EAD or
LGD for non-retail exposures as well as for retail exposures, remove an
existing PRA expectation that additional drawings beyond a 12-month time
horizon need not be incorporated in model estimates, and clarify that pre-
default additional drawings would be required to be reflected in EAD
estimates; and
• remove the wholesale EAD framework.

3.144 The PRA received seven responses to this section in the CP. The substantive
issues raised by respondents are set out below.

Exposure at default modelling of on-balance sheet items

3.145 Three respondents requested clarification that firms can model EAD for certain
on-balance sheet exposures, such as fully drawn down retail mortgage loans under
the PRA’s proposals. The PRA clarifies that its near-final rules do not permit EAD
modelling for any on-balance sheet exposures which are unconnected to a revolving
facility. The PRA considers that this will lead to greater consistency and simplicity in
the EAD framework because firms will not be required to switch from not modelling
non-revolving commitments before they are drawn down to modelling the exposure
once it moves onto the balance sheet. It also ensures a consistent approach to
modelling by product type.

Requirement for a 12-month ‘fixed-horizon’ approach for exposure at

default modelling
3.146 Four respondents commented on the PRA’s proposal to prohibit the use of the
‘cohort approach’ to EAD modelling and to require use of the fixed horizon approach.
Three of these respondents argued that the PRA’s proposal may cause
Bank of England | Prudential Regulation Authority Page 166

inconsistency between PD, LGD and EAD estimation which could impact RWAs and
estimates of expected loss. One respondent argued that the PRA’s proposals would
be difficult to implement.

3.147 Having considered these responses, the PRA has decided to maintain its
proposal. It considers that the benefits of standardising the time horizon for EAD
modelling across firms domestically and internationally in reducing risk weight
variability among firms and aligning with the Basel 3.1 standards are justified despite
the concerns raised by respondents.

Exposures for which exposure at default or a conversion factor must be

estimated
3.148 Four respondents commented on the proposed revisions to the CRR definition
of CF set out in HMT’s consultation – Implementation of the Basel 3.1 standards,
and highlighted their concern that the proposed definition, when read in conjunction
with the PRA’s draft rules, may imply that CFs would be multiplied by an off-balance
sheet amount calculated with reference to the unadvised limit, rather than the
advised limit, which could result in materially higher capital requirements.
Respondents also argued that calculating capital requirements with reference to
unadvised limits would be inconsistent with the PRA’s proposed definition of
commitment, given the proposed definition refers to contractual facilities which are
offered and accepted by the obligor.

3.149 The PRA did not intend to require firms using non-modelled approaches to
apply CFs to unadvised limits. The PRA notes that HMT has stated that it will
remove the concept of unadvised limits from the CRR definition of CF, if it is to
remain in legislation at the point the PRA’s near-final rules take effect (such that the
updated definition would also take effect at this point).47

3.150 The PRA has considered the position for exposures where EAD or CFs would
be modelled under the AIRB approach. For these exposures, the PRA clarifies that it
expects firms’ models to capture the ‘balance at default’ regardless of whether this
arises from an advised or unadvised limit. Therefore, while CFs should be measured
as a proportion of the advised limit only, the entire balance at default should be
reflected in realised and modelled EADs and CFs regardless of whether the balance

47As part of work to complete revocation of the rest of the CRR, the PRA is working with HMT to
assess which definitions from the CRR will need to remain in legislation and which definitions should
be revoked to be replaced by PRA rules, and to determine the timetable to complete this work.
Bank of England | Prudential Regulation Authority Page 167

arose from an advised or unadvised limit. This may result in CFs exceeding 100%.
The PRA considers this is appropriate as modelling under the AIRB approach is
intended to be more risk-sensitive than the SA. The PRA has amended its draft SS –
Credit risk internal ratings based approach accordingly.

3.151 As set out in Chapter 2 – Credit risk – standardised approach, six respondents
requested that the PRA revise its proposed definition of commitment to exercise the
national discretion in the Basel 3.1 standards to permit firms to exempt from the
definition of commitment certain arrangements in relation to corporates and SMEs.48
As set out in Chapter 2 – Credit risk – standardised approach, the PRA has decided
to maintain its proposed definition of commitment. The PRA has, however, decided
to amend its draft SS – Credit risk internal ratings based approach, to delete a
reference relating to the circumstances in which an EAD or CF should be estimated,
which was inconsistent with this definition of commitment.

PRA objectives and ‘have regards’ analysis

3.152 The near-final rules on EAD estimation are materially aligned with those in
CP16/22 and therefore the PRA considers its analysis of its objectives and have
regards in CP16/22 remains appropriate.

Maturity
3.153 The PRA proposed a number of clarifications to its rules regarding the
calculation of maturity. The PRA received six responses to this section in the CP.
The substantive issues raised by respondents are set out below.

Calculation of maturity
3.154 The PRA proposed to require firms applying the FIRB approach to calculate
effective maturity rather than applying fixed parameters. This proposal was
supported by one respondent. Three respondents requested that the PRA clarify the
treatment that would apply to certain exposures with indeterminate tenor. The PRA

48Basel CRE 20.94, footnote 43. ‘At national discretion, a jurisdiction may exempt certain
arrangements from the definition of commitments provided that the following conditions are met: (i)
the bank receives no fees or commissions to establish or maintain the arrangements; (ii) the client is
required to apply to the bank for the initial and each subsequent drawdown; (iii) the bank has full
authority, regardless of the fulfilment by the client of the conditions set out in the facility
documentation, over the execution of each drawdown; and (iv) the bank’s decision on the execution of
each drawdown is only made after assessing the creditworthiness of the client immediately prior to
drawdown. Exempted arrangements that meet the above criteria are limited to certain arrangements
for corporates and SMEs, where counterparties are closely monitored on an ongoing basis.’
Bank of England | Prudential Regulation Authority Page 168

can clarify that these would be subject to the general five-year maturity cap because
it does not consider that it would be prudent to apply a lower maturity cap for these
exposures.

Other issues relating to maturity

3.155 Other substantive responses focused on a range of technical issues:

• Purchased receivables: four respondents recommended that purchased

receivables should be eligible for the proposed one-day maturity floor that
would apply to exposures meeting certain conditions, rather than being
subject to a one-year floor in every case. The PRA notes that the proposed
change to the maturity floor for purchased receivables was not intended to
override the provisions surrounding the application of the one-day floor. In
cases where purchased receivables meet the relevant conditions, they will still
be subject to a one-day floor. The PRA has made minor drafting changes in
the near-final rules to clarify this.
• Scope of one-day floor: two respondents requested that the PRA extend the
scope of the one-day floor. They requested in particular that this should apply
to inter-bank deposits and nostro accounts. The PRA has decided not to
change the scope of the one-day floor because it is not intended to apply to all
short-term exposures, and the PRA considers that even if a firm is permitted
to withdraw an inter-bank or nostro deposit, it may choose not to do so for
business or practical reasons, meaning it would be imprudent to apply a one-
day floor.
• Secured lending transactions: two respondents commented that the PRA’s
proposed amendments relating to secured lending transactions, which
referred to daily margining, appeared to be inconsistent with the proposed
definition (in the Credit Risk Mitigation Part) of a secured lending transaction
as a transaction without daily margining. The PRA has amended the near-final
rules to address this inconsistency by removing the tailored maturity treatment
for secured lending transactions.

3.156 In preparing the near-final rules, the PRA has made other minor changes to
improve the clarity of the requirements, in particular relating to the calculation of
effective maturity for exposures subject to a master netting agreement and the
interaction between the provisions regarding the maturity calculation for different
transaction types and the provisions regarding the application of a one-day floor.
Bank of England | Prudential Regulation Authority Page 169

PRA objectives and ‘have regards’ analysis

3.157 The near-final rules on maturity, incorporating the minor changes and
clarifications described above, are materially aligned with those proposed in
CP16/22. Therefore, the PRA considers its analysis of its objectives and ‘have
regards’ in CP16/22 remains appropriate.

Specialised lending
3.158 In CP16/22, the PRA proposed to make a number of changes to the IRB
approach for specialised lending exposures including the slotting approach. This
included changes to the definition of specialised lending and changes to introduce
additional risk-sensitivity to the slotting approach.

3.159 The PRA received 13 responses to this section of the CP. The substantive
issues raised by respondents are set out below.

High volatility commercial real estate

3.160 The PRA proposed to introduce a new specialised lending category of high
volatility commercial real estate (HVCRE), which would be subject to higher risk
weights than other specialised lending categories and would align with the Basel 3.1
standards. The PRA proposed to apply a definition of HVCRE that was based on the
definition in the Basel 3.1 standards, with some adjustments, with the intention of
reducing the scope for inconsistent interpretations across firms. The PRA considered
that the introduction of an HVCRE category would promote the safety and
soundness of firms by increasing the risk sensitivity of the specialised lending
framework.

3.161 Five respondents opposed the introduction of the HVCRE category and ten
respondents provided feedback on the proposed definition of HVCRE. Regarding the
proposed introduction of an HVCRE specialised lending category, respondents
argued that not introducing HVCRE would maintain alignment with the expected EU
approach, thereby supporting international competitiveness and simplicity for firms
that operate in both jurisdictions. Respondents argued that the additional complexity
would not be justified by its impact on capital requirements and argued that the
increased risk associated with HVCRE exposures could be reflected by capturing the
risk drivers of HVCRE in the slotting criteria.
Bank of England | Prudential Regulation Authority Page 170

3.162 Regarding the proposed definition of HVCRE, respondents argued that the
definition is complex and subjective. They argued that the application of the HVCRE
treatment to certain exposures, in particular residential real estate exposures, would
not be appropriate. Respondents argued that if the PRA does introduce the HVCRE
category, then it should simplify the definition, align it more closely with the definition
in the Basel 3.1 standards, and permit firms to recognise other regulators’ definitions
of HVCRE.

3.163 Having considered these responses, the PRA has decided to proceed with the
introduction of an HVCRE category, but to amend the definition to align more closely
with the Basel 3.1 standards in line with the responses received. The revised
definition clarifies that HVCRE only includes commercial real estate and real estate
under development where the ultimate use will be commercial. The PRA has
introduced further expectations on the application of this definition in the near-final
SS4/24, including the types of exposure that the PRA considers exhibit higher
volatilities in the UK and in other jurisdictions with similar commercial real estate
markets and planning systems. The PRA continues to consider that the introduction
of HVCRE will advance safety and soundness by increasing the risk sensitivity of the
specialised lending framework. The PRA considers that the revised definition
addresses concerns raised by respondents, in particular by improving consistency
with the way HVCRE is defined in other jurisdictions.

HVCRE risk weights

3.164 Two respondents noted an error in the PRA’s proposed risk weights that would
apply to certain HVCRE exposures in the good category. The PRA stated in its draft
rule that those exposures would be assigned a risk weight of 90% under the slotting
approach. The PRA has corrected the near-final rules to require firms to apply a risk
weight of 95%. This is in line with the PRA’s intention, as set out in CP16/22, to align
the treatment of HVCRE with the Basel 3.1 standards.

Introduction of additional risk sensitivity in the slotting approach

3.165 The PRA proposed several changes to the slotting approach to increase risk-
sensitivity, including:

• introducing an additional condition to the application of the maturity-based

lower risk weights for exposures in the good and strong categories;
Bank of England | Prudential Regulation Authority Page 171

• introducing a lower risk weight for income producing real estate (IPRE)
exposures that are substantially stronger than the criteria specified for the
‘strong’ rating grade; and
• aligning the treatment of EL with the lower risk weight treatments for all
specialised lending categories, except for HVCRE.

The application of lower risk weights based on maturity

3.166 Under the CRR framework, firms are permitted to apply a lower risk weight in
the slotting approach to exposures in the strong and good categories if the remaining
maturity of the exposures is less than 2.5 years. The PRA proposed to restrict the
exposures that benefit from this approach to those where the firm reasonably
considers that the obligor would be able to refinance the exposure in a severe but
plausible stress in the refinancing market. This would have prevented exposures that
would likely have a longer maturity in practice from being assigned a lower risk
weight where that would be inappropriate. This additional restriction is not part of the
Basel 3.1 standards.

3.167 One respondent supported this proposal, while 11 respondents opposed it.
Those opposed argued that the additional restriction adds unnecessary complexity,
subjectivity and would be operationally difficult to apply. Six respondents additionally
argued that the risk that the PRA sought to address with the additional restriction is
already covered by the slotting approach criteria. One respondent argued that
refinancing risk should be captured in Pillar 2B rather than Pillar 1.

3.168 Having considered these responses, the PRA considers that the risk it was
seeking to address would be adequately mitigated if firms correctly reflected the
refinancing risk arising from an obligor’s contractual obligations at the point of
maturity in their assessment of the exposure against the slotting factors. The PRA
has therefore decided to not proceed with its proposal and to instead introduce an
expectation in its near-final SS4/24 that firms should, when assessing exposures
against the ‘stress analysis’ slotting subfactor, assess the obligor’s ability to meet its
obligations without the firm refinancing the exposure to extend it beyond its current
maturity or the firm otherwise providing any forbearance.

Substantially stronger IPRE exposures

3.169 The PRA proposed that IPRE exposures in the strong slotting category could
receive a lower risk weight where they are substantially stronger than the criteria for
Bank of England | Prudential Regulation Authority Page 172

the strong category. The PRA proposed criteria for this treatment which it considered
were aligned with the Basel 3.1 standards and would lead to a more risk-sensitive
slotting approach. The PRA proposed to introduce an expectation into its draft SS –
Credit risk internal ratings based approach, that ‘substantially stronger’ exposures
would broadly correspond to an EL-based credit rating of BBB+.

3.170 While respondents generally supported the PRA’s proposals, they requested
that the PRA revise the proposed criteria. Respondents argued that the proposed
criteria are too conservative and would result in very few exposures receiving the
lower risk weight. Four respondents argued that the PRA’s proposed criterion
relating to the leverage of the obligor was circular and would not achieve the PRA’s
policy intent of capturing the highest-quality exposures. Two respondents argued
that the PRA’s proposal relating to the source of cashflows was unclear and would
be difficult to apply. One respondent argued that the three proposed criteria overlap
and that exposures should not have to meet all three to be eligible for the lower risk
weight.

3.171 Having considered these responses, the PRA notes that its proposals could be
read as introducing a stricter requirement than the PRA intended. In order to
potentially qualify as substantially stronger, the PRA’s intention was to propose that
exposures would need to be assigned to the ‘strong’ category in all of the ‘financial
strength’, ‘asset characteristics’, ‘strength of sponsor/developer’ and ‘security
package’ slotting factors, rather than every slotting sub-factor. The PRA considers
that, with this clarification, the PRA’s proposal was less stringent than was clear to
respondents.

3.172 Notwithstanding this, and having considered the responses received, the PRA
has decided to amend its proposed criteria to make them clearer, easier to apply by
firms, more aligned with the Basel 3.1 standards, and more appropriately calibrated
to the risk of IPRE exposures. The PRA has made the following adjustments to the
proposed criteria in the near-final rule:

• replaced the proposed criterion that the exposure receives a ‘Strong’ grade in
all slotting factors with a requirement that the risk characteristics of the
exposure and the firm’s underwriting standards are ‘substantially stronger’
than specified in the slotting criteria. The PRA considers that this criterion is
operationally easier for firms to apply and aligns the scope of exposures to
which the lower risk weights apply with the Basel 3.1 standards.
Bank of England | Prudential Regulation Authority Page 173

• revise the proposed criterion that the leverage of the obligor is substantially
below the market norm. Under the near-final rules, the leverage of the obligor
is required to be ‘very low’ in order to receive the lower risk weight. The PRA
considers that this addresses respondents’ comments that the PRA’s
proposed criterion was circular and would not achieve the PRA’s policy intent.
• revise the proposed criterion regarding the quality of the income stream of the
exposure. Under the revised near-final rules, the income stream is required to
be consistent with one that a firm would expect for an investment-grade
exposure, and 100% of the obligor’s debt service obligations must be covered
by tenant income, in order to receive the lower risk weight. The PRA
considers that this addresses respondents’ comments that the PRA’s
proposed criterion was unclear and difficult to apply.

3.173 The PRA has decided to adjust its proposed expectation that exposures which
receive the lower risk weight broadly correspond to an external credit rating of BBB+
to link it to the first criterion above. Under its near-final rules, the PRA expects that,
when firms consider whether the exposure’s risk characteristics and the firm’s
underwriting standards are substantially stronger than specified in the slotting
criteria, this broadly corresponds to an external credit rating of BBB+.

3.174 The PRA considers that these revisions better align the lower risk weights with
the risk of exposures, are easier for firms to implement, and align with the scope of
exposures to which the lower risk weights apply in the Basel 3.1 standards.

Application of lower risk weights to commercial ADC exposures

3.175 The PRA has reassessed its overall policy on specialised lending in light of the
adjustments above. The PRA notes that the Basel 3.1 standards do not permit the
lower risk weights to apply to commercial acquisition, development, and construction
(ADC) exposures that are classified as IPRE rather than HVCRE. The PRA has
decided to implement this restriction in its near-final rules. Following the changes set
out above to the conditions for lower risk weights on the basis of maturity or being
‘substantially stronger’, the PRA considers that, given the risks involved in
commercial ADC exposures, it would not be prudent to apply lower risk weights to
these exposures where they are in the IPRE category. This will also support
competition with firms applying the SA, where such exposures would be subject to a
150% risk weight.

Project finance
Bank of England | Prudential Regulation Authority Page 174

3.176 The PRA did not propose any changes specific to the risk weights for project
finance exposures on the slotting approach. However, these exposures would be
impacted by the changes to the slotting approach proposed more generally and the
proposal to remove the infrastructure support factor.

3.177 In response to the proposal to remove the infrastructure support factor, as

discussed in ‘Calculation of RWAs and EL’, one respondent requested that the PRA
introduce more risk sensitivity in the slotting approach for project finance by
introducing a ‘super strong category’. The respondent argued that risk weights would
otherwise be too high for high quality project finance exposures compared to both
SA risk weights and the default risk of this type of exposure.

3.178 Having considered this response, the PRA has decided to introduce a new
‘substantially stronger’ category for project finance exposures on the slotting
approach. This category would include exposures where the risk characteristics of
the exposure and the firm’s underwriting standards are substantially stronger than
specified in the slotting criteria. The PRA has also decided to introduce an
expectation in its near-final SS4/24 that this corresponds to exposures that are
broadly equivalent to an EL-based credit rating of BBB+ or better.

3.179 The majority of project finance exposures subject to the slotting approach are
currently in the strong category, leading to limited risk differentiation for these
exposures. The PRA considers that this change will therefore improve risk
differentiation of project finance exposures, and that it will be in line with the
underlying risk of the exposures. The PRA considers that this change will partially
offset some of the impact of removing the infrastructure support factor for exposures
on the slotting approach. The PRA considers that this approach aligns with the Basel
3.1 standards that explicitly permit a ‘substantially stronger’ treatment for these
exposures.

Object finance
3.180 In CP16/22, the PRA proposed to introduce a 25% LGD floor for senior
unsecured exposures to corporates under the AIRB approach. The PRA proposed to
introduce an LGD of 40% for senior unsecured exposures to non-financial corporates
under the FIRB approach. Firms using the FIRB approach would be permitted to
apply a 25% LGD to the secured portion of an exposure following the application of
haircuts as appropriate. This is in line with the Basel 3.1 standards. Five respondents
argued that this would result in LGDs that are inappropriately high for some object
finance exposures. Those respondents cited public data on observed loss rates for
Bank of England | Prudential Regulation Authority Page 175

maritime and aviation finance exposures to argue that lower LGDs should be
permitted.

3.181 Having considered these responses, the PRA has decided to maintain its
proposal. The PRA considers that the evidence provided is not sufficient to address
the PRA’s concerns as it does not sufficiently reflect a downturn scenario. The
idiosyncratic nature of object finance collateral and its generally poor resilience to
stress, which respondents recognised, mean that it is appropriate that firms apply
LGDs that are appropriately calibrated to a downturn scenario.

Other issues relating to specialised lending

3.182 Other substantive responses focused on the following issues:

• Use of the slotting approach for IPRE and HVCRE exposures: one
respondent argued that the PRA’s proposal to require firms to apply the
slotting approach to IPRE and HVCRE exposures puts firms in the UK at a
disadvantage to firms in jurisdictions that permit the use of modelled IRB
approaches. The PRA has decided to maintain its proposal to no longer
permit firms to apply the AIRB and FIRB approaches to IPRE and HVCRE
exposures. The PRA continues to consider that this decision will contribute to
improving the robustness of RWAs, given the persistent modelling challenges
observed for these exposures. The PRA considers that this decision will not
result in significant RWA changes, given that the PRA already expects that
these exposures are risk-weighted under the slotting approach.
• Additional risk sensitivity in the slotting approach: one respondent
requested that the PRA increase the risk sensitivity of the slotting approach by
increasing the number of slotting categories. They requested that the PRA
includes LTV as a driver of lower risk weights. They alternatively requested
that the PRA redesigns the slotting approach such that firms use it to estimate
PDs of specialised lending exposures rather than risk weights. The PRA has
decided not to implement these suggestions. The PRA considers that the
slotting approach is less risk-sensitive than the modelled IRB approaches by
design, and that the near-final rules on the slotting approach are consistent
with international standards.
• Definition of specialised lending against specific transaction structures:
one respondent requested that the PRA provide further guidance on how to
allocate exposures with specific transaction structures between the general
corporate and specialised lending exposure sub-classes. The PRA considers
Bank of England | Prudential Regulation Authority Page 176

that the allocation of exposures will have to be done on a case-by-case basis

and it has decided to not provide further guidance on specific transaction
structures.

PRA objectives analysis

3.183 The PRA considers that its near-final policy relating to specialised lending
advances its objectives. The PRA notes the following updates to the analysis it
presented in CP16/22 to reflect its decisions.

3.184 The PRA considers that introducing a substantially stronger category for
project finance exposures, together with the changes made to the application of the
substantially stronger category for IPRE and the maturity-based lower risk weights,
will increase risk sensitivity in the slotting approach. The PRA considers the changes
will advance its primary objective by better aligning risk weights with the risk of
exposures and ensuring an appropriate degree of consistency between firms’
approaches.

3.185 The PRA considers that its decisions advance its secondary objective. It
considers that the increased risk sensitivity for project finance lending will benefit
firms with exposures on the slotting approach relative to firms modelling using the
FIRB and AIRB approaches, and relative to firms applying the SA.

‘Have regards’ analysis

3.186 In developing these near-final rules, the PRA has had regard to its framework
of regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR. Where the proposed new rules are CRR rules, the PRA
has also taken into consideration the matters to which it is required to have regard to
when proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
changes:

1. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:

• The PRA considers that its decisions will advance the competitiveness of UK
firms. The PRA considers that the introduction of a ‘substantially stronger’
category for project finance exposures, and the revisions to its proposed
Bank of England | Prudential Regulation Authority Page 177

scope of the ‘substantially stronger treatment’ for IPRE exposures, will make it
easier for UK firms to compete for those types of business.

2. Relevant international standards:

• The PRA considers that the changes to the definition of HVCRE presented in
this PS, and the approach to applying lower risk weights for certain
specialised lending exposures, are better aligned with the Basel 3.1 standards
than the proposed definition in CP16/22.

3. Climate change:

• The PRA considers that climate change considerations are nuanced and
complex for the near-final rules on specialised lending. The near-final rules
should apply a more risk-sensitive approach to the financing of environmental
infrastructure projects where these are low risk and eligible for the
‘substantially stronger’ slotting category. Respondents raised concerns that
the removal of the infrastructure support factor could hinder investment in
environmental projects. The PRA acknowledges that the potentially wider
applicability of the infrastructure support factor compared to the project
finance substantially stronger treatment may impact lending to ‘green’
projects. However, exposures currently benefitting from the infrastructure
support factor are small in aggregate and the criteria do not require that the
project in question contributes to environmental objectives.
Bank of England | Prudential Regulation Authority Page 178

4: Credit risk mitigation

Introduction
4.1 This chapter provides feedback to responses to chapter 5 of consultation paper
(CP) 16/22 – Implementation of the Basel 3.1 standards, which set out proposals
to implement the Basel 3.1 standards for credit risk mitigation (CRM), and to amend
the Prudential Regulatory Authority’s (PRA) expectations in respect of CRM. This
chapter also sets out the PRA’s near-final policy on CRM following the consultation.

4.2 Throughout this chapter, the PRA refers to the following CRM methods outlined
in Table 6 and Table 7 below:

Table 6: CRM methods referenced in this chapter applying to Funded Credit

Protection (FCP)
CRM method Description
On-balance sheet netting A method for recognising on-balance sheet netting
under all approaches to credit risk, which the PRA
is restricting to recognition through exposure value
only.
Financial collateral simple A method for recognising financial collateral by
method (FCSM) reducing risk-weights, which can only be used by
firms applying the standardised approach (SA).
Financial collateral A method for recognising financial collateral by
comprehensive method reducing exposure values, which will only be
(FCCM) available for (a) exposures that give rise to
counterparty credit risk (other than derivatives)
under all credit risk approaches, (b) exposures that
do not give rise to counterparty credit risk under
the SA and, as set out in this near-final PS, (c)
exposures subject to the slotting approach. Firms
are currently able to model the volatility
adjustments used within this method if they have
permission from the PRA; however, the PRA is
withdrawing this option.
Bank of England | Prudential Regulation Authority Page 179

Foundation collateral method A new method for recognising financial and non-
financial collateral, which the PRA is introducing for
firms using the foundation internal ratings based
(FIRB) approach and which will replace existing
similar methods.
Other funded credit A bespoke method for recognising other funded
protection (OFCP) method credit protection (pledged cash and cash-
assimilated instruments, pledged life assurance
policies, and instruments issued by third-party
institutions that will be repurchased on request)
under the SA and the FIRB approach which the
PRA is retaining.
Loss given default (LGD) A method for firms using the advanced internal
modelling collateral method ratings based (AIRB) approach to recognise the
effects of financial and non-financial collateral in
LGD estimates.
Securities financing A method for calculating the exposure value of
transactions value at risk SFTs49 which firms may apply subject to PRA
(SFT VaR) method permission. The method currently applies to
(previously known as the exposures covered by Master Netting Agreements
‘internal models approach for (MNAs) only; however, the PRA is extending it to
master netting agreements’) also cover single transactions.
Internal models method A method for modelling exposure value for
(IMM) derivatives and SFTs in accordance with
counterparty credit risk requirements.50

Table 7: CRM methods referenced in this chapter applying to Unfunded

Credit Protection (UFCP)
CRM method Description
Risk weight substitution A method that involves substituting the risk weight
method of the exposure with that of the protection provider
to reflect the effect of UFCP. It will apply to all
exposures subject to the SA, and to exposures

49 Throughout this document, ‘SFT’ means a ‘repurchase transaction, a securities or commodities

lending or borrowing transaction, or a margin lending transaction’.
50 The Counterparty Credit Risk chapter of the CRR and the Counterparty Credit Risk (CRR) Part of

the PRA Rulebook.

Bank of England | Prudential Regulation Authority Page 180

subject to the FIRB and AIRB approaches where

comparable direct exposures to the protection
provider51 would be subject to the SA. The PRA is
extending this method to exposures subject to the
slotting approach in certain circumstances.
Parameter substitution A method that involves substituting probabilities of
method default (PDs) and, optionally, FIRB LGD values, of
the exposure with those of the protection provider
to reflect the effect of UFCP. This method is
applied by firms using the FIRB and AIRB
approaches where they are not applying the risk
weight substitution method or, for AIRB
approaches, the LGD adjustment method.
LGD adjustment method A method that involves firms making adjustments
to modelled LGD values to reflect the effect of
UFCP. The PRA is restricting this approach to
exposures subject for the AIRB approach where
comparable direct exposures to the protection
provider are also subject to the AIRB approach.

4.3 In CP16/22, the PRA proposed amendments which it considered would reduce
complexity, improve coherence, and provide greater clarity to firms regarding the
availability of CRM methods. Key proposals included:

• under the SA, removing certain methods for calculating the effects of FCP and
amendments to the methods that would remain available;
• amendments to existing methods for calculating the effects of FCP under the
FIRB approach, including new supervisory LGD values and collateral volatility
adjustments;
• restrictions on existing UFCP methods where firms adjust probabilities of
default (PDs) and/or obligor grades in internal ratings based approach (IRB)
models; and

51A ‘comparable direct exposure to the protection provider’ means a direct exposure to the protection
provider of the same type and with the same characteristics as the exposure to the obligor in the
absence of any UFCP.
Bank of England | Prudential Regulation Authority Page 181

• new restrictions on recognising and modelling UFCP which would depend on

the credit risk approach applicable to comparable direct exposures to the
protection provider.

4.4 The PRA received 31 responses to its proposals on CRM. Comments focused
on:

• collateral eligibility for repurchase transactions, securities borrowing and

lending transactions, and margin lending transactions in the trading book;
• eligibility of collateral where there is material positive correlation between the
collateral value and the exposure value for limited recourse securities;
• the risk weight treatment and eligibility criteria applied under the risk weight
substitution method;
• CRM for exposures subject to the slotting approach; and
• the risk weight treatment applied to credit insurance as a form of UFCP.

4.5 Having considered the responses, the PRA has decided to amend the draft rules
and draft amendments to its supervisory statement in certain areas. This chapter
describes the comments and amendments that the PRA considers are more
material. As described in Chapter 1 – Overview, the PRA has also made a number of
less material amendments and clarifications to the draft rules, which are not
described in this chapter. These amendments are reflected in the near-final PRA
Rulebook: CRR Firms: (CRR) Instrument [2024] in Appendix 2. Please refer to the
document titled Comparison of Draft PRA Rulebook (CRR) Instrument [2023]
against Near-final PRA Rulebook: CRR Firms (CRR) Instrument [2024], which
contains a comparison of the near-final rules with the draft rules as set out in
CP16/22 for ease of identifying all of the changes made.

4.6 The appendices to this near-final policy statement (PS) contain the PRA’s near-
final policy, which will:

• introduce a new Credit Risk Mitigation (CRR) Part of the PRA Rulebook
(Appendix 2) to replace the CRR articles HM Treasury (HMT) intends to
revoke;
• insert an additional provision into the Counterparty Credit Risk (CRR) Part of
the PRA Rulebook;
• amend SS17/13 - Credit risk mitigation (Appendix 10); and
• amend SS12/13 – Counterparty credit risk (Appendix 11).
Bank of England | Prudential Regulation Authority Page 182

4.7 The sections below have been structured broadly along the same lines as
chapter 5 of CP16/22, covering the main areas where the PRA received comments
from respondents as follows:

• Methods for recognising CRM;

• FCP; and
• UFCP.

Methods for recognising credit risk mitigation

4.8 The PRA proposed to implement the Basel 3.1 standards while introducing
additional clarifications on the application of the CRM framework, in order to reduce
excessive variability of risk weighted assets (RWAs) and reduce complexity. The
PRA received 11 responses to this section of CP16/22. The substantive issues
raised by respondents are set out below.

FCP securing UFCP obligations

4.9 The PRA proposed to require that where a firm recognises both FCP and UFCP
covering the same exposure, it should do so in an appropriate manner and in a way
that does not double count the effects of the credit protection.

4.10 Two respondents argued that the PRA’s proposed approach would lead to an
inappropriately conservative treatment in the case where a firm receives FCP that
secures the obligations of an UFCP provider made in respect of an exposure, for
example for collateralised guarantees. These respondents argued that firms should
be permitted to recognise FCP where the UFCP has been provided by a protection
provider that is not included in the list of eligible protection providers set out in the
Credit Risk Mitigation (CRR) Part Article 201, but where the other UFCP eligibility
criteria are met.

4.11 Having considered the responses, the PRA has decided to amend its draft rules
to include a decision tree and related provisions to specify the treatment of FCP
securing UFCP obligations. The PRA has also added further guidance on the
treatment of FCP securing UFCP obligations in supervisory statements (SS)17/13 –
Credit risk mitigation and SS4/24 – Credit risk internal ratings based approach (as
set out in Chapter 3 – Credit risk – internal ratings based approach).
Bank of England | Prudential Regulation Authority Page 183

4.12 The PRA recognises that the credit quality of the UFCP provider does not
impact the risk-mitigating effect of the FCP, and it has therefore decided to permit
recognition of eligible FCP where the UFCP has been provided by a CRM-ineligible
protection provider as long as all other UFCP eligibility criteria have been met. The
PRA has decided to cap the amount of FCP that may be recognised at the value of
the UFCP and firms will not be able to take the UFCP itself into account in this
scenario (because the protection provider is not eligible).

4.13 The PRA has also decided that if both the UFCP and the FCP meet all relevant
eligibility criteria, then firms will be permitted to take both into account. The amount
of FCP that may be recognised will again be capped at the value of the UFCP.

4.14 The PRA has decided that firms should be permitted to recognise FCP securing
UFCP obligations in line with the decision tree below. This is a simplified version of a
decision tree included in the near-final rules which sets out in more detail how the
calculations will work in each case.

Chart 2: Summary of the framework for recognition of FCP securing UFCP

obligations

FCP recognition for exposures subject to the slotting approach

Bank of England | Prudential Regulation Authority Page 184

4.15 The PRA proposed that, for exposures subject to the slotting approach,
collateral would not be recognised via the CRM framework but would instead
continue to be reflected in the assignment of exposures to slotting categories.

4.16 One respondent opposed this proposal because it would mean that a fully cash-
collateralised exposure could not receive a risk weight lower than 50%. This
respondent argued that this risk weight treatment would be overly punitive for cash-
collateralised exposures and suggested that either FCP should be recognised via the
CRM framework where exposures are subject to the slotting approach, or that the
PRA should explain how cash collateral should be reflected within the slotting
approach itself.

4.17 Having considered the response, the PRA has decided to amend its draft rules
to permit firms to apply the FCCM to exposures on the slotting approach, subject to
restrictions to prevent collateral being double counted. Where an exposure is
collateralised, the PRA agrees that a minimum 50% risk weight with no adjustment to
the exposure value would be disproportionately conservative. The PRA considers it
justifiable from a risk perspective that firms should be able to recognise any FCCM
eligible collateral in their calculation of an exposure value, and then apply the
standard slotting risk weights to the reduced exposure value. In such cases, the
collateral will not be recognised in the slotting assessment, to avoid double counting.

Other issues regarding methods for recognising CRM

4.18 Other substantive responses focused on a range of technical issues:

• Application of CRM to modelled approaches: three respondents suggested

clarifying the instances that the CRM rules apply to firms using the IMM. The
PRA has amended its draft rules to clarify that certain provisions in the Credit
Risk Mitigation (CRR) Part of the PRA Rulebook apply to firms using the IMM
in accordance with the relevant cross-references.
• CRM decision trees: two respondents supported the use of decision trees in
the draft rules that set out available CRM methods as they considered that
these would provide greater clarity on the CRM approach and methodology to
be used; however, they requested the PRA includes rule references within
each box of the decision tree. The PRA has decided not to add rule
references into the decision trees because the PRA considers that the near-
final rules already provide sufficient clarity about the scope of each article.
Bank of England | Prudential Regulation Authority Page 185

• Recognition of collateral under different CRM methods: one respondent

requested that the PRA clarify what approach should be used for receivables,
other physical collateral and collateralised lease exposures when not applying
the foundation collateral method. The PRA clarifies that the only alternative
method for recognising these types of collateral is the LGD modelling
collateral method, which is only available where a firm is permitted to use the
AIRB approach.
• Use of automated valuation processes: four respondents requested that
the PRA clarify that automated valuation models would be permitted under the
foundation collateral method. The PRA has clarified in its near-final rules that
valuations can be provided by a suitably robust statistical model, which could
include an automated valuation model.

PRA objectives analysis

4.19 The PRA considers its analysis of its objectives, as presented in CP16/22,
remains appropriate, subject to the updates below.

4.20 The PRA considers that it is prudentially appropriate for firms to recognise FCP
securing a UFCP obligation regardless of the guarantor, provided all other UFCP
and FCP eligibility criteria are met, for the reasons set out above. The PRA
considers that the revised approach broadly maintains the current level of prudence
of the capital requirements framework and is consistent with its primary objective to
promote the safety and soundness of the firms it regulates.

4.21 The PRA considers that its decision to permit firms to apply the FCCM to
exposures on the slotting approach will improve the risk sensitivity of the framework
while containing appropriate safeguards to prevent collateral from being double
counted, and therefore is consistent with its primary objective.

‘Have regards’ analysis

4.22 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Relative standing of the UK as a place for internationally active firms to

operate and competitiveness:
Bank of England | Prudential Regulation Authority Page 186

• While there remains uncertainty about the final approach that will be taken by
other regulators, the PRA has not identified any adverse impact on the
competitiveness of the UK arising from the changes to the PRA’s proposals
as set out in this section. The PRA considers that the amendments to its draft
rules may potentially benefit UK competitiveness to the extent that other
regulators take a less permissive approach.

2. Relevant international standards:

• The PRA considers that its near-final policy remains broadly aligned with
international standards. As set out in CP16/22, there is ambiguity regarding
the availability of CRM methods in the Basel 3.1 standards, and the PRA has
sought to achieve an implementation of the standards that will reduce
unwarranted variation in risk weights and minimise uncertainty for firms.

3. Efficient and economic use of PRA resources:

• The PRA considers that its updated approach for FCP securing UFCP
obligations clarifies its original proposals and will support a more consistent
treatment across firms. The PRA considers the additional clarity will contribute
towards efficient and economic use of PRA resources.

Funded credit protection

4.23 The PRA proposed to implement the Basel 3.1 standards while introducing
additional clarifications relating to the FCP framework, including:

• a series of changes to the FCCM formula and supervisory volatility

adjustments; and
• changes to the collateral eligibility requirements for SFTs in the trading book.

4.24 The PRA proposed to maintain the CRR treatment in a number of areas,
including:

• collateral eligibility requirements for own-issued securities; and

• identification of cases with material positive correlation.

4.25 The PRA received 12 responses to this section of CP16/22. The substantive
issues raised by respondents are set out below.
Bank of England | Prudential Regulation Authority Page 187

The financial collateral comprehensive method

4.26 The PRA proposed to make the volatility adjustments that apply under the
FCCM (to reflect possible future volatility in the value of the collateral) more risk-
sensitive, and to introduce a revised formula for reflecting the effect of eligible MNAs
across multiple SFTs.

4.27 Responses focused on a number of areas:

• Volatility adjustments under the FCCM: two respondents noted conflicting

language in the draft rules regarding volatility adjustments applied to secured
lending transactions and capital market-driven transactions, which could be
read as implying that these overlap. The PRA has made minor changes in the
near-final rules to reflect that there is no overlap. The PRA considers that the
clarification removes any ambiguity in the rules.
• Margin frequency under the FCCM: the PRA proposed to not retain CRR
Article 225(2)(c), which provides a formula for scaling up or down volatility
adjustments to reflect shorter or longer liquidation periods, because it relates
to the own estimates approach which the PRA proposed to withdraw. Two
respondents requested that the formula in CRR Article 225(2)(c) is added
back into the PRA’s rules. They argued it was relevant to other situations
where supervisory haircuts are applied for non-standard liquidation periods.
The PRA has amended its draft rules to introduce a formula for when
collateral has a non-standard liquidation period.
• The FCCM formula for MNAs: two respondents provided suggestions to
amend the proposed FCCM formula for MNAs. The PRA has made minor
drafting changes to its draft rules to: (i) ensure consistent use of the term
‘groups of securities’; (ii) clarify where ineligible groups of securities should be
excluded from the terms of the formula; and (iii) correct the calculation of Enet.
• Recognition of FCCM-eligible collateral: one respondent requested that the
collateral eligibility requirements under the standardised approach to
counterparty credit risk (SA-CCR) regime be brought in line with the FCCM.
This response related to concerns that were outside the scope of the
proposals in CP16/22. Consequently, the PRA has decided to make no
changes to its proposed policy.

Collateral eligibility for SFTs in the trading book

Extended collateral eligibility for certain trading book exposures

Bank of England | Prudential Regulation Authority Page 188

4.28 Firms applying the Counterparty Credit Risk chapter of the CRR to repurchase
transactions and securities or commodities lending or borrowing transactions in the
trading book are currently permitted to treat all financial instruments and
commodities that are eligible to be included in the trading book as eligible collateral,
even if the firm does not currently trade them and they are not held in the trading
book. This extends the set of eligible collateral beyond that which could be otherwise
recognised under the CRM framework.

4.29 The PRA proposed to limit this treatment to financial instruments and
commodities that are held in a firm’s trading book. This proposal aligned with pre-
existing Basel standards and was intended to prevent the recognition of collateral
that firms would not always be able to promptly liquidate in practice because they are
not currently trading it.

4.30 Six respondents opposed this proposal. These respondents raised concerns
over the operational burden of the proposed requirement and argued that collateral
inventories would need to be monitored on a daily basis and that changes in the
stock of inventory would cause volatility in capital requirements and large exposures
limits.

4.31 Having considered the responses, the PRA has amended its draft rules to
remove the requirement that the financial instruments or commodities must be
included in the firm’s trading book and to revert to the existing requirement that they
must be eligible for inclusion in the trading book. The PRA has however decided to
introduce three additional eligibility requirements, that the firm: (i) has assessed the
market liquidity of securities received as collateral and is able to demonstrate
sufficient depth within the market to exit the position; (ii) has the legal and
operational capabilities to trade the financial instruments; and (iii) has the capability
to risk manage and value the financial instrument within the trading book. The PRA
considers that it is appropriate to add these requirements in order to mitigate the risk
that firms recognise additional types of collateral which cannot easily be liquidated
and traded in a timely manner.

Application of extended collateral eligibility to margin lending transactions

4.32 The extended collateral eligibility criteria for certain trading book exposures
referred to above apply only to ‘repurchase transactions and securities or
commodities lending or borrowing transactions’ in the trading book. However, the
PRA’s proposals describing this treatment incorrectly referred to ‘securities financing
Bank of England | Prudential Regulation Authority Page 189

transactions’ (SFTs) in the trading book. SFTs are defined in the CRR as
‘repurchase transactions and securities or commodities lending or borrowing
transactions, and margin lending transactions’, and as a result, margin lending
transactions in the trading book were inadvertently included in the set of exposures
to which extended collateral eligibility criteria would apply in the PRA’s draft rules.

4.33 Four respondents agreed with the inclusion of margin lending transactions in
the scope of this treatment, arguing there is no intrinsic difference between the
securities received as collateral and the related market liquidity of those securities, or
the firm’s ability to trade them upon a default event, in any type of SFT. However,
some of these respondents noted that the Basel standards refer to ‘repo style
transactions’, which does not include margin lending, and asked for clarification of
the PRA’s intention.

4.34 The PRA notes that ‘securities or commodities borrowing or lending

transactions’ and margin lending transactions are not mutually exclusive concepts.
The PRA considers that margin cash loans that entail transfer of legal title of the
securities collateral to the lender can currently fall within the scope of securities
borrowing transactions on the part of the margin lender, and can therefore fall within
scope of this treatment, provided they also satisfy the provision’s other conditions.

4.35 The PRA considers that a key difference between title-transfer transactions and
non-title transfer transactions is the length of time it might take the firm to liquidate
the position. Where the firm does not have legal title to the collateral, it must take
steps to take legal ownership following a counterparty default. This increases the
length of time over which the value of the collateral might change, and therefore the
risk that the eventual sale price is not sufficient to cover the loss on the position. This
is not the case for transactions where the firm holds legal title from the time the
collateral is posted. The PRA also notes that ‘repurchase transactions and securities
or commodities lending or borrowing transactions’ will only include title-transfer
transactions, whereas margin lending may or may not involve title-transfer
transactions.

4.36 Having considered the responses, the PRA has decided to amend its draft rules
to clarify that the extended collateral eligibility criteria do not apply to all SFTs, but
only to repurchase transactions and securities or commodities lending or borrowing
transactions. This means not all margin lending is automatically in scope. Consistent
with the analysis above, margin lending is in scope if the transactions involve title
transfer and the provision’s other conditions met.
Bank of England | Prudential Regulation Authority Page 190

Collateral eligibility requirements

Own-issued securities

4.37 In line with the CRR eligibility criteria, for firms using the FCSM, the FCCM, the
foundation collateral method and the SFT VaR method, the PRA proposed that firms
would not be permitted to: (i) recognise collateral where there is material positive
correlation between the value of the collateral and the credit quality of the obligor;
and (ii) recognise own-issued securities as collateral. The PRA proposed to retain an
existing carve-out from the prohibition on recognising own-issued securities as
collateral for qualifying covered bonds where they are posted as collateral for
repurchase transactions and there is no material positive correlation.

4.38 Three respondents argued that there are examples of own-issued securities
other than qualifying covered bonds without material positive correlation which may
still be an effective risk mitigant. Additionally, respondents argued that the PRA
should widen the definition of qualifying covered bonds to include non-UK covered
bonds (see Chapter 2 – Credit risk – standardised approach, exposures to
institutions and covered bonds and Chapter 3 – Credit risk – internal ratings based
approach, LGD estimation). These respondents argued that restricting the scope of
FCP-eligible own-issued securities to only qualifying covered bonds is overly prudent
and widening the scope to other specific securities would be consistent with the
Basel 3.1 standards.

4.39 Having considered the responses, the PRA has decided to maintain its
proposals regarding the eligibility of own-issued securities. The PRA considers that
the general prohibition on recognising own-issued securities as eligible collateral is
appropriate because these are less likely to provide effective risk mitigation relative
to other eligible types of collateral. The PRA considers that extending the existing
carve-out from this requirement would not align with international standards.

Guidance on identifying cases with material positive correlation

4.40 The PRA proposed to set an expectation that any financial collateral asset
whose value has a material positive correlation with the total value of all of the
assets to which the lender has legal recourse (including collateral posted by the
obligor and any other assets to which the firm has legal recourse) would not be
considered eligible collateral on the basis of the material positive correlation
prohibition, as described above in own-issued securities.
Bank of England | Prudential Regulation Authority Page 191

4.41 Three respondents argued that this expectation was inappropriate for certain
derivative transactions where the exposure value is a function of the value of the
collateral, for example, sold covered call options. In such cases, if the value of the
collateral asset declines, the collateral value would still cover the exposure to the
obligor as the exposure value will have reduced in line with the collateral value. As
such, these respondents argued that the assessment of material positive correlation
should not solely consider the value of the collateral asset and the total value of all
assets to which a firm has legal recourse but should also consider the correlation of
the collateral to the value of the exposure.

4.42 Having considered the responses, the PRA acknowledges that in the situations
described by the respondents it would be appropriate to consider the collateral to be
eligible. The PRA has therefore amended its draft amendments to SS17/13 to
introduce a transaction-specific carve-out from this prohibition, exempting
transactions that are structured so that the exposure value directly depends on the
collateral value in such a way that the proportion of the exposure value that is
collateralised does not fall if the value of the collateral falls.

Treatment of FCP in RWA calculations

4.43 The PRA proposed to retain an existing requirement to apply a 100%

conversion factor (CF) for the purpose of determining the portion of an exposure that
is covered by FCP even if a lower CF applies for the purpose of determining the
exposure value.52

4.44 One respondent made three arguments against the use of a 100% CF for
determining the CRM coverage:

• the requirement is not part of the Basel 3.1 standards;

• applying a 100% CF would be inconsistent with the purpose of applying CFs,
which is to reflect the likelihood of the relevant undrawn exposure being drawn
prior to default; and
• applying a 100% CF would make the effective cost of such protection
disproportionately higher for a firm than would be the case for the same
protection provided in respect of an on-balance sheet item. This is because

52 The same approach applies under UFCP.

Bank of England | Prudential Regulation Authority Page 192

the same amount of protection is required to fully cover the exposure in each
case despite the actual risk being lower for the off-balance sheet item.

4.45 Having considered the responses, the PRA has decided to retain the proposed
100% CF for the purpose of determining the portion of the exposure that is covered
by CRM. The PRA considers that using a lower CF could result in imprudent
outcomes.

4.46 For example, if an exposure were subject to a 40% CF, then under the FCCM a
firm holding collateral valued at 40% of the exposure value after haircuts would have
a zero-capital requirement for the exposure. The realised CF could be higher or
lower than 40% in practice due to statistical variation. For the purpose of calculating
exposure value, these effects can be expected to average out across a portfolio, but
for the purpose of calculating collateral coverage, the effects are asymmetric. This is
because if the realised CF is more than 40% then the firm would have a positive
exposure at default (potentially leading to a loss), but if the realised CF is less than
40%, excess collateral would be returned to the counterparty (leading to a zero
gain). Across a portfolio there would on average be a positive exposure leading to a
positive loss which should be capitalised.

4.47 The PRA therefore considers that use of a 100% CF for the purpose of
calculating CRM coverage is consistent with its primary objective as it mitigates the
risk that insufficient capital is held against off-balance sheet exposures.

Other issues regarding funded credit protection

4.48 Other substantive responses focused on a range of technical issues:

• Liquidation periods under the FCCM and SFT VaR method: the PRA
proposed that a 5-day liquidation period be applied to repurchase transactions
in the FCCM and SFT VaR method. Three respondents argued the 5-day
liquidation period should also be applied to all SFTs (and not only repurchase
transactions), given all SFTs benefit from daily re-margining and prompt
liquidation or set-off of collateral upon the event of default. The PRA has
decided to maintain its proposal that a 5-day liquidation period shall be
applied to repurchase transactions and a 10-day liquidation period shall be
applied to other capital market transactions, on the basis that it is prudent to
apply a longer liquidation period to non-title transfer transactions, for the
Bank of England | Prudential Regulation Authority Page 193

reasons set out in paragraph 4.35. The PRA also considers its proposal to be
consistent with the Basel 3.1 standards.
• The look through approach (LTA) for collective investment undertaking
(CIU) collateral: four respondents argued that under the PRA’s proposals,
most CIU collateral has little value because it is only eligible to the extent that
the CIU is required by its mandate to invest in eligible collateral, rather than
considering the current amount of eligible collateral the CIU holds as
investments. This means the PRA’s proposal to apply the LTA for calculating
volatility adjustments for CIU collateral would provide limited benefit. The PRA
agrees with respondents that this approach would be overly conservative and
has amended the eligibility criteria for CIU collateral in its draft rules so that
where a firm is applying the LTA, a portion of a CIU exposure can be
considered eligible collateral, reflecting the extent that the CIU currently
invests in assets that are eligible collateral. The PRA has also amended the
draft rules so that the value of CIU collateral that can be recognised reflects
the proportion of CIU shares that are pledged as collateral, in line with the
existing credit risk treatment for direct exposures to CIUs.
• Physical inspection of inventories: in respect of collateral eligibility
requirements which would apply under the foundation collateral method,53 the
PRA proposed that other non-financial collateral would only be eligible where
the periodic revaluation process includes physical inspection of the collateral.
One respondent requested that the PRA clarify what constitutes a physical
inspection. The PRA clarifies that this would entail a physical inspection by a
suitably qualified valuer.
• Settlement currency: for firms using the FCCM, the PRA proposed that in
the case of over the counter (OTC) derivatives transactions covered by netting
agreements recognised by the PRA under CRR Articles 295 to 298, firms
would apply a volatility adjustment reflecting currency volatility when there is a
mismatch between the collateral currency and the settlement currency. One
respondent requested that the PRA clarify the definition of settlement
currency. The PRA clarifies that settlement currency refers to the termination
currency.
• Valuation of immovable property: for firms using the foundation collateral
method, the PRA proposed to retain the existing treatment where, when
determining the value of immovable property collateral, the value is first
reduced to account for higher priority claims on the property and then the

53 And in some cases indirectly to firms using the LGD modelling collateral method.
Bank of England | Prudential Regulation Authority Page 194

applicable haircuts are applied. Having considered the treatment of these

types of exposures under the SA, as set out in Chapter 2 – Credit risk –
standardised approach, the PRA has also reviewed the treatment under the
foundation collateral method. The PRA has amended its draft rules so that the
value is first reduced by the applicable haircuts and then allocated to the
charges in order of priority. The PRA considers this treatment is aligned with
the Basel 3.1 standards and ensures the approach will be consistent with that
used under the SA.
• Maturity mismatches in on-balance sheet netting: the PRA proposed to
clarify that maturity mismatch requirements apply where firms recognise on-
balance sheet netting. The PRA notes that there is a potential ambiguity in its
draft rules relating to the calculation of the maturity of the credit protection for
on-balance sheet netting which could lead to inconsistent application by firms.
The PRA has decided to clarify in its near-final rules that the maturity date of
the credit protection should be taken as the earlier of the termination date of
the netting agreement and the date on which the off-setting balances may be
withdrawn. This means that on-balance sheet netting arrangements applied to
instant access deposits will be deemed to have a residual maturity of zero
days for the purpose of the maturity mismatch near-final rules.
• Equities traded on a recognised exchange: for firms using the FCCM, the
PRA proposed that equities or convertible bonds traded on a recognised
exchange would be considered eligible collateral. One respondent noted an
inconsistency compared to the terminology used when setting out volatility
adjustments, where in one case the PRA referred to other equities or
convertible bonds listed on a recognised exchange. They recommended using
the term ‘traded’ rather than ‘listed’ consistently. The PRA’s proposal to refer
to traded securities when determining collateral eligibility came from a desire
to use standardised language, but the intention was not to change the scope
relative to the current framework. The PRA notes that a security may be
traded on an exchange but not listed there, so the PRA’s proposal would
result in wider collateral eligibility. The PRA considers this may not be
prudent, and notes this would be inconsistent with the Basel standards which
refer to securities listed on a recognised exchange. The PRA has amended its
draft rules to consistently refer to other equities or convertible bonds listed on
a recognised exchange.
Bank of England | Prudential Regulation Authority Page 195

PRA objectives analysis

4.49 The PRA considers its analysis of its objectives, as presented in CP16/22,
remains appropriate, subject to the below updates.

4.50 The PRA considers that its near-final policy relating to collateral eligibility for
SFTs in the trading book is consistent with its primary objective, by permitting trading
book collateral to be eligible only if firms have the necessary risk management
capabilities and a credible process to instigate trading if, and when, required.

4.51 The PRA considers that its near-final policy relating to valuation of immovable
property is consistent with its primary objective as it will appropriately capture the
risks associated with second charge mortgages. The PRA also considers its
approach to facilitate the secondary competition objective as the treatment under the
FIRB approach is now aligned with that under the SA.

‘Have regards’ analysis

4.52 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Relevant international standards:

• While the PRA recognises that its decision to base extended collateral
eligibility for certain trading book exposures on a firm’s ability to risk manage
and liquidate the collateral differs from the approach in the Basel standards,
the PRA considers this approach should deliver broadly similar prudential
outcomes to the Basel standards.

2. Proportionality:

• The PRA considers that the near-final rules on collateral eligibility

requirements for SFTs in the trading book provide a proportionate approach to
addressing the risk that a firm may have difficulty liquidating collateral which is
not currently in the trading book.
Bank of England | Prudential Regulation Authority Page 196

Unfunded credit protection

4.53 The PRA proposed to implement the Basel 3.1 standards relating to the UFCP
framework while introducing additional clarifications, including on the eligibility
criteria for recognising UFCP and the application of UFCP methods. The PRA
received 24 responses to this section of CP16/22. The substantive issues raised by
respondents are set out below.

Eligibility criteria for recognising unfunded credit protection

The slotting approach – risk weight substitution method

4.54 The PRA proposed to extend the use of the risk weight substitution method to
exposures subject to the slotting approach in certain circumstances. The PRA also
proposed that the eligibility criteria for UFCP would depend on the CRM method
being used, because it considered it appropriate for all firms to be subject to the
same eligibility criteria when they employ a given UFCP methodology.

4.55 The effect of these proposals was that firms would only be able to recognise
UFCP for exposures subject to the slotting approach where the eligibility criteria
applicable under the risk weight substitution method are met, including that corporate
protection providers must be externally rated.

4.56 Three respondents supported the PRA’s proposed extension of the risk weight
substitution method to exposures subject to the slotting approach. These
respondents argued however that the PRA should also permit recognition of UFCP
provided by corporates which are internally rated using the IRB approach, as this
can be recognised for exposures subject to other IRB approaches because the
parameter substitution method is available.

4.57 Having considered the responses, the PRA has decided to maintain its overall
proposal that the eligibility criteria for UFCP applied to exposures subject to the
slotting approach should depend on the CRM method that is being used. The PRA
considers that it is important to maintain this principle to reduce complexity in the
CRM framework and improve the consistency and comparability of the application of
the CRM framework across firms.

Application of unfunded credit protection methods

Risk weight substitution method: revised formula
Bank of England | Prudential Regulation Authority Page 197

4.58 The PRA proposed that under the risk weight substitution method firms would
substitute the risk weight of the exposure with that of the protection provider as
calculated under the SA, even if direct exposures to the protection provider are risk
weighted under the IRB approach.

4.59 Eight respondents argued that the PRA should permit substitution of the risk
weight applicable to the protection provider under the IRB approach, where
available. Respondents argued that the ability to take account of parental guarantees
is an integral part of firms’ client management framework for global banking
business. Where UFCP is being used in respect of a parental guarantee, permitting
substitution of an IRB risk weight would allow firms to recognise a CRM benefit for
parental support where exposures to the parent are subject to the IRB approach and
exposures to the subsidiaries are subject to the SA approach.

4.60 Having considered the responses, the PRA has decided to maintain its proposal
to require the risk weight of the protection provider that can be substituted to be
calculated under the SA. The PRA considers that if firms were permitted to substitute
risk weights calculated under the IRB approach, then the reduction in capital
requirements due to the risk weight substitution method would often be driven more
by the difference in risk weights between the IRB and SA approaches, rather than by
the risk reduction offered by the UFCP. The PRA considers this would not be
appropriate, as the intention of recognising CRM in capital requirements is to reflect
its effect as a risk mitigation tool. The PRA also considers that permitting substitution
of the risk weight calculated under the IRB approach would not be consistent with
the Basel Committee on Banking Supervision’s intention in developing the Basel 3.1
standards to restrict modelling in the SA regime or with requirements in other
jurisdictions.

4.61 The PRA also notes that permitting substitution of an IRB risk weight would
mean that a firm that applies the SA to some exposures and the IRB approach to
other exposures could apply lower risk weights to its exposures on the SA relative to
a firm that applied the SA to all exposures. Permitting substitution of an IRB risk
weight would therefore negatively impact the PRA’s secondary objective.

Parameter substitution method: revised formula

4.62 The PRA proposed a revised formula for calculating risk weights under the
parameter substitution method. Under this formula, the risk weight that would be
applied to the protected portion of the exposure is calculated using the PD and risk
Bank of England | Prudential Regulation Authority Page 198

weight function applicable to the protection provider in conjunction with either the
LGD applicable to the exposure (as if there was no UFCP) or the FIRB approach
LGD applicable to the protection provider. One respondent argued that the risk
weight formula applicable to the underlying obligor rather the protection provider
should instead be used to calculate RWAs. Having considered the responses, the
PRA has decided to retain its proposal because it considers that the risk weight
formula for the protection provider will produce risk weights that better reflect the risk
of the protection. The PRA also notes that this is aligned with the Basel 3.1
standards.

Requirements for applying UFCP

4.63 For firms using the LGD adjustment method, the risk weight substitution
method, or the parameter substitution method, the PRA proposed to introduce an
explicit requirement that UFCP would only be eligible if it does not contain any
clause which would allow the protection provider to change the credit protection
unilaterally to the detriment of the lender. Four respondents argued that there are
already a number of eligibility criteria, and it was not clear what further value this
clause would add. They noted that it would be operationally burdensome to check all
existing arrangements for compliance. Respondents requested that if this additional
criterion was introduced, the PRA should also introduce a carve out such that
evidence of compliance is not required for existing UFCP arrangements, in order to
reduce the operational burden.

4.64 Having considered the responses, the PRA has decided to maintain its
proposals in CP16/22 for new UFCP arrangements, on the basis that it is prudent to
prevent recognition of protection which is potentially ineffective if the provider
changes the terms of protection. In view of the responses received on operational
burden, the PRA has however decided to introduce a transitional provision in the
Credit Risk: General Provisions (CRR) Part of its near-final rules so that the new
criterion will not apply to existing UFCP arrangements (those agreed prior to 1
January 2026) until 1 July 2028.

Calculating RWAs under the SA

4.65 The PRA proposed a new formula to clarify how expected loss (EL) is
calculated under the risk weight substitution method. The purpose of this formula
was to ensure there is no ‘EL minus provision’ adjustment for the protected part of
the exposure. The formula would achieve this by setting the EL amount for the
Bank of England | Prudential Regulation Authority Page 199

protected part equal to a pro-rated share of the specific provisions associated with
the exposure.

4.66 Four respondents questioned whether this new formula is necessary, and
asked how EL should be reported for the protected part of the exposure, given that
the protected part of the exposure is subject to an SA risk weight, and there is no
concept of EL in SA.

4.67 Having considered the responses, the PRA has decided to amend its draft rules
so that EL is not calculated for the protected part of the exposure, and the provisions
relating to the protected part of the exposure are not included in the ‘EL minus
provision’ adjustment.

Credit insurance as UFCP

4.68 The PRA proposed to remove the AIRB approach for risk weighting exposures
to financial corporates and to only permit use of the LGD modelling collateral method
where both the exposure subject to UFCP and direct exposures to the protection
provider are subject to the AIRB approach. The PRA proposed this because it
shares the Basel Committee on Banking Supervision’s concerns regarding the
robustness of LGD and exposure at default (EAD) models for exposures to financial
corporates. Therefore, under the PRA’s proposals, firms using the IRB approach
would be required to use prescribed FIRB LGDs under the parameter substitution
method to determine the risk weight where the protection provider is on the FIRB
approach. Under the PRA’s proposals, the prescribed FIRB LGD for senior
unsecured claims on an insurer would be 45%. Therefore, under the parameter
substitution method this would be the lowest LGD that could be substituted in the
case of an exposure with credit insurance.

4.69 Sixteen respondents commented on the PRA’s proposals for the treatment of
credit insurance as UFCP. Respondents argued that the 45% FIRB LGD was
excessive for policy claims on insurance firms for reasons including that:

• insurance policyholders rank senior to all other creditors in the creditor

hierarchy;
• the insurance industry is less positively correlated with the economic cycle
than the banking industry;
• insurance firms are subject to separate prudential regulation; and
Bank of England | Prudential Regulation Authority Page 200

• the PRA’s proposals could reduce the benefit of using credit insurance and as
such incentivise the use of riskier CRM tools.

4.70 Respondents also argued that it would be aligned with international standards
to permit firms to use a lower FIRB LGD for policy claims on insurance firms,
because the Basel 3.1 standards state that firms may use an LGD which takes ‘into
account’ the seniority of the guarantee, which in this case would be the super-
seniority of the policy claim compared to a direct exposure to an insurer.

4.71 Having considered the responses, the PRA has decided to maintain its
proposals. The PRA was not persuaded by respondents’ arguments for a lower FIRB
LGD given the lack of evidence that losses on exposures protected by credit
insurance justify a LGD below 45%. The PRA considers that some of the arguments
made by respondents regarding the low-risk nature of credit insurance relate more to
PD (which firms can still model under FIRB) than LGD. Indeed, the lack of default
data for exposures to insurers is a key reason why the Basel Committee on Banking
Supervision has removed the AIRB approach for these exposures as the lack of data
points makes it difficult to robustly estimate LGD. Therefore, the PRA considers that
allowing a lower FIRB LGD for exposures protected by credit insurance would not be
consistent with its primary objective.

4.72 While the PRA acknowledges that insurance policy claims would rank more
senior in the creditor hierarchy than a direct exposure to an insurer, the majority of
most insurers’ liabilities are policy claims. Therefore, the PRA does not consider that
the super-senior status of policyholder claims in the creditor hierarchy would
necessarily justify a lower LGD than for senior claims against other financial sector
entities (for example, bank guarantees) in the event of a default.

4.73 The PRA does not agree with respondents’ claim that the Basel 3.1 standards
permit applying a FIRB LGD for credit insurance policies that is lower than 45%. The
Basel 3.1 standards prescribe two potential FIRB LGDs for unsecured exposures to
financial corporates: 45% for senior claims and 75% for subordinated claims. The
Basel 3.1 standards also state that the 45% LGD may be used if the guarantee
represents a senior claim, regardless of whether the exposure is a senior claim. The
PRA therefore considers that its near-final rules are consistent with the Basel 3.1
standards.

4.74 Given the use of credit insurance as UFCP is not exclusive to the UK, the PRA
considers that should further evidence on the risk mitigation provided by credit
Bank of England | Prudential Regulation Authority Page 201

insurance emerge which could justify a different approach for credit insurance, it
would be preferable for this to be agreed internationally in order to avoid excessive
inconsistency across jurisdictions.

Other issues regarding unfunded credit protection

4.75 Other substantive responses focused on a range of technical issues:

• Credit default swaps (CDS): under the risk weight substitution method and
the parameter substitution method, the PRA proposed to retain the CRR
treatment and only permit full recognition of CDS as UFCP if restructuring
which results in a credit loss is included as a credit event. The Basel 3.1
standards include a national discretion to not apply this requirement where a
100% vote is needed to amend the maturity, principal, coupon, currency or
seniority of the protected exposures and the legal domicile in which the
corporate exposure is governed has a well-established bankruptcy code that
allows for a company to reorganise/restructure and provides for an orderly
settlement of creditor claims. One respondent requested that the PRA
implement this national discretion, noting that while it is common for CDS on
European corporate and financial entities to include restructuring clauses, that
was not the case for CDS on North American corporate and financial entities.
The respondent argued this was the type of arrangement which was intended
to be captured by the national discretion. Having considered the response, the
PRA has decided to amend its draft rules to implement this national
discretion. The PRA considers, based on the evidence it received, this is
consistent with its primary objective and with the requirements implemented in
other jurisdictions.
• Indirect counter guarantees: aligned with the Basel 3.1 standards, the PRA
proposed to restrict the eligibility of indirect counter-guarantees, under the risk
weight substitution method and the parameter substitution method, to those
provided by central governments and central banks. One respondent argued
that an exception should be made to this requirement where UFCP is
provided by a special purpose entity (SPE), which then benefits from a
counter-guarantee from an entity which is an eligible protection provider. The
PRA has decided to maintain its proposal to restrict the eligibility of indirect
counter-guarantees to those provided by central governments and central
banks. The PRA considers that this is appropriate because the complexity of
indirect credit arrangements such as that described by the respondent means
Bank of England | Prudential Regulation Authority Page 202

that they are in general less likely to be effective than direct credit protection
arrangements.
• UFCP provided by central counterparties: the PRA proposed that
qualifying central counterparties may be considered eligible providers of
UFCP under the risk weight substitution method and the parameter
substitution method. One respondent requested that the PRA clarify whether
the reference to calculation of RWAs in Credit Risk: General Provisions (CRR)
Part Article 107(2) was intended to cover the scenario of a firm calculating the
effect of UFCP provided by a central counterparty. The PRA clarifies that the
reference in Article 107 does not cover cases where the central counterparty
is providing a guarantee and the exposure itself is not to a central
counterparty.
• Treatment of UFCP in RWA calculations: as set out in paragraph 4.45 for
FCP, the PRA has decided to maintain the proposed 100% CF for the
purpose of determining the portion of the exposure that is covered by CRM as
it considers that using a lower CF would result in imprudent outcomes.
• Presentation of risk weight calculations: as set out in Chapter 8 –
Reporting, credit risk standardised approach (SA), respondents raised
concerns about the reporting of exposures subject to the risk weight
substitution method. The PRA has made minor amendments to the
presentation of the risk weight calculations to be performed under the risk
weight substitution method and parameter substitution method to clarify that
firms should separate each exposure subject to these methods into a covered
part and an uncovered part. The PRA considers that this improves the clarity
of the rules and will facilitate the reporting of these exposures.

PRA objectives and ‘have regards’ analysis

4.76 The amendments noted in this section, including on how EL is calculated under
the risk weight substitution method and on CDS, are not expected to materially affect
the outcomes of the UFCP framework. Therefore, the PRA considers the near-final
rules are materially aligned with those in CP16/22 and its analysis of its objectives
and ‘have regards’ in CP16/22 remain appropriate.
Bank of England | Prudential Regulation Authority Page 203

5: Output floor

Introduction
5.1 This chapter provides feedback to responses to chapter 9 of consultation paper
(CP) 16/22 – Implementation of the Basel 3.1 standards, which set out proposals
to implement the Basel 3.1 standards for the output floor with respect to firms’
calculation of own fund requirements. This chapter also sets out the Prudential
Regulation Authority’s (PRA) near-final policy on the output floor following the
consultation.

5.2 In CP16/22, the PRA proposed:

• to introduce a floor on risk-weighted assets (RWAs) that would require firms in

scope of the output floor, with internal model (IM) permissions, to calculate
RWAs as the higher of: (i) the total RWAs calculated using all approaches that
they have supervisory approval to use (including IM approaches); and (ii)
72.5% of RWAs calculated using only standardised approaches (SAs) (where
the latter is called ‘the output floor’ or ‘floored RWAs’);
• to apply the requirement to UK firms that are not part of a group
headquartered overseas. For those firms, the output floor would be applied on
a consolidated basis at the level of the UK consolidation group where such a
group exists, or on an individual basis where the firm is not part of a group. In
addition, where a firm is a ring-fenced body (RFB), the output floor would be
applied on a consolidated basis at the level of the ring-fenced sub-group, or
on an individual basis where the RFB is not part of a ring-fenced sub-group;
• to require those firms to apply floored RWAs in the calculation of all own funds
requirements and buffers when bound by the output floor;
• to require that those firms apply the PRA’s proposed implementation of the SA
in the same manner as firms without permission to use IMs; and
• to apply transitional arrangements for the output floor, consistent with the
Basel 3.1 standards regarding the length of the transitional period, beginning
on 1 January 2025.
Bank of England | Prudential Regulation Authority Page 204

5.3 The PRA received 49 responses to its proposals on the output floor. Comments
generally supported the overall approach. Respondents focused on:54

• the implementation of the output floor, in particular the treatment of accounting

provisions;
• its scope and levels of application, including for international subsidiaries; and
• the application of the output floor to minimum requirements and buffers.

5.4 Having considered the responses to the consultation, the PRA has decided to
amend the draft rules relating to the treatment of accounting provisions and the
transitional period. This chapter describes the comments and amendments that the
PRA considers are more material. These amendments are reflected in the near-final
PRA Rulebook: CRR Firms: (CRR) Instrument [2024] in Appendix 2. The document
titled Comparison of Draft PRA Rulebook (CRR) Instrument [2023] against
Near-final PRA Rulebook: CRR Firms (CRR) Instrument [2024] contains a
comparison of the near-final rules with the draft rules as set out in CP16/22 for ease
of identifying all of the changes made.

5.5 The appendices to this near-final policy statement (PS) contain the PRA’s near-
final policy, which will:

• introduce a new Required Level of Own Funds (CRR) Part of the PRA
Rulebook to replace CRR articles that HM Treasury (HMT) plans to revoke.

5.6 The sections below have been structured broadly along the same lines as
chapter 9 of CP16/22, covering the main areas where the PRA received comments
from respondents as follows:

• Implementation of an output floor;

• Scope and levels of application;
• Application of the output floor to minimum requirements and buffers;
• Application of the output floor to securitisation exposures; and
• Transitional arrangements.

5.7 Unless specified otherwise, the near-final rules are consistent with those in
CP16/22 and therefore the PRA considers its analysis of its objectives and ‘have

54 Comments relating to standardised approach methodologies used in the calculation of the output
floor have been considered in the relevant SA chapters. Securitisations methodologies are discussed
below.
Bank of England | Prudential Regulation Authority Page 205

regards’ in CP16/22, with respect to the areas mentioned in paragraph 5.5 above,
remains appropriate.

Implementation of an output floor

5.8 The PRA allows firms to measure risk and calculate associated RWAs in two
different ways, depending on the risk concerned: the SAs, in which the PRA defines
the risk weights that should be applied to different exposures and risks; and IM
approaches, where the PRA allows firms with the requisite permissions to model
certain parameters. Aligned with the Basel 3.1 standards, the PRA proposed to
implement an output floor. The output floor, a central new element in the Basel 3.1
standards, would ensure that RWAs for firms with IM permissions do not fall below a
defined percentage of the RWAs calculated under the SAs.

5.9 A firm within the scope of the proposed output floor would be required to
calculate RWAs, for the purposes of compliance with own funds requirements and
buffers, as the higher of: (i) the total RWAs calculated using all approaches which it
has supervisory approval to use (including IM approaches); and (ii) 72.5% of RWAs
calculated using only standardised approaches.

5.10 The proposed output floor was constructed to reduce excessive cyclicality in
RWAs, enhance comparability of RWAs among firms, and protect against model risk,
promoting the credibility of the risk-weighted regulatory capital framework.

5.11 The PRA received 17 responses to this section of CP16/22. 16 respondents

indicated that the proposed floor the PRA consulted on may result in an increase in
capital requirements. The PRA considers that the proposed output floor could
increase capital requirements where it addresses previously uncaptured model risk.

5.12 A number of respondents also discussed the calculation of the output floor
itself, in particular the treatment of accounting provisions, as set out below.

Calculation of the output floor

5.13 The PRA proposed the following equation for the calculation of total RWAs
under the output floor:

Total RWA = max [RWAs (all approaches), 0.725 *RWAs (SAs only)]
Bank of England | Prudential Regulation Authority Page 206

5.14 The proposed output floor calculation did not include any adjustments for the
differing treatments of accounting provisions under the credit risk SA and internal
ratings based (IRB) approach. Instead, CP16/22 noted that firms using IM
approaches ‘would not be required to make any adjustments to the treatment of
accounting provisions with respect to own funds to align with SAs, regardless of
whether they are bound by the output floor’.

5.15 For exposures subject to the IRB approach, firms are required to compare the
total amount of accounting provisions (including various adjustments) (P) with the
total expected loss (EL) amount and adjust capital resources as follows:55

• where the EL amount exceeds P, firms must deduct the difference from
Common Equity Tier 1 (CET1) capital;
• where P is greater than the EL amount, firms may add the difference to Tier 2
(T2) capital up to a cap; and
• if specific provisions exceed EL amounts for defaulted exposures, a separate
calculation is required, resulting in both a CET1 deduction and a T2 add-on.

5.16 For exposures subject to the credit risk SA, firms are not required to calculate
regulatory EL or make any equivalent comparison with P. Firms may however add
General Provisions (where relevant under the applicable accounting framework) to
T2 capital, up to a cap (specific provisions are reflected in credit risk SA RWAs as
the exposure value used is net of specific provisions).

5.17 The Basel 3.1 standards for the output floor do not specify an approach for
reflecting differences between EL amounts and accounting provisions, or General
Provisions. In CP16/22, the PRA proposed to make no adjustment because it
considered that, although this arguably resulted in a less comparable basis for the
output floor, the cost was outweighed by the benefit of applying a simpler approach,
consistent with the output floor acting as a backstop.

5.18 The PRA received eight responses on the proposed treatment of accounting
provisions in the calculation of the output floor. Seven, including industry
representative bodies, expressed a strong preference for the PRA to place more
weight on consistency of the treatment of firms that use the IRB approach and firms
that do not under the output floor rather than on simplicity, and therefore argued to
include an adjustment for accounting provisions. Four respondents argued that the

55 See Article 92 of the Required Level of Own Funds Part of the PRA Rulebook.
Bank of England | Prudential Regulation Authority Page 207

approach proposed in CP16/22 could also introduce some double counting into the
framework.

5.19 The PRA has considered the responses and on balance has decided to
introduce an adjustment in its near-final rules, which adjusts for EL and accounting
provisions, in order to better approximate the capital ratio that would have applied if
all exposures had been subject to the SAs. The PRA considers that the revised
equation remains aligned with the Basel 3.1 standards, but takes into account
respondents’ preference for a calculation that brings output floor and SA
methodologies into closer alignment.

5.20 The output floor calculation will be as follows:

Total RWA = max [RWAs (all approaches), 0.725 *RWAs (SAs only) + Output Floor
Adjustment]

Where:

• Output Floor Adjustment = 12.5 * (IRB T2 – IRB CET1 – GCRA + SA T2);

• IRB T2 is the P greater than EL that may be added to T2 up to a cap;
• IRB CET1 is the EL greater than P that may be deducted from CET1;
• General Credit Risk Adjustments (GCRA) are the General Provisions (GP)
which may be added back to T2 up to a cap in the SA framework, calculated
assuming all exposures are subject to the SA, as per the expectations of the
output floor; and
• SA T2 is the GP already reflected in T2 due to exposures on the Credit Risk
SA.

5.21 The new adjustment converts the effect of the difference between EL and P on
capital resources into equivalent RWAs by multiplying by 12.5, so that they can be
directly taken into account in the calculation of the output floor. This is to ensure the
approach is as straightforward to implement as possible. Both IRB-related
adjustments (the IRB T2 - IRB CET1 terms) and SA-related adjustments (the GCRA
+ SA T2 terms) are included to provide the most comparable basis for the
calculation.
Bank of England | Prudential Regulation Authority Page 208

PRA objectives analysis

5.22 With the exception of the above adjustment for accounting provisions, the PRA
considers that the near-final output floor rules remain aligned with the proposals in
CP16/22 and, therefore, the PRA considers its analysis of its objectives and have
regards for those areas in CP16/22 remains appropriate.

5.23 With respect to the PRA’s decision to introduce an adjustment for accounting
provisions, the PRA considers that the approach continues to advance the PRA’s
primary objective by prescribing a transparent and comparable approach to
calculating the output floor. As the adjustment is applied via a consistent
methodology for all firms that use the IRB approach, and brings floor-bound and SA
methodologies closer in alignment, the PRA considers the adjustment to be
consistent with its secondary competition objective.

‘Have regards’ analysis

5.24 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing changes to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in CP16/22, remains appropriate, subject to the following
updates:

1. Relevant international standards:

• The PRA considers that the adjustment for accounting provisions is aligned
with international standards.

2. Proportionality:

• The PRA considers that the additional complexity of the new adjustment for
accounting provisions is justified in light of consultation feedback supporting
the feasibility of a more complex calculation.

Scope and levels of application

5.25 The PRA proposed the output floor would apply to firms in scope of the PRA’s
CRR requirements in the following way:

• on a consolidated basis only, at the UK consolidation level (the ultimate UK

group level) of UK-headquartered groups;
Bank of England | Prudential Regulation Authority Page 209

• on an individual basis to UK stand-alone firms; and

• on a sub-consolidated basis for RFB sub-groups, or individual basis where the
RFB is not part of a ring-fenced sub-group.

5.26 The proposed approach would exclude UK-based subsidiaries of banking

groups headquartered overseas (‘international subsidiaries’), where they are subject
to group consolidation outside the UK.56

5.27 The PRA received 37 responses relating to the scope and levels of application
of the output floor. Seven respondents expressed support for application at the
consolidated level as set out in CP16/22. The most substantive comments related to
the treatment of international subsidiaries, and the impact of applying the output floor
to mutuals and other firms specialising in retail lending as described below.

5.28 In CP16/22, the PRA recognised that it may, in the future, consider there is a
prudential case to review the scope of the output floor. The PRA recognises that
clear expectations about capital requirements benefit safety and soundness. Any
future change would need to be supported by evidence and be consistent with the
PRA’s objectives and ‘have regards’. Any proposed change to the policy would be
subject to further consultation. However, the PRA is aware that jurisdictions may
implement final rules at different times. Therefore, to support the consistent
application of requirements, the PRA has introduced a permission it may grant for
firms to be treated as international subsidiaries, where the PRA is satisfied that there
is a public commitment by the relevant authorities to implement an output floor (as
per Article 92 of the Required Level of Own Funds Part of the PRA Rulebook). The
PRA will shortly provide details of how to apply for this permission on its
Permissions (CRR firms) webpage.

International subsidiaries
5.29 The PRA proposed that international subsidiaries would not be subject to the
output floor requirement. CP16/22 also noted that the PRA may still request firms
excluded from the scope, including international subsidiaries, to participate in ad hoc
data gathering exercise(s) on the impact of the output floor.

5.30 The PRA received a range of comments from respondents:

56‘International subsidiary’ is defined as a firm subject to the application of an output floor (as per
Article 92 of the Required Level of Own Funds Part of the PRA Rulebook) at the level of a group
consolidated parent in another jurisdiction.
Bank of England | Prudential Regulation Authority Page 210

• four respondents supported the approach to international subsidiaries;

• two respondents argued against the exclusion of international subsidiaries
from the scope of the output floor, citing concerns about competition from EU-
headquartered groups;
• two respondents requested transparency around any expected role of
equivalence in the scope of the output floor; and
• two respondents considered the ad hoc data gathering to be potentially
burdensome.

5.31 Having considered these responses, the PRA has decided not to amend the
proposed treatment of international subsidiaries. The output floor is an aggregate
backstop, aiming to address issues of variability, accuracy, and consistency in RWAs
at a broad level, rather than activity by activity. As such, the PRA considers that the
output floor is applied most effectively at the consolidated level, to allow the
recognition of diversification between risks, and minimise potential impact on specific
business activities.

5.32 The PRA has considered the concerns of respondents on the impact of the
scope of application of the output floor on competition between UK-headquartered
firms and international subsidiaries, including those that would be part of EU-
headquartered groups. The PRA recognises these concerns; however, it considers
that its approach to only exclude international subsidiaries from the scope of the
output floor in cases where they are subject to the floor at consolidated level (and not
subject to ring-fencing at the sub-consolidated level), should minimise any
competition effects. With regard to the role of equivalence in determining the scope
of the output floor, the PRA does not currently envisage a direct link to equivalence
determinations. International subsidiaries will however continue to be subject to PRA
supervision, which recognises the quality of home jurisdiction capital regulation
(including its equivalence), as well as associated supervisory powers. Over time, the
PRA will monitor the implementation of international standards across home
jurisdictions in the context of its supervision of UK-regulated firms.

5.33 With regards to ad hoc data gathering for international subsidiaries, these
exercises will be limited to the UK group consolidation level and apply only to firms
with permission to use IMs. The PRA will aim to minimise items collected, to limit
operational disruption and burden. The PRA considers such data collections
necessary to support the legal requirement to carry out impact assessment and
evaluation.
Bank of England | Prudential Regulation Authority Page 211

Impact on retail lenders

5.34 The PRA proposed that the output floor would apply to mutuals and other firms,
including those that specialise in retail lending. In CP16/22, it acknowledged that
mutuals with IM permissions may experience a relatively higher impact from the
output floor because of their lack of diversification. The size of this effect would
depend on the extent to which the IRB approach continues to produce lower average
risk weights relative to the Basel 3.1 SA following changes including the introduction
of hybrid modelling,57 the IRB roadmap58 and the lowering of some SA risk weights
in the Basel 3.1 standards.

5.35 The PRA also proposed to implement the output floor at the level of ring-fenced
sub-groups (or individual RFBs if there is no sub-group). This was consistent with the
prudential function of the ring-fence (treating the ring-fenced sub-group as equivalent
to the UK consolidation level, within the ring-fence). The PRA considered this
important in supporting its secondary competition objective, as it would promote a
level playing field with the specialised mutuals in the provision of finance to the UK
domestic retail market.

5.36 The PRA received ten responses on the impact of the output floor on non-RFBs
specialised in retail lending, including mutuals. Respondents expressed concern that
the potential impact of the output floor could be disproportionate.

5.37 The PRA received five responses supporting the application of the output floor
to RFBs, and four suggesting the impact may be disproportionate. Of the responses
that supported application at the RFB level, three specifically cited consistency of
competition in the UK domestic retail market.

5.38 Having considered these responses, the PRA has decided to maintain the
approach set out in CP16/22, which includes applying the output floor to mutuals and
ring-fenced sub-groups. Specialisation in retail lending, and in particular residential
mortgages, does not preclude a firm from having model risk, and may amplify it, due
to less diversified model use. The PRA considers application of the output floor at
the RFB level to be consistent with the prudential function of the ring-fence. The PRA
also considers that this level of application supports fair competition between RFBs,

57See SS11/13 – Internal Ratings Based (IRB) approaches, October 2021 update.
58See PS7/19 – Credit risk: The definition of default; March 2019 on the definition of default; and
PRA PS11/20 – Credit risk: Probability of Default and Loss Given Default estimation, May 2020
on Probability of Default and Loss Given Default estimation.
Bank of England | Prudential Regulation Authority Page 212

mutuals and other retail lenders. The PRA notes that the impact of the output floor
on all firms focused on the UK domestic retail market may also be smaller when
considered alongside the combined impact of any other applicable elements of the
capital framework, including Basel 3.1, hybrid modelling, the IRB roadmap and the
leverage ratio.

5.39 The PRA recognises the role that applying the output floor to RFBs plays in
supporting fair competition between retail lenders, and the concern raised by
respondents regarding the potential impact of any change to the ring-fencing regime.
Should a change in the regulatory landscape result in material risk to the PRA’s
objectives, the PRA would assess the case for addressing any material concerns
through routine supervisory powers or, if deemed necessary, consult on a revised
scope of the output floor.

PRA objectives and ‘have regards’ analysis

5.40 The near-final rules are materially consistent with those in CP16/22. In addition,
further information including from other jurisdictions made available since the
publication of CP16/22 has not materially altered our judgements with regards to
competitiveness. Therefore, the PRA considers its analysis of its objectives and have
regards in CP16/22 remains appropriate.

Application of the output floor to minimum requirements

and buffers
5.41 The PRA proposed that when the output floor is ‘activated’ (when 72.5% of
RWAs calculated using SAs exceed RWAs calculated using IM approaches),
‘floored’ RWAs would be used as the applicable RWAs wherever relevant in all
elements of the capital stack.

5.42 In particular, the ‘floored’ RWAs would be used as the basis for the calculation
of buffers, where relevant, including:

• the capital conservation buffer (CCoB), set at 2.5% of RWAs, and

countercyclical capital buffer (CCyB);
• higher loss absorbency requirements for systemic firms, ie for firms identified
as global systemically important banks (G-SIBs) or other systemically
important institutions (O-SIIs); and
• the PRA buffer (also referred to as Pillar 2B).
Bank of England | Prudential Regulation Authority Page 213

5.43 Firms within scope of the leverage ratio framework would also remain subject to
leverage ratio requirements.

5.44 The PRA received 12 responses regarding the application of floored RWAs
through the capital stack:

• eight respondents raised concerns about the application of floored RWAs to

Pillar 2 and buffers. The substantive comments related to concerns about
double-counting, where the same risk is fully captured twice by two different
requirements, and the potential for a competitive disadvantage with other
jurisdictions. The respondents also requested further clarification on the
expected approach where granular ie portfolio or asset level RWAs, rather
than total RWAs, are used, such as in the calculation of credit concentration
risk, as set out in statement of policy (SoP) – The PRA’s methodologies for
setting Pillar 2 capital.
• four respondents specifically referred to potential interactions of the output
floor with the PRA buffer, via stress testing, in particular raising concern that
the phase-in of the output floor may be effectively brought forward by stress
testing and resultant PRA buffer calculations.

5.45 Having considered these responses, the PRA has decided to retain the
proposed approach of applying the output floor to the whole capital stack. The PRA
has not identified any double-counting between the output floor and other elements
of the capital stack, including through consideration of evidence provided as part of
responses to CP16/22. Any refinements related to the Basel 3.1 standards which
improve risk capture and could produce double-counting in Pillar 2A, will be
addressed in an off-cycle review of firm-specific capital requirements, as set out in
Chapter 6 of PS17/23 – Implementation of the Basel 3.1 standards near final
part 1.

5.46 The PRA recognises that the introduction and phase-in of the output floor may
have operational impacts on the calculation of Pillar 2, as set out in PS17/23. To
promote a smooth and consistent transition, the PRA has decided:

• to rebase59 firms’ Day 1 Pillar 2 (both variable parts of Pillar 2A and the PRA
buffer) as part of the off-cycle review; and

59 Rebasing means taking firms’ existing nominal Pillar 2 requirement and rescaling it as a percentage
of projected RWAs under the Basel 3.1 standards. Given these Pillar 2 requirements are set as a
percentage of total RWAs, they will continue to scale with changes in firms’ RWAs arising from the
implementation of the Basel 3.1 standards.
Bank of England | Prudential Regulation Authority Page 214

• to rebase firms’ variable Pillar 2A requirements during the output floor

transitional period, so that any changes to RWAs resulting from the output
floor multiplier do not impact Pillar 2A capital requirements where the relevant
risk level has not changed.

5.47 In response to questions raised during the consultation, the PRA is able to
clarify the expected interaction between the output floor and Pillar 2A. The output
floor applies at a firm-wide level (or RFB), and not to individual asset classes,
models or risk weights. As such, the PRA does not expect or require firms, when
becoming bound by the output floor, to change the granular risk-weights used for the
purposes of calculating individual components of Pillar 2A.60 The PRA considers this
position consistent with the PRA’s proposal in CP16/22 regarding the calculation of
CCyB pass-through rates.

5.48 The PRA has also considered feedback regarding the interaction between the
PRA buffer and stress testing. The PRA buffer is an amount of capital firms should
maintain in addition to their total capital requirement (and the combined buffer). The
PRA buffer is generally calibrated to absorb losses that may arise under a severe
stress scenario, while avoiding duplication with the combined buffers. Its size is
informed by a range of factors including the results of relevant stress-testing and
supervisory judgement. The PRA recognises the output floor may increase
complexities in the setting of the PRA buffer for some UK firms. Where the output
floor impacts a firm’s RWAs, it might in turn affect the extent of a capital drawdown
and / or RWA increases in a severe stress scenario. The PRA acknowledges that
there will be interactions between Basel 3.1, stress testing and the PRA buffer and
will provide firms with more guidance as part of the next concurrent exercise
involving firm submissions of stressed projections.

5.49 In setting the PRA Buffer, the PRA will be particularly alert to the intended effect
of the transitional arrangements for the output floor, and will also consider any other
relevant factors, including the extent to which the output floor is expected to bind
during stress.

60Ie regardless of whether the output floor is ‘activated’, where they have relevant permissions, the
PRA expects firms to continue to use modelled outcomes in parts of the capital stack wherever sub-
aggregate RWAs are used.
Bank of England | Prudential Regulation Authority Page 215

Application of the output floor to securitisation exposures

5.50 The PRA proposed that when applying the output floor, IM firms would apply
the PRA’s proposed implementation of the SA in the same manner as for firms
without permission to use IM. This was because the PRA considered that a robust
and consistent application of SA methodologies by IM firms subject to the output
floor is necessary to achieve the prudential objectives of the output floor and
facilitate the secondary competition objective.

5.51 Consistent with this, the PRA proposed that securitisation exposures would be
included in the output floor calculations, aligned with the Basel 3.1 standards. The
PRA also proposed to engage with firms originating significant risk transfer (SRT)
securitisations and market participants, to understand the impact of the proposed
use of standardised methodologies for securitisations for the purposes of the output
floor.

5.52 The PRA received 13 responses regarding the application of the output floor to
securitisation exposures. Respondents expressed concern that the output floor could
cause securitisation transactions to become uneconomic, because of the higher risk
weights under SEC-SA compared to SEC-IRBA, and this could in turn reduce their
lending capacity. Respondents asked that the PRA reconsider the design of the
application of the output floor to securitisation, potentially by adjusting the SEC-SA
framework. Respondents indicated that they would consider the impact of the output
floor at the securitisation transaction level when considering capital allocation within
their consolidated group.

5.53 The PRA published discussion paper (DP)3/23 – Securitisation: capital

requirements to seek views and evidence from market participants on policy options
related to this issue. The PRA will consider industry feedback on this issue with the
intention of informing the PRA’s approach in a future consultation, subject to HMT
making the necessary legislation.

Transitional arrangements
5.54 The PRA proposed to align with the Basel 3.1 standards by including a five-year
transitional period, beginning on 1 January 2025, in line with the PRA’s proposed
implementation date. The transitional period was intended to support the
implementation of the output floor in an orderly manner, and reduce potential cliff
Bank of England | Prudential Regulation Authority Page 216

edges in own funds requirements. The PRA proposed not to apply the RWA cap61
during the transitional period.

5.55 The PRA received two responses regarding the transitional period. One
respondent supported the PRA pursuing international consistency where feasible
and one respondent supported the proposed start date, but argued that the total
length of the transitional period was excessive.

5.56 Four respondents commented on the RWA cap. Three respondents supported
the PRA’s proposal, while one suggested a cap would be desirable in the context of
different international transitional arrangements.

5.57 As set out in Chapter 1 – Overview, the PRA has decided to amend the
implementation date for the Basel 3.1 standards to 1 January 2026. With regards to
the output floor transitional period, the PRA has decided to retain the proposed end-
date of 31 December 2029. Therefore, the transitional period will begin on 1 January
2026, with 55% becoming the initial multiplier. The following transitional multipliers
would remain in line with the PRA’s proposal. The PRA considers that this approach
supports consistency in industry expectations, and alignment with other jurisdictions,
while guarding against cliff edge effects.

5.58 In line with CP16/22 and industry responses, the PRA is not implementing the
transitional cap. The PRA considers that the cap would create a cliff-edge when
removed, introducing additional volatility and undermining the benefits of the output
floor to safety and soundness.

5.59 As a result of the above, for the transitional period the output floor will be
calibrated as set out below:

Date Transitional multiplier

1 January 2026 55%

61A national discretion given in the Basel 3.1 standards whereby jurisdictions may cap the
incremental increase in RWAs as a result of application of the output floor at 25% for the duration of
the transitional period.
Bank of England | Prudential Regulation Authority Page 217

Date Transitional multiplier

1 January 2027 60%

1 January 2028 65%

1 January 2029 70%

PRA objectives and ‘have regards’ analysis

5.60 The near-final rules, incorporating the clarifications with regards to the start date
of the transitional period made above, are materially consistent with those in
CP16/22 and therefore the PRA considers its analysis of its objectives and have
regards in CP16/22 remains appropriate.
Bank of England | Prudential Regulation Authority Page 218

6: Pillar 2

Introduction
6.1 This chapter provides feedback to responses to chapter 10 of consultation paper
(CP)16/22 – Implementation of the Basel 3.1 standards, which described the
implications of the proposed changes to the Pillar 1 risk-weighting framework for the
Prudential Regulation Authority’s (PRA) Pillar 2 framework.62 This chapter sits
alongside chapter 6 of PS17/23 – Implementation of the Basel 3.1 standards
near-final part 1 and focuses on the responses relating to the Pillar 2A credit risk
methodology and the interaction between Pillar 2 and the output floor.

Pillar 2 review
6.2 CP16/22 did not contain any policy proposals for Pillar 2, but it set out the topics
the PRA is considering so that Pillar 2 requirements are updated as necessary for
the implementation of the Basel 3.1 standards. In particular, it outlined the PRA’s
principle that it would not double count capital requirements for the same risks in
both Pillar 1 and Pillar 2A.

6.3 Taking responses to CP16/22 into account, in PS17/23 the PRA stated its
intention to sequence its Pillar 2 review work by first addressing the consequential
impacts of Basel 3.1 Pillar 1 changes on Pillar 2 within the existing methodologies in
an off-cycle review of firm-specific requirements, and then reviewing the Pillar 2A
methodologies after the PRA’s rules to implement the Basel 3.1 standards are
finalised.

6.4 In chapter 6 of PS17/23, the PRA indicated it would provide more details
regarding the way forward for the refined methodology to Pillar 2A63 when this
second near-final PS is published. For this purpose, the PRA issued CP9/24 –
Streamlining the Pillar 2A capital framework and capital communications
process, which proposes to retire the refined methodology and streamline firm-
specific capital communications. For the avoidance of doubt, CP9/24, as well as the
off-cycle review of firm-specific capital requirements set out in PS17/23 and updated

62 The PRA’s methodologies for setting Pillar 2 capital requirements are set out in full in SoP – The
PRA’s methodologies for setting Pillar 2 capital.
63 The methodology is set out in PS22/17 – Refining the PRA's Pillar 2A capital framework.
Bank of England | Prudential Regulation Authority Page 219

below (which supports the implementation of the Basel 3.1 standards), do not form
part of the PRA’s the future review of the Pillar 2A methodologies.

6.5 In chapter 6 of PS17/23, the PRA also said it would publish proposals on capital-
related measures under the Strong and Simple framework in Q2 2024, which would
cover simplifications to Pillar 2. The PRA published CP7/24 – The Strong and
Simple Framework: the simplified capital regime for Small Domestic Deposit
Takers (SDDTs). Please refer to that document for further detail.

Update on the off-cycle review of firm-specific capital

requirements
6.6 As set out in PS17/23, the PRA will conduct an off-cycle review of firm-specific
Pillar 2 capital requirements using the PRA’s existing Pillar 2 methodologies.64 The
review will address double counting and unwarranted increases or decreases in
capital arising from changes in risk-weighted assets (RWAs) as a result of the
implementation of the Basel 3.1 standards. The PRA also plans to apply firm-specific
structural adjustments to Pillar 2A (the ‘SME lending adjustment’ and ‘infrastructure
lending adjustment’) to ensure that overall capital requirements for SME and
infrastructure lending do not increase as a result of the removal of the Pillar 1
support factors in this off-cycle review.65 The PRA is conducting a data collection
exercise to inform the PRA’s assessments on the adjustments needed. As set out in
PS17/23, the PRA does not expect firms to conduct a full Internal Capital Adequacy
Assessment Process (ICAAP) for the purposes of this review. The PRA plans to
communicate the adjusted Pillar 2 requirements to firms (ie the outcome of this off-
cycle review), ahead of the implementation date of the Basel 3.1 standards on 1
January 2026 (‘day 1’), so that firm-specific requirements will be updated at the
same time as the Basel 3.1 standards are implemented.

Pillar 2A – Credit risk

6.7 In CP16/22, the PRA stated that while changes to credit risk methodologies
would improve risk capture, some deficiencies may remain and a Pillar 2A
methodology for credit risk would likely continue to be required. The PRA did not

64 As outlined in PS17/23, Interim Capital regime (ICR) firms and ICR consolidation entities would not
be subject to this Basel 3.1 Pillar 2 off-cycle review. Please refer to Chapter 8 of CP7/24 for specific
proposals for ICR firms.
65 Please refer to Chapter 2 - Credit risk – standardised approach for further details.
Bank of England | Prudential Regulation Authority Page 220

propose any policy changes within CP16/22 and set out its intention to reflect further
on its Pillar 2A methodology as part of its Pillar 2A review.

6.8 17 respondents provided feedback on the PRA’s approach to Pillar 2A credit

risk. These included questions on the PRA’s future Pillar 2A credit risk methodology,
particularly how the use of internal ratings based (IRB) benchmarks will be reviewed
and updated, and how the Pillar 2 framework could be reviewed in light of the
changes in the Pillar 1 credit risk approach.

6.9 The PRA intends to consider the Pillar 2A credit risk methodology (including the
use of IRB benchmarks), including any necessary updates and changes, as part of
the future Pillar 2A methodologies review, which will be subject to a separate
consultation. In line with the PRA’s intention to adjust specific elements of firms’
Pillar 2 requirements ahead of implementation via the off-cycle review, the PRA will
rebase66 Pillar 2A capital add-ons for credit risk.67 The PRA considers that this is the
most pragmatic approach given existing Pillar 2A credit risk add-ons are small
relative to firms' overall capital requirements, and typically for idiosyncratic risks that
are not captured by the Pillar 1 credit risk approach. Credit risk add-ons are also
typically less relevant to firms which use the IRB approach because where there are
deficiencies in IRB models, the PRA requires the firm to remediate the shortcomings
of the Pillar 1 models rather than setting Pillar 2A capital requirements.

Interaction with the output floor

6.10 As stated in CP16/22, the PRA considers that no material methodological
overlap will exist between the output floor and the PRA’s Pillar 2 methodologies
given model risk is not captured specifically under Pillar 2. Further, where there are
deficiencies in Pillar 1 models, the PRA requires firms to remediate the shortcomings
rather than setting additional Pillar 2A capital requirements. The PRA stated it would
consider how, or if, the output floor should be taken into account in any revised IRB
benchmark and Pillar 2A credit risks add-on.

66 Rebasing means taking firms’ existing nominal Pillar 2 requirement and rescaling it as a percentage
of projected RWAs under the Basel 3.1 standards. Given these Pillar 2 requirements are set as a
percentage of total RWAs, they will continue to scale with changes in firms’ RWAs arising from the
implementation of the Basel 3.1 standards.
67 In some cases, the PRA may exercise supervisory judgement to review firms’ specific add-on on a
case-by-case basis.
Bank of England | Prudential Regulation Authority Page 221

6.11 The PRA has provided more specific feedback to the responses related to the
output floor, and its interaction with the Pillar 2 framework in Chapter 5 – Output floor
of this PS. In line with the PRA’s plan to adjust specific elements of firms’ Pillar 2
requirements in the off-cycle review as set out above and in PS17/23, the PRA will
take into account the impact of the output floor (if any) by:

• rebasing firms’ day 1 Pillar 2 (both variable parts of Pillar 2A and the PRA
buffer) as part of the off-cycle review; and
• rebasing firms’ variable Pillar 2A requirements during the output floor
transitional period, so that any changes to RWAs resulting from the output
floor multiplier do not impact Pillar 2A capital requirements where the relevant
risk level has not changed.
Bank of England | Prudential Regulation Authority Page 222

7: Disclosure (Pillar 3)

Introduction
7.1 This chapter provides feedback to responses to chapter 11 of consultation paper
(CP)16/22 – Implementation of the Basel 3.1 standards, which set out proposals
to update the Prudential Regulation Authority’s (PRA) Pillar 3 disclosure
requirements to reflect its proposals on calculating Pillar 1 risk-weighted assets
(RWAs). This chapter also sets out the PRA’s near-final policy on disclosure (Pillar
3) following the consultation.

7.2 In CP16/22, the PRA proposed to:

• update disclosure requirements in respect of credit risk, market risk, credit

valuation adjustment (CVA) risk, counterparty credit risk (CCR), operational
risk and the output floor, as well as capital and risk management summaries;
• modify, delete existing and introduce new disclosure templates to align with
the disclosure requirements under the Basel 3.1 standards and reflect the
proposals set out in the CP; and
• continue to apply the existing proportionality approach set out in the
Disclosure (CRR) Part of the PRA Rulebook whereby the frequency of
disclosure is varied according to a firm’s size category and listing status.

7.3 The PRA received ten responses to its proposals on disclosure (Pillar 3) relating
to:

• clarifications on the technical detail of the disclosure templates and

instructions;
• identification of minor errors within the disclosure templates and instructions;
• clarifications of the scope of application of disclosures about subsidiaries;
• reduction in the frequency of quarterly disclosure templates;
• disclosures to only be required at the highest level of consolidation for
disclosing entities; and
• out of scope feedback to the proposals set out in CP16/22, such as requests
for the PRA to review disclosure requirements for mid-tier banks that would
Bank of England | Prudential Regulation Authority Page 223

not fall in scope of the PRA’s Small Domestic Deposit Taker (SDDT) criteria
for reduced disclosure.

7.4 Having considered the responses, the PRA has amended the Pillar 3 disclosure
templates and instructions in certain areas. This chapter summarises the responses
to CP16/22 and sets out the material amendments that the PRA had made to Pillar 3
requirements.

7.5 As described in Chapter 1 – Overview, the PRA has also made a number of less
material amendments and clarifications to the proposed disclosure templates and
instructions, which are not described separately in this chapter. These amendments
are reflected in the near-final PRA Rulebook: CRR Firms: (CRR) Instrument [2024] in
Appendix 2. Please refer to Comparison of Draft PRA Rulebook (CRR)
Instrument [2023] against Near-final PRA Rulebook: CRR Firms (CRR)
Instrument [2024], which contains a comparison of the near-final rules with the
proposed rules as set out in CP16/22 for ease of identifying all of the changes made.
The appendices to this near-final policy statement (PS), contain the PRA’s near-final
policy, which will amend the Disclosure (CRR) Part of the PRA Rulebook. The PRA
will update the hyperlinks to the underlying workbooks containing the updated
disclosure templates and instructions in this near-final PS.

7.6 The sections below have been structured broadly along the same lines as
chapter 11 of CP16/22, covering the main areas where the PRA received comments
from respondents as follows:

• Credit risk
• Market risk
• Credit Valuation Adjustment (CVA)
• Counterparty Credit Risk (CCR)
• Operational risk
• Output Floor
• Consequential updates to capital summary disclosures
• Additional feedback.

7.7 Unless specified otherwise, the near-final rules are consistent with those in
CP16/22 and therefore the PRA considers its analysis of its objectives and ‘have
regards’ in CP16/22 with respect to the areas mentioned in the paragraph above
remains appropriate.
Bank of England | Prudential Regulation Authority Page 224

Credit risk

Standardised approach
7.8 The PRA proposed in CP16/22 to amend existing standardised approach (SA)
disclosure templates UKB CRD, UKB CR4 and UKB CR5 to broadly align the
disclosures with the templates under the Basel 3.1 standards, but with UK-specific
modifications to reflect the PRA’s proposed implementation of the SA approach.

7.9 The PRA received two responses to its SA disclosure proposals, which both
sought minor clarification of the instructions for template UKB CR5 and its SA
template instructions. The PRA has amended the proposed disclosure instructions in
order to make corrections and provide further clarity.

Internal ratings based approach

7.10 The PRA proposed to amend existing disclosure templates UKB CRE, UKB
CR6, UKB CR6-A, UKB CR7, UKB CR7-A and UKB CR10 to broadly align the
existing internal ratings based (IRB) disclosure templates with the templates under
the Basel 3.1 standards.

7.11 The PRA received two responses on:

• minor inconsistencies in referencing in template UKB CR10 against the PRA

Rulebook;

• template UKB CMS2, which was a proposal under the output floor in
CP16/22. However, the responses related to credit risk data items and
respondents:

o requested the PRA align the sub exposure classes in this template to
those used under the SA and the IRB approach; and

o sought clarification on disclosure requirements for purchased

receivables, institutions that are not quasi-sovereign and the ‘other’
category.

7.12 The PRA has updated the above templates and instructions for UKB CR10 to
improve consistency between the exposure class breakdown in other credit risk
disclosure templates and updated the template and instructions for UKB CMS2 to
improve consistency and clarity. The PRA has introduced additional fields in UKB
CR7 and UKB CR7-A to align with its decision to permit certain credit risk mitigation
techniques in respect of exposures subject to the slotting approach.
Bank of England | Prudential Regulation Authority Page 225

Market risk
7.13. The PRA proposed to introduce five new market risk disclosure templates and
delete seven existing disclosure templates. Of the five new templates, two require
firms to disclose qualitative information relating to firms’ market risk management
framework (UKB MRA) and for Internal Model Approach (IMA) firms, details of the
approved trading desks and models used (UKB MRB). The remaining three
templates would require firms to provide details in relation to the market risk
calculation approach they use, either the alternative standardised approach (ASA)
(UKB MR1), IMA (UKB MR2) or simplified standardised approach (SSA) (UKB MR3).

7.14 The PRA received two responses to its market risk disclosure proposals. Both
respondents requested clarification on whether IMA exposures should be included in
the disclosure template UKB MR1 for the purpose of the output floor requirement.

7.15 The PRA can confirm that firms are not required to disclose the information in
disclosure template UKB MR1 and other market risk disclosure templates for the
purpose of output floor requirement.

7.16 The PRA has not amended the market risk disclosure templates and
instructions and will implement the disclosure requirements as set out in CP16/22.

Credit valuation adjustment

7.17 The PRA proposed to introduce six new disclosure templates on CVA, and to
delete the existing UK CCR2 template. The PRA also proposed that the six new
templates would align CVA disclosures with the Basel 3.1 standards on disclosure.

7.18 The new templates would require firms to provide high level data on their capital
requirements under the basic approach to CVA (BA-CVA), the standardised
approach to CVA (SA-CVA), and/or the alternative approach to CVA (AA-CVA)
where applicable, as well as qualitative data providing information on the
methodology used.

7.19 The PRA received two responses in relation to the CVA disclosure template
proposals. These related to a request to clarify the disclosure requirements of BA-
CVA in UKB CVA1 and to address the inconsistent use of the term ‘capital
requirements’ and ‘RWAs’ in templates UKB CVA2, UKB CVA3 and UKB CV4.
Bank of England | Prudential Regulation Authority Page 226

7.20 Both respondents identified a difference in the calculation formula of the

systematic and idiosyncratic components for BA-CVA between the disclosure
template UKB CVA1 and reporting template CAP 26.02. They noted that the
disclosure instructions required firms to include a component not essential for the
capital requirement for CVA and requested that the disclosure templates be
amended to align to the reporting template. Additionally, one respondent asked the
PRA to confirm whether netting sets calculated under the full BA-CVA and disclosed
in UKB CVA2 still need to be disclosed under the reduced BA-CVA in template UKB
CVA1.

7.21 For the difference in calculation components, the PRA’s proposed disclosure
template is consistent with the BCBS disclosure requirements, although it differs
from the PRA’s proposed reporting template. For supervisory purposes, the PRA
considers the definitions of the systematic and idiosyncratic components in the
reporting template to be most appropriate but that this does not warrant a change to
the disclosure templates. As such, the definitions contained in UKB CV1, which are
consistent with the Basel Committee on Banking Supervision (BCBS) disclosure
standards, remain appropriate for disclosure and the PRA has not amended the
disclosure templates and instructions for UKB CV1.

7.22 The PRA confirms that only netting sets subject to the reduced BA-CVA are
disclosed in CVA1. This approach is consistent with the BCBS disclosure standards.

7.23 The PRA has retained the use of the term ‘capital requirements’, to maintain
consistency with the corresponding reporting template.

7.24 The PRA will implement the CVA disclosure templates and instructions as set
out in CP16/22.

Counterparty credit risk

7.25 The PRA proposed updating one existing disclosure template, UKB CCR1, to
reflect the calculation of non-financial counterparties (NFCs) and pension scheme
arrangement under standardised approach to CCR (SA-CCR) and simplified SA-
CCR.

7.26 The PRA received no responses to these proposals and will implement these in
full as set out in CP16/22. The PRA has also decided to make minor amendments to
Bank of England | Prudential Regulation Authority Page 227

CCR3 to reflect the near-final credit risk standardised approach rules as set out in
this PS.

Operational risk
7.27 The PRA proposed to delete template UK OR1, introduce three new Pillar 3
templates UKB OR1, UKB OR2 and UKB OR3 and amend existing template UK
ORA in order to align to the disclosure requirements under the Basel 3.1 standards
in terms of content and format.

7.28 The PRA received two responses to its proposals for operational risk
disclosures, which challenged disclosure of historical loss data in template UKB
OR1, given the proposed separate reporting of this information to the PRA.
Respondents also sought clarification on the level of information expected in the
accompanying narrative required in UKB OR1 and UKB OR3.

7.29 The PRA considers it important that the proposed operational risk templates
and instructions align to the disclosure requirements under the BCBS disclosure
standards and is not amending the proposed approach. The PRA has updated the
instructions to templates UKB OR1, UKB OR3 and UKB OR2 to provide further
clarifications, including the definition of rapid and insurance recoveries, as well as
further guidance on the exclusion of loss events and the information firms should
disclose in the accompanying narrative. The PRA has also made some amendments
to improve clarity in the templates and instructions.

Output floor
7.30 The PRA proposed to introduce two new disclosure templates on the output
floor which are aligned with the Basel 3.1 standards. The proposals included two
quantitative templates, one for all firms within the scope of the output floor (UKB
CMS1), and one for firms with permission to use the IRB approach for calculating
credit risk (UKB CMS2).

7.31 The PRA received three responses to these proposals, and all these were in
respect of template UKB CMS2. These related specifically to credit risk and the
responses and PRA feedback are captured in the credit risk section of this chapter.
Bank of England | Prudential Regulation Authority Page 228

Consequential updates to capital summary disclosures

7.32 The PRA proposed to implement consequential amendments under the Basel
3.1 standards relevant to the existing templates UK KM1 and UK OV1 for all firms
within the proposed scope of application of the Basel 3.1.

7.33 The PRA received no responses to these proposals and will implement these in
full as outlined in CP16/22.

Additional feedback
7.34 The PRA received a number of general comments on disclosures, which were
not specific to any template, as well as comments on disclosure topics out of scope
of CP16/22. The most substantive responses covered:

• clarification on whether third-country large subsidiaries are subject to

disclosure requirements of the Disclosure (CRR) part of Rulebook based on
the CRR large institution definition;
• requests for disclosure requirements not to apply to subsidiaries;
• a request for the PRA to consider reducing the frequency of quarterly Pillar 3
requirements for firms that do not publish quarterly financial information to
half yearly because they view Pillar 3 disclosures as uninformative without
the supporting financial statements;
• a request for the PRA to review disclosure requirements for mid-tier firms and
large groups;
• acceleration of the implementation of CP4/23 – The Strong and Simple
Framework: Liquidity and Disclosure requirements for Simpler-regime
Firms, disclosure policy for SDDTs; and
• comments referring to disclosure requirements out of scope of CP16/22 or
not CRR disclosures.

7.35 The PRA did not propose any changes to the scope of disclosure requirements
for large subsidiaries in CP16/22. Rule 1.1 of the Disclosure (CRR) Part of the PRA
Rulebook sets out the scope of firms subject to the PRA’s Pillar 3 disclosure
requirements. A broader review of subsidiary disclosure requirements is beyond the
scope of the proposals in CP16/22.

7.36 The PRA has taken a proportionate approach to developing its disclosure
requirements and so the quarterly disclosure requirements only apply to the largest
Bank of England | Prudential Regulation Authority Page 229

firms or those firms that are listed. The proposals to require quarterly disclosures, set
out in CP16/22, are aligned to the BCBS disclosure requirements. The broader
disclosure frequency of Pillar 3 is out of scope of this near – final PS which is
focused on implementing the Basel 3.1 specific changes to Pillar 3. Therefore, the
PRA will implement the frequencies for disclosure consulted on in CP16/22.
Bank of England | Prudential Regulation Authority Page 230

8: Reporting

Introduction
8.1 This chapter provides feedback to responses to chapter 12 of consultation paper
(CP)16/22 – Implementation of the Basel 3.1 standards, which set out proposals
for how firms would report on the proposed framework for the calculation of Pillar 1
risk-weighted assets (RWAs) to the Prudential Regulation Authority (PRA). This
chapter also sets out the PRA’s near-final policy on reporting following the
consultation.

8.2 In CP16/22, the PRA proposed to amend existing and introduce new reporting
requirements, as well as delete redundant reporting in order to align reporting with
the revised approaches to RWA calculation under the Basel 3.1 standards. CP16/22
proposed to:

• revise existing common reporting (COREP) templates and instructions on own

funds, and own funds’ requirements to reflect the CP proposals;
• delete certain COREP templates that would become obsolete under the CP
proposals;
• introduce new COREP templates to reflect the proposed new Pillar 1 RWA
calculations, and proposed internal model use conditions;
• delete the FSA005 Market risk template to reflect the proposed
discontinuation of the ‘risks not in value-at-risk’ (RNIV) methodology for the
calculation of market risk; and
• revise the Capital+ templates and instructions to reflect the CP proposals.

8.3 The PRA received ten responses to its proposals on reporting. Respondents
were generally supportive of the reporting proposals and the responses covered:

• reduction to the frequency or removal of the historical loss and internal loss
multiplier (ILM) reporting requirements;
• clarification of certain reporting requirements;
• identification of minor errors within the reporting templates and instructions;
and
• guidance on reporting processes beyond the proposed rules-based policy.
Bank of England | Prudential Regulation Authority Page 231

8.4 Having considered the responses, the PRA has decided to amend the draft rules
in certain areas. This chapter describes the comments and amendments that the
PRA considers are more material. As described in Chapter 1 – Overview, the PRA
has also made a number of less material amendments and clarifications to the draft
rules, including the reporting templates and instructions, which are not described in
this chapter. These amendments are reflected in the near-final PRA Rulebook: CRR
Firms: (CRR) Instrument [2024] in Appendix 2. Please refer to the document titled
Comparison of Draft PRA Rulebook (CRR) Instrument [2023] against Near-final
PRA Rulebook: CRR Firms (CRR) Instrument [2024], which contains a
comparison of the near-final rules with the draft rules as set out in CP16/22.

8.5 The appendices to this near-final policy statement (PS), contain the PRA’s near-
final policy, which will:

• amend the Reporting (CRR) Part of the PRA Rulebook (Appendix 2);
• amend the Regulatory Reporting Part of the PRA Rulebook (Appendix 2);
• amend the Reporting Pillar 2 Part of the PRA Rulebook (Appendix 2); and
• amend supervisory statement (SS) 34/15 – guidelines for completing
regulatory reports (Appendix 15).

8.6 The sections below have been structured broadly along the same lines as
chapter 12 of CP16/22, covering the main areas where the PRA received comments
from respondents as follows:

• Credit risk
• Market risk
• Credit valuation adjustment (CVA)
• Counterparty credit risk (CCR)
• Operational risk
• Output floor
• Capital+
• Taxonomy implementation
• Additional feedback

8.7 Unless specified otherwise, the near-final rules are consistent with those in
CP16/22 and therefore the PRA considers its analysis of its objectives and ‘have
regards’ in CP16/22 with respect to the areas mentioned in paragraph 8.6 above
remains appropriate.
Bank of England | Prudential Regulation Authority Page 232

8.8 The near-final updated templates and instructions are attached to this near-final
PS, (see Appendix 14), alongside amendments to SS34/15 – guidelines for
completing regulatory reports (Appendix 15) which include minor restructuring within
the annexes for clarity, and the reporting rule instruments (Appendix 2).

Credit risk

Standardised approach
8.9 For firms that apply the standardised approach (SA), the PRA proposed in
CP16/22 to amend three existing COREP templates and instructions to align with the
proposed changes to the SA.

8.10 The PRA received two responses. The points raised were that:

• the inclusion of counterparty credit risk within credit risk SA reporting

(template CAP 07.00) was burdensome and that counterparty credit risk
should be reported separately;
• the PRA could request a more granular breakdown of retail exposures in
template CAP 09.01; and
• the PRA’s proposed policy for risk weighting exposures subject to unfunded
credit protection (UFCP) would be overly burdensome to implement and as a
consequence would result in the submission of poor-quality data.

8.11 The PRA considers that the inclusion of the CCR reporting within the 07.00
template continues to be useful for the PRA’s purposes. However, in due course, the
PRA plans to review the full range of bank reporting data it collects with a view to
making improvements and efficiencies. Similarly, the PRA considers that the risk
weight breakdown of retail exposures already provided in template 07.00 is
sufficient, without adding further granularity to template 09.01.

8.12 As set out in Chapter 4 – Credit risk mitigation, the PRA has made minor
amendments to the calculation of RWAs, relating to exposures subject to UFCP. The
PRA, as a result, has amended reporting instructions on covered and uncovered
portions to align with this change and to make the data reported more relevant.

8.13 The PRA has also amended credit risk SA reporting to reflect responses
received on the SA policy as part of CP16/22, which is explained separately in this
near-final PS. The PRA has:
Bank of England | Prudential Regulation Authority Page 233

• introduced a row in CAP 07.00 to report the currency mismatch multiplier;

• included a column in CAP 07.00 for the reporting of the new conversion factor
of 40% for other commitments and for a breakdown of specialised lending
project finance exposures; and
• made several adjustments to template CAP 07.00 relating to the reporting of
real estate exposures to reflect structural changes in the underlying policy.

Internal ratings based approach

8.14 For firms that apply the internal ratings based (IRB) approach, the PRA
proposed in CP16/22 to amend ten existing COREP templates and instructions to
align with proposed changes to the IRB framework.

8.15 The PRA received two responses to its IRB reporting proposals. The responses
identified minor errors in the templates and instructions. The PRA has corrected the
errors and reflected changes in the near-final reporting templates and instructions.

8.16 The PRA has made amendments to the near-final IRB policy, as set out in this
near-final PS. These amendments have resulted in further changes to IRB reporting
in respect of templates C08.01, 08.02, 08.03, 08.05, 08.05.01, 08.06, 08.07, 09.02
and 34.07. The PRA has:

• removed references to quasi-sovereign exposure for which the PRA has

decided to withdraw the IRB approach as set out in Chapter 3 – Credit risk –
internal ratings based approach; and
• introduced new columns to allow recognition of funded credit protection (FCP)
for exposures subject to slotting and introduced data points to reflect policy
which the PRA has decided to introduce in the framework.

8.17 The PRA has made several amendments to template C08.07 and the
accompanying instructions, to require firms to report data that reflect their use of
‘permanent partial use’ (PPU) of the SA for some exposures, accurately reflecting
the PRA’s requirements. The PRA considers that these amendments will improve
the accuracy of firms’ reporting of PPU and its ability to supervise firms’ compliance
with PPU requirements.

Market risk
8.18 In CP16/22, the PRA proposed to:
Bank of England | Prudential Regulation Authority Page 234

• introduce ten new reporting templates on the new market risk advanced
standardised approach (ASA) and three new reporting templates on the new
market risk internal model approach (IMA);
• introduce a summary template on the size of a firm’s balance sheet and the
relevant approaches applied to calculate the firm’s market risk capital
requirement;
• retain COREP templates C18.00–C23.00 for reporting by firms that will apply
the simplified standardised approach (SSA); and
• delete templates C24.00 and FSA005 that report market risk capital
requirements under the existing IMA.

8.19 The PRA received four responses to its market risk reporting proposals, which
broadly covered the following areas:

• respondents noted the importance of capturing the information on IMA trading

desks in CAP 24.31-24.39 but requested the PRA consider reducing the
quarterly reporting frequency;
• requests for the PRA to consider reducing the scope of parts of template CAP
25.1, such that firms do not complete less relevant information;
• respondents raised the issue that the requirement to compute separate stand-
alone ASA-Sensitivities-based Method (SbM) measures for collective
investment undertakings (CIUs) that is captured through the look through
approach under the memorandum items, is difficult due to those positions
having been aggregated and diversified within the wider portfolio;
• minor typographical errors in the reporting templates and instructions;
• clarifications to the reporting requirements across the templates with the key
points relating to:
o how firms should report the values of FX and commodity positions that
are allocated either in the trading book or non-trading book;
o how firms should report the aggregated bucket-level ‘Own funds
requirements’ across the Delta, Vega and Curvature sensitivities under
the ASA-SbM;
o how firms should report the aggregated rating-level ‘Own funds
requirements’ for the ASA Default Risk Charge (DRC). Firms also
noted that there is no split between sovereign, corporates and local
governments/municipalities for non-securitisations risk class; and
o whether template C14.00, which was not consulted on but links to
C19.00, will have its instructions updated to clarify whether market risk
Bank of England | Prudential Regulation Authority Page 235

data is only reported where the SSA is used for securitisation market
risk.

8.20 The PRA has amended the market risk templates and instructions where it
considers that clarity can be enhanced. In particular, the PRA:

• confirms that no updates are being made to template C14.00 reporting

instructions at this stage as the PRA may consider reviewing securitisation
reporting as part of the banking data review (BDR);
• clarifies that, when computing the value of trading book FX and commodity
positions for determining the size of its balance-sheet business that is subject
to market risk, firms should take the market value of those positions that is
consistent with how firms value their trading book positions. For non-trading
book FX positions, firms should consider those positions as an overall net
foreign exchange position, valued in accordance with Article 352 of the Market
Risk: Simplified Standardised Approach (CRR) Part of the PRA Rulebook.
Similarly for non-trading book commodity positions, firms should compute the
value of those positions in accordance with Articles 357 and 358 of the Market
Risk: Simplified Standardised Approach (CRR) Part of the PRA Rulebook;
• clarifies that firms should identify the correlation scenario that maximises the
own funds requirements across the Delta, Vega and Curvature sensitivities
only at risk-class level as opposed to risk-bucket level. This means for
template CAP 25.01-25.07, firms should not be required to identify separate
correlation scenarios that maximise the own funds requirements for each risk-
bucket. The PRA considers the Market Risk: Advanced Standardised
Approach (CRR) Part of the PRA Rulebook is already clear but has updated
the template by not requiring firms to report total risk-bucket level 'own funds
requirement'; and
• has updated the template CAP 25.08 and instructions to split the ‘non-
securitisations’ risk class into ‘Sovereign’; ‘Local governments/Municipalities’;
and ‘Corporates’ risk types. Firms should also report the own funds
requirements across each risk class, and not across the individual rating.

8.21 With regards to the feedback to reduce reporting frequency for template CAP
24.31-24.39, the PRA has decided to retain quarterly reporting as per CP16/22.
Firms must implement and comply with certain IMA requirements, including specific
requirements for their trading desk, on a quarterly basis. In order to allow the PRA to
monitor that firms are meeting these requirements and therefore ensure firms’ IMA
Bank of England | Prudential Regulation Authority Page 236

models remain appropriate, the PRA has maintained the reporting requirements in
CAP 24.31-24.39 on a quarterly basis.

8.22 The PRA has updated the CAP 25.11 instructions to specify that IMA firms will
not be required to report their balance sheet sizes. The requirement will be retained
for ASA firms to monitor the ongoing appropriateness of the threshold.

8.23 The PRA recognises that for CIUs where the capital has been calculated using
the look through approach (LTA), the capital for those CIUs is disaggregated and
calculated with other positions in the portfolio. The PRA considers the proposed
separate reporting of those CIU positions where the capital has been calculated
using the LTA is necessary as it quantifies the materiality of a firm’s CIUs exposures
calculated using LTA. Therefore, the PRA has decided not to make any changes to
the reporting on CIU exposures for market risk.

‘Have regards’ analysis

8.24 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in chapter 12 of CP16/22, remains appropriate, subject to the
following updates:

1. Proportionality:

• In updating the reporting templates and instructions for clarity and separating
out the reporting of ‘non-securitisations’ risk class into ‘Sovereign’; ‘Local
governments/Municipalities’; and ‘Corporates’ risk types, the PRA has
considered the proportionality in its reporting requirements by amending them
to make them clearer to firms, reducing the time for interpretation and
reporting burden.

Credit valuation adjustment

8.25 In CP16/22, the PRA proposed to implement changes to reporting to reflect the
proposed CVA capital framework which comprises three new standardised
methodologies to calculate CVA capital requirements. The PRA proposed to delete
the existing CVA template C25.00 for firms in scope of the proposal and replace
these with three new templates. The new templates would require reporting on the
Bank of England | Prudential Regulation Authority Page 237

respective CVA capital requirements in use (alternative approach for CVA (AA-CVA),
full and reduced version of basic approach (BA-CVA) or the standardised approach
for CVA (SA-CVA)).

8.26 The PRA received three responses to the CVA reporting proposals. The
responses related to:

• identification of minor errors in the templates and instructions and

inconsistencies with the CVA Part of the PRA Rulebook;
• clarification on whether legacy trades (which remain exempt from CVA
requirements under the CP16/22 proposals) are required to be reported for
firms using either the BA-CVA or the SA-CVA;
• requesting the PRA explains the rationale for requiring reporting of CCR
exposures and RWAs within table CAP 26.13 of template CAP 26.01 which is
meant for CVA capital requirements;
• requests for the rationale for the requirement to report hedging benefit in table
26.21 of template CAP 26.02 when this is not required for the capital
calculation; and
• requesting the PRA to clarify how the ‘other’ bucket should be calculated in
table CAP 26.33-34 in template CAP 26.03.
• clarification on whether firms should report exposures under the reduced BA-
CVA when using the full BA-CVA.

8.27 The PRA has reviewed the responses received. It has amended the templates
and instructions for the minor errors and inconsistencies identified.

8.28 The PRA clarifies that firms using the transitional arrangement originally
proposed in CP 16/22 must report this in the new data points in CAP 26.01. The
PRA also clarifies that firms will be able to exclude legacy trades from calculations in
CAP 26.01 and CAP 26.02, as long as it is specified in the new data points. As part
of PS17/23 – Implementation of the Basel 3.1 standards near-final part 1, the
PRA introduced an additional transitional arrangement aimed at facilitating netting
set calculations and phasing-in legacy trades on a gradual basis. Under this
‘alternative’ transitional approach, firms will calculate total CVA capital requirements
using the reduced BA-CVA methodology on a fully loaded basis (including both
legacy and non-legacy trades), to which will be applied a discount factor (equal to
the proportion of legacy trades at the start of the transitional), reducing linearly in
time. Firms are required to report the use of this approach in the updated CAP 26.01
data points alongside the value of the legacy ratio at the start of the transitional. CVA
Bank of England | Prudential Regulation Authority Page 238

capital requirements arising from both legacy and non-legacy trades must be
included in calculations for the purposes of CAP 26.21, to which will be applied a
final discount.

8.29 The PRA has considered the responses on the inclusion of CCR exposures
reporting in CAP 26.1301 and has removed the requirements to report these data
points.

8.30 In response to comments requesting the rationale for the requirement to report
the hedging benefit in table 26.21 of template CAP 26.02, the PRA has removed this
datapoint as it can be derived from existing datapoints.

8.31 The PRA has considered the policy intention of the proposed buckets specified
in table 26.32 of template 26.03 and the alignment to the CVA Part 5.27(1) of the
Rulebook. The PRA considers that pension funds should be part of a new separate
bucket to financials, even though both would still be part of bucket 2. The PRA
agrees that the reporting should follow the policy intention and has amended the
templates and instructions to add a separate row to add pension funds. On further
consideration, the PRA will similarly make a distinction between bucket (1)a.
'Sovereigns including central banks, multilateral development banks' and (1)b. 'Local
government, government-backed non-financials, education and public administration'
and add another row to the template to report this information. The instructions have
been amended accordingly.

8.32 The PRA confirms that under CVA Part 5.25 of the Rulebook, interest rate risk
class (CAP 26.33) buckets are set at an individual level to further clarify how the
‘other’ data item in table CAP 26.33-34 in template CAP 26.03 should be reported.
This also applies for foreign exchange risk (rule 5.26, CAP 26.34). The 'other' row
has an open-table format to enable firms to report as many new currencies as
required. The PRA confirms that firms using the full BA-CVA should also report
exposures under the reduced BA-CVA, given that these are an input for the full
calculation.

‘Have regards’ analysis

8.33 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
Bank of England | Prudential Regulation Authority Page 239

regards’, as presented in chapter 12 of CP16/22, remains appropriate, subject to the

following updates:

1. Proportionality:

• In removing the CCR exposure data points the PRA has taken a proportionate
approach in considering the reporting burden on firms.

Counterparty credit risk

8.34 In CP16/22 the PRA proposed not to make any amendments to reporting for
CCR. The PRA noted that any reporting amendments resulting from the targeted
recalibrations to the SA of the counterparty credit risk (SA-CCR) framework for
calculating exposures to non-financial counterparties (NFCs) and pension scheme
arrangements would be small. However, it proposed to revise the reporting
instructions for template C34.02. The PRA set out that it may consider amending
CCR reporting in the future in connection with the Bank’s BDR, as highlighted in
CP16/22.

8.35 The PRA received one response in respect of CCR reporting querying where
the revised alpha factor would be reported. The PRA confirms that it has amended
the reporting instructions to template C34.02 to state where in the template the alpha
factor will be reported as per its proposal in CP16/22.

Operational risk
8.36 In CP16/22, the PRA proposed to delete the existing three operational risk
reporting templates C16.00, C17.01, and C17.02 and replace them with a single
template CAP16.00. This would require firms to report on the underlying components
of the new standardised approach for calculating operational risk capital
requirements.

8.37 The PRA received four responses to these proposals. The responses related to:

• requests for the PRA to explain the rationale for or remove the requirement to
report historical loss data and the ILM which do not feed into the Pillar 1
operational risk capital requirements, or consider collecting this information
through Pillar 2 reporting;
Bank of England | Prudential Regulation Authority Page 240

• requests to reduce the frequency of reporting historical loss information and

ILM to annual (from quarterly) to align with the Pillar 3 disclosure frequency of
this information;
• clarification of reporting requirements relating to rapid recoveries, insurance
recoveries and divested activities;
• identification of minor errors in the templates and instructions; and
• requests for cross validation of the Business Indicator (BI) subcomponents in
template CAP 16.00 with similar data reporting in Financial Reporting
(FINREP).

8.38 The PRA has considered the proposed requirement to report historical loss
information and ILM and has decided to maintain the proposal in CP16/22 to collect
this information. The PRA recognises that while this information is not used in
calculating the Pillar 1 operational risk capital requirements, this data remains
important to monitor the capital impact of a variable ILM as part of policy evaluation
of setting the ILM to 1. Further, as highlighted in CP16/22, the PRA considers that
collecting this loss data would facilitate improved and closer management of
operational risk events, which supports firms’ overall management of systems,
processes, and governance. It would also provide the PRA with consistent loss data
to better support cross-firm comparison. As firms will be required to disclose
historical loss data in Pillar 3 (see Chapter 7 – Disclosure (Pillar 3)), the PRA
considers that the underlying information will be accessible to firms to report. The
PRA also intends to review the Pillar 2 reporting templates as part of the future Pillar
2A methodologies review, to address any potential interaction.

8.39 The PRA has considered the responses on the frequency of historical loss
reporting and of the ILM and has reduced the frequency of the historical loss
component and the ILM of operational risk reporting from quarterly to an annual
basis. The requirement for quarterly reporting will remain for the operational risk
capital requirements and the elements that feed into the Pillar 1 calculation.
Retaining quarterly reporting for operational risk Pillar 1 calculations aligns with Pillar
1 reporting for other risk areas. While the BI uses annual data, the PRA considers
collecting this information on a quarterly basis is important to the timely supervision
of RWAs.

8.40 The PRA has revised the reporting instructions to provide further clarifications,
including the definition of rapid and insurance recoveries and the dates to report in
relation to divested activities permissions. The PRA has also made some
amendments to correct minor errors in the templates and instructions.
Bank of England | Prudential Regulation Authority Page 241

8.41 In response to the request made for the PRA to provide cross validations of BI
subcomponent data to FINREP, the PRA’s position is that the instructions on the
data items to be reported are clear. Therefore, the PRA does not deem it necessary
to undertake such a cross validation exercise at this time.

‘Have regards’ analysis

8.42 In developing these near-final rules, the PRA has had regard to its framework of
regulatory principles and the matters to which it is required to have regard when
proposing amendments to CRR rules. The PRA considers its analysis of its ‘have
regards’, as presented in chapter 12 of CP16/22, remains appropriate, subject to the
following updates:

1. Proportionality:

• In reducing the reporting frequency for historical loss information and the ILM
the PRA has taken a proportionate approach in reducing the reporting burden
on firms.

Output Floor
8.43 The PRA proposed to collect new reporting on the Output Floor in CP16/22 to
allow the PRA to effectively supervise this new measure. The PRA proposed to
modify two existing reporting templates (C02.00 and C08.01) and introduce one new
template CAP02.01.

8.44 The PRA received two responses to its Output Floor reporting proposals, and
these requested the PRA to provide further clarity on the requirements. The key
areas related to:

• identification of minor errors in the templates and instructions; and

• for template CAP 02.01, respondents requested clarification on:
o where ‘Risk exposure amounts for contributions to the default fund of a
central clearing party (CCP)’ should be reported, identifying the option
of either row 0020 Counterparty Credit risk; or row 0070 of Residual
RWA;
o whether the instructions for row 0040 should refer to securitisation
(SEC) rather than CVA; and
Bank of England | Prudential Regulation Authority Page 242

o the specific examples of items which should be included in row 0070

(Residual RWAs).

8.45 The PRA has reviewed the responses received. For the minor errors and
inconsistencies identified in the templates and instructions, it has amended these.
With regards to residual RWAs, the instructions have been amended to include
specific examples. With regards to ‘Risk exposure amounts for contributions to the
default fund of a CCP’, the PRA can confirm this should be reported under Residual
RWA in CAP 02.01. The PRA has updated instructions to row 0040 and confirms
that SEC should be referred to rather than CVA.

8.46 In line with the revisions to the calculation of the output floor set out in Chapter
5 – Output Floor (paragraph 5.18), the PRA has added a single additional row to
C02.00 and updated labels in C02.00 and C02.01, to capture the Output Floor
Adjustment. The PRA considers the addition and updates necessary to ensure the
transparent and accurate application of the near-final rules.

Capital+
8.47 The PRA proposed changes to Capital+ reporting to reflect the proposed
changes made to the CAP 02.00 that are relevant to Capital+ reporting.

8.48 The PRA received one response to its Capital+ proposals, seeking clarification
of whether the information required in PRA 101a-103a would be identical to reporting
template CAP 02.00. As set out in CP16/22 and highlighted above, CAP 02.00 is the
basis for templates PRA 101a-103a and these are the same in terms of structure
and data point definitions. Only high-level information from CAP 02.00 will be
required to be reported in PRA101a-103a on a forecast basis and the PRA has not
introduced additional data points to Capital+ beyond those added to CAP 02.00.

8.49 The PRA has made further amendments to PRA101a-103a to align to the
changes made to CAP02.00 in response to comments received to CP16/22.

Taxonomy implementation
8.50 Firms in scope of the Basel 3.1 standards will no longer report own funds and
own fund requirements to the PRA using an European Banking Authority (EBA)
authored taxonomy (effective from the implementation date). A Public Working Draft
of the Bank of England Banking taxonomy v3.7.0 was released 31 May 2023 to set
Bank of England | Prudential Regulation Authority Page 243

out the technical implementation of the CP16/22 proposals and a final version is
planned to be released following publication of this near-final PS.

8.51 Seven respondents requested the PRA provide final rules and an associated
taxonomy at least 12 months ahead of the implementation date, to allow them
sufficient time to develop systems and processes to implement the reporting
changes. As set out above, a final taxonomy will be published subsequently to this
near-final PS. The PRA received additional comments on the practical
implementation of the reporting. These were:

• requesting the PRA to confirm the reporting submission platform(s) that will be
used; and
• a request for the PRA to provide a test environment for the final taxonomy as
soon as possible.

8.52 The PRA confirms that firms will continue to use the existing submission
platforms: RegData for Own Funds Reporting and BEEDS for Capital+ returns.
Reporting requirements will remain unchanged until the implementation date of 1
January 2026. Firms should continue to use the EBA Taxonomy 3.0 for Own Funds
reporting and the Bank of England Banking taxonomy for Capital+ reporting up until
the implementation date, reflecting the reporting requirements in force.

8.53 The PRA has renamed certain near-final templates set out in the PS in order to
distinguish these from those currently reported, and reporting submitted by firms not
in scope of this near-final PS. CP16/22 referred to the proposed templates using
prefixes such as ‘C’, ‘CAP’ and ‘PRA 101a to 103a’, and this convention has been
retained in this PS for consistency. The final template prefixes are set out in near-
final mapping of reporting template codes (Appendix 13) and the draft Rule
instrument included in Appendix 2. The proposed templates with the prefix of CAP
and C will be referred to as ‘OF’ reflecting the own funds content. Capital+ templates
will be renumbered as PRA 112 to PRA 114. Only the templates consulted upon in
CP16/22 will have their template codes updated. The PRA plans to consult on
updating the remaining templates codes at a later date. The PRA has also
disaggregated the templates behind the hyperlinks in Annex I of the Reporting (CRR)
Part of the PRA Rulebook. This means that each hyperlink will link to a single
template rather than, as currently, a workbook containing many templates. This
change has been applied to all the templates in Annex I, for consistency and in order
to avoid retaining any hyperlinks to workbooks containing outdated templates. This
will increase the clarity and simplicity of the reporting requirements in the Rulebook.
Bank of England | Prudential Regulation Authority Page 244

The appendices to this near-final PS includes the disaggregated Annex I templates

referred to in this chapter. All remaining Annex I templates will be included in the
final PS which follows. These are (C 01.00, 03.00, 04.00, 05.01, 05.02, 06.01, 06.02,
08.04, 09.04, 11.00, 13.01, 14.00, 14.01, 34.01, 34.02, 34.03, 34.04, 34.05, 34.06,
34.08, 34.09, 34.10, 34.11, 32.01, 32.02, 32.03, 32.04 and C 33.00).

8.54 The PRA will be updating the final Basel 3.1 taxonomy to reflect the deletion of
the non-performing exposures (NPEs) data items set out in PS14/23 – The non-
performing exposures capital deduction, as well as the deletion of the ‘Minimum
value commitment shortfall’ in COREP template CA1 and Capital+ in PS17/21 –
Implementation of Basel standards. While this policy is in effect, Taxonomy 3.0
does not currently reflect these deletions.

Additional feedback
8.55 The PRA received nine responses that went beyond the scope of the PRA
Rulebook and policy material consulted upon. Respondents raised questions on
surrounding processes to reporting and disclosure requirements. Respondents
requested the following from the PRA:

• a question and answer (Q&A) style process in the lead up to the

implementation date to provide firms with an additional avenue to seek
clarification;
• a data point mapping between the Pillar 3 disclosure and reporting templates,
similar to that previously published by the EBA, to support data quality across
both sets of templates;
• illustrative examples within reporting instructions;
• a roadmap of the different regulatory initiatives over 2023-2024 to support
firms in sequencing and prioritisation;
• a review of the PRA’s reporting validations and the set-up of cross validations
across different PRA returns for identical data points;
• a review of certain aspects of FINREP regulatory reporting;
• adoption of business day deadlines;
• engagement with software vendors as part of policy development;
• align format of final rules to Regulatory Reporting Part of the PRA Rulebook
and
• a review of reporting for mid-tier firms.
Bank of England | Prudential Regulation Authority Page 245

8.56 As set out in this chapter, the PRA has updated the reporting templates and
instructions to reflect CP16/22 responses requesting clarifications. In so doing, the
PRA considers it has made the requirements clearer for firms. The PRA therefore
considers that firms should be able to successfully implement and follow the
requirements. Given the PRA’s commitment to minimise the breadth of policy
materials firms are required to follow, set out in CP27/23 – The Prudential
Regulation Authority’s approach to policy, the PRA will not introduce
supplementary guidance in the format requested above for the implementation of the
Basel 3.1 standards at this time.

8.57 To address the request for a roadmap, the PRA is able to signpost firms to the
Regulatory Initiatives Grid which sets out the planned regulatory initiatives for the
next 24 months.

8.58 The PRA considers an introduction of cross reporting validations and a review
of FINREP outside the scope of CP16/22 and will not be undertaking these exercises
for the purposes of the implementation of the Basel 3.1 standards. These are topics
that the PRA may consider in the future, along with a potential Q&A process.

8.59 The PRA considers that the existing remittance dates in the Reporting (CRR)
Part of the PRA Rulebook already take sufficient account of weekends and will not
make changes to the remittance dates of the near-final reporting set out in the PS.
Bank of England | Prudential Regulation Authority Page 246

9: Interim capital regime

Introduction
9.1 This chapter sets out the updated near-final policy following feedback to
responses to chapter 2 of consultation paper (CP)16/22 – Implementation of the
Basel 3.1 standards, which proposed that firms meeting the Small Domestic
Deposit Taker (SDDT) criteria would not have to apply the Basel 3.1 standards set
out in the CP.

9.2 The Prudential Regulation Authority (PRA) received 14 responses regarding the
Interim Capital Regime (ICR) proposals in CP16/22. The respondents generally
welcomed the PRA’s proposal to introduce an interim regime based on the existing
Capital Requirements Regulation (CRR) capital provisions. In chapter 8 of near-final
policy statement (PS)17/23 – Implementation of the Basel 3.1 standards near-
final part 1, the PRA set out its feedback to those responses, and the various
amendments made to the draft policy.

9.3 In PS17/23, the PRA set out its near-final policy to introduce the ICR that would
allow firms that meet the SDDT criteria to remain subject to existing CRR provisions
until the permanent risk-based capital framework for SDDTs (SDDT capital rules) is
implemented. Likewise, the ICR would allow consolidation entities meeting the SDDT
consolidation entity criteria to remain subject to existing CRR provisions until the
SDDT capital rules are implemented. PS17/23 also included the near-final statement
of policy (SoP) – Operating the Interim Capital Regime, and the first iteration of
near-final ICR rules relating to market and operational risk.

9.4 This chapter restates the PRA’s near-final policy on the ICR and sets out the
amendments the PRA has made to the near-final rule instrument since the
publication of PS17/23. It also sets out further details on the rule modification
process, through which firms and CRR consolidation entities would enter the ICR,
which will be made available upon the publication of the final ICR rules.

9.5 The near-final SoP – Operating the Interim Capital Regime, published in
PS17/23, is unaffected by the policies in this chapter and therefore remains
unchanged.
Bank of England | Prudential Regulation Authority Page 247

9.6 For the purposes of this chapter, any references in relation to a firm should,
where appropriate, be treated as applicable to both a firm and a CRR consolidation
entity. The appendices to this near-final PS contain the PRA’s updated near-final
policy, which will:

• introduce a new PRA Rulebook: CRR Firms: SDDT Regime (Interim Capital
Regime) Instrument [2024] which contains the SDDT Regime – Interim Capital
Regime Part of the PRA Rulebook (Appendix 17).

9.7 The near-final rules included in Appendix 17 are relevant to UK banks and
building societies that expect to meet the SDDT criteria, CRR consolidation entities
that expect to meet the criteria for SDDT consolidation entities, and firms and
consolidation entities that would wish to be treated in the same way as firms and
consolidation entities meeting those criteria.

9.8 The policies in this chapter will take effect at the same time as the
implementation date for the Basel 3.1 standards.

Updates to the Interim Capital Regime near-final rule

instrument
9.9 As set out in PS17/23, for the ICR, the PRA intends to make rules to replace the
existing CRR articles and technical standards that HM Treasury (HMT) plans to
revoke, in order to preserve their effect as appropriate for firms meeting the SDDT
criteria.

9.10 To reflect the near-final credit risk policies covered in this PS, the near-final ICR
rule instrument (Appendix 17) has been updated to include the CRR articles and
technical standards that would be revoked for credit risk. The PRA rules that would
be amended under the near-final policies in this PS have also been added to the
near-final rule instrument. The PRA does not consider that the impact of these rules,
as updated, will be significantly different on mutuals as compared to the consultation
draft, nor as compared to other PRA-regulated firms.

9.11 Subject to HMT’s revocation of CRR provisions, the PRA does not intend to
make further material alterations to the near-final instrument before the making of the
final policy material.
Bank of England | Prudential Regulation Authority Page 248

Time window for joining the Interim Capital Regime

9.12 The near-final SoP sets out that eligible firms and consolidation entities would
enter the ICR by way of modification by consent (MbC).

9.13 In CP16/22, the PRA stated it would publish the draft modification directions for
the ICR and the terms on which the directions would be offered when made
available. The PRA no longer considers this necessary because the modification for
joining the SDDT regime has since been published68 and, although the modifications
for the ICR and the SDDT regime are separate, the ICR MbC would be based on the
approach used in the already available SDDT MbC.69 Therefore, firms should have a
reasonable view of what the ICR MbC will look like.

9.14 As set out in the near-final ICR rule instrument, and subject to any additional
modification of the rules, a firm must certify that it meets the SDDT criteria to be
eligible for the ICR.

9.15 The offer of the modification directions for the ICR will be available at the point
of the publication of the final ICR rules, which will be published at the same time as
the final Basel 3.1 PS on the Basel 3.1 standards.

9.16 The ICR MbC will be available for eligible firms to take up from the point at
which the final ICR rules are published until the ICR is revoked, unless there are
specific reasons to revoke the modification relating to a particular firm.

9.17 In practice, to prepare for the practical implementation of the ICR and the Basel
3.1 standards, the PRA will need notification in advance of the Basel 3.1
implementation date as to whether an eligible firm will be moving to the ICR or will be
subject to the Basel 3.1 standards.

9.18 This is because, as set out in PS17/23, the PRA will conduct an off-cycle review
of firm-specific Pillar 2 capital requirements. The off-cycle review will aim to address

68 The MbC forms for eligible firms and CRR consolidation entities to join the SDDT regime can be
found in: www.bankofengland.co.uk/prudential-regulation/authorisations/waivers-and-
modifications-of-rules.
69 The MbC forms for eligible firms and CRR consolidation entities to join the SDDT regime can be

found in: www.bankofengland.co.uk/prudential-regulation/authorisations/waivers-and-

modifications-of-rules.
Bank of England | Prudential Regulation Authority Page 249

potential double counting and changes in risk-weighted assets arising as a result of

the implementation of the Basel 3.1 standards. To carry out this review smoothly (ie
to provide the PRA sufficient time to perform the review and target it at the correct
firms), the PRA needs notification in advance of the Basel 3.1 implementation date of
which firms are going to be subject to the Basel 3.1 regime, including those that are
SDDT-eligible but have decided not to opt in to the ICR.70

9.19 The PRA therefore intends to set out a window of at least six weeks for firms to
consent to the ICR MbC (and for CRR consolidation entities to consent to the ICR
consolidation entity MbC) if they wish to be subject to the ICR upon the Basel 3.1
implementation date.

9.20 If a firm has not consented to the ICR MbC, or at least contacted the PRA
during this time window to indicate that it wishes to do so, the PRA will proceed on
the assumption that the firm has chosen to be subject to the Basel 3.1 standards,
and will carry out the necessary changes to adjust the firm’s Pillar 2 requirements to
a Basel 3.1 basis. By this stage, a firm not intending to enter the ICR should already
have provided necessary data for these Basel 3.1 related Pillar 2 adjustments. The
PRA would request necessary data from the firm at short notice if the firm had not
previously provided data because it had indicated it was going to consent to the ICR
MbC.

9.21 The PRA intends to communicate timings for when firms would need to confirm
if they would opt into the ICR by taking up the offer of the ICR modification, at the
same time as the final Basel 3.1 PS on the Basel 3.1 standards.

PRA objectives and ‘have regards’ analysis

9.22 The near-final rules are consistent with those in CP16/22 and therefore the PRA
considers its analysis of its ‘have regards’, as presented in chapter 2 of CP16/22,
remains appropriate subject to the following update:

1. Efficient and economic use of PRA resources:

• The PRA considers the plans for a time window for eligible firms to consent to
the ICR MbC are appropriate, as they will provide the PRA with an
understanding on which SDDT-eligible firms will be choosing either the ICR or

70See chapter 6 of PS17/23 – Implementation of the Basel 3.1 standards near-final part 1 for
details on the PRA’s off-cycle review of firms’ Pillar 2 capital requirements.
Bank of England | Prudential Regulation Authority Page 250

the Basel 3.1 regime in advance of the Basel 3.1 implementation date. This
will help ensure the PRA has sufficient time to carry out the off-cycle review of
Pillar 2 requirements for SDDT-eligible firms moving to the Basel 3.1
standards ahead of the Basel 3.1 implementation date. It will also support a
more efficient use of PRA resources by avoiding the risk of the PRA carrying
out an off-cycle review of Pillar 2 requirements for SDDT-eligible firms that
intend to move on to the ICR.