What is Basel 3.1?
In 2024, the Prudential Regulation Authority (PRA) is taking significant steps to finalize the implementation of Basel 3.1 standards in the UK. The focus is on strengthening the rules around how financial institutions calculate their risk exposure, particularly through changes in Risk-Weighted Asset (RWA) calculations. These new rules are designed to improve the accuracy and reliability of risk assessments, ensuring UK banks and other financial institutions are more resilient in the face of economic challenges. Recent updates also aim to streamline capital requirements, making it easier for smaller institutions to comply while maintaining robust standards. This is part of the PRA’s “Strong and Simple” approach, designed to reduce the regulatory burden on small domestic deposit takers without compromising financial stability.
Key objectives of Basel 3.1
⇢ Strengthening capital requirements
Basel 3.1 is focused on enhancing capital adequacy by making RWA calculations more sensitive to actual risks and reducing variability between institutions.
⇢ Introduction of the Output Floor
A backstop for modelled risk weights to ensure consistency and prevent underestimation of risk.
⇢ Improving risk management
Enhancing the robustness of RWAs to better capture credit, market, and operational risks, ensuring more accurate and reliable risk assessments for UK institutions.
Overall, Basel 3.1 aims to ensure more accurate and reliable risk assessments for UK institutions.
Who does Basel 3.1 affect?
Basel 3.1 impacts PRA-authorized banks, building societies, Capital Requirements Regulation (CRR) consolidation entities, and firms applying for small deposit taker authorization. It is particularly relevant for institutions expected to meet the small domestic deposit takers (SDDT) or small CRR consolidation criteria, as well as those wishing to be treated similarly. This includes firms expecting to meet the small remuneration firm criteria under the PRA Rulebook. Key stakeholders, such as compliance officers and risk managers, need to prepare for these regulatory changes.
Key challenges to Basel 3.1 compliance
⇢ Complexity in RWA calculations
Firms must recalibrate their RWA calculations to align with the new risk-sensitivity and output floor standards, which can be resource-intensive.
⇢ Data and reporting requirements
Enhanced data accuracy and transparency will require significant upgrades in systems to meet the new regulatory reporting standards.
⇢ Operational and compliance costs
Adapting to Basel 3.1 may lead to increased compliance costs, including technology investments and additional staffing for regulatory processes.