"Seven Awkward Questions" - food for thought for new bank applicants
07 February 2019
Last week Bank of England Deputy Governor for Prudential Regulation and CEO of the Prudential Regulation Authority (PRA), Sam Woods, gave a speech titled “Seven Awkward Questions” on how the PRA has been supporting it’s secondary competition objective since its inception in 2013. For us, working with new banks on a daily basis, much of what Mr Woods had to say was very familiar. Here’s some thoughts on how the PRA’s approach to authorising new banks has changed over the past 5 years.
Mr Woods highlighted the success of the New Banks Unit in his speech which is a joint venture between the PRA and FCA. The unit has been highly beneficial in clearly setting out the process and regulatory gates through which firms have to pass on their authorisations journey, which has undoubtedly made the applications process easier. How the application process is approached in practise by the regulators appears to be evolving over time. Applicants are now waiting longer for feedback on submissions than we saw previously and they regularly receive feedback that the regulators want addressed earlier in the process than was expected for earlier applicants The implications of this for current applicants is that they should build in more conservative timelines and contingency plans than had previously been needed.
Capital requirements is an area where we’ve seen several changes for new banks. The PRA attempted to level the playing field with the “Barriers to Entry” paper that Mr Woods noted in his speech. This change made the capital buffer calculation simpler for new banks. However, it generally results in a higher capital requirement than would be needed for the applicant were they to use the traditional stress testing approach. Plus over time we have found supervisory feedback from the PRA to show they want to see some stress testing from firms in their banking licence application documents too. The PRA has also tightened its approach to capital structures over the past couple of years in a push for simplicity.
Proportionality is often used by regulators to describe the differing expectations for smaller banks and was rightly cited as an issue for the PRA that requires careful navigation by Mr Woods. The concept is straightforward – it would not be sensible to impart the same operational and risk management requirements on the new entrants as are expected of the big high street banks; no firm would be able to launch with that level of complexity. Inevitably as the PRA evaluates more applications the standard required becomes more readily apparent at an early stage of the application process. Therefore, in our view, it is important that all applicants have robust research to support their proposed strategy and a good handle of the risks and proposed approach to managing these at the earliest possible stage.
Mr Woods identified the potential conflict arising between the PRA’s primary objective to protect financial soundness and the secondary objective to allow competition. The recovery and resolution regime is one way in which the PRA is able to get comfortable with the risks associated with the launch of a new bank, protecting financial soundness whilst allowing new entrants to compete. We are seeing the PRA put greater emphasis on solvent wind down plans for new bank applicants which appears very sensible. If a new bank really can be easily and quickly wound down with limited impact on the financial system, the expectations placed on new banks in other areas could be reined in. This would allow new banks to focus more on getting the commercial nature of their business right, allowing markets and competition to discern which business models will succeed.