On 20 April, the PRA published its 2022/23 Business Plan setting out its forward-looking strategy, workplan and budget. Financial resilience, operational risk and resilience and governance and risk management continue to be key themes alongside broader horizon scanning activities. The PRA recognises the material improvement in the overall resilience of the banking and insurance sectors and is now turning its attention to maintaining that improved level of resilience.

Following a strategic review in 2021, last year's eight strategic goals have been replaced with four strategic priorities (SPs):

  • Retain and build on the strength of the banking and insurance sectors delivered by the financial crisis reforms
  • Be at the forefront of identifying new and emerging risks, and developing international policy
  • Support competitive and dynamic markets in the sectors that the PRA regulates
  • Run an inclusive, efficient, and modern regulator within the central bank

The SPs have been introduced to reflect the changing regulatory and external environment, for example the greater post-Brexit rule-making role that the government has proposed for the PRA as part of the future regulatory framework review (FRF), and the need to keep pace with innovation and emerging risks. Key areas of focus include the ongoing digitalisation of financial services and the growth of crypto assets, the increasing use of artificial intelligence and machine learning, developments in FinTech and the management of risks to firms' safety and soundness from climate change. Unsurprisingly, the conflict in Ukraine has led the PRA to reprioritise some work to ensure the safety and soundness of regulated firms whilst also continuing to progress its business as usual work plan.

Budget

The PRA's budget will increase by 8% to £320.9m in 2022/2023, driven by the increase in its responsibilities following the UK's withdrawal from the EU, together with the priorities of operational and cyber resilience, and developments in its data analytics and technology capability. It is looking to hire 100 more staff in the supervisory risk specialist, policy and data science divisions.

For more on relevant areas impacting regulated firms, see below:

  

SP1 — Retain and build on the strength of the banking and insurance sectors delivered by the financial crisis reforms

Under the first strategic priority, the PRA considers the financial resilience of banks and insurers, operational resilience and governance:

In Q4 2022, the PRA will consult on the UK implementation of the  final Basel reforms (variously referred to as Basel 3.1 or Basel 4) which aim to enhance the robustness and risk sensitivity of the standardised approaches for credit, market and operational risk, control the use of internally-modelled approaches and introduce an output floor to restrict the use of unduly low, modelled risk-weights.
 
There will be further changes to the UK leverage ratio framework from 1 January 2023, when the scope of the minimum leverage ratio requirement will extend to a wider range of firms including those with non-UK assets above £10bn. The PRA is also assessing the risks from contingent leverage, through transactions or trade structures that receive a lower leverage ratio exposure measure value than economically equivalent alternatives. A data-gathering exercise on large firms' use of this type of trades will follow in due course.
 
The annual cyclical scenario (ACS) stress test will return in 2022 to test system-wide resilience under severe but plausible scenarios. The launch of the ACS has been delayed in light of uncertainty over the situation in Ukraine and to help lenders focus on managing related financial markets disruption. The revised timeline is expected to be announced in Q2.
 
Assessment of capital, liquidity and funding profiles — core supervisory processes including periodic summary meetings and technical risk reviews will be used to assess whether firms are adequately capitalised and have sufficient liquidity and stable funding profiles. Firms' resilience and vulnerabilities will also be assessed using thematic and firm-specific asset quality reviews.
 
The PRA will continue to work with firms on internal models, in particular on internal ratings based (IRB) model review processes and the subsequent updating of IRB permissions. In response to increasing reliance on internal models and the introduction of new, sophisticated modelling techniques, the PRA plans to set out all its expectations, rules and requirements on model governance, model validation and general model risk management in a single overarching supervisory framework. Expect a supervisory statement later in 2022.

Work on the review of Solvency II continues and, in due course, the PRA will consult on a package of reforms to insurance regulation. The proposals will seek to retain the underlying principles of the existing regime while tailoring key elements to the UK insurance sector.

The Insurance Stress Test (now launched), covering the largest general and life insurers, will assess sector resilience to severe but plausible adverse scenarios. Results will guide future supervisory activity. The PRA will also work on the design of the longer-term strategy for stress testing, incorporating findings from HM Treasury's (HMT's) review of Solvency II.

The PRA will continue to scrutinise internal models, particularly in relation to internal model drift, to better understand firms' risk profiles and the strength of their calibrations. It will also analyse internal model output to support comparisons between firms across different risk categories.

Life insurers should expect close monitoring of their credit risk and exposure to downgrades and defaults. The PRA will focus particularly on credit concentration risks in longer term annuity businesses. Firms are expected to properly identify, measure, control, and report risks, in line with the prudent person principle. Market risk sensitivity data will be gathered for the largest life insurance firms, to better understand their solvency and exposure to market movements. The PRA will also engage with industry to determine the most effective means of collecting and using regular reporting and ad-hoc data requests, and to introduce new reporting requirements where new risks have been identified or new information needs to be captured. There will also be a survey of firms with significant derivative holdings to improve the PRA's understanding of potential margin calls and the impact on liquidity positions.

For general insurers, there will be further firm engagement to understand how economic inflation risk is monitored, how general and social inflation risk drivers are factored into reserving decisions, the impacts on the cost of claims, and the potential impacts on financial resilience. The PRA will continue to assess how contract uncertainty risk is managed.

The PRA will be looking to assess the extent to which firms meet the supervisory expectations published in 2021, around  delivering important business services within impact tolerances and other requirements around third parties and outsourcing.
 
There will be a joint Bank of England (BoE), PRA and FCA discussion paper on additional measures which could be taken to enhance the oversight of systemic risks from critical third party service providers.
 
The regulators will also co-ordinate on longer term approaches to supervising cyber risk and improving the collection of operational incident and outsourcing data.
The PRA will make full use of senior accountability and prudent incentive setting under the  SM&CR regime to improve risk management practices and deliver better prudential outcomes across firms.
 
There will be further skilled person reviews through 2022 and 2023 on governance and controls around the provision of regulatory reporting data.
 
The PRA views diversity and inclusion as an important part of corporate culture and mitigant to group think. The BoE, PRA and FCA will consult in the autumn on new proposals, with final policy to be published in 2023.

  

SP2 — Be at the forefront of identifying new and emerging risks, and developing international policy

The second strategic priority sets out areas where the PRA will focus its attention in order to respond to external events and future risks. It also covers the PRA's international engagement in order to shaping regulatory policy on a wider stage:

The impacts of Russia's invasion of Ukraine on the financial sector and markets have led the PRA to reprioritise work to ensure the safety and soundness of firms. This includes rapid escalation measures, cross-regulator information sharing and decision-making and heightened levels of engagement with and monitoring of firms. Focus on first and second order impacts will continue.

From 2022, the PRA approach to climate-related financial risk will switch from assessing implementation to actively supervising against threats — this will be embedded in the relevant aspects of the business as usual supervisory cycle:

  • The PRA expects firms to “refine, innovate and integrate” their climate-related financial risk management practices.
  • The largest banks, and a sample of others (on a proportionate basis) will be asked to report on how they have embedded the management of climate-related financial risks into their existing risk management frameworks alongside their 2021/22 ICAAP (for deposit-takers) or ORSA (for insurers).
  • The PRA will continue to look at whether broader changes are needed to capital frameworks to better capture climate-related financial risks. A research conference is planned for 19 October.
  • The results of the 2022 Climate Biennial Exploratory Scenario (CBES) stress test, expected on an aggregated basis on 24 May, will inform future supervisory priorities.

The PRA will continue to monitor remaining dependencies on LIBOR and support the transition away from USD LIBOR by June 2023 to more robust alternative rates, including monitoring use of credit-sensitive rates.

The PRA works closely with the BoE and FCA to take a proactive approach to identifying and responding to the risks and opportunities raised by digitalisation for regulated firms. It has taken on recommendations from the 2019 Future of Finance (PDF 1.75MB) report and the Kalifa (PDF 9.89MB) review of Fintech and is also working with HMT, the FCA and other international bodies. Key activities in 2022/23 will include:

  • Monitoring developments in key products (such as the impact of buy now pay later on unsecured lending) and the emergence of new banking business models with payments as a core component.
  • Continued use of the CBEST threat penetration testing framework, alongside other cyber assessment tools.
  • Consideration of digitalisation risks to the insurance sector, in particular potential fragmentation of the value chain due to increased outsourcing of processes to InsurTechs, and other disruption from large tech companies entering financial markets or generating unacceptable levels of concentration. Focus on financial inclusion where increased pricing granularity could reduce access to insurance for higher risk individuals and increased monitoring of complex non-linear and machine learning models.
  • Continued work on cryptoassets — firms will be asked to report their cryptoasset exposures, treatments and future investment plans. And the PRA will work with international partners including BCBS to establish a common international framework for the treatment of cryptoasset exposures.

AI models can bring benefits for households, firms and the economy, but speed, scale, model complexity and data-related issues have the potential to amplify existing consumer harm, impact the safety and soundness of individual firms, and generate systemic risks to financial stability.

The PRA will publish a Discussion Paper later in the year considering the appropriate role of regulators in supervising potential data and systematic risks which stem from firms' use of AI or machine learning systems. This will build on the work of the AIPPF and broaden engagement to a wider set of stakeholders.

  

SP3 — Support competitive and dynamic markets in regulated sectors

The third strategic priority considers ways in which the PRA can advance its primary and secondary objectives through regulation — this includes taking advantage of the opportunities to tailor regulation to the needs of the UK market which may result from the FRF review.

HMT's FRF consultation in November 2021 included proposals to introduce a new secondary competition objective for the PRA, incorporate climate change into existing regulatory principles to ensure that a net zero economy can be achieved by 2050, enhance accountability and scrutiny mechanisms for the PRA and empower HMT to repeal parts of retained EU law to enable regulators to replace those provisions with its own rules. A new Financial Services Bill is expected to go before Parliament later in 2022.

The PRA aims to be more responsive, targeted and proactive in safeguarding resilience and competition, and it will have greater discretion over rule-making under the new framework. A PRA Discussion Paper on the FRF will be published in 2022, setting out the longer term approach to prudential policymaking.

In addition, work will start on a new website for the PRA Rulebook and an index of prudential and resolution policies.

The PRA plans to consult in 2022/23 on a “strong and simple” regime for banks and building societies that are neither systemic nor internationally active and provide standard lending or deposit banking products to UK customers. For insurers, the PRA will also look to enhance competition by simplifying the authorisations process, consulting on a mobilisation regime to reduce barriers to entry for new retail firms and raising thresholds for the application of Solvency II requirements. The case for a simpler regime for insurers and friendly societies will also be considered.

The PRA will continue to work with HMT to examine the recommendations on ring-fencing and proprietary trading published (PDF 2.17MB) in March 2022 by an independent panel.

The PRA will continue work to develop a market which firms can easily enter and exit, and to increase confidence that firms can exit the market without disturbing it, in an orderly way and without having to rely on the backstop of an insolvency or resolution process. This will include reviewing the approach to wind-down and run-off planning and looking at potential reforms to the Financial Services Compensation Scheme to offer greater consumer protection.

The PRA will continue to influence international regulatory standards, participate actively in global standard-setting bodies and contribute to international policy fora. Memorandums of Understanding will be agreed with additional jurisdictions. And the PRA, together with the FCA and EU authorities, will take any remaining EU banking and insurance branches which are under the temporary permissions regime (TPR) through the authorisation process.

  

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