PS15/26 – Pillar 2A review – Phase 1

1: Overview

1.1 In consultation paper (CP) 12/25 – Pillar 2A review – Phase 1, the Prudential Regulation Authority (PRA) proposed updates to Pillar 2A methodologies and guidance as the first phase of a two-stage review. Pillar 2A capital requirements are set for firms to address risks not already, or not sufficiently, captured by Pillar 1.

1.2 The CP marked the beginning of a programme of work to modernise the PRA’s approach to Pillar 2A capital by improving the information, guidance and transparency around the setting of Pillar 2A capital over time. It also outlined the PRA’s proposals to address the consequential impacts of the PRA rules that would implement the Basel 3.1 standards.^{footnote [1]} In particular, the Pillar 2A credit risk proposals were to: (i) address areas of undercapitalisation that remained in the Standardised Approach (SA) framework, and (ii) update the approach to idiosyncratic risk given the improvement in risk capture under the Basel 3.1 standards. Other proposals in the CP were intended to be the first steps in improving information, guidance and transparency for firms, including about the methodologies used by the PRA to inform the setting of Pillar 2A capital. The PRA also proposed certain changes to improve the proportionality of the policy and reduce reporting burden.

1.3 This policy statement (PS) provides feedback to responses to CP12/25. It also contains the PRA’s final policy, as follows:

• amendments to the Reporting Pillar 2 Part of the PRA Rulebook (Appendix 2);
• updated statement of policy (SoP) 5/15 – The PRA’s methodologies for setting Pillar 2 capital (Appendix 3);
• updated SoP5/25 – The PRA’s methodologies for setting Pillar 2 capital for Small Domestic Deposit Takers (SDDTs) (Appendix 4);
• updated supervisory statement (SS) 31/15 – The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP) (Appendix 5);
• updated SS4/25 – The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP) for Small Domestic Deposit Takers (SDDTs) (Appendix 6);
• updated SS32/15 – Pillar 2 reporting (Appendix 7);
• updated Pillar 2 reporting schedule (Appendix 8); and
• updated Pillar 2 data items and instructions (FSA072–FSA076 and FSA081) (Appendix 9).

1.4 This PS is relevant to all PRA-regulated banks, building societies, designated investment firms, all PRA-approved or PRA-designated holding companies, including those which are Small Domestic Deposit Takers (SDDTs)^{footnote [2]} (collectively ‘firms’). Please see individual chapters in this PS for details on the applicability to firms. This PS is not relevant to credit unions.

1.5 This PS is structured into the following chapters, similar to the structure of the CP. Some areas are rearranged to better respond to related issues. The responses have been grouped as follows:

• Chapter 2 – Credit risk
• Chapter 3 – Operational risk
• Chapter 4 – Pension obligation risk
• Chapter 5 – Market risk and counterparty credit risk
• Chapter 6 – General responses

1.6 Following the completion of this first phase of Pillar 2A review, the PRA will conduct a more in-depth review of certain individual methodologies within Pillar 2A. The PRA will publish a further CP on these proposals in 2027.

Summary of responses

1.7 The PRA received 20 responses to the CP. Respondents to the CP who consented to their names being published are set out in Appendix 1. As well as those who consented, the PRA received three responses from respondents who did not consent to publication of their names.

1.8 Respondents generally welcomed the PRA’s commitment and intention to address the consequential impacts of the implementation of the Basel 3.1 standards, as well as increase the transparency and proportionality of the PRA’s policy. In many areas, respondents requested that the PRA further reduce complexity, increase proportionality and provide clarity.

1.9 The PRA received the most responses on the credit risk proposals. In this area, respondents expressed a range of views, with comments focused on:

• the case to retain the benchmarking methodology;
• the calibration and scope of the two proposed systematic methodologies for certain exposures; and
• the level of prescription and the proportionality of the proposed approach to assessing idiosyncratic credit risk.

1.10 The PRA received several responses that did not relate directly to the draft policy in CP12/25. Instead, these responses were related to areas such as phase 2 of the Pillar 2A review, the refined methodology to Pillar 2A, and the Strong and Simple framework. The PRA has not provided feedback to these responses in this PS, and would encourage respondents to refer to the below PSs for further details on the PRA’s feedback and final policy in these areas:

• PS7/25 – Update to PS9/24 on the SME and infrastructure lending adjustments;
• PS2/26 – Retiring the refined methodology to Pillar 2A – final; and
• PS4/26 – The Strong and Simple Framework: The simplified capital regime for SDDTs – final.

Changes to draft policy

1.11 Having considered the responses to CP12/25, the PRA has made changes to the draft policy materials for the purpose of providing greater detail and increasing clarity where it considers appropriate. In addition, the PRA has also made minor editorial amendments to refresh obsolete references and improve consistency in its policy materials. The more material changes are highlighted below, with further details provided in the relevant chapters in this PS:

• credit risk: excluding exposures to SMEs from the systematic methodology for unconditionally cancellable commitments in the retail exposure class (retail UCCs);
• credit risk: providing greater flexibility in how firms are expected to assess their idiosyncratic credit risks, compared to the CP proposal to introduce expectations for firms to use credit scenarios;
• operational risk: clarificatory updates to improve transparency and guidance for all firms, and changes to the SDDT policy materials to align the operational risk Pillar 2A methodology for SDDTs and non-SDDTs;^{footnote [3]} and
• implementation date: setting the implementation date for all final policy and rules in this PS as Friday 1 January 2027.

Implementation and next steps

1.12 The amended Reporting Pillar 2 Part of the PRA Rulebook, reporting templates, reporting instructions and schedule, SSs and SoPs will come into force on Friday 1 January 2027.

1.13 References related to the UK’s membership of the EU in the SS and SoP covered by the policy in this PS have been updated to reflect the UK’s withdrawal from the EU. Unless otherwise stated, any remaining references to EU or assimilated legislation refer to the version of that legislation which forms part of assimilated law.^{footnote [4]}

PRA’s accountability framework

1.14 Before making any proposed rules, the PRA is required by the Financial Services and Markets Act 2000 (FSMA) to have regard to any representations made to it in response to the consultation, and to publish an account, in general terms, of those representations and its feedback to them.^{footnote [5]} In this PS, the ‘Summary of responses’ section above contains a general account of the representations made in response to the CP. The subsequent individual chapters in this PS contain the PRA’s feedback to responses to individual risk areas, and its final decisions.

1.15 When making rules, the PRA is required to comply with several legal obligations. In CP12/25, the PRA published its explanation of why the CP proposals (including rules) were compatible with its objectives and with its duty to have regard to the regulatory principles.^{footnote [6]}

1.16 The ‘Changes to draft policy’ section above refers to that explanation, taking into account consultation responses where relevant. The PRA considers that the CP explanation remains valid but has updated the analyses to reflect the final policy, with details provided in the relevant chapters in this PS.

1.17 Following CP12/25, the PRA has made minor changes to the draft rule instrument. Where the final rules differ from the draft in the CP in a way which is, in the opinion of the PRA, significant, the FSMA^{footnote [7]} requires the PRA to publish:

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

1.18 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.^{footnote [8]} The PRA considers this to be the case in this PS. The PRA considers that changes in the draft policy and rules are not significant in terms of the anticipated impact on firms. The PRA does not consider that the impact of the final policy and rules in this PS would have a significantly different impact on mutuals relative to the impact of the draft policy and rules on mutuals, or relative to the impact of the final policy and rules on other PRA-authorised firms. In the relevant chapters in this PS below, the PRA has updated the CBA relating to the final policy for credit risk and operational risk to provide more details as appropriate.

1.19 In this PS, the PRA has decided to implement the policy as proposed for pension risk and market and counterparty credit risk, with minor changes compared to the initial proposals in the CP. For these proposals, the PRA considers that the CBA in CP12/25 remains valid.

1.20 The PRA also maintains the view that the changes proposed in the CP, and the final policy as confirmed in this PS, do not meet the materiality threshold for CBA Panel review as outlined in SoP14/24 – The PRA’s approach to CBA.^{footnote [9]}

2: Credit risk

Introduction

2.1 This chapter provides feedback to responses to Chapter 2 of CP12/25 and sets out the PRA’s final policy. In CP12/25, the PRA proposed the following relating to credit risk:

• removing the benchmarking methodology (including the internal ratings based (IRB) approach benchmarks) set out in the existing SoP5/15; 
• introducing two systematic methodologies to assess the two areas where the PRA considered firms’ capital requirements would often be underestimated under the Pillar 1 SA: (i) exposures to central governments or central banks (CG/CBs) and exposures to regional governments or local authorities (RG/LAs); and (ii) retail UCCs; and
• introducing expectations for firms to use credit scenarios to assess the idiosyncratic risks in their book, ensuring firms are adequately capitalised for credit risks arising from their SA exposures.

2.2 The PRA also proposed related changes to reporting requirements which would have the overall effect of reducing the number of data points reported by firms.

2.3 This chapter is relevant to banks, building societies, PRA-designated investment firms and all PRA-approved or PRA-designated holding companies. This chapter does not apply to firms that opt in to the SDDT regime, except for a consequential update related to Basel 3.1 that was made to paragraph 2.22 in the draft SS4/25, regarding the eligibility of guarantees and credit derivatives as Credit Risk Mitigation (CRM).

2.4 The PRA received 19 responses to the credit risk proposals. Having considered the responses, the PRA has decided to maintain parts of its CP proposals, whilst amending other parts, as detailed in the following sections.

Removal of the benchmarking methodology

2.5 In CP12/25, the PRA proposed to remove the benchmarking methodology (including the IRB benchmarks), as it considered this would no longer be an appropriate approach to assess potential credit risk underestimation under the SA.

2.6 Four respondents supported the proposal, stating that the removal of the IRB benchmarking methodology would allow them to focus on other assessments of credit risk, rather than compliance with the benchmarking methodology. One respondent noted the proposal to replace the benchmarking methodology with systematic methodologies would promote consistency.

2.7 Eight respondents disagreed with the removal of the benchmarks, noting that they found the benchmarks helpful in informing their ICAAP assessments. Some respondents also expressed concerns that differences may persist between IRB approach and SA risk weights after the implementation of the Basel 3.1 standards, which could give rise to potential competition issues. While acknowledging that data availability might be more limited going forward, some respondents suggested that the PRA should continue to publish selected benchmarks (eg Probability of Default (PD) tables for residential mortgages) in order to enhance transparency and support firms’ own assessments. Three respondents requested that the PRA provide additional details in the CBA in relation to the removal of the benchmarking methodology.

2.8 Having considered the responses, the PRA has decided to maintain the proposal to remove the benchmarking methodology. As set out in CP12/25, the implementation of the Basel 3.1 standards will enhance the risk capture and risk sensitivity of the SA, such that SA risk-weighted assets (RWAs) will generally better reflect the relative riskiness of firms’ portfolios. The PRA explained in the CP its view that IRB risk weights are not always an appropriate comparator to SA risk weights. The PRA also explained how the implementation of the Basel 3.1 standards would also reduce the feasibility of maintaining IRB benchmarks. The PRA did not receive persuasive evidence to change this proposal.

2.9 The PRA acknowledges that the current benchmarking methodology is mechanical and, for some firms, operationally simple. However, the PRA considers that the introduction of the systematic methodologies will provide a more targeted and appropriate tool than the broad benchmarks, while reducing firms’ reporting requirements (ie through a simplified FSA076, and decommissioned FSA077).

2.10 The PRA does not intend to publish benchmarks as a reference to support firms’ own assessments in their ICAAP, as it considers that these will be of limited benefit following the implementation of the Basel 3.1 standards and would increase reporting and operational burden on some firms and the PRA.

Systematic methodology for exposures to central governments and central banks (CG/CBs), and regional governments and local authorities (RG/LAs)

2.11 In CP12/25, the PRA proposed ‘minimum effective risk weights’ in Pillar 2A for non-UK central government and central bank (CG/CB) and regional government and local authority (RG/LA) exposures, to contribute to the setting of Pillar 2A add-ons where Pillar 1 SA risk weights may not adequately reflect the riskiness of the exposure, following application of the treatments set out in Capital Requirements Regulation^{footnote [10]} (CRR) Articles 114(7) or 115(4).^{footnote [11]}

Table 1: Minimum effective risk weights proposed in CP12/25

2.12 One respondent supported the overall proposal. Four respondents disagreed with the proposal, citing competitiveness concerns, the necessity of holding local reserves and debt to support overseas operations, and an argument that the proposals go beyond the Basel standards. One respondent expressed concern that the use of the Pillar 2A systematic methodologies may undermine the principle of self-assessment. One respondent sought more details on how the PRA had calibrated the minimum effective risk weights.

2.13 Three respondents disagreed with the proposed 5% risk weight floor for CQS2/3 CG/CB exposures in particular. One respondent challenged the PRA’s use of external credit assessment institution default rate data where the outcome window exceeded one year, given that capital is to cover unexpected losses over the one-year horizon. The respondents also made suggestions, including: a 2.5% minimum effective risk weight for CQS2/3 CG/GB exposures, relying on capitalisation via Pillar 2B, or addressing the risk of undercapitalisation via the equivalence process instead. Two respondents expressed concern that this part of the proposal would worsen diversification of firms’ portfolios by incentivising firms to hold UK exposures, potentially resulting in higher countercyclical capital and Pillar 2B buffers.

2.14 Respondents raised two issues relating to interactions with the CRM framework. For RG/LA exposures, one respondent argued that the minimum effective risk weights do not reflect the lower risk of RG/LA exposures where they are guaranteed by a CG/CB. One respondent argued that the part of any exposure which is secured by sovereign collateral and recognised through the Financial Collateral Simple Method (FCSM) should be excluded from the minimum effective risk weight, reflecting the haircut to the value of the collateral which is required in Pillar 1.

2.15 Having considered the responses, the PRA has decided to maintain its proposals, with the exception that it has decided to remove exposures secured by collateral recognised through the FCSM from the scope of the systematic methodology. The PRA also clarifies that the calibration of the minimum effective risk weights was informed by its own analysis, which drew on a mix of sources, such as firms’ regulatory returns, external data and research, including external credit assessment institutions’ historical default rate data referenced in CP12/25.

2.16 After conducting further analysis on whether the PRA’s proposals would impact the competitiveness of UK firms when operating overseas, the PRA continues to conclude that this is unlikely. The PRA notes that other comparable jurisdictions use the Pillar 2 framework to address credit risks that are not fully captured under Pillar 1. Further, the PRA observes that certain jurisdictions continue to permit IRB modelling for CG/CB and RG/LA exposures, which will result in positive Pillar 1 risk weights.

2.17 The PRA also notes that respondents’ comparisons to the Basel standards were not like-for like, as they compared the Pillar 2 treatment with standards for Pillar 1. The PRA notes that the Pillar 2 supervisory review process under the Basel framework sets out expectations for firms to ‘have methodologies that enable them to assess the credit risk involved in exposures to individual borrowers or counterparties as well as at the portfolio level’,^{footnote [12]} which the PRA’s proposals are consistent with.

2.18 The PRA considers it unlikely that its proposals would result in a material reallocation of exposures from overseas exposures to UK exposures, given the estimated size of the capital add-on, and firms’ wider motivations for holding non-UK exposures.

2.19 The PRA has re-examined its use of external credit assessment institution’s default data which informed the proposals, in order to evaluate respondents’ comments about the interpretation of the data. The PRA continues to consider that it is appropriate to assess the credit risk of CQS2/3 exposures relative to CQS1 with reference to default data for outcome horizons longer than 1 year. The PRA considers that the absence of positive 1-year default rates for CQS2/3 within the period of data available (1993–2003) does not necessarily imply that the forward looking 1-year probability of default is also zero. This is due to the inherent uncertainty involved in inferring PDs for low default portfolios. The PRA therefore considers that it remains appropriate for it to consider data from longer outcome windows to infer differences in risk between CQS2/3 and CQS1 exposures. The PRA also notes that the definition of default used for the external credit assessment institution’s study, including the treatment of distressed restructurings, is broadly consistent with the definition used in PRA rules.

2.20 The PRA considers that its proposal of a 5% minimum effective risk weight for CQS2/3 CG/CB exposures remains an appropriate calibration. To evaluate respondents’ arguments for a 2.5% minimum effective risk weight, the PRA has inputted various Loss Given Default values and PD values into the IRB formula, but found that implausibly low input values were required to generate a risk weight as low as 2.5%. The PRA also considers that it would not be appropriate to capitalise sovereign credit risks through Pillar 2B stress testing alone. As set out in the Bank of England’s December 2025 ‘Financial Stability in Focus: The FPC’s assessment of bank capital requirements’ publication, risk-based capital requirements comprise buffers, Pillar 1 and Pillar 2A, which have different purposes. Pillar 2B stress testing informs the setting of buffers, which are held alongside – and not instead of – the total capital requirements (TCR) comprising Pillar 1 and Pillar 2A.

2.21 Regarding the approach to RG/LA exposures, the PRA notes that exposures to RG/LAs, which are subject to a guarantee from a CG/CB that is eligible under the Credit Risk Mitigation (CRR) Part of the PRA Rulebook, will be subject to the minimum effective risk weight for CG/CBs for the purpose of calculating the systematic add-on. The PRA considers it appropriate for exposures to RG/LAs which are not covered by a CRM-eligible guarantee from a CG/CB to be subject to the minimum effective risk weight for RG/LAs, reflecting the lower risk mitigation provided by guarantees that are not CRM-eligible, and aligning the recognition of guarantees with Pillar 1. However, the PRA notes that an exposure to an RG/LA with an eligible CQS1 central government or central bank guarantee will not incur additional capital requirements as a result of this systematic approach.

2.22 As noted above, the PRA has decided to exclude exposures secured by collateral recognised through the FCSM from the systematic methodology in the final policy. The PRA considers that the haircut to the value of the collateral that can be recognised under the FCSM in Pillar 1 may not provide adequate risk mitigation in all circumstances. The PRA recognises, however, that the combination of the haircut and Pillar 2A systematic methodology may be overly conservative and does not consider that a bespoke systematic methodology for these exposures would be proportionate.

Systematic methodology for retail UCCs

2.23 In CP12/25, the PRA proposed to introduce a methodology to address the risk of undercapitalisation of retail UCCs in Pillar 1 SA. This was informed by the PRA’s analysis which showed that the 10% Pillar 1 SA conversion factor (CF) for retail UCCs was substantially below that of firms using the IRB approach, and that capital requirements for similar exposures were on average 23% higher for these firms than for firms using the SA.^{footnote [13]}

2.24 As explained in CP12/25, the PRA considered that a new capital treatment in Pillar 2A was the most appropriate way to address this potential undercapitalisation (rather than increasing the Pillar 1 CF across the board) because of the flexibility it affords to reflect firms’ individual circumstances. This enables firms to continue to use a CF that may be higher or lower than the reference point (floored at the Pillar 1 CF treatment), where they have robust evidence that this is adequate.

2.25 The PRA proposed that a firm’s relevant add-on would be equal to the difference between applying the Pillar 1 CF of 10% and:

• a prescribed CF reference point of 20%; or
• a CF provided by the firm, where the PRA considers the CF to be robustly substantiated.

Calibration of the methodology

2.26 Six respondents argued that the assumptions used by the PRA to calibrate the CF reference point were not reflective of their portfolios. Respondents also argued that the reference point was super-equivalent to the Basel standards, placing UK lenders at a competitive disadvantage internationally.

2.27 Having considered the responses, the PRA has decided to maintain the calibration of the CF reference point at 20%. Respondents did not provide data to substantiate their claims regarding the appropriateness of the calibration, and the PRA considers its initial analysis in the CP remains robust and reflects the best data available to it. As such, the PRA considers that this calibration is necessary to address the Pillar 1 underestimation of the risk of drawdown associated with these exposures in a default event.

2.28 On respondents’ comments about international competitiveness, the PRA notes that Pillar 2 approaches vary across jurisdictions. Therefore, assessing the implications for UK competitiveness via direct comparison with other jurisdictions is challenging. However, the PRA considers that retail lending by most UK firms is domestically focussed, and that its final policy should therefore not materially impact the international competitiveness of most UK firms.

2.29 Three respondents argued that new and growing banks would be at a disadvantage, as they are less likely than established banks to have sufficient data to challenge the CF reference point. One of the respondents queried whether the PRA would publish acceptable proxy data sources that these firms may use as an alternative. The PRA observes that the analysis informing the calibration included data from new and growing firms as well as established firms. Therefore, the PRA considers that the CF reference point has been calibrated to be appropriate for a wide range of firms. The PRA also notes that paragraph 2.13I of SoP5/15 sets out what the PRA considers to be robustly substantiated data. The PRA therefore does not intend to publish and maintain a list of acceptable proxy data sources.

Scope of the systematic methodology for retail UCCs

2.30 Three respondents highlighted that the PRA’s analysis that informed the calibration of the retail UCC methodology was based on QRRE data that covered UCCs to individuals, but not to retail SMEs. Respondents argued that SME-specific UCC facilities have different characteristics to those extended to individuals and that the methodology should therefore not be applied to UCCs to retail SMEs. Furthermore, respondents stated that the proposed methodology would impact the availability of finance to SMEs.

2.31 The PRA acknowledges that the QRRE data used in its initial analysis only included exposures to individuals. In light of this, the PRA accepts that its proposed methodology may not be appropriate for retail SMEs in all cases. The PRA also recognises respondents’ concerns regarding the potential impact on UK competitiveness and growth of even limited increases in capital requirements for SME lending.

2.32 The PRA has therefore amended its proposal and removed SMEs from the scope of the systematic methodology for retail UCCs. The PRA considers that this will not materially impact its primary objective, as regulatory reporting data indicates that retail UCCs to SMEs are generally of low materiality. The PRA will continue to monitor the appropriateness of this policy and may reconsider its approach should evidence emerge that UCCs to retail SMEs are systematically undercapitalised in Pillar 1.

Other issues related to the systematic methodology for retail UCCs

2.33 One respondent requested that the PRA apply a materiality threshold for the systematic methodology for retail UCCs, such that only firms with material retail UCC portfolios would be expected to apply the CF reference point. The respondent argued this would be in line with the materiality threshold applied to portfolios in scope of the proposed credit scenarios.

2.34 Having considered the response, the PRA has decided not to introduce a materiality threshold. The PRA considers that the relatively mechanical nature of the systematic methodologies allows them to be applied by firms without incurring significant operational costs.

2.35 One respondent supported increasing the capital requirements for retail UCCs but requested that the PRA do so in Pillar 1 to ensure a consistent approach between firms. Having considered the response, the PRA has decided not to change the design of the methodology. The PRA considers that the flexibility provided by its systematic methodology ensures that firms are able to apply a lower CF that is reflective of the risks of their portfolio where this can be robustly substantiated.

2.36 One respondent sought clarification on how the PRA will convert an underestimation of RWAs to an underestimation of capital requirements, when calculating a firm’s Pillar 2A capital requirements generated by the systematic methodology for retail UCCs. Having considered this response, the PRA has amended the formula in paragraph 2.13E of draft SoP5/15 to clarify that the RWA underestimation will be multiplied by 8% in order to obtain the capital requirements underestimation. The PRA has also made a similar amendment to the formula in paragraph 2.13H of draft SoP5/15 in relation to the systematic methodology for exposures to CG/CB or RG/LA.

Approach to assessing idiosyncratic credit risk

2.37 In CP12/25, the PRA proposed to introduce expectations that firms use credit scenarios to assess their idiosyncratic credit risk. This would inform the PRA’s assessment of whether firms are adequately capitalised for credit risk across exposures on the SA. The PRA proposed to introduce expectations for firms on the severity of credit scenarios, to ensure that they were applied consistently.

2.38 The PRA received 16 responses to this proposal. While some respondents welcomed the introduction of credit scenario expectations, the PRA received several responses requesting the PRA clarify or amend the proposal:

• Five respondents requested more flexibility in the methodology of assessment. Respondents argued that the principle of Pillar 2 is for firms to take responsibility for ensuring their own capital adequacy. They cited alternative methods, such as economic capital models and greater flexibility on proxy IRB approaches, that the PRA should consider permitting alongside credit scenarios.
• Two respondents stated that credit scenarios would need substantial resources to set up, and that expecting firms to assess their entire portfolio would be disproportionate. They requested that the PRA limit the scope of credit scenarios to exposures that are deemed high risk.
• Nine respondents stated that the PRA’s guidance on credit scenarios was too high level, and requested more detail on their severity, design and application.
• One respondent requested that the PRA clarify its expectations for the scenario analysis of foreign sovereign debt.
• One respondent requested further details on the costs and benefits of the proposed expectations on firms’ use of credit scenarios.

2.39 Having considered the responses, the PRA has amended its proposed expectations relating to the assessment of idiosyncratic credit risk. Under the final policy, firms have greater flexibility to choose their approach to assessing idiosyncratic credit risk, rather than being expected to undertake credit scenario analysis. The PRA agrees that this more flexible approach is more proportionate and better aligns with the principle that the ICAAP is a firm-owned assessment. Additionally, under the final policy, detailed assessment will only be expected for a smaller subset of exposures. By enabling firms to apply a more high-level assessment of capital adequacy to portfolios where Pillar 1 is likely to be sufficient, the PRA expects to reduce the operational burden and cost of the Pillar 2A credit risk approach.

2.40 The PRA has therefore amended the draft SS31/15 to state that firms will only be expected to undertake detailed assessments for SA exposures that are more likely to have idiosyncratic credit risk that is not captured by Pillar 1 capital requirements (and where relevant, the Pillar 2A systematic methodologies). In order to promote consistency of application, the PRA has provided guidance on the types of lending that may require a more detailed assessment, which may include, but is not limited to:

• lending to niche markets which are more susceptible to economic fluctuations and industry-specific challenges;
• lending which consists of product types that are new to the market;
• lending with higher than typical market pricing due to elevated risk factors;
• portfolios where a firm observes a high variance in the rate of default over the previous 12 months; and
• for mortgages: sub-prime and near prime lending, shared equity, lifetime mortgages and retirement interest only mortgages.

2.41 The PRA considers that the inclusion of new products in the list above is not necessarily related to the inherent risk of these products, noting that they may be more or less risky than more traditional lending. However, given their innovative nature, the PRA considers that firms should give greater consideration as to how these risks are captured by the existing capital framework through a detailed assessment.

2.42 For more detailed assessments, firms are expected to ensure that their assessment is calibrated to a level of severity commensurate with Pillar 1 capital requirements, such that their Pillar 1 and Pillar 2A capital requirements are of sufficient capacity to absorb losses incurred in high-severity tail events over a 12-month horizon. These methodologies, which could involve credit scenarios, proxy IRB, or other approaches, should be robust and proportionate to the nature, scale and complexity of a firm’s activities. The PRA has amended the draft SS31/15 to set out expectations relating to the scope, quality, severity, and documentation of these approaches.

2.43 The PRA has also included additional CBA analysis of the changes to the final policy under ‘Cost benefit analysis’ section below in this chapter.

Proxy IRB approaches

2.44 In CP12/25, the PRA proposed that it would consider alternative assessments, including proxy IRB approaches, to inform its assessment of whether firms are adequately capitalised against credit risk for exposures on the SA. However, the PRA proposed that firms would not be able to use proxy IRB approaches where they were not available under Pillar 1.

2.45 Two respondents supported allowing proxy IRB approaches in the Pillar 2A credit risk assessment. Two respondents requested that the PRA allow wider use of proxy IRB approaches, provided a firm can justify their use in their ICAAP. Four respondents requested that the PRA clarify the meaning of a proxy IRB approach and the conditions under which proxy IRB approaches would be deemed acceptable.

2.46 The PRA clarifies that a proxy IRB approach is an approach to assessing idiosyncratic credit risk that is based on internal modelling similar to the IRB approach in Pillar 1. Examples may include a firm estimating risk parameters based on historical performance of its own credit portfolios, or a firm using the slotting approach. The PRA has amended the draft SS31/15 to clarify this point, with the same clarification made to the draft SS4/25 to ensure consistency in the SDDT regime.

2.47 Having considered the responses, the PRA has amended the draft SS31/15 such that firms have greater flexibility in assessing their idiosyncratic risks using proxy IRB approaches. Where a firm uses proxy IRB approaches in its detailed assessment, it should provide sufficient detail to enable the PRA to understand the modelling methodology and assumptions.

Issues affecting both idiosyncratic and systematic methodologies

Interaction of idiosyncratic credit risk assessments with systematic methodologies

2.48 In CP12/25, the PRA proposed that firms may, when running credit scenarios on their lending portfolios, assess whether credit risk exposures are adequately capitalised at a whole balance sheet level, allowing netting across different credit portfolios. In other words, firms may offset overcapitalisation identified in their Pillar 1 credit risk capital requirements (based on a detailed assessment of the characteristics of their exposures) with undercapitalisation identified in their credit scenarios. The PRA proposed that this would be appropriate only where firms can robustly substantiate the idiosyncratic factors in their portfolios that they consider to give rise to this overcapitalisation.

2.49 One respondent asked the PRA to clarify whether a firm could be subject to no credit risk add-on (including zero systematic add-ons) where this could be demonstrated through a firm’s ICAAP assessment.

2.50 Having considered this response, the PRA has amended the draft SoP5/15 to clarify that credit risk add‑ons derived from systematic methodologies (the ‘systematic components’), where applicable, constitute the baseline of a firm’s Pillar 2A credit risk add-ons and cannot be reduced through the idiosyncratic assessment. The PRA also clarifies that a firm’s Pillar 2A capital requirement for credit risk, where applicable, will consist of:

• the systematic components; and
• any additional capital requirements for idiosyncratic credit risk.

2.51 The PRA will continue to allow netting of overcapitalisation against undercapitalisation across different credit portfolios, where these have been subject to a detailed assessment under the firm’s chosen methodology for assessing idiosyncratic credit risk. However, the PRA has clarified in the draft SoP5/15 that it does not consider standard lending portfolios to be overcapitalised in Pillar 1. As such, the PRA would only reduce the size of a firm’s Pillar 2A credit risk add-on where a firm has provided robust and compelling evidence that the unique characteristics of the exposures in question mean that the PRA’s Pillar 1 rules are delivering a level of capitalisation that is materially higher than the underlying credit risk.

2.52 One respondent asked what specific expectations the PRA would have for credit scenarios relating to non-UK sovereign exposures under the proposed Pillar 2A framework. The PRA acknowledges that the systematic add‑ons for CG/CB exposures, and for RG/LA exposures, may be sufficient to capture idiosyncratic losses associated with exposures within the scope of the relevant add‑ons. Accordingly, the PRA has amended the draft SS31/15 to clarify that, where firms are satisfied that these risks are already sufficiently captured, firms need not undertake further assessment of these risks as part of their idiosyncratic credit risk assessment.

Exposures in scope of credit risk add-ons

2.53 Two respondents enquired how counterparty credit risk exposures which are assigned a risk weight in accordance with the credit risk SA should be treated. This is relevant both to the systematic methodologies, and firms’ own assessment of idiosyncratic credit risk.

2.54 Having considered the responses, the PRA has amended the draft SS31/15, SoP5/15 and FSA076 reporting instructions to clarify that all banking book and trading book exposures which are assigned a risk weight in accordance with the credit risk SA are within scope of the credit risk systematic methodologies. This fully aligns the guidance and reporting instructions with the amendments to the PRA rules which were originally proposed in CP12/25. The PRA has also clarified in SS31/15 that firms should assess whether the Pillar 1 risk weight (plus, where applicable, the Pillar 2A credit risk systematic add-on) is sufficient for these exposures as part of the firm’s assessment of idiosyncratic credit risk.

Interaction between Pillar 2A credit risk and other parts of the capital framework

2.55 The PRA received nine responses on how the proposed Pillar 2A credit risk methodology interacts with other parts of the capital framework. Respondents expressed concerns that the proposed credit scenario expectations could create an overlap in risk capture between the proposed Pillar 2A credit underestimation risk approach, the Pillar 2A credit concentration risk approach and/or the PRA buffer.

2.56 The PRA considers that Pillar 2A credit concentration risk, Pillar 2A credit underestimation risk, and the PRA buffer are all conceptually distinct. Pillar 2A forms part of minimum requirements and either captures risks not measured at all under Pillar 1 (eg credit concentration risk) and/or adjusts for inadequate risk measurement under Pillar 1 (eg credit risk). Specifically:

• Under Pillar 2A credit concentration risk, the PRA considers what additional capital might be needed for firms that have single name, sector or geographical concentrations. The Pillar 1 approach to credit risk does not consider the additional risks that firms may face from having an undiversified credit portfolio.
• Pillar 2A credit underestimation risk, on the other hand, focuses on areas where the SA for credit risk in Pillar 1 may underestimate risk due to the idiosyncrasies of a firm’s portfolios. For example, a firm heavily exposed to sub-prime mortgages may face significantly higher default risk than reflected under the SA. These risks would not be captured in credit concentration risk.
• Buffers, such as the PRA buffer, are set on top of minimum requirements and aim to ensure that firms can meet these requirements in a severe but plausible stress. These buffers generally assume that minimum requirements are already accurately set.

Reporting

2.57 The PRA received five responses supporting the proposal to streamline reporting by simplifying FSA076 and decommissioning FSA077 and FSA082. Respondents noted that the proposals would reduce reporting burden and improve alignment with the revised Pillar 2A framework.

2.58 Two respondents raised concerns that the simplified reporting could disproportionately affect firms that had previously relied on the benchmarking methodology and/or have the Pillar 2A refined methodology applied.

2.59 The PRA considers that the proposed changes to these templates are appropriate in light of the final policy. In particular, the Pillar 2A refined methodology will be retired with effect from 1 January 2027, as confirmed in PS2/26 – Retiring the refined methodology to Pillar 2A – final, and the associated reporting will therefore no longer be required. The streamlined reporting requirements are also consistent with the PRA’s intention of reducing reporting burden as appropriate.

2.60 One respondent queried how firms would report relevant sovereign exposures, how the proposals would apply to subsidiaries, and how a CQS would be assigned to relevant CG/CB and RG/LA exposures. After considering the response, the PRA notes that both the scope of firms subject to the systematic add-on, and the approach to assigning a CQS to an exposure for the purposes of the add-on, are set out in the Reporting Pillar 2 Part of the PRA Rulebook.

2.61 Further to the changes proposed in the CP, the PRA has made the following amendments to the FSA076 data item and instructions to enhance clarity:

• updating the instructions to the ‘Central governments, central banks, regional governments and local authorities’ table to clarify that it also captures certain counterparty credit risk exposures that are assigned a risk weight in accordance with CRR Articles 114(7) or 115(4); and
• updating the naming of items in the ‘Unconditionally cancellable commitments’ table in the FSA076 data item and instructions, to clarify that retail SME exposures are excluded.

Cost benefit analysis

2.62 In CP12/25, the PRA set out a CBA of the proposed changes to the Pillar 2A credit risk proposals and the estimated impact on firms’ overall capital requirements (with a stylised example). Overall, the PRA expected more firms may have Pillar 2A credit risk add-ons in the future due to the removal of the benchmarking methodology and the introduction of the two systematic methodologies. However, the PRA did not expect firms’ TCR across Pillar 1 and Pillar 2A to change substantially. The PRA also analysed that its reporting proposals would have the overall effect of reducing the number of data points reported by firms.

2.63 The PRA considers that the analysis set out in CP12/25 remains appropriate. In the PRA’s view, the amendments set out in this PS would not significantly increase costs for firms relative to the costs implied by the proposals in CP12/25. This section provides updates to the CBA as appropriate for the final policy.

Excluding exposures to SMEs from the systematic methodology for retail UCCs

2.64 The PRA does not expect the revised scope of the systematic methodology for retail UCCs to materially affect firms’ implementation and operational costs relative to its proposals, as firms are already required to identify exposures to SMEs for the purposes of Pillar 1 reporting. The PRA does not expect material changes to the resulting capital requirements, as regulatory reporting data indicates that retail UCCs to SMEs are generally of low materiality.

Providing greater flexibility for firms’ idiosyncratic credit risks assessments (compared to the CP proposal)

2.65 The PRA considers that this amendment reduces potential operational and compliance costs relative to the CP proposal, as firms have discretion to select approaches that are proportionate and less resource‑intensive, where firms can demonstrate they are suitably robust. The PRA also considers that this approach better aligns with the principle that the ICAAP is a firm‑owned assessment, while preserving the PRA’s ability to challenge firms’ methodologies and outcomes through supervision.

Impact on firms’ overall capital requirements

2.66 In CP12/25, the PRA set out its analysis that it did not expect the proposals to substantially change firms’ TCR across Pillar 1 and Pillar 2A in aggregate, although the impact on capital requirements for individual firms will vary, depending on their specific portfolios. The PRA considers that this analysis remains valid under the final policy.

2.67 One respondent requested that the PRA provide further detail on the impact of the proposals for mutual business models and mortgage lending.

2.68 The PRA does not consider that the final policy has an impact on mutuals or firms with mortgage‑focused business models that is materially different from other firms. Mutuals and more domestically focused firms could be less likely to be affected by the systematic methodology for CG/CB and RG/LA exposures, given their predominant holdings of UK government debt and reserves. Furthermore, firms with mortgage‑focused business models may also be less affected by the systematic methodology for retail UCCs, as these firms typically have limited exposures to unsecured retail lending. The final policy for addressing idiosyncratic credit risk also provides firms with more flexibility to assess Pillar 2A credit risk using methodologies that are most appropriate to their specific business activities.

PRA objectives analysis

2.69 In Chapter 2 of CP12/25, the PRA set out why it considered the proposals would advance its objectives. The PRA considers its objectives analysis in the CP remains valid, subject to the following updates.

2.70 The PRA considers that the final policy remains consistent with its primary objective of promoting the safety and soundness of firms. The changes made by the PRA, after considering the CP responses, should help ensure that firms are adequately capitalised for the risks that they face and maintain firms’ responsibility for assessing their own capital adequacy.

2.71 The PRA has also analysed the impact of changes in its final policy to its secondary objectives:

• The final policy is less prescriptive in how firms should assess idiosyncratic credit risk relative to the CP proposal. While this may result in greater variation in approaches across firms, the PRA considers that any resulting risks to effective competition are minimal. This reflects the expected low materiality of Pillar 2A credit risk add‑ons arising from idiosyncratic credit risks in practice, together with the benefits of increased proportionality and firm‑specific risk sensitivity.
• The PRA considers that the final policy is designed to enhance risk sensitivity and ensure firms are adequately capitalised, which supports economic growth by ensuring firms are able to absorb losses in a high severity tail event. Moreover, after considering the responses, the PRA has decided not to apply the systematic UCC methodology to retail SME exposures. The PRA considers that this is a more proportionate approach which will reduce any potential impacts on lending to the real economy.
• As explained in CP12/25, assessing the impact on international competitiveness of the PRA’s Pillar 2 framework via direct comparison with other jurisdictions is challenging, given the significant degree of supervisory judgement and discretion applied internationally under Pillar 2 frameworks. As set out in paragraph 2.28, the PRA does not consider that its final policy will materially impact the international competitiveness of UK firms. The PRA therefore considers that the final policy does not have material impact on the PRA’s secondary competitiveness and growth objective.

‘Have regards’ analysis

2.72 In developing the final policy set out in this chapter, the PRA has had regard to its framework of regulatory principles. In CP12/25, the PRA set out the regulatory principles it considered most significant to the Pillar 2A credit risk methodology. The PRA considers that this analysis remains valid, subject to the following updates:

• Proportionality of regulation (FSMA regulatory principles): The additional flexibility introduced in the final policy allows firms to select a methodology that is proportionate to their risk profiles and better tailored to firms’ specific circumstances.
• Recognition of differences between businesses (FSMA regulatory principles): The revised approach to idiosyncratic credit risk enables firms to tailor their assessments to their portfolios and risk management practices, while remaining subject to supervisory review to ensure robustness and consistency of outcomes across firms.
• Creating a regulatory environment which facilitates growth through supporting competition and innovation (HMT recommendations letter to PRC – November 2024): Please see details under objective analysis in paragraph 2.71.

3: Operational risk

Introduction

3.1 This chapter provides feedback to responses to Chapter 3 of CP12/25 and sets out the PRA’s final policy. In CP12/25, the PRA did not propose changes to its Pillar 2A operational risk methodology. Instead, the PRA proposed to update its policy materials to enhance the transparency of its methodology and provide more guidance to firms. The PRA proposed to:

• introduce clearer expectations on scenario analysis in SS31/15 to all firms to improve the quality and consistency of their ICAAP scenario analysis;
• provide greater transparency in SoP5/15, clarifying what factors the PRA considers when setting Pillar 2A capital requirements for operational risk for all firms, as well as additional factors considered for significant firms;^{footnote [14]}
• introduce a set of good practices for significant firms in maintaining a robust operational risk measurement framework in SS31/15 for firms to consider;
• make minor clarification changes to the instructions of FSA072–075 templates; and
• update references and obsolete terms across the policy documents, including removing specific requirements on firms with advanced measurement approach (AMA) permissions, given AMA would be removed with the implementation of the Basel 3.1 standards.

3.2 This section is relevant to all PRA-regulated banks, building societies, designated investment firms, and all PRA-approved or PRA-designated holding companies, including those which are SDDTs.

3.3 The PRA received comments from 14 respondents on the operational risk proposals in CP12/25. Respondents were generally supportive of the operational risk proposals. The following sections cover the PRA’s feedback, grouped by proposals in the CP.

Expectations on scenario analysis for all firms

3.4 In CP12/25, the PRA proposed clearer and more proportionate expectations for firms’ operational risk scenario analysis within the ICAAP. Eight respondents expressed broad support for the proposal. Several respondents requested further clarity and practical guidance on specific aspects of the PRA’s expectations. The PRA therefore has decided to proceed with the policy largely as consulted on, with minor refinements to reflect responses, set out below.

3.5 Three respondents requested clarification to avoid potential double counting of operational risk events across Pillar 2A and Pillar 2B, in particular, in relation to the treatment of conduct risk within Pillar 2A scenario analysis.

3.6 Having considered the responses, the PRA has amended the draft SoP5/15 to clarify its approach to assessing the capital required for conduct risk for significant firms. In its Pillar 2A assessment, the PRA focuses on the risk of losses arising from misconduct events that are currently unknown, as the potential losses associated with specific misconduct events that are already known are generally captured under Pillar 2B assessment. This clarification is intended to reflect the current practice, rather than a change in the PRA’s assessment.

3.7 Three respondents requested clarification of the PRA’s expectations for operational risk scenario analysis, including how scenarios may be aggregated. In response, the PRA has amended the draft SS31/15 to set out that a proportionate way for smaller firms is to use a simplified approach to aggregate individual scenarios, provided that the approach is justified and the resulting capital assessment remains prudent.

3.8 One respondent asked whether a single scenario may be used across multiple regulatory frameworks, including Pillar 2A, operational resilience, and operational continuity and resolution. The PRA clarifies that the relevant frameworks serve distinct purposes and are designed to address different regulatory considerations. While firms may draw on common underlying risk events to inform their analysis, the PRA does not consider it appropriate for a single scenario to be relied upon to meet multiple regulatory requirements.

3.9 One respondent asked whether insurance can be used as a capital offset. The PRA confirms that insurance is not permitted as a capital offset for Pillar 2A. The PRA also confirms that, in operational risk scenario analysis, firms should assess the potential impact of failures in risk mitigations and controls, without recognising operational risk insurance as a capital mitigant.

More transparency on the PRA’s Pillar 2A operational risk methodology

3.10 In CP12/25, the PRA proposed to set out factors that the PRA considers when setting Pillar 2A in the SoP5/15, to enhance clarity and transparency to all firms (significant and non-significant firms). This included:

• the firm’s business model and its exposure to operational risk;
• the firm’s analysis in its ICAAP, with a focus on scenario analysis;
• the quality of the firm’s own Pillar 2A assessment, including appropriateness and robustness;
• any insights gathered through engagement with the firm; and
• peer group comparison.

3.11 Respondents generally welcomed the PRA’s efforts to improve transparency, with five respondents explicitly supporting the proposals. However, several respondents noted that while the proposed factors were helpful, there were areas where the PRA could provide further transparency.

3.12 Six respondents suggested that the PRA provide further guidance on how it applies supervisory judgement when setting Pillar 2A requirements and additional information on the internal methodologies used by the PRA. Four respondents commented on the use of historical data sources. For example, they recommended that the PRA publish the Pareto distributions and associated shape parameters referenced in SoP5/15 that are used to calibrate operational risk capital for each Basel event type.

3.13 The PRA considered these responses but has decided not to publish any predetermined parameters or loss data, as this could undermine firms’ own responsibility to develop independent operational risk assessments. It may also lead to undue reliance on supervisory parameters rather than firm-specific analysis. To provide greater clarity on its assessment of Pillar 2A capital requirements, the PRA has amended the draft SoP5/15 to clarify the aspects considered by the PRA when assessing the quality of firms’ assessments, including appropriateness and robustness of the analysis and the data used, the strength of the firm’s evidence, and the rigour of its methodologies.

3.14 One respondent suggested that the PRA provide clarity regarding how dependency on critical third-party vendors is reflected in the Pillar 2A assessment. The PRA confirms that firms are expected to, where relevant, cover at least all the Basel event types, as set out in Annex 2 of the Operational Risk Part of the PRA Rulebook.^{footnote [15]} This includes any operational risk relevant to external fraud, business disruption and system failures. For example, if a firm considers the increasing reliance on third-party service providers would lead to increased risks to the firm, the firm may consider setting this out in the ICAAP for consideration in its Pillar 2A assessment.

3.15 One respondent argued that historical losses and peer group comparison are not always an appropriate basis for operational risk capital add‑ons, noting that this may penalise firms for loss events that are no longer relevant due to improved controls or peer weaknesses. The PRA acknowledges that a mechanical link between capital requirements and past losses would not be appropriate, as historical events may not be reliable indicators of future operational risk exposures. The PRA amended the draft SoP5/15 to clarify that while historical losses form an important input into the PRA’s assessment, supervisory judgement may be applied in evaluating the relevance of past losses to a firm’s forward‑looking operational risk profile. The PRA also amended the draft SoP5/15 to clarify that while peer group comparison provides contextual insight to inform supervisory judgement, this does not replace the PRA’s assessment of the firm’s own analysis, evidence, and risk profile.

Good practices in maintaining a robust operational risk measurement framework

3.16 In CP12/25, the PRA proposed to include a set of good practices in SS31/15 for significant firms in maintaining a robust operational risk measurement framework. This proposal was intended to support the transition following the retirement of the AMA under the Basel 3.1 standards, by onboarding the relevant requirements and guidelines^{footnote [16]} that remain useful for promoting good practices.

3.17 Three respondents sought greater clarity on the proposed good practices, including the meaning and scope of the terms such as ‘measurement systems’ and ‘diversification’ within the proposed good practices. After considering these responses, the PRA has amended the draft SS31/15 to provide further clarification, which includes adding the definition of the operational risk measurement framework based on the current AMA requirements.

Clarification of changes to the instructions of FSA072–075 templates

3.18 In CP12/25, the PRA proposed to retain the FSA072–075 reporting requirements for significant firms, with minor clarifications reflecting the removal of AMA permissions under the Basel 3.1 standards and the complementary interaction between Pillar 1 and Pillar 2 operational risk reporting. Three respondents welcomed the proposals but raised points on proportionality and the interaction between Pillar 1 and Pillar 2 reporting, including the treatment of insurance recoveries.

3.19 Having considered these responses, the PRA has not made changes to the policy, noting that Pillar 1 and Pillar 2 reporting serve distinct purposes. As set out in existing reporting instructions, Pillar 2 operational risk reporting is based on gross losses net of direct recoveries, excluding insurance recoveries; whereas Pillar 1 reporting under the Basel 3.1 standards includes insurance recoveries. Firms should therefore ensure that loss data used for ICAAP purposes is prepared on a basis consistent with the applicable Pillar 2 reporting templates and instructions.

3.20 One respondent requested clarification on whether reporting by Basel event type refers to event type Level 1 or Level 2 classification, and whether firms may use internal taxonomies with clear mapping to Basel event types. The PRA confirms that, for the purposes of Pillar 2A operational risk assessment and where relevant, reporting should be mapped to cover the Basel event types set out in Annex 2 (Detailed loss event type classification) of the Operational Risk Part of the PRA Rulebook.

3.21 For reporting purposes, significant firms are required to report Level 1 event types in FSA072 only, and a further breakdown by Level 2 event type categories in FSA073. Firms should therefore ensure that loss data are prepared in line with the applicable Pillar 2 reporting templates and instructions.

3.22 One respondent requested clarification on the treatment of boundary credit-related operational risk events in the FSA072 and FSA073 reporting templates. The PRA confirms that such losses should be excluded from these templates. One respondent requested clarification on the treatment of operational risk losses that arose prior to the implementation of the ring-fencing regime, where ring-fenced bodies and non-ring-fenced bodies did not exist as separate legal entities. The PRA clarifies that in these cases, it is for firms to assess the circumstances in which such losses arose and to determine the legal entity to which the relevant risk should be attributed.

3.23 One respondent requested greater clarity on the expectations for non‑significant firms to submit reporting data. The PRA considered this response, but has decided not to change the draft text for rule 2.3 of the Reporting Pillar 2 Part of the PRA Rulebook. Although there are data items that are generally only submitted by significant firms, the PRA may also request that other firms report the same data. In these cases, the PRA will notify the firm accordingly in advance of its submission of an ICAAP document.

Other responses

3.24 Three respondents suggested replacing the term ‘significant firm’ with a defined supervisory classification, such as the ‘potential impact category’ used in the PRA’s supervisory framework. Having considered these responses, the PRA has amended the draft SoP5/15 to confirm that a ‘significant firm’ generally refers to the Category 1 firms outlined in The PRA’s approach to banking supervision. As mentioned in CP12/25, the PRA noted that ‘Category 1 firm’ and ‘significant firm’ are often used interchangeably, and the alignment of the SoP5/15 and Reporting Pillar 2 rules aims to provide consistency and clarity.

3.25 Two respondents requested clarification on the interaction between Pillar 2A operational risk capital and the introduction of the Basel 3.1 standardised approach to operational risk, including whether Pillar 2A capital requirements would be reduced in response to increases in Pillar 1 capital requirements.

3.26 In PS17/23 – Implementation of the Basel 3.1 standards near-final part 1, the PRA confirmed its plans to mechanically adjust firms’ Pillar 2A operational risk requirements in line with changes in Pillar 1 RWAs due to the implementation of Basel 3.1 standards, so that the total nominal operational risk requirements for most firms would remain unchanged as a result of the Basel 3.1 standards being implemented. The PRA confirms that its position remains the same and that the off-cycle review of firm-specific capital requirements is currently underway.^{footnote [17]} In this PS, the PRA is not proposing changes to the Pillar 2A operational risk methodology, but is instead providing greater transparency and guidance.

Application to SDDTs

3.27 In CP12/25, the PRA noted that, at the time of publication, the proposed Pillar 2A operational risk methodology for SDDTs was set out in CP7/24 – The Strong and Simple Framework: The simplified capital regime for Small Domestic Deposit Takers (SDDTs), and that the proposals in CP12/25 would not change the proposals in CP7/24.

3.28 Respondents raised the point that, for any methodology and/or expectations which are applicable to significant firms, the PRA should clarify that these are not relevant to, and should not be treated as best practice for, non-significant firms (including SDDTs). At the same time, respondents welcomed the clarity set out in SS31/15 that the proposed good practices do not apply to non-significant firms, to avoid unintended gold-plating. Having considered the responses, the PRA has amended the draft SS31/15 and draft SoP5/15 to provide further clarity on these aspects.

3.29 In October 2025, the PRA published PS20/25 – The Strong and Simple Framework: The simplified capital regime for Small Domestic Deposit Takers SDDTs – near-final, which set out its decision to align the methodology for SDDTs with that for non-SDDTs, in response to concerns from respondents over the proposed bucketing approach set out in CP7/24. The PRA stated in PS20/25 that it would review responses to the clarifications and expectations proposed in CP12/25 for non-significant firms on operational risk. The PRA noted that it would consider whether the SDDT policy documents would benefit from similar amendments and clarifications.

3.30 Accordingly, the PRA has made minor, clarificatory updates to draft SS4/25 and draft SoP5/25 to align with SS31/15 and SoP5/15 respectively. This aligns the Pillar 2A operational risk methodology for SDDTs with that for non-SDDTs. These updates do not create any new expectations for SDDTs. The PRA confirms it will continue to take a proportionate approach when reviewing firms’ operational risk assessments, including for non-significant firms.

3.31 To reflect the final policy, the PRA has updated the CBA, PRA objectives analysis and the ‘have regards’ analysis to cover SDDTs.

Cost benefit analysis

3.32 In CP12/25, the PRA provided a CBA on the operational risk proposals. We consider this analysis remains valid, as the final policy confirmed in this PS does not contain any policy changes. However, the analysis has been updated to reflect the alignment of the Pillar 2A operational risk methodology for both non-SDDTs and SDDTs. In particular, the PRA has extended the CBA to cover SDDTs, reflecting the alignment of the SDDT policy materials with the regime for non-SDDTs.

Benefits

3.33 The clarifications to the draft SS31/15 and draft SoP5/15, together with the accompanying operational risk policy materials for SDDTs (ie draft SS4/25 and draft SoP5/25) enhance transparency around the PRA’s Pillar 2A operational risk methodology. The clarifications also enhance the transparency regarding the expectations on scenario analysis applying to different types of firms. This provides greater clarity for firms, including significant firms, non-significant firms and SDDTs, on how the PRA assesses operational risk. This reduces uncertainty and the need for supervisory clarification.

3.34 At the same time, expectations that apply only to significant firms are clearly identified. This supports a proportionate, consistent and predictable application of the Pillar 2A framework, while allowing supervisory judgement to reflect firms’ individual risk profiles and without extending practices intended for larger or more complex firms to SDDTs.

Costs

3.35 The PRA does not expect the clarificatory updates to result in material additional costs for firms, including SDDTs, as no new expectations are introduced. All firms may incur limited one-off familiarisation costs in understanding the clarified scope and application of the operational risk materials.

3.36 The PRA does not expect the clarifications to result in changes to firms’ overall Pillar 2A operational risk capital requirements, all else being equal, as the PRA is not changing the underlying methodology used to set capital add‑ons, but providing the benefit of greater transparency and clarity on its application.

PRA objectives analysis

3.37 In Chapter 3 of CP12/25, the PRA set out why it considered that the proposals to enhance transparency and clarify expectations for Pillar 2A operational risk would advance the PRA’s primary and secondary objectives. The PRA considers this analysis remains valid, subject to the following updates.

3.38 The PRA considers that extending the Pillar 2A operational risk framework to SDDTs further advances the PRA’s primary objective of safety and soundness. Applying a consistent approach across both SDDTs and non‑SDDTs ensures that all firms hold capital commensurate with their operational risk profile, while allowing supervisors to continue to apply proportionality in line with the SDDT framework. This supports a coherent and predictable capital framework across firm types.

3.39 The PRA considers that aligning the operational risk approach between SDDTs and non‑SDDTs supports the PRA’s secondary competition objective and the secondary competitiveness and growth objective. The application of the same methodology across both regimes will create consistency between firms and reduces the risk of creating barriers to entering or exiting the SDDT regime. It also improves comparability across firms of different sizes. It ensures that SDDTs are not subject to different treatments that could increase uncertainty or compliance burden. This aligned approach facilitates effective competition between firms of different sizes while maintaining appropriate risk sensitivity, thereby enabling smaller firms to support growth in the medium to long term.

‘Have regards’ analysis

3.40 In developing the final policy set out in this chapter, the PRA has had regard to its framework of regulatory principles. In CP12/25, the PRA set out the regulatory principles it considered most significant to the operational risk methodology. The PRA considers that this analysis remains valid, subject to the following updates.

• Proportionality of regulation (FSMA regulatory principles): The PRA considers that the alignment of the SDDT operational risk policy materials with the regime for non-SDDTs supports regulatory proportionality. The amendments clarify the scope and application of expectations, including by clearly identifying those that apply only to significant firms, without extending new expectations to SDDTs.
• Recognition of differences between businesses (FSMA regulatory principles): The PRA considers that applying a common methodology for Pillar 2A operational risk to all firms, while clearly distinguishing elements that apply only to significant firms, continues to recognise differences in firms’ business models. This allows supervisory judgement and firm-specific risk assessments to reflect variations in size, complexity, and risk profile, including for SDDTs.
• Transparent exercise of the PRA’s functions (FSMA regulatory principles): The PRA considers that clarifying the scope and application of the operational risk policy materials enhances transparency by reducing uncertainty around how the Pillar 2A methodology applies to different groups of firms. In particular, clearer identification of expectations that apply only to significant firms supports firms’ understanding of the PRA’s approach, while maintaining flexibility of supervisory judgement.

4: Pension obligation risk

Introduction

4.1 This chapter provides feedback to responses to Chapter 4 of CP12/25, which sets out the PRA’s proposals for pension obligation risk (pension risk). These included removing the PRA-prescribed stress scenarios and reducing the burden of the Pillar 2A pension risk assessment and associated reporting for certain schemes.

4.2 This chapter is relevant to banks, building societies, and PRA-designated investment firms, including those which are SDDTs.

4.3 The PRA received 12 responses to its pension risk proposals. Respondents widely supported the proposals, with a few requests for further clarification or minor amendments. Having considered the responses, the PRA has decided to implement the policy as proposed, with minor modification to the FSA081 reporting template and instructions.

Remove the PRA’s two published stress scenarios for pension risk

4.4 The PRA proposed removing ‘Stress scenario 1’ and ‘Stress scenario 2’ from Section II of the FSA081 template. In doing so, the PRA sought to reduce the burden of disclosure on firms, without materially impacting the PRA’s ability to undertake an assessment of Pillar 2A pension risk capital. Seven respondents supported this proposal.

4.5 Two respondents asked for further guidance on the calibration of certain stress elements, such as longevity risk. The PRA considered these responses, but has decided not to publish any further guidance on the calibration of such risks, as this could undermine firms’ own responsibilities to develop an independent pension risk assessment.

Reduce firms’ Pillar 2A pension risk assessments and lighten reporting requirements where schemes are fully bought-in or sufficiently well-funded

4.6 The PRA proposed that a firm need not provide a full submission of the FSA081 template if its pension scheme meets one of these criteria: (i) fully bought-in, or (ii) has a funding ratio of at least 130% (on the firm’s accounting basis). These criteria would be applied on an individual scheme-by-scheme basis. Eight respondents supported the proposal.

4.7 Two respondents commented that the PRA’s proposal would mean that partially bought-in schemes with a significant residual surplus would be ineligible for the reporting exemptions. They suggested removing insured annuities from the definition of the scheme’s funding ratio. After considering the responses, the PRA agrees that the formula should be modified and has updated the FSA081 template and instructions to reflect this suggestion.

4.8 Five respondents requested more details about assessing pension risk in their ICAAP, such as the assessment of residual risks after a full-scheme buy-in. The PRA expects firms to take a proportionate approach and document this in the pension risk section of their ICAAP. A qualitative assessment may be proportionate, but firms should consider the most appropriate approach commensurate with the nature, scale and complexity of the residual risks. Specifically, a qualitative assessment may be adequate to demonstrate that the residual risk is either sufficiently small, or sufficiently remote, so as not to require a quantitative assessment.

4.9 Three respondents suggested that the Financial Services Compensation Scheme could be used to reduce the firm’s assessment of residual risks following a buy-in. The PRA expects firms to exclude the Financial Services Compensation Scheme in their assessment. The PRA recognises that any assessment of capital to be held against loss on insurer default should take account of available mitigations. However, the PRA does not consider it consistent with its primary objective, to promote the safety and soundness of the firms it regulates, to allow firms to rely on compensation from the Financial Services Compensation Scheme to mitigate the risk of insurer default.

4.10 One respondent noted the risk of a scheme’s funding ratio falling below 130% near the ICAAP reference date, resulting in the firm being required to produce the full submission of the FSA081 template for that scheme (as the scheme does not meet the exemption criteria). The PRA considers that an exemption criterion based on the balance sheet date is the most straightforward way to implement the policy, and most consistent with the rest of the Pillar 2 framework. Should such a situation occur, the PRA expects firms to have arrangements in place to be able to provide a full dataset.

4.11 One respondent asked whether pension schemes exempted under Pillar 2A reporting requirements would also be similarly exempted under the Stress Testing Data Framework, which relates to the Bank Capital Stress Test. The PRA notes that a full FSA081 submission may still be required in the Bank Capital Stress Test, the required submission for which will be communicated with participating firms in the usual way.

4.12 One respondent asked for clarity that the PRA will not expect pension scheme trustees to be involved in producing firms’ ICAAP or Pillar 2A submissions. The PRA confirms that it does not expect the proposals to result in additional input from the trustees over and above current levels of engagement.

5: Market risk and counterparty credit risk

Introduction

5.1 This chapter provides feedback to responses to Chapter 5 of CP12/25, which sets out the PRA’s proposals to provide more information on the existing methodologies used for setting Pillar 2A capital requirements for market risk and counterparty credit risk.

5.2 This chapter is relevant to banks, building societies, and PRA-designated investment firms, including those which are SDDTs. The PRA considers that market risk and counterparty credit risk are generally not relevant for SDDTs. SDDTs are typically not exposed to market risk or counterparty credit risk as the SDDT criteria requires that, to be eligible for the regime, firms must have limited trading activity.^{footnote [18]} However, the materiality of these risks varies across firms and the PRA expects SDDTs to adequately capitalise against risks they are exposed to. If an SDDT is exposed to these risks, the relevant sections in SoP5/15 and SS31/15 will apply.

5.3 The PRA received seven responses to its market risk and counterparty credit risk proposals. Respondents generally supported the proposals and asked for more details and explanations in certain areas. Having considered the responses, the PRA has decided to implement the policy as proposed and to make minor updates to SoP5/15 for clarity.

Update information about the PRA’s market risk Pillar 2A assessment methodology

5.4 The PRA proposed to provide more information on the methodology used to inform the setting of Pillar 2A capital requirements for market risk, including illiquid risks. One respondent explicitly supported the proposal.

5.5 Two respondents were of the view that the syndicated loan information proposed in SoP5/15 was new and requested an appropriate timeframe to implement. Two respondents commented on the PRA’s stress-testing approach used to assess syndicated loan underwriting risk for Pillar 2A. One respondent stated that the stressed price shocks did not represent an appropriate calibration across all syndicated loans. Another respondent suggested the PRA consider additional factors in its assessment.

5.6 The PRA considers that the syndicated loan information is not new, but a reflection of established supervisory practice. Moreover, firms are allowed to assess their syndicated loan risk under Pillar 2A with additional factors and more granular shocks, as supported by historical evidence. The PRA conducts its own assessment alongside firms’ assessment, to inform the setting of Pillar 2A capital for the relevant risk.

5.7 Two respondents asked the PRA to reconfirm its previous position in PS9/24 – Implementation of the Basel 3.1 standards near-final part 2 that firms’ Pillar 2A capital requirements would be reduced to address potential double-counting through the off-cycle review of firm-specific capital requirements in the context of market risk. The PRA confirms that its position remains the same and that the off-cycle review of firm-specific capital requirements is currently underway.^{footnote [19]}

5.8 Two respondents shared their interpretation that the PRA only expects firms to monitor, instead of capitalise, intraday risk. The PRA is of the view that intraday exposure can present an important risk for some firms, potentially requiring capitalisation under Pillar 2A.

5.9 Two respondents requested the PRA to clarify the meaning of ‘gap risk’ and any relationship with the Fundamental Review of the Trading Book. Having considered the response, the PRA has added a new footnote to paragraph 3.6 of SoP5/15 for clarity.

5.10 One respondent enquired whether Credit Spread Risk in the Banking Book (CSRBB) is covered as one of the ‘other risks’ in the PRA’s methodology for assessing Pillar 2A capital for market risk. The PRA confirms that CSRBB is not covered in the ‘other risks’ subsection of market risk in SoP5/15. CSRBB is assessed as part of Interest Rate Risk in the Banking Book.

Update information about the PRA’s counterparty credit risk Pillar 2A assessment methodology

5.11 The PRA proposed to provide more information on the methodology used to inform the setting of Pillar 2A capital requirements for counterparty credit risk. Two respondents explicitly supported the proposal.

5.12 One respondent enquired whether ‘cluster of correlated defaults’ refers to defaults of collateral issuer or counterparties. The PRA confirms that its methodology mainly aims to consider counterparty defaults. However, if a firm has significant concentrations of collateral such that default of a single issuer or group of closely related issuers may result in material losses, the PRA will also consider whether the firm has adequately capitalised these in its ICAAP. After considering the response, the PRA has added this elaboration in paragraph 5.15B of the draft SoP5/15 for clarity.

5.13 One respondent requested more details from the PRA on the methodology to assess wrong way risk. The PRA is not currently planning to prescribe a methodology for how it assesses wrong way risk.

5.14 Two respondents asked the PRA to reconfirm its previous position in PS9/24 – Implementation of the Basel 3.1 standards near-final part 2 that firms’ Pillar 2A capital requirements would be reduced to address potential double-counting through the off-cycle review of firm-specific capital requirements in the context of credit valuation adjustment. The PRA confirms that its position remains the same and that the off-cycle review of firm-specific capital requirements is currently underway.^{footnote [20]}

6: General responses

6.1 This chapter provides feedback to general points raised by respondents which are not covered in the relevant risk-specific chapters in this PS.

Implementation date

6.2 The PRA proposed that the implementation date for changes to the credit risk and operational risk policy as consulted in CP12/25 would be aligned with the date of the PRA’s implementation of the Basel 3.1 standards (Friday 1 January 2027). For the pension risk, market risk and counterparty credit risk proposals in CP12/25, the PRA initially proposed an implementation date of Monday 2 March 2026. This was later amended to Wednesday 1 July 2026 due to the extension of the consultation period.

6.3 Two respondents commented that they were unclear about how to incorporate the multiple implementation dates of the proposed Pillar 2A methodologies into firms’ ICAAPs. One respondent asked about the interaction with implementation dates for other policies. One respondent suggested that the PRA pilot the proposed methodologies with certain firms in a pre-implementation period.

6.4 After considering the responses, the PRA has decided to set the implementation date for all final policy and rules in this PS as Friday 1 January 2027. This means that the changes to pension risk and market risk and counterparty credit risk will no longer have separate implementation dates in 2026 as initially proposed. This harmonisation is intended to make planning and implementation easier for firms.

6.5 As confirmed in January 2026,^{footnote [21]} ICAAPs signed off by boards in 2026 should include an impact assessment of the Basel 3.1 standards. ICAAPs signed off by boards from 1 January 2027 should be prepared on a Basel 3.1 basis, including the impact of any final policy changes as outlined in this PS.

Aggregated cost benefit analysis

6.6 In CP12/25, the PRA analysed the costs and benefits of the proposals. The PRA considered that the proposals would further its primary objective of promoting the safety and soundness of firms by facilitating the implementation of the Basel 3.1 standards. The proposals would also have the benefits of improving risk capture and increasing proportionality and transparency. The PRA identified that firms might incur minor costs in understanding and implementing the final policy, including one-off costs to implement the amended reporting templates.

6.7 One respondent disagreed with the PRA’s use of the current Pillar 1 and Pillar 2A framework as the baseline for the CBA. The respondent argued that the CBA should compare against the counterfactual of having no Pillar 2 requirements in place. After considering this response, the PRA maintains the view that the baseline should compare the incremental changes proposed by the CP against the current Pillar 1 and Pillar 2A framework, as explained in paragraph 1.28 to 1.29 of CP12/25.

6.8 Two respondents argued that Pillar 2A can materially impact firms, so the proposals should have been referred to the CBA Panel. Three respondents disagreed with the PRA’s impact analysis of the expected aggregated costs and benefits of implementing the proposals in the CP. They estimated that the capital increase for individual firms could be higher than stated by the PRA.

6.9 After considering the responses, the PRA maintains the view that the approach to the CBA for the proposals is appropriate and consistent with SoP14/24. As stated in the CP, the PRA did not expect the proposals in the CP to substantially change firms’ TCR across Pillar 1 and Pillar 2A in aggregate. Nor did the PRA expect the proposals to impose substantial ongoing operational costs on firms. Therefore, the proposals did not meet the quantitative threshold for consulting the CBA Panel set out in SoP14/24. The PRA notes that the impact on capital requirements for individual firms will vary, depending on their specific portfolios. However, these impacts are aligned with introducing greater risk sensitivity and the PRA’s primary objective of promoting safety and soundness. The PRA has provided more details on the costs and benefits of the final policy on credit risk and operational risk in the relevant chapters in this PS.

Other responses

6.10 In CP12/25, the PRA proposed certain minor updates, such as terms of references which relate to the Bank’s updated approach to stress testing the UK banking system and the frequency of the SREP cycle.

6.11 Three respondents commented on the update to SoP5/15 that clarified that, for firms other than major UK firms, the SREP cycle could be every two to four years (instead of every two to three years). One of the respondents suggested that, for firms with a relatively infrequent C-SREP, the PRA should consider how capital requirements could be adjusted in a more timely manner. Two of the respondents commented that fast-growing firms should have more frequent C-SREP, at least every two years.

6.12 After considering the responses, the PRA has decided not to change the minor update to SoP5/15 on SREP frequency. As noted in paragraph 5.8A of SS31/15, the PRA applies the principle of proportionality to the SREP, and relates the frequency of the SREP to firms’ nature, scale and complexity. In line with the existing approach, the PRA may conduct off-cycle C-SREP assessments in certain exceptional circumstances. For example, these could be circumstances where material developments, or findings relating to a firm, impact the accuracy or appropriateness of the PRA’s previously set capital requirements. In launching the Scale-up Unit in October 2025, the PRA committed to facilitating out-of-cycle capital reviews for those participating firms that are rapidly growing, or whose business models have changed significantly.