The global banking turmoil last March demonstrated how quickly, particularly in the age of social media and internet/mobile banking, negative sentiment about a bank’s business model can precipitate deposit flight and close funding markets. Retail and commercial banks will therefore face scrutiny from supervisors, investors and the broader market of their business model viability and medium-term sustainability in 2024, especially given that Net Interest Margin has likely peaked and credit impairments are rising. This will manifest through some common operational, financial resilience and conduct challenges, although the particular issues and responses will vary with the size and specific business model of the bank.

Banks’ failure to deliver these major regulatory programmes and/or reliance on tactical solutions will be costly. Not only will remediation costs be high, but they also face capital add‑ons, including to reflect management and governance weakness.

Supervisors will likely be very robust in responding to failure by banks to remedy identified weaknesses, given the prominence placed on timely action in the various lessons learned reports from the March 2023 turmoil. The ECB intends to go one step further in this regard, imposing “periodic penalty payments”²on SSM banks which fail to resolve supervisory findings on time – including those related to climate risk management, which is now firmly part of ‘business as usual’ supervision.

Following the bank failures in 2023, banks should expect supervisors to re-assess resolution regimes, and look at their appetite for branches relative to subsidiaries. The European Banking Authority has issued revised guidelines on resolvability³ and the Capital Requirements Directive (CRD6) will re-draw the line – more tightly – for third country branch operations in the EU. Indications are that the Prudential Regulation Authority (PRA) will review⁴ its expectations and thresholds for when operations in the UK should be run in a subsidiary.

Supervisory capacity is just as constrained as banks’. The PRA and ECB’s time to approve new capital models, or changes to existing ones, is an example with both typically taking years, not months.

Banks must do what they can to make their interactions with regulators and supervisors more productive. Taking the model approval example, alongside governance, validation, business involvement and data quality, poor model documentation often leads to delayed approval. Regulators expect banks to produce clear, concise, intuitive and objective model documentation and have commented that this is an area of frequent weakness. Banks that comply closely with regulatory rules and guidelines (PRA’s SS1/23 and the ECB’s Guide to Internal Models) are likely to reap benefits in terms of quicker model approvals.

Financial resilience

Basel finalisation will be the key financial risk programme for most banks in 2024. Internationally active banks face significant challenges given divergence in the timing and substance of final rules in the EU, UK and US. Affected banks must understand the implications of divergence in timing, taking current timelines as the central case but developing contingency plans for different scenarios of UK, US and EU implementation dates.

With the publication of near-final versions of the EU’s CRD6 and CRR3⁴, and part one of the near-final UK policy⁵, differences in rules between jurisdictions are becoming clearer. Where rules differ, international banks need to decide whether to adopt a single version of a rule across all jurisdictions (accepting gold-plating where the capital impact is manageable) or to build capability to adopt different versions of rules in different jurisdictions (where justified by capital savings). Each bank’s answer must be driven by cost/benefit analysis at portfolio, entity and group level. Producing such analysis may be easier said than done, but investment in calculation engines should deliver a commercial return.

Beyond immediate implementation challenges, many banks have made little progress addressing the strategy, product design and pricing impacts of Basel – for example, deciding how (or whether) to incorporate the Output Floor into pricing decisions, or reshaping balance sheets to account for portfolios that are less attractive under Basel 3.1 (e.g. buy-to-let mortgages under Standardised). Banks will gain competitive advantage by allocating more time and resource to this analysis in 2024 and taking necessary strategic actions.

Recent supervisor‑led stress tests show that large banks are capitalised sufficiently to absorb a very significant credit shock while continuing to lend through any downturn⁶. However, we see a significant difference between banks’ ability to keep lending and their willingness to do so, particularly in a scenario where impairments rise and risk-weighted assets (RWAs) inflate through increases in Probability of Defaults (PDs), putting pressure on banks’ management buffers. The BCBS asked - but did not fully answer - the question about usability of capital buffers in the lessons learned from Covid. It may have to revisit it.

For banks not subject to supervisor-led stress testing, credit risk may be a greater concern. Here we expect even closer supervisory monitoring, especially of early credit warning indicators.

Banks should be challenging the assumptions in liquidity stress tests in light of the evidence⁷ from bank failures in 2023 and the increasing competition for retail deposits. Deposit competition has seen substantial deposit volumes move out of big banks, some to challengers, some to other assets including government securities. All banks, particularly those with concentrated funding sources, should be undertaking a range of reverse stress tests (RST)⁸ and taking action as a result, including diversifying funding sources. Banks that do not currently have a formal liquidity RST regime in place should implement one before their next Internal Liquidity Assessment Process (ILAAP)/Supervisory Liquidity Review Process (SLRP) round.

Banks should use H1 2024 to analyse the impact of a fully phased-in Duty and understand its effect on the bank’s business model sustainability. This includes identifying where bank profitability relies on products whose benefits to consumers are less clear cut, such as customers in persistent overdraft and back-book savings accounts whose interest rates have not kept pace with newer accounts. The FCA is clear that such products are in its sights. Boards and senior management need confidence these products satisfy the Duty’s price and value expectations. If not, the pricing and/or target market of the product will need to be changed, and the effect on business sustainability assessed. This analysis will be a key input into the Board report on Duty compliance that banks have to complete by July 2024.

Supervisory attention on how banks reflect base rate changes in customer rates will continue, focussing on both the speed and proportion of pass-through. If predicted downward base rate movements occur in 2024, regulators will compare downward changes with upward ones, and scrutinise relative changes – how quickly deposit rates change relative to lending rates.

Conclusion

2024 is a turning point for several major regulatory programmes, with implementation complicated by ongoing geopolitical risks, macroeconomic stress and associated pressure on banks’ costs. Executing these programmes well has two broad benefits - positioning banks to capitalise on commercial opportunities emerging from the changing regulatory landscape and avoiding supervisory interventions and remediation costs arising from flawed delivery of regulatory programmes.

In detail

Read more about Basel implementation, liquidity and funding, business models and governance, credit risk, Consumer Duty, CRD6, accelerated settlement, financial crime/debanking, model risk management, climate & environmental-related financial risk, transition planning, diversity and inclusion and operational resilience.