BoE throws SMEs a lifeline in Basel 3.1 shake-up
The Bank of England has announced that banks will face no increase in capital requirements for loans to small and medium-sized enterprises (SMEs) under its final Basel 3.1 implementation package. This unexpected concession, revealed in a comprehensive policy statement on September 12, marks a significant shift from earlier proposals and underscores the central bank’s commitment to supporting economic growth while maintaining financial stability.
The Prudential Regulation Authority (PRA), the Bank’s regulatory arm, unveiled its near-final rules for implementing the Basel 3.1 standards, introducing a range of changes that will reshape how UK banks calculate their capital requirements. While the package includes various technical adjustments, the SME lending provision stands out as a clear win for both the banking sector and the broader business community.
The PRA’s announcement outlines several crucial aspects of the Basel 3.1 implementation:
The PRA’s decision to maintain current capital requirements for SME lending represents a significant shift from its original proposals. Initially, the regulator had planned to remove the SME support factor, which could have led to increased capital requirements for banks lending to small businesses. However, after extensive consultation with industry stakeholders, the PRA has introduced a novel approach.
Phil Evans, Executive Director for Financial Stability Strategy and Risk at the Bank of England, explained the rationale behind this change in a speech accompanying the announcement.
“Mindful of competitiveness and growth considerations we will take steps through an ongoing structural adjustment to Pillar 2 requirements to ensure that the removal of the support factors does not result in an increase in capital requirements for SME lending,” he said
This “SME lending adjustment” effectively neutralizes any potential increase in capital requirements that might have resulted from the removal of the SME support factor. The PRA’s approach aims to strike a balance between maintaining the risk sensitivity of the Basel 3.1 framework and supporting the flow of credit to small businesses, which are often described as the backbone of the UK economy.
The preservation of current capital requirements for SME lending is expected to have far-reaching implications for both the banking sector and the broader economy. By avoiding an increase in the cost of capital for SME loans, the PRA’s decision could help maintain or potentially increase the availability of credit to small businesses.
Evans highlighted the importance of this decision: “The PRA considers that the likely decrease in RWAs following the decisions made on the CFs for ‘transaction-related contingent items’ and some ‘other commitments’ will result in capital requirements that are more reflective of the risk of the exposures. This should facilitate firms’ willingness to provide these off-balance sheet items and commitments which may be positive for economic activity.”
This approach aligns with the PRA’s new secondary objective to facilitate growth and competitiveness in the UK financial sector, while still prioritizing its primary objective of maintaining the safety and soundness of regulated firms.
Similar to the SME lending adjustment, the PRA has introduced an “infrastructure lending adjustment” to ensure that capital requirements for infrastructure financing do not increase. This decision reflects the critical role that infrastructure investment plays in long-term economic growth and productivity.
In the realm of trade finance, the PRA’s decision to maintain the existing 20% conversion factor for ‘transaction-related contingent items’ is noteworthy. This move, which diverges from the Basel Committee’s recommendation of a 50% factor, demonstrates the PRA’s willingness to tailor international standards to the UK context where appropriate.
Evans commented on this decision: “The PRA agrees with respondents that the empirical evidence provided by the International Chamber of Commerce and Global Credit Data sufficiently addresses the PRA’s previous concerns that a 20% CF may not fully reflect the probability of a ‘trigger event’ occurring or the behaviour in downturn conditions.”
Alongside the Basel 3.1 implementation package, the PRA has also launched a consultation on a simplified capital regime for Small Domestic Deposit Takers (SDDTs). This initiative, part of the broader “Strong and Simple” framework, aims to reduce the regulatory burden on smaller banks and building societies while maintaining their resilience.
The proposed SDDT framework includes simplifications to all elements of the capital stack:
The PRA proposes that the implementation date for this simplified capital regime will be January 1, 2027, with the consultation period closing on December 12, 2024.
While the PRA’s near-final rules largely align with the Basel 3.1 standards, they also reflect UK-specific considerations. The adjustments made for SME and infrastructure lending, as well as the approach to trade finance, demonstrate the PRA’s commitment to tailoring international standards to the UK context where deemed necessary.
Evans emphasized this balance: “By delivering a package that includes evidence-based adjustments to reflect the UK’s financial system, but remains aligned with international standards, the PRA considers that the near-final rules will both support competitiveness and facilitate the flow of capital within the UK banking system.”
The PRA has set an implementation date of January 1, 2026, for the Basel 3.1 standards, with a four-year transitional period ending on December 31, 2029. This timeline aligns with other major jurisdictions and provides banks with adequate time to adjust their systems and processes.
It’s important to note that these rules are currently “near-final.” The PRA does not expect to make material changes before the final rules are published, but the distinction is worth noting. The final rules will be released once HM Treasury has made the necessary legislative changes to revoke relevant parts of the existing Capital Requirements Regulation.