Assessing capital adequacy under Pillar 2

Policy Statement 17/15 | Consultation Paper 1/15

Assessing capital adequacy under Pillar 2 - PS17/15

Update published on 3 August 2015

PS17/15 has been updated to align references to the updates made in Supervisory Statement 31/15 ‘The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP)’  to incorporate a new chapter on reverse stress testing. This update does not change the PRA’s policy as set out in the original statement, published on 29 July 2015.

PDFPolicy Statement 17/15 UPDATE - August 2015

Published on 29 July 2017

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:

PDFThe 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’.

PDFPolicy Statement 17/15 (including Appendix 1)

Appendices

Supervisory Statement 31/15

Statement of Policy

Supervisory Statement 32/15


Assessing capital adequacy under Pillar 2 - CP1/15

Update 29 July 2015

The PRA published:

Update 30 April 2015

The PRA published consultation on a new reverse stress testing section for supervisory statement ‘The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP)’. See CP17/15 PRA Rulebook: Part 3 for further details.

Published on 19 January 2015

Background

This consultation paper (CP) sets out proposed changes to the PRA’s Pillar 2 framework for the banking sector, including changes to rules and supervisory statements. Under the Pillar 2 framework, the PRA assesses those risks either not adequately covered, or not covered at all, under Pillar 1 capital requirements, as well as seeking to ensure that firms can continue to meet their minimum capital requirements throughout a stress. It also introduces the content of a proposed new statement of policy: The PRA’s methodologies to setting Pillar 2 capital. This sets out the methodologies that the PRA proposes to inform its setting of firms’ Pillar 2A capital requirements.

The proposed policy 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 the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD). It is also intended to encourage firms to develop and use better risk management techniques in monitoring and managing their risks. Pillar 2 therefore acts to further the safety and soundness of firms, in line with the PRA’s objectives. The PRA intends that the publication of its proposed methodologies to set Pillar 2 capital will help firms to understand the rationale for the PRA’s decisions and plan capital accordingly. CP1/15 continues the reform of Pillar 2 following the PRA’s consultation on changes to the framework in CP5/13 and final policy in PS7/13.

This consultation is relevant to banks, building societies and PRA-designated investment firms (‘firms’).

Proposals covered by the CP

The CP covers the following:

  • Overview and background on the proposed Pillar 2 framework.
  • Pillar 2A methodologies, including the proposed new approaches the PRA will use for assessing Pillar 2A capital for credit risk, operational risk, credit concentration risk and pension obligation risk, alongside the existing approaches for market risk, counterparty credit risk and interest rate risk in the non-trading book (usually referred to as interest rate risk in the banking book (IRRBB)). It also details the proposed associated data requirements.
  • The PRA buffer and how the PRA proposes to operate this new buffer regime.
  • Governance and risk management, including proposals to tackle significantly weak governance and risk management under Pillar 2. 
  • Disclosure, including the impact of the proposed Pillar 2 reforms on capital disclosure and proposals for a more transparent regime. 
  • Analysis on the impact of the proposed reforms. 

The reader is also referred to Appendices covering the: 

  • draft rules on Pillar 2 reporting, including reporting templates and instructions; 
  • draft supervisory statement: The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP); and 
  • draft statement of policy: The PRA’s methodologies for setting Pillar 2 capital. 

Responses

This consultation closed on Friday 17 April 2015.

PDFConsultation Paper 1/15

Reporting templates and instructions contained in Appendix 1

The templates and guidance notes below include links to the documents contained in Appendix 1 of CP1/15. Readers should refer to the draft rules, supervisory statement and statement of policy in the consultation paper to determine which templates they may need to submit. The PRA welcomes feedback on the templates and log files, including the required data and the accompanying instructions.

The full sets of templates and guidance notes can be found here.

ExcelPillar 2 data templates

PDFPillar 2 guidance notes

The reporting schedule provides a summary of the Pillar 2 reporting requirements.

PDFReporting schedule

Guidance on terms used in the templates is set out in the attached document.

PDFGuidance on terms used

Each Excel template has a corresponding log file which includes notes on how to complete the template.

Number and template name Template LOG file
Summary of P2 data template
FSA071 - Firm information and
Pillar 2 Summary assessment
ExcelDownload template PDFDownload PDF

Operational Risk Templates

FSA072 - Pillar 2 OpR Historical losses
FSA073 - Pillar 2 OpR Historical Loss Details
FSA074 - Pillar 2 OpR Forecast Losses
FSA075 - Pillar 2 OpR Scenario Data

Excel Download template 
PDF Download PDF
Credit Risk Standardised Approach Templates
FSA076 - Pillar 2 Credit
Standardised Approach Wholesale
FSA077 - Pillar 2 Credit
Standardised Approach Retail
Excel Download template  PDF Download PDF 

Concentration Risk Templates

FSA078 - Pillar 2 Concentration
Minimum data requirements
FSA079 - Pillar 2 Concentration
Additional data requirements

Excel Download template  PDF Download PDF 

Market Risk Template

FSA080 - Pillar 2 Market Risk

Excel Download template  PDF Download PDF 

Pension Risk Template

FSA081 - Pillar 2 Pension Risk

Excel Download template  PDF Download PDF 

Credit Risk Internal Ratings
Based Approach Templates

FSA082 - Pillar 2 Credit IRB retail

Excel Download template  PDF Download PDF 
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