Bank of England's prudential regulator consults banks on capital requirements

The Bank of England's Prudential Regulatory Authority (PRA) on Friday released a consultation asking banks, building societies and investment firms that it regulates for submissions on the quality of capital they should be required to hold in European-mandated buffers.

The consultation, running to October this year, will guide the PRA on how it implements the new European legal framework on bank capital, known as CRD IV, which was adopted by the Council of the European Union in June this year.

The new regulations from Brussels place greater emphasis, the PRA said, on the highest quality of capital, known as core equity Tier 1 (CET1), than the current regime does and strengthens the criteria used to determine what can be used as CET1.

The PRA said it is, for now, making enhancements to the quality of capital held against 'Pillar 2', the capital financial firms have to hold in an effort to ensure they have adequate capital to support all the relevant risks in their business. Pillar 2 is divided into capital held against risks not captured or not fully captured by the regulations (Pillar 2A), and risks to which a firm may become exposed over a forward-looking planning horizon (Pillar 2B).

Under the existing regime CRD IV, Pillar 2A can be met with any regulatory capital. The PRA is proposing that firms should meet this requirement with at least 56% CET1 capital from January 1, 2015, thus bringing the capital quality of Pillar 2A in line with that of Pillar 1.

PRA-regulated institutions are being asked, however, whether or not they believe the Pillar 2A requirement should, from January 1, 2016 onwards, be met with CET1 only or a different combination of capital.

The final form of the new capital regime emphasises that Pillar 2 capital requirements should be met by fully loss absorbing capital, thus by CET1. But, the PRA said, "in the light of actions being taken, UK banks are in a stronger position to allow judgements to be made about the appropriate path of transition to the final form, and these judgements can helpfully support lending and economic activity".

To that end, the PRA consultation also asks whether Pillar 2A should be "a firm-specific requirement... to hold a specified amount of capital" or "guidance on the capital the PRA believes a firm should hold to meet the overall financial adequacy rule".

It also asks financial institutions to tell the PRA what the benefits and costs would be of requiring Pillar 2A capital to be conform to CET1, and what the implications would be of different minimum standards for the quality of eligible capital to be held against Pillar 1 and Pillar 2A risks.

CRD IV also creates a combined capital buffer that all financial institutions will be expected to meet in addition to their Pillar 1 and Pillar 2 capital requirements. The combined buffer requirement will consist of a capital conservation buffer, a counter-cyclical capital buffer and buffers intended to mitigate systemic risk (where applicable). The combined capital buffer must be met with CET1 capital.

Bonus restrictions could get tighter

The consultation does "not cover substantive changes to the PRA's rules regarding remuneration", it said – despite CRD IV including new provisions on remuneration. The PRA said it will consider its approach to remuneration in the context of the Parliamentary Commission on Banking Standarda (PCBS) report, which also came out this year.

CRD IV caps bankers' bonuses at 100% of salary in any given year, or 200% of salary with the agreement of shareholders. In addition, a minimum of 25% of any bonus exceeding 25% of salary will have to be deferred for at least five years.

Sharon Bowles, the UK MEP who chairs the European Parliament's Committee on Economic and Monetary Affairs, which played a key role in drafting CRD IV, said on Friday she was "astonished that [the] PRA consultation says nothing on bonuses". "The PCBS can not prevent CRD IV, and adding [the two] together may be too far," she said.

However, in its report, the PCBS said it expects the UK government and the Bank of England "to ensure that the technical standards under CRD IV contain sufficient flexibility for national regulators to impose requirements in relation to instruments in which deferred bonuses can be paid which are compatible with our recommendations".