Basel 3.1 near-final rules part 2: is it the final countdown?

Target audience:

Board Risk Committees, CFOs, CROs, Basel Programme Leads, Heads of Credit, Heads of Reporting

The PRA has published its last set of near-final rules¹ for Basel 3.1. The package is wide-ranging, covering credit risk, credit risk mitigation, the output floor, Pillar 2, Pillar 3, and reporting. The PRA has also published a consultation on the capital regime for Small Domestic Deposit Takers. The key points include:

• The implementation date for the whole Basel 3.1 package is delayed until 1 January 2026.
• In line with the PRA’s CP16/22 proposals, infrastructure and SME supporting factors will be removed from Pillar 1, increasing RWAs in the core Pillar 1 measure. However, the PRA has undertaken to reverse the effect of removing the supporting factors in Pillar 2A. This change in particular is evidence of the PRA taking seriously its secondary competitiveness objective, albeit the PRA will need to address a number of industry concerns as a result:
  1. it gives control over the capital effect to the PRA;
  2. it is not clear where the capacity exists in Pillar 2A to “give back” the capital;
  3. leaving the increase in Pillar 1 means that, as the macro-prudential buffers are based on Pillar 1 RWAs, there could be a gearing effect to total capital;
  4. it will put the onus on firms to provide data to demonstrate the value of the increase in capital in each category; and
  5. it is not clear how the adjustment will work over time, as firms’ exposures in the affected portfolios evolve.
• There is no change to the risk weights for exposures to unrated non-SME corporate obligors, which remain at 65% for investment-grade and 135% for non-investment-grade if firms choose to apply to use the risk-sensitive approach, or 100% for all non-SME obligors otherwise.
• Where the PRA has made changes to the proposal on which it consulted in 2022 these are predominantly due to industry providing compelling data to support proposed amendments, including:
  1. reduced conversion factors for transaction-related facilities;
  2. reduced conversion factors for “other facilities”;
  3. removing the 100% risk weight floor for SME lending secured by real estate (when the real estate is used by the SME for its business); and
  4. lower risk weights for “super strong” obligors in IPRE and Project Finance categories.
• We have published a separate analysis of the key provisions of the Small Domestic Deposit Takers regime:
  1. firms will have to implement the rules by 1 January 2027;
  2. the credit rules are a slightly simplified version of the Basel 3.1 Standardised approach for Pillar 1 credit, the approach for operational risk is as per Basel 3.1, and a more substantially revised and simplified Pillar 2 approach is proposed; and
  3. from 1 January 2026 to 1 January 2027, firms will be able to apply what are essentially the current CRR rules under an Interim Capital Regime.
• As always, there is devil in the detail: there are a number of detailed changes to the rules that will affect how, for example, real estate valuation processes operate in practice. Firms will need to undertake a comprehensive review of the regulatory interpretations that underpin their analysis of the impact of Basel 3.1 on their business strategy at the portfolio and product level.  They will also need to review their programme plans to ensure that where details have changed in the underlying rules these are incorporated into the flow of data and exposures through the capital calculation process. The “Digging deeper” section below gives an example of a detail change and its implications.

For firms with a UK and EU footprint the immediate competitive advantages of each regime are now clear. Revised US Basel endgame proposals have not yet been published, but the direction of travel indicated by officials includes broad and material changes across credit risk, operational risk, and market risk and significantly lower the capital impacts versus the prior proposal. Implementation may be further delayed if US regulators want to allow a 12-month period for firms to implement once rules are finalised.

Firms adopting Basel 3.1 should expect the PRA to have little to no sympathy for a less than fully compliant implementation on 1 January 2026.

Read the full ECRS Perspective on the PRA Basel 3.1 near-final rules by downloading it here.

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Reference:

¹ The rules are badged as “near-final” because HMT needs to lay legislation to repeal parts of the existing legal instruments to allow the PRA to finalise the rules. To all intents and purposes these rules are final.