On 30 September, the PRA published Consultation Paper CP14/20 (PDF 800 KB) which sets outs proposals to introduce new expectations for Internal Ratings Based (IRB) UK mortgage risk weights.
The proposals primarily aim to address the prudential risks caused by inappropriately low IRB UK mortgage risk weights. As an added benefit, they should also narrow the differentials between IRB and standardised approach (SA) UK mortgage risk weights and limit future divergence, supporting competition between firms that take different approaches.
The PRA proposes to introduce two requirements, as it considers that models delivering risk weights materially below these levels are likely to be materially deficient in risk capture:
Incoming reforms to the IRB and SA approaches (including the “hybrid approach”) will reduce excessive variability of firms' risk weighted assets and make risk-based capital ratios more transparent and comparable. This may lead to an increase in the lowest IRB risk weights, but the extent of this is uncertain. The PRA is therefore proposing its own measures to address prudential risks associated with:
The PRA has considered whether other capital measures already provide adequate mitigation and concluded that they do not for an asset class as substantial as residential mortgages:
The CP is relevant for PRA-authorised banks, building societies and ring-fenced banks holding IRB permissions. It may also be of interest to firms considering applying for IRB permission and to other market participants.
Both proposals would apply at all levels of consolidation and cover all UK residential mortgages exposures.
The PRA does not expect the changes proposed in this CP to have a significant implementation cost for firms. However, firms whose risk weights increase as a result of the proposals, and where capital requirements are not already determined by other capital measures such as leverage, will have costs associated with the additional capital required.
The proposals are not expected to limit the overall growth of the mortgage market.
The consultation will close on 30 January 2021, with resulting policy expected to take effect from 1 January 2022, alongside other IRB reforms.