The PRA's SS4/24 and Basel 3.1 IRB: What firms need to know

UK banks face significant changes to regulatory capital requirements under the Basel 3.1 framework. The PRA’s recent publication, PS9/24, sheds further light on these changes but also brings new challenges for firms working to meet compliance standards.

In this post, we’ll focus on the IRB part of the ruleset, detailing the essential steps firms need to take to achieve compliance by the 2026 deadline.

Basel 3.1 IRB update: What’s new

On September 12, 2024, the Prudential Regulation Authority (PRA) released PS9/24, which is the second part of the near-final rule set focusing on credit risk, the output floor and Pillar 3 disclosures.

The rules were published alongside supervisory statements on the Definition of Default (SS3/24) and Internal Ratings-Based (IRB) approaches (SS4/24). Additionally, the PRA released consultation papers on Pillar 2A, the definition of capital, the UK framework for capital buffers, and the strong and simple framework for small domestic deposit takers (SDDT).

Understanding the regulatory evolution

The transition to Basel 3.1 involves significant changes to the UK's regulatory framework. These changes affect multiple existing regulations and guidelines, creating a new structure that's more suited to the UK's post-EU regulatory environment.

The below diagram shows how the PRA Policy Statement PS9/24 consolidates various regulations, including the European Union CRR, Basel 3 Regulations, and the UK Technical Standards from PRA PS23/21. The new framework updates these requirements to create a unified UK approach.

The PRA Supervisory Statement SS3/24 represents a key change in how credit risk definition of default is managed. It combines and updates guidance from the EBA Guidelines on PD and LGD estimation with existing PRA requirements, particularly focusing on IRB approaches for mortgages.

SS4/24 brings together multiple sources of guidance on the UK’s IRB approach to credit risk. It consolidates EBA guidelines on PD and LGD estimation, including specific requirements for downturn conditions, with existing PRA supervisory statements.

PRA SS4/24: Key changes to the structure of the UK IRB regulations

Here are the primary structural changes:

Capital Requirements Regulation (CRR) will be replaced by the PRA Rulebook: The wording is contained in Appendix 2 of the PS9/24 release. This updates earlier versions of the rulebook shared with CP16/22 and PS17/23. The format of the new regulations is broadly similar to CRR, and article numbers have been kept consistent, with additional articles inserted as 143A, 143B etc.

SS4/24 replaces the existing IRB guidelines: Our assessment shows that SS4/24 is broadly a combination of the EBA guidelines on PD and LGD models (EBA GL 2017/16), downturn LGD models (EBA 2019/03) and SS11/13 (with relevant updates and additions for Basel 3.1). Some elements of SS11/13 – such as slotting criteria and risk weights – have now been excluded from SS4/24 but instead included in the PRA rulebook.

The identification of the nature, severity, and duration of an economic incorporated into the PRA Rulebook: The UK Regulatory Technical Standards (PS23/21), which was inherited from the EBA version EBA-RTS-2018-04 (in draft at the time of the EU exit), has now been included in the PRA near final rulebook as Articles 181A, 181B and 181C.

Language and nomenclature revisions: The revised statements use more “typical” PRA language (e.g. “the PRA expects that ….”, “firms” in SS4/24 instead of “institutions” in EBA guidelines), and replace thresholds (e.g. retail) with £ denominated amounts broadly equivalent to the Euro amounts used by EBA.

PRA SS4/24: Key changes to the UK IRB rules

SS4/24 finalises the significant changes from the existing regulations and guidance defined in Part 1 of the near-final rules:

The ability to use the IRB approach has been removed or amended for larger, low volume exposures such as sovereigns and large corporates.

For smaller, high-volume exposures i.e. retail, specialised lending and smaller corporates, the regulations still present challenges to firms to comply before the deadline of 1 January 2026 however the PRA have allowed for material compliance, with the rollout plan.

New “input floors” for PD, EAD and LGD:

• For PD, the “blanket” 0.03% floor has been raised to 0.1% for QRRE transactors and residential mortgages, and 0.05% for all other retail exposures.
• The requirements for 5% account level and 10% exposure weighted portfolio level LGD floors for mortgages have been retained but moved from SS to regulation.
• LGD floors of 50% for QRRE (both transactors and revolvers) and 30% for other unsecured retail have been introduced.
• For EAD, conversion factor floors of 50% of standardised / foundation values have been introduced for modelled EADs for revolving balances.

New “output floor” as laid out in the PRA Rulebook article 92: 72.5% of standardised RWA, adjusting for differences in the treatment of accounting provisions. The treatment of accounting provisions was changed following consultation CP6/22 (PS9/24 5.13 – 5.21).

In addition, firms will need to transition their existing attestation documents to align with the new regulations. This process should include identifying areas of change as well as requirements that remain consistent.

Basel 3.1 IRB updates: What firms should do next

Since many firms have likely begun assessing the changes proposed in consultation paper CP16/22, we recommend updating these assessments and plans to align with the “near-final” regulations. This process should ideally follow several critical steps:

1. Conduct a gap analysis - identify changes to rules e.g. those that impact capital, implementation or reporting

2. Assess the capital impact

3. Evaluate compliance impacts

4. Review of capital strategy and stress testing framework

Following these steps will equip firms to meet the new regulatory requirements efficiently, reducing risk and aligning their capital strategy with the updated Basel 3.1 framework.