The Government has today launched a Recovery Loan Scheme (‘RLS’) as part of its continued Covid-19 support for UK businesses, as previously announced by HM Treasury on 3 March 2021.
This statement sets out the PRA’s observations on whether the guarantees provided by the Secretary of State for Business, Energy and Industrial Strategy under the RLS are eligible for recognition as unfunded credit risk mitigation (CRM) under the UK Capital Requirements Regulation (‘the CRR’).
This statement does not provide an exhaustive description of the prudential requirements that apply to loans extended by participating banks to businesses under the RLS, nor is it a comprehensive description of the regime under which CRM techniques impact the calculation of risk-weighted exposure amounts. Firms are encouraged to review relevant articles of the CRR, and any relevant PRA rules and guidance (including expectations set out in the PRA’s Supervisory Statement on credit risk mitigation – SS17/13 ‘Credit risk mitigation’). For example, we expect firms to fully understand the duties and standards of care imposed on participating firms, and have appropriate systems and controls to ensure they are able to comply with the terms of the scheme.
Where necessary, firms should seek independent advice to confirm that all the applicable requirements and expectations have been satisfied.
In the continuing extraordinary situation brought about by Covid-19, it remains challenging for many businesses to provide forecast financial information with a high degree of confidence to support firms’ loan underwriting processes. Given that, we continue to expect lenders to use their judgement on what information is required to make credit decisions. Lenders are reminded that they should consider the range of information available to them including (but not limited to): the performance of the business prior to the Covid-19 outbreak; a view of how the loan will be repaid in due course, relying on judgement in the absence of financial forecast information; and the general prospects for the sector in which the business operates once the effects of the pandemic have receded.
CRM eligibility of the RLS guarantee
A guarantee is one form of unfunded credit protection which, where it meets the conditions in Articles 194 and 213-215 CRR, may allow a firm to adjust risk weights and expected loss amounts. The RLS guarantee is provided by the Secretary of State in the context of the Covid-19 pandemic. Under the terms of the guarantee, the Secretary of State may set a limit on the aggregate number of claims (the ‘Claim Limit’) that a lender can make for a future ‘Scheme Period’ in respect of an RLS facility.
The PRA considers that for ‘Scheme Periods’ where the ‘Claim Limit’ is set at not less than 100%, the terms of the guarantee provided by the Secretary of State under the RLS do not contain features that would render the guarantee ineligible for recognition as unfunded credit risk protection, and the effects of the guarantee would appear to justify such treatment. Were the Claim Limit to be set lower for subsequent Scheme Periods this guidance would not apply, and the effect of the guarantee on regulatory capital requirements would need to be carefully assessed against the law and guidance applicable at the time.
Additional observations on RLS scope of protection
Not all the RLS guarantees include cover for interest and fees. In accordance with the CRR, firms recognising the RLS guarantee as eligible unfunded protection in relation to an exposure are required to adjust the exposure amount to exclude elements not covered by the RLS guarantee.