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
Previous ArticleOSFI Updates Timelines for Implementation of IFRS 17
The European Banking Authority (EBA) proposed implementing technical standards on the interest rate risk in the banking book (IRRBB) reporting requirements, with the comment period ending on May 02, 2023.
The U.S. Federal Reserve Board (FED) set out details of the pilot climate scenario analysis exercise to be conducted among the six largest U.S. bank holding companies.
The Board of Governors of the Federal Reserve System (FED) adopted the final rule on Adjustable Interest Rate (LIBOR) Act.
The European Central Bank (ECB) published an updated list of supervised entities, a report on the supervision of less significant institutions (LSIs), a statement on macro-prudential policy.
The Hong Kong Monetary Authority (HKMA) published a circular on the prudential treatment of crypto-asset exposures, an update on the status of transition to new interest rate benchmarks.
The European Commission (EC) adopted the standards addressing supervisory reporting of risk concentrations and intra-group transactions, benchmarking of internal approaches, and authorization of credit institutions.
The China Banking and Insurance Regulatory Commission (CBIRC) issued rules to manage the risk of off-balance sheet business of commercial banks and rules on corporate governance of financial institutions.
The Hong Kong Monetary Authority (HKMA) made announcements to address sustainability issues in the financial sector.
The European Banking Authority (EBA) published regulatory standards on identification of a group of connected clients (GCC) as well as updated the lists of identified financial conglomerates.
The General Board of the European Systemic Risk Board (ESRB), at its December meeting, issued an updated risk assessment via the quarterly risk dashboard and held discussions on key policy priorities to address the systemic risks in the European Union.