15 October 2012

Bank of England: The Prudential Regulation Authority’s approach to banking supervision

The PRA will become the UK's prudential regulator for deposit-takers, insurance companies and some investment firms in 2013. This paper sets out how the PRA will carry out its role in respect of deposit-takers and investment firms.

The paper is designed to help regulated firms and the market understand how the PRA will supervise these institutions, and to aid accountability to the public and Parliament.

The PRA will have a statutory objective to promote the safety and soundness of firms. It is required to pursue this primarily by seeking to avoid adverse effects on financial stability, and in particular seeking to minimise adverse effects resulting from disruption to the continuity of financial services that can be caused by the way firms run their business or upon their failure. A stable financial system, that is resilient in providing the critical financial services the economy needs, is a necessary condition for a healthy and successful economy.

Seeking to minimise the adverse effect of the failure of a firm does not require the PRA to take steps to avoid any and all such adverse effects or to prevent all instances of failure. The statute is explicit that it will not be the PRA’s role to ensure that no firm fails. Firm failures will happen, but the PRA will seek to ensure that they do not result in significant disruption to the supply of critical financial services, including depositors’ ability to make payments. Assessing and planning to contain the impact of failure will be a core part of the PRA’s work. This will depend on the efficacy of the statutory resolution regime, on which the PRA will work with the rest of the Bank.

The requirements that firms will need to meet in order to remain safe and sound will be rooted in the PRA’s statutory objective, the statutory Threshold Conditions for authorisation, and UK and EU law. The PRA’s new statutory Threshold Conditions, which will set out the minimum requirements that firms must meet in order to be permitted to carry on the regulated activities in which they engage, are designed to promote safety and soundness and will be crucial to the operation of the new regime. In broad terms, they will require firms to have an appropriate amount and quality of capital and liquidity, to have appropriate resources to measure, monitor and manage risk, to be fit and proper, and to conduct their business prudently. The PRA will expect firms not merely to meet and continue to meet the letter of these requirements, but also to consider the overriding principle of safety and soundness. Maintaining safety and soundness will at times require firms to act more prudently than they might otherwise choose. Their incentives can sometimes be to take more risk, and so to impose more risk on the stability of the financial system and economy, than is in the public interest. It is the responsibility of each firm’s board of directors and senior management to manage their firm prudently, with a view to maintaining its safety and soundness, thereby contributing to the continued stability of the financial system. This will be in firms’ collective interest as well as in the public interest. It is vital that boards and senior management understand and uphold this objective, and establish within their firms a culture that supports it.

Within the statutory framework, the PRA’s approach will rely significantly on judgement. The PRA will supervise firms to judge whether they are safe and sound, and whether they meet, and are likely to continue to meet, the Threshold Conditions. The PRA’s approach will be forward-looking; it will assess firms not just against current risks, but also against those that could plausibly arise in the future. The PRA will focus on those issues and those firms that pose the greatest risk to the stability of the UK financial system. The PRA’s regulatory decision-making will be rigorous and well documented, consistent with public law.

An effective framework for financial stability needs to combine firm-specific supervision with work to protect and enhance the resilience of the financial system as a whole. The PRA will therefore work closely with the rest of the Bank of England, including, crucially, the Financial Policy Committee, which will be able to make recommendations and give directions to the PRA. The PRA will cooperate closely with the Financial Conduct Authority, which will be the conduct regulator for PRA-authorised firms and the conduct and prudential regulator for many other UK firms. Reflecting the international nature of the banking industry and capital markets, and in particular the United Kingdom’s membership of the single market in EU financial services, the PRA will play a full and active role with its counterparts globally and in the European Union in developing and implementing prudential standards and in supervising international firms.

Full document

FSA-press release © FSA

© Bank of England