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Home > Prudential Regulation Authority > Assessing capital adequacy under Pillar 2 - PS17/15
 

Assessing capital adequacy under Pillar 2 - PS17/15

29 July 2015

3 August 2015 - The policy statement has been updated, see

Assessing capital adequacy under Pillar 2 - PS17/15 UPDATE

For information only, the original publication issued on 29 July 2015 is available below.

This policy statement (PS) sets out the Prudential Regulation Authority’s (PRA) responses to the feedback on Consultation Paper 1/15 ‘Assessing capital adequacy under Pillar 2’ (the CP). It sets out changes to rules and supervisory statements and finalises a statement of policy: ‘The PRA’s methodologies for setting Pillar 2 capital’. The PS is relevant to banks, building societies and PRA-designated investment firms.

Background

The Pillar 2 capital framework for the banking sector is intended to ensure that firms have adequate capital to support the relevant risks in their business, and that they have appropriate processes to ensure compliance with CRD IV (see note 1 below).

A firm must carry out an Internal Capital Adequacy Assessment Process (ICAAP) in accordance with the PRA’s Internal Capital Adequacy Assessment (ICAA) rules. These require firms to have in place sound, effective and comprehensive strategies and processes to assess and maintain, on an ongoing basis, the amounts, types and distribution of financial resources they consider adequate to cover the nature and level of the risks to which they are or might be exposed. The existence of the PRA’s own methodologies does not remove this obligation. The PRA expects a firm’s ICAAP to be the responsibility of a firm’s management body and to be an integral part of the firm’s management process and decision making. The PRA’s methodologies inform the PRA’s setting of Individual Capital Guidance (ICG) alongside supervisory judgement and a firm’s own assessment. If a firm is merely attempting to replicate the PRA’s own methodologies it will not be carrying out its own assessment in accordance with the ICAA rules. As such, the Pillar 2 capital framework is intended to encourage firms to develop and use better risk management techniques in monitoring and managing their risks and Pillar 2 therefore acts to further the safety and soundness of firms, in line with the PRA’s objectives.

The PRA is required by the Financial Services and Markets Act 2000 (FSMA) to have regard to any representations made to the proposals in its consultations, and to publish an account, in general terms, of those representations and its response to them. The PRA received 18 responses to the CP.

For more information about the Pillar 2 framework, see:

The Pillar 2 framework - background

Summary of the policy statement

This PS follows the same chapter structure as CP1/15. Where relevant, each section includes:

  • the approach taken on the most significant issues raised by respondents, in particular noting those areas where the PRA is making a substantive change to the proposals contained in the CP. Where an issue is not addressed, the PRA is maintaining the policy approach set out in the CP; and
  • clarifications, where the PRA considers it appropriate to use this PS to clarify issues of uncertainty raised in responses to the CP.

As set out in paragraph 2.30, the PRA recognises that some smaller institutions have short-term exposures to financial institutions for liquidity purposes and in practice might find it more difficult to diversify than larger firms. Supervisors may exercise judgement for smaller firms where they identify that the credit concentration risk methodology could overstate risks, or could incentivise risk-taking behaviour. 

Implementation

The new Pillar 2 framework will come into force from 1 January 2016. Where Supervisory Review and Evaluation Process (SREP) reviews are planned between August and December 2015, the PRA will discuss with the firm the application of the revised Pillar 2A methodologies. New ICG will be applicable from 1 January 2016.

The PRA will write to all firms before 1 January 2016 to convert their existing Capital Planning Buffer into a PRA buffer that offsets against the CRD IV combined buffer. Where firms have an existing Pillar 2A add-on for risk management and governance, the PRA will relocate this to their PRA buffer and update ICGs accordingly. 

Note 1: The Capital Requirements Regulation (575/2013) (CRR) and Capital Requirements Directive (2013/36/EU) (CRD), jointly ‘CRD IV’.

Policy Statement

Assessing capital adequacy under Pillar 2 – PS17/15 (inclusing Appendix 1) 

Appendices

2.  Supervisory statement 31/15: The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process(SREP)

3.  Statement of policy - The PRA’s methodologies for setting Pillar 2 capital 

4.  Supervisory statement 32/15: Pillar 2 reporting, including instructions for completing data items FSA071 to FSA082


 
 
 
 
 
 
 
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