UK Challenger Banks Await Regulatory Approval for Internal Models
Three of the UK’s oldest challenger banks – Metro Bank, Close Brothers, and Paragon – have expressed growing concerns over delays in regulatory approvals that could have significant financial implications. These banks have been advocating for the use of their own internal models to calculate risk-weighted assets, a key factor in determining capital ratios. However, they have faced resistance from the Bank of England Prudential Regulator (PRA) for the past three years.
The use of internal models, as opposed to standardized versions set by global regulators, is preferred by banks because it generally leads to less punitive capital requirements. This privilege is typically granted to banks with a long lending history. If these challenger banks succeed in obtaining approval from the PRA, they would be able to set aside less capital for future losses, allowing them to lend more or return capital to shareholders, similar to major banks like HSBC and Barclays.
The ongoing delays in the regulatory approval process have already impeded lending activities for some challenger banks. It has become increasingly urgent for an agreement to be reached before the introduction of new global capital rules in 2025. The latest iteration of these rules, known as Basel IV, introduces tougher risk treatments for certain types of assets, further incentivizing banks to switch to internal models.
The potential benefits of internal models for older challenger banks are significant, as they have longer records that can be used to predict future performance. However, progress in the industry as a whole has been slow, much to the disappointment of these banks. The PRA’s declaration of support for challengers, proposing a simplified approach for banks with assets under £20bn, adds to the frustration felt by industry figures.
Some executives in challenger banks attribute the delays to understaffing at the PRA and the high volume of other work the regulatory teams are handling. Nevertheless, the PRA has yet to comment on the issue, and the uncertainty surrounding the approval of tailored models continues.
Potential Implications and Perspectives
The challenges faced by UK challenger banks in obtaining regulatory approval for internal models have far-reaching implications for their operations and competitiveness. Here are some key insights and perspectives on the matter:
1. Capital Relief and Competitive Advantage
The approval of internal models would provide capital relief for challenger banks, enabling them to allocate resources more efficiently. This relief would allow them to either increase lending activities or return capital to shareholders, boosting their overall competitiveness in the market. By adopting tailored models, these banks can better tailor their risk calculations to their specific portfolios, leading to more accurate risk assessment and improved risk management.
2. Striking the Right Balance: Prudential Regulation vs. Banking Innovation
The delays in regulatory approvals reflect a broader tension between prudential regulation and the need for banking innovation. While stringent regulations and standardized approaches promote stability and protect against excessive risk-taking, they may also hinder the ability of challenger banks to compete effectively. Striking the right balance between prudential regulation and fostering innovation is crucial to maintain a dynamic and competitive banking sector.
3. Challenges for Understaffed Regulatory Teams
The challenges faced by challenger banks in obtaining regulatory approval can, in part, be attributed to the understaffing of specialized PRA teams and their workload. The volume of work and limited resources available can slow down the approval process and hamper effective communication between regulators and banks. Strengthening regulatory teams and ensuring adequate resources could contribute to a smoother and more efficient approval process.
4. Impact on Investor Confidence and Funding
Investors are closely monitoring the progress of challenger banks in securing regulatory approval for internal models. The ability to utilize tailored risk models affects capital adequacy, lending capacity, and overall business performance. Delays and uncertainties in the approval process may erode investor confidence and limit funding opportunities for these banks. Clear communication between regulators, banks, and investors is necessary to address concerns and maintain trust in the system.
Conclusion
The lengthy process of obtaining regulatory approval for internal models has become a significant concern for UK challenger banks. Delays in gaining approval to use tailored risk models have implications for their competitiveness, lending capacity, and investor confidence. Regulators need to streamline the approval process, address staffing issues, and strike a balance between prudential regulation and fostering innovation. The successful implementation of internal models in challenger banks can contribute to a more dynamic and resilient banking sector in the UK.
Summary:
Three of the oldest UK challenger banks – Metro Bank, Close Brothers, and Paragon – are facing delays in obtaining regulatory approval for internal models to calculate risk-weighted assets. These banks have been advocating for the use of their own models to determine capital ratios, which would result in less capital being set aside for future losses. However, the Bank of England Prudential Regulator has been resistant to granting approval. The delays have already impacted lending activities, and achieving an agreement before the new global capital rules take effect in 2025 is crucial. The challenges faced by challenger banks in obtaining approval have broader implications for their competitiveness and investor confidence. Striking the right balance between prudential regulation and fostering innovation is necessary to ensure a dynamic and competitive banking sector.
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Three of the UK’s oldest challenger banks are increasingly concerned about delays in regulatory approvals that could save them hundreds of millions of pounds.
Metro Bank, Close Brothers and Paragon have spent years pushing the Bank of England Prudential Regulator to allow them to use their own internal models to calculate their own risk-weighted assets, according to people familiar with the situation. RWAs provide the denominator of the all-important capital ratios that banks must maintain.
Banks they prefer internal models rather than a standardized version set by global regulators because they tend to be less punishing. Typically, only banks with a long history of lending are allowed to use internal models.
If the trio of challenging banks manage to get the PRA, would allow them to set aside less capital for future losses, in line with big banks, such as HSBC and Barclays. This would help them lend more or return capital to shareholders.
Failure to reach agreement on regulatory approvals has already forced some challenger banks to curb lending, people say. Talks between the individual banks and the regulator have now dragged on for more than three years.
The situation has become more difficult as banks want to reach an agreement before the new one rules of global capital they will go into effect in 2025, people familiar with the process say.
While the variation between the results of internal and standardized models has been smoothed out by regulators in recent years, the latest iteration of global rulesknown as Basel IV, it imposes tougher risk treatments for certain types of assets, such as development finance, which leads to higher capital requirements and a greater incentive for banks to switch to internal models.
John Cronin, UK banking analyst at Goodbody, said: “[The challenger banks] we are very disappointed that progress has not been faster across the industry.”
He added that the potential gains were “quite significant” for older challenger banks because they have longer records that can be used as a predictor of likely future performance used in internal models.
A senior industry figure said the situation was “major frustration” for banks as the PRA declared its support for challengers by proposing a “strong and simple” approach that would ease the regulatory burden on banks with less than £20bn of assets.
Some executives at the challenger bank attribute the delays to understaffing at the specialized PRA teams involved in the talks, as well as the volume of other work they have to do.
The PRA, which does not publish figures on the length of the modeling approval process, declined to comment.
The CEO of a challenger bank described how the 2025 rules could lead to a significant increase in capital for his bank if he can’t use tailored models to calculate his potential losses.
He said his bank had “provided everything they (the PRA) asked for” but he was still unsure if their models would be approved in time to go live in 2025.
Another major challenger bank has become so disillusioned with the process that last year it suspended its bid three years ago to get approval for an internal model that would have allowed it to set aside less capital, a person familiar said. of the situation.
Metro Bank chief executive Dan Frumkin told the Financial Times that his bank would like to give investors an implementation date for the new models, which it had requested in 2018, but “it is beyond our means”.
“[Investors] they are very interested in discussions with regulators [on moving to internal models] – comes up in most conversations with debt and equity investors,” he added.
Close Brothers and Paragon declined to comment.
Additional report by Siddharth Venkataramakrishnan in London
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