The role of research in Prudential Regulation − speech by David Bailey

Speech

Introduction

Good morning and thank you for the invitation to speak today. It is a pleasure to join the IFABS conference and to contribute to the discussion.

This year’s conference is titled Financial Regulation, Innovation, and Growth: Building the Foundations for a Resilient Future. It is a title that resonates strongly with our work at the Prudential Regulation Authority (PRA). Our role is to provide the core foundations of a trusted, efficient and proportionate regulatory framework that keeps the financial system resilient while enabling innovation and growth to flourish.

I am therefore delighted to be here among researchers, policymakers, and practitioners to explore how regulation and innovation can together support medium to long-term productivity and sustainable growth, both in the financial sector and in the wider economy. In that context, I want to use this speech to set out how research sits at the heart of our policymaking, and in particular how it shapes our approach to competitiveness and growth.

When I refer to research, I mean work that brings academic rigour to policy questions – so more than just evidence for the decision in front of us, but analysis that can contribute to the wider debate on how regulation affects firms, markets and the economy. And let me be clear at the outset about the purpose of what I will say today. This is not a presentation of new policy developments, nor does it provide definitive answers on the links between financial regulation and growth. Instead, it attempts to explain how rigorous research – as conducted by our researchers, often in collaboration with external academics – helps us make better informed and grounded policy decisions in a way that is consistent with our statutory objectives.

In my view, there are at least two reasons why policymakers should be deeply interested in research. First, research helps to shed light on and often quantify the mechanisms through which policy operates, providing a more structured understanding of cause and effect and helping policymakers to identify and assess the trade-offs inherent in different policy designs. This in turn helps us set policy priorities effectively.

Research also informs our assessment of risks, shapes our understanding of how firms are likely to respond to policy, and underpins some of our cost-benefit analysis. Earlier this year, we published our macroeconomic CBA methodology for banks, which is underpinned by our research, and we are now developing an equivalent framework for the insurance sector.

Then, post-implementation, research can help us to evaluate whether some of our policies have delivered the intended outcomes.^{footnote [1]} It allows us to test our assumptions, to identify unintended consequences, and to adjust our approach over time, ensuring in this way that our rules remain proportionate, effective and aligned with our objectives.

We have set out our approach to reviewing PRA Rules publicly^{footnote [2]} and research is an important input into that process. It helps build the evidence base that allows us to assess what is working well, and where change may be needed.

The second reason, and equally importantly, as Catherine Mann mentioned in a recent speech, “good research lends credibility to the institution”. And for a central bank and a regulator, credibility underpins the effectiveness of its policies and anchors its legitimacy.

Against that backdrop, I want to frame the rest of this speech around how we use research to advance all of our objectives, but in particular our secondary competitiveness and growth objective (SCGO) as that is core to the theme of this conference. I will begin by briefly recalling the framework we have put in place to understand the impacts that as a prudential regulator we can have on competitiveness and growth, before turning to three specific areas where research has played a key role.

A reminder of the SCGO framework

The relationship between regulation, competitiveness and growth is complex. There is no single measure of competitiveness, and no simple mapping from regulatory choices to economic outcomes, although some researchers have begun to explore this complex relationship^{footnote [3]}.

Therefore, to guide our approach to advancing the SCGO, we have developed a framework that sets out how regulation can facilitate competitiveness and growth. It is built on three foundations:

• Maintaining trust in the UK financial system and its resilience so that firms, domestic or international, have the confidence to invest and build their businesses; 
• Operating efficiently, so that regulatory requirements and processes are timely, proportionate and cost-effective for firms to engage with; and 
• Being responsive to new developments, and in doing so supporting the safe adoption of innovation across the financial services sector directly, and the provision of new and more dynamic services to the customers it supports. 

In turn, these foundations support growth and competitiveness by improving the efficient allocation of capital, attracting financial sector business to the UK, and supporting the ability of UK firms to sell their services abroad. These are all crucial channels through which our work supports the UK’s role as a major global financial centre.

Research has been central to how we calibrate policies across each of these foundations and has provided useful tools to help us navigate the complexities inherent in policy making. I will take them in turn.

Foundation one: Maintaining trust in the UK financial system

Trust is our starting point.

We are required to pursue our secondary objective – facilitating competitiveness and growth – subject to, and not at the expense of, advancing our primary objective of safety and soundness.

This is not simply a legal formulation. It reflects an economic reality. A financial system that is not resilient will not support long-term economic growth. Research suggests that the average net present value cost of a financial crisis, even if well managed, is around 43% of GDP.^{footnote [4]} Trust in the regulatory framework is therefore a precondition for supporting sustainable growth and attracting investment and businesses in the UK.

For that reason, maintaining trust is at the core of our prudential framework and our first foundation of the SCGO. And trust, among other things, is underpinned by policymaking that is grounded in evidence, as well as expert judgement.

One clear example of this is the work that informed the Financial Policy Committee’s decision to update its benchmark for capital requirements in December 2025. As part of a broader body of evidence and analysis, Bank staff reviewed over 70 academic studies to identify the optimal level of capital requirements that maximises long-term growth. This built on, and updated, the earlier Brooke et al. (2015) analysis. The updated benchmark, which the FPC reaffirmed last week, represents its judgement as to the sector‑wide capital requirements that will best support long‑term UK growth as measured through GDP. It does this by balancing the benefits of capital in reducing the risks of financial crises and the costs of capital in making it more expensive for banks to lend and support their customers’ needs. Simply put, too little capital increases the risk of a financial crisis to an unacceptable level, and too much capital can be detrimental by constraining the supply of financial services to households and businesses.

Because the various academic studies used different approaches and assumptions, their results were not directly comparable. So our colleagues recalibrated them onto a consistent basis to produce a robust estimate. Further details are set out in the December Financial Stability Report.

Building on this, the FPC published a further update last week, setting out how we intend to make adjustments to the capital framework - including through targeted reforms to the leverage ratio framework and measures to improve buffer usability.

To inform the latter, bank researchers have analysed the presence of capital buffer usability frictions, as well as the benefits of releasability, during the Covid-19 shock. They found that releasing buffers can help mitigate buffer usability frictions and procyclical deleveraging.^{footnote [5]} These are good examples of how research informs policy development. But sometimes, for new, innovative and fast-moving market developments, we do not have ready-made research to draw from, and we need to rely on other sources of evidence to inform policymaking, such as supervisory information, third-party analysis and our own modelling.

This was the case with our recent proposals on the use of Funded Reinsurance, which represents another key initiative that we are taking forward to maintain trust in the financial system. We expect benefits from these proposals in the form of improved sector resilience and enhanced UK financial stability (with evidence gathered from stress-tests) and costs to insurers and, indirectly, through corporates (modelled using information provided by insurers).  

Research was therefore an important input, alongside other sources, for the analysis of the costs and benefits of the proposals. We would welcome research contributions in this area.

Foundation Two: Operating efficiently and ensuring proportionality

The second foundation is efficiency and proportionality.

Regulation inevitably imposes costs on firms. Those costs are justified where they help us advance our objectives – the benefits outweigh the costs if you like. But they can also affect competitiveness and the ability of firms to innovate. Therefore, we want to ensure that our regulation is well‑targeted and proportionate, avoiding costs for firms where they do not add sufficient prudential value.

Research is central to achieving this. It helps us to distinguish between measures that are necessary to achieve prudential outcomes, and those that may impose unnecessary or unintended constraints.

One example often cited is the work that informed the reforms to remuneration rules, and in particular removal of the so-called ‘bonus cap’, which was a policy we inherited from the EU. It capped the ratio of variable to fixed pay for bank managers.

Our research, alongside others, found that total compensation growth did not slow down following the reform. Instead, compensation structures adjusted, with remuneration packages shifting towards higher fixed pay and lower variable pay.^{footnote [6]} 

This adjustment was an unintended consequence of the policy, as it weakened the link between managerial pay and risk-taking incentives. We therefore removed the cap when we were able to.

The reforms were informed by a combination of academic expertise in causal inference and policy experience in remuneration regulation, including a detailed understanding of the evolution of remuneration rules over time, as well as access to unique firm-level regulatory data.

Foundation Three: Responsiveness and enabling safe innovation

The third foundation to the SCGO is responsiveness, and in particular enabling safe innovation.

This is an area where it is important to be candid. We do not have all the answers for any of the channels I have been discussing, but that is especially true for this one. The relationship between regulation and innovation is complex and, by definition, innovation involves the provision of new products and services on which limited data and evidence may be available. What we can do, however, is to identify the key mechanisms through which regulation affects innovation, and incentivise researchers to explore them.

I would highlight three such mechanisms.^{footnote [7]}

The first is uncertainty. Regulation can reduce uncertainty about the future policy and risk environment. When firms have greater clarity about the rules of the game, they are better able to invest, to plan and to innovate. Conversely, uncertainty – whether about policy direction or supervisory expectations – can act as a barrier to innovation.

We have seen this pattern play out repeatedly over time. In the 19th century, banks had no clear understanding of when, or how, the Bank of England would intervene in a crisis. That uncertainty mattered. As Bagehot put it, it made banks “timid and cautious”, constraining lending and slowing financial development.^{footnote [8]} His 1873 articulation of the lender of last resort principles changed that by establishing a more predictable framework. With greater certainty came greater confidence, and with that a more innovative and effective financial system.

And we see it again in more recent history. The slowdown in financial innovation following the global financial crisis is well documented. Heightened uncertainty dampened long-term investment, in turn weakening R&D funding and innovation.^{footnote [9]}

The second is the degree of prescription. Outcome‑based approaches, which focus on the description of the world once risks have been managed rather than the precise means of managing them, tend to leave more room for firms to innovate. Highly prescriptive rules, by contrast, can narrow the set of possible solutions and may crowd out innovation. The challenge is to strike the right balance between clarity and flexibility. So, referring back to my earlier example, whilst greater certainty might have worked in the 19^th century, it might not always be the answer in the 21^st.

Take AI as an example. Our approach to date has been open, flexible and technology‑agnostic, grounded in extensive engagement with industry and other stakeholders. We already have established frameworks in areas such as model risk management, operational resilience and third-party outsourcing, and our view is that these can, in large part, be applied to AI just as they are to other technologies and processes. On that basis, we have not so far concluded that there is a need for detailed, AI-specific rules as the technology – and its use by banks and insurers – continues to evolve. But we continue monitoring developments closely, especially given rapid developments over the course of this year in the capabilities of Frontier AI models.

The third mechanism is risk measurement. Innovation often follows when previously hard‑to‑measure risks become quantifiable and integrated into decision‑making frameworks. Tools such as stress testing and regulation on modelling risk‑sensitive capital requirements can play a role here. By bringing risks into the realm of measurement and management, they can facilitate new products and new business models.

Conclusions

Let me conclude.

The central message of this speech is that rigorous research matters for the PRA. It is integral to how we make policy and how we evaluate outcomes. It helps us to make choices that are credible, transparent and grounded in evidence.

In the context of our SCGO, research is particularly important. Competitiveness and growth are complex, multifaceted concepts. They evolve over time and they are influenced by a wide range of factors beyond regulation. Research provides the tools we need to navigate that complexity.

The examples I have discussed today illustrate how research informs our approach in practice. It supports the calibration of policy, the assessment of trade‑offs, and the evaluation of outcomes.

But there is much more to learn. The relationship between regulation, competitiveness and growth is not fully understood. Particularly through innovation. Continued collaboration between policymakers and researchers will be essential if we are to deepen our understanding, to challenge our assumptions, and to refine our approach over time.

To incentivise collaboration, we publish our priority research questions as part of the PRA Business plan. These include the barriers to entry in banking and insurance, the link between competition and efficient capital allocation, measuring the financial sector’s contribution to GDP, and the impact of prudential regulation on the UK’s position as a global financial centre. Typically, collaborative research projects start organically through conversations between our researchers and external academics, often at conferences and workshops, like this one.^{footnote [10]} So I hope the conference this week won’t be an exception.

For our part, we remain committed to embedding research at the heart of our work. We will continue to draw on the best available evidence, to engage with the academic community, and to contribute to the development of new insights.

In doing so, we aim to support a financial system that is resilient, efficient and dynamic, and a regulatory framework that maintains trust, is proportionate and enables innovation, contributing to the long‑term growth of the UK economy.

Thank you.

I would like to thank Elisabetta Vitello, Benjamin Guin, Mahmoud Fatouh for their assistance in preparing these remarks, and to Walter Beckert, Nat Benjamin, Phil Evans, Felipe Netto, Tamarah Shakir, Alan Sheppard, Vicky White for valuable comments.