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Assessing risk

Assessing risk  |  Information for smaller firms  |  Mitigating risk  |  Proactive intervention framework  |  Regulation of insurance 

​The Prudential Regulation Authority (PRA) aims to develop a rounded, robust and comprehensive view of firms, in order to judge whether they are being run in a safe and sound manner, consistent with the stability of the financial system and policyholder protection. It undertakes a varied set of supervisory activities - conducting its assessment on a continuous cycle - to inform this view.

The PRA weights its supervision towards those issues and those firms that, in its judgement, pose the greatest risk to the stability of the UK financial system, and to insurance policyholders. The composition, frequency and intensity of its supervisory activities vary reflecting the particular circumstances of a firm.

The PRA’s approach to assessing risks includes the potential impact a firm could have on the financial system, its proximity to failure, the context in which the firm operates and a bespoke selection of activities which supervisors deploy as they judge necessary.

Potential impact

As a core part of its work, the PRA assesses the ‘potential impact’ that firms could have on financial stability or policyholders by failing, coming under stress, or the way it carries on its business. The PRA divides all firms it supervises into five “categories” of potential impact. The intensity of supervision applied to firms will vary in proportion to this.

A firm’s potential impact depends both on the functions it provides and its significance within the system. In broad terms, the critical economic functions that firms provide are: payment, settlement and clearing; retail banking; corporate banking; intra-financial system borrowing and lending; investment banking; custody services; life insurance; and general insurance. The scale of a firm’s potential impact depends on its size, complexity, business type and interconnectedness with the rest of the system.

Proximity to failure and resolvability

The PRA will also vary the resource it applies to firms based on their proximity to failure and resolvability, given the possible adverse effects of disorderly firm failure on its objectives. Judgements about a firm’s proximity to failure are encapsulated in the PRA’s Proactive Intervention Framework.

Establishing context

Any assessment of the risks facing firms requires an understanding of the external context in which they operate. The PRA’s supervision therefore includes an assessment of how system-wide risks, for example from low interest rates, excess credit growth or international imbalances, are likely to affect firms. The PRA draws on work by other parts of the Bank, including the views of the Financial Policy Committee (FPC) on the macroprudential environment, in forming its view.

The PRA also considers the particular risks that a firm faces and poses given its individual business model, in the context of that external economic environment. The PRA examines both the threats to the viability of a firm’s business model and the ways in which a firm could create adverse effects on other participants in the system by the way it carries on its business. This analysis includes an assessment of where and how a firm makes money, the risks it takes in so doing, and how it funds its activities. The analysis take places at the level of the sector or the individual firm, as appropriate, with peer analysis providing an important means of identifying firms that pose different risks relative to their sector.

Supervisory activities

The PRA is not formulaic about the supervisory activities it performs to assess the risks that firms pose to its objectives, since its focus on the issues that pose the greatest risk means that its work depends on a firm’s particular circumstances. For every firm its work comprises a selection of activities which supervisors deploy as they judge necessary. For example, the PRA:

  • makes use of data gathered in firms’ regulatory returns, information in the public domain (for example, annual reports);
  • makes use of other firm-specific data such as management information or forecasts;
  • requires firms to participate in meetings with supervisors, focusing both on strategic issues and analytical work;
  • conducts, as appropriate, detailed on-site testing, including stress testing;
  • uses its statutory powers to gather information or commission Skilled Person reports where necessary.