PRA eases certain capital requirements for banks ahead of implementation of new risk regime

The Prudential Regulation Authority (PRA) will instead only require 56% of the capital used by banks to meet so-called 'Pillar 2A' risks to be in the form of Common Equity Tier 1 (Tier 1) capital; the same proportion as allowed in relation to 'Pillar 1' risks. Banks will be able to meet the remaining requirements using any form of regulatory capital, including contingent debt. The announcement follows a consultation on whether banks should have to assign Tier 1 capital to all of their Pillar 2A risks, a category which covers each bank's individual liabilities.

In its response to its August consultation on the new requirements (2-page / 158KB PDF), the PRA also confirmed that it would require firms to meet a 4% Tier 1 capital requirement against Pillar 1 liabilities, which would rise to 4.5% from 1 January 2015. Over the same period, the required Pillar 1 Tier 1 capital ratio will be set at 5.5% rising to 6% from 1 January 2015 onwards. The total Pillar 1 Tier 1 capital requirement will remain 8%.

"These decisions will enhance the stability of the financial sector and strengthen the capital regime in the UK," the PRA said in a statement.

"Although the PRA has not finalised all aspects of the rules, it is setting out a number of key decisions in order to give firms clarity on the key policy issues that affect the minimum level of Common Equity Tier 1 capital which firms need to maintain ... The PRA has confirmed that, in line with its consultation proposals, it will introduce the final definition of [Tier 1 capital] as quickly as possible," it said.

The statement sets out how the PRA will implement the requirements of the new Capital Requirements Directive (CRD4) and Capital Requirements Regulation (CRR), which together implement the Basel III international banking agreement in Europe. CRD4 gives EU member states some flexibility to impose more stringent requirements than those set at an international level, while CRR will introduce the first EU-wide set of prudential rules for banks.

Under the new regime, banks will be required to set aside good quality capital amounting to a minimum of 8% of their risk-weighted assets, with 56% of this - or 4.5% of liabilities overall - in the form of Tier 1 capital. This capital must be reasonably liquid, meaning readily convertible into the cash needed to pay depositors and creditors in an emergency. Tier one capital mainly consists of shareholders' equity, disclosed reserves and other high-quality assets.

The PRA has also confirmed that it will expect the UK's largest banks and building societies to meet a 7% capital ratio from 1 January 2014. They will also be expected to comply with a 3% leverage ratio, meaning they will be expected to hold 3% of the value of their assets on a non-risk weighted basis as capital. These requirements will apply to Barclays, HSBC, Santander, Lloyds, RBS, The Co-operative Bank, Nationwide and Standard Chartered, according to the PRA's supervisory statement on the new requirements (5-page / 1.9MB PDF).