PRA is proposing, via the consultation paper CP14/20, to introduce two complementary expectations on the level of mortgage risk-weights in UK for banks applying the internal ratings-based approaches. PRA considers that models delivering risk-weights below the newly proposed expectations are likely to be materially deficient. The comment period on CP14/20 ends on January 30, 2021. The finalization of this proposal would result in changes to the Supervisory Statement SS11/13 on internal ratings-based approaches. PRA proposes that the final policy resulting from CP14/20 to take effect from January 01, 2022.
The purpose of these proposals is to address the prudential risks stemming from inappropriately low internal ratings-based UK mortgage risk-weights. In the consultation paper, PRA sets out its expectations that it considers models delivering risk-weights below the following levels are likely to be materially deficient in risk capture:
- A risk-weight of at least 7% for each individual UK residential mortgage exposure
- An exposure-weighted average risk-weight of at least 10% for all UK residential mortgage exposures to which a firm applies the internal ratings-based approach
Risk-weighting is a key part of the capital framework in UK. A number of typically larger UK firms use internal ratings-based models when calculating their risk-weights as inputs to risk-weighted capital requirements and ratios. The average internal ratings-based UK mortgage risk-weight is just under 10%, having fallen from c.13% in 2014. These are historically low average internal ratings-based UK risk-weights. This average conceals significant firm variation in these risk weights, which range from c.4% to c. 17%. Even for the same loan quality, as measured by a given loan-to-value (LTV) bucket, different models currently give very different risk-weights. By comparison, the lowest standardized approach UK mortgage risk-weight is 35%, while the EU average internal ratings-based mortgage risk-weight is c. 13%. The proposed changes would result in narrowing of differentials between the internal ratings-based and standardized approach UK mortgage risk-weights.
Both proposals would apply at all levels of consolidation and cover all UK residential mortgage exposures. CP14/20 is relevant to authorized UK banks, building societies, and ring-fenced banks holding internal ratings-based model permissions. It may also be of interest to other firms, including those considering applying for internal ratings-based model permission. Other countries, including Norway, Finland, Sweden, Belgium, and the Netherlands, have also introduced measures to address the low internal ratings-based mortgage risk-weights.
Comment Due Date: January 30, 2021
Effective Date (Proposed): January 01, 2022
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