2
Overview of the PRA’s supervisory approach for new and growing banks
2.1
The PRA’s primary aim is to promote the safety and soundness of the firms it regulates. In doing so it recognises the importance of competition in the banking sector and, since 2013, the PRA has aimed to be proportionate in the requirements for new banks in order to facilitate greater competition, in line with the PRA’s secondary competition objective. The guidance published in the 2013 report is clear that applicant banks must meet the PRA’s Threshold Conditions[41] in order to be authorised as a deposit-taker. The PRA’s assessment is proportionate to the size and complexity of the bank. It also takes into account that new banks are unlikely to meet all the expectations the PRA has of an established bank from inception, and in many cases new banks will require time to build, and demonstrate capabilities.
Footnotes
- 41. Sections 55B to 55D and Schedule 6 of the Financial Services and Markets Act 2000: https://www.legislation.gov.uk/ukpga/2000/8/contents.
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2.2
The PRA’s approach has been successful in supporting the authorisation of a number of banks. However new and growing banks have often underestimated the work involved post-authorisation to become a successful, and established bank that is able to exit the market in an orderly way in the event the firm becomes non-viable. In recognition that authorisation is the start of the journey for a bank, this SS sets out the PRA’s expectations of how banks should progress from being a new and growing bank to becoming an established bank. In addition to ensuring they can complete a solvent exit of their business, firms must also be able to show at all times how the preferred resolution strategy set for them (either via the Bank Insolvency Procedure or use of resolution tools where justified by the supply of transactional accounts or other critical functions at sufficient scale) could be carried out in an orderly way.
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2.3
Competitive markets involve firms being able to enter and exit. The PRA’s objective is not to ensure no firm exits the market, but instead to make sure that firms are able to exit the market in an orderly manner, such as via resolution if all other reasonable options have failed or are, in the Bank’s view, likely to fail. While firms may fail at any stage of their maturity, the likelihood of failure may be higher during the early stages of a firm’s development.[42]
Footnotes
- 42. This is common across industries, see for example: Geroski, P.A. (1995) ‘What do we know about entry?’ International Journal of Industrial Organisation, 13 421–441; or Kücher, A. et al. (2020) ‘Firm age dynamics and causes of corporate bankruptcy: age dependent explanations for business failure’, Review of Managerial Science, 14: 633–661.
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Progress to date
2.4
The PRA has placed emphasis on promoting competition in the banking sector over the last few years. The 2013 report articulated how this would be achieved including, for example, proposals to reduce a number of prudential requirements that had often been applied at the point of authorisation, including the removal of automatic capital ‘add-ons’ or ‘scalars’ simply because a bank was new.
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2.5
The 2013 report also introduced improvements to the authorisation process. This included a significant expansion of support during the pre-application stage of the process,[43] designed to support banks in progressing towards authorisation as quickly as possible. Along with this, it introduced the option for banks to be initially authorised with restrictions (‘mobilisation’). This option recognised that banks often need the certainty of being authorised in order to raise capital and the time to set up the necessary infrastructure.
Footnotes
- 43. Previously there had been one pre-application meeting.
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2.6
Figure 1 illustrates the journey of a bank from pre-authorisation to established bank.
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Figure 1: the journey from pre-authorisation to established bank
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Common issues for new and growing banks and how the PRA’s approach evolves
2.7
While there has been progress in supporting competition in the banking sector, it is clear that new banks typically face considerable challenges upon authorisation. Often banks are focused on the ambition of becoming authorised and lose the longer term focus of becoming sustainable businesses or fail to appreciate the ongoing need to invest in systems and controls to ensure they remain commensurate with the evolving needs of the business. There is also insufficient focus on planning for downside scenarios, including the ability to effect an orderly exit, which should be of particular focus given the greater likelihood of being non-viable in the early years of operation.
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2.8
New banks’ business models, risk management, and governance are untested at the point of authorisation, and are unlikely to meet PRA expectations of established banks. This proportionate approach for new banks is regarded as appropriate given that orderly exit of a bank at an early stage in its life is likely to have no or minimal impact on financial stability and is a natural part of a competitive economy. However, if a new bank is to become a successful, established bank, it needs to mature rapidly across all aspects of its business. New and growing banks should expect to invest significantly in developing governance, controls and capabilities in their early years of operation.
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2.9
The table overleaf shows how the PRA’s expectations of banks increase as the bank matures. This focuses on the common areas where the PRA has seen new and growing banks struggle as they seek to become established banks: business model, governance, risk management, and capital. These areas of focus will be elaborated on in subsequent chapters. New and growing banks should ensure they also understand PRA expectations and requirements on topics not covered in this SS, including liquidity, credit risk management, operational risk, and resilience. In addition, Table 2 only covers the five years following exit from mobilisation (or upon authorisation if a firm does not follow the mobilisation route). The PRA expects banks to continue to develop across all these areas beyond this point, in line with the growth of the business, where appropriate.
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Table 2: The PRA’s expectations of banks as they mature
| Year 0[44] | Year 3 | Year 5 | |
| Business model | Untested business model, most banks loss making |
Business model refined based on experience Forecasts are more accurate Credible strategy to achieve profitability |
Settled business model Either profitable or a credible strategy to achieve profitability with definite capital support to achieve that Realistic forecasts |
| Governance |
Appropriate number of independent non-executive directors. Established good practice is at least two Chair must not perform an executive function and there is a strong expectation that they should be independent[45] |
Appropriate number of independent non-executive directors. Established good practice is at least three, including the chair[46] |
Appropriate number of independent non-executive directors. Established good practice is at least a majority independent board |
| Risk management |
Framework and policies in place Untested as firm has not yet operated as a bank |
Bank is testing and refining framework and policies in light of experience Risk management is fit for purpose, with a focus on developing risk management and controls for the most material risks |
Mature control environment Fully embedded risk management framework linked into stable business model Framework provides forward looking view across all risk types Continuous improvement to ensure framework remains fit for purpose given business and regulatory developments |
| Capital |
PRA buffer set on new bank basis (six months forward operating expenses) In addition to buffers, hold enough capital to meet business plan while remaining above buffers for 12 months Internal Capital Adequacy Assessment Process (ICAAP) meets minimum standards but untested, and is fit for purpose |
PRA buffer set on new bank basis (6 months forward operating expenses)[47] Undertaking advanced stress testing and a clear plan for transitioning to stress test buffer Forward looking view of capital to ensure buffers are not used in the usual course of business ICAAP meets minimum standards and is fit for purpose |
PRA buffer set on stress test basis Sophisticated capital management with credible capital models ICAAP is a robust document which is an integral part of the firm’s management process and decision making |
| Liquidity | Internal Liquidity Adequacy Assessment Process (ILAAP) meets minimum standards but untested, and is fit for purpose |
ILAAP meets minimum standards and is fit for purpose. |
ILAAP is a robust document which is an integral part of the firm’s management process and decision making |
| Operational resilience | Design operational resilience into business processes and controls from the outset, and follow all relevant policies. |
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| Recovery and Resolvability |
Credible recovery plans in place - sufficiently detailed and practical to ensure they reflect the complexity and size of the firm and would be useable in a stress. Preparations for solvent exit approved by the Board. Undertake a forward-looking, realistic assessment of how its preparations for resolution would enable the bank to achieve the outcomes for resolvability. Meet the PRA rules on depositor protection. |
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Footnotes
- 44. At authorisation / exit from mobilisation.
- 45. The optimal board composition will depend on the complexity, organisation structure and size of the firm at each stage. For instance a greater or smaller number of INEDs than those outlined in Table 2 might be appropriate for different firms at the same stage of development.
- 46. The optimal board composition will depend on the complexity, organisational structure and size of the firm at each stage. For instance a greater or smaller number of independent non-executive directors than those outlined in Table 2 might be appropriate for different firms at the same stage of development.
- 47. Although the PRA buffer could be set on a stress test basis by this point if the bank has reached profitability (see paragraph 4.8).
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Box 1 – Supervision of UK bank subsidiaries of international groups
The expectations set out in this statement will be tailored for banks that are subsidiaries of international groups.
In its role as host supervisor for international banks, the PRA considers the degree of equivalence of the home state regulatory and supervisory regime, and the degree of cooperation with the home state supervisor.
For subsidiaries of international groups, the PRA applies the same regulatory requirements and follows the same supervisory framework as for a UK headquartered firm but its supervisory approach takes into account the links between the subsidiary and the rest of the group of which it forms part. The PRA will adapt its supervisory approach according to the nature, scale and complexity of a firm’s UK operations and the potential impact on financial stability in the UK. Accordingly, the PRA’s expectations of subsidiaries may well differ in some areas from those of UK headquartered firms.[48]
Board composition is one example of where the PRA’s expectations differ from those set out in paragraph 3.11. The extent to which the PRA believes the boards of significant regulated subsidiaries need to be independent will be influenced by a number of factors, including the size, scope and nature of the subsidiary’s business, its business model, and the degree of strategic and operational dependence between the subsidiary and the wider group. The local board structure will need to recognise that connectivity. The objective is to ensure that the governance of the subsidiary is effective and that its board is capable of taking decisions in the interests of the safety and soundness of that firm.[49]
Other matters where there may be a difference of approach for subsidiaries of international firms include, but are not limited to, profitability, governance, recovery, resolution and solvent exit.
The PRA will discuss its expectations with firms during the authorisation process and through the ongoing supervisory dialogue. Firms should speak with their normal supervisory contact if further clarity is required.
Footnotes
- 48. 2023 Approach documents (para 154 – 160), July 2023: https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors and SS5/21 (International banks: The PRA’s approach to branch and subsidiary supervision): July 2021: https://www.bankofengland.co.uk/prudential-regulation/publication/2021/july/pra-approach-to-branch-and-subsidiary-supervision-ss
- 49. SS5/16, July 2018: https://www.bankofengland.co.uk/prudential-regulation/publication/2016/corporate-governance-board-responsibilities-ss.
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