Regulated firms: A matter of life and death

As the PRA transitions from a “rule-taker” to a “rule-maker”, small and medium-sized banks operating in the UK can expect to benefit from a more “streamlined” regulatory regime that could be easier to interpret, implement and maintain; but at the same time, they can also expect the PRA to be progressively more involved in scrutinising their plans for an orderly wind-down. This article explores how banks could respond to this impending trade-off between an easier “life” and a closely managed “death”.

Banks operating in the UK are regulated by the PRA, whose objective is to promote their safety and soundness, focusing on the adverse effects that they can have on the stability of the UK’s financial system. New banks are “born” when they receive authorisation from the PRA to operate in the UK, and there have been many births since Brexit.  The PRA’s prudential regime binds these banks during their “lifetime”, and they’re also required to prepare for an “orderly” death, ensuring that they can wind down without disrupting the system in which they operate. Most will agree that the PRA’s focus, with regard to meeting its objective, has primarily been on the safety and soundness of banks during their “lifetime”, in comparison to their “births” or “deaths”. However, with Brexit, this will soon change.

The UK is now flying solo, and to maintain (or even enhance) the attractiveness of its financial sector, the PRA intends to make banks’ “lives” easier. However, this is easier said than done because there aren’t many who’d like to return to the woes of 2008. As the pandemic has shown, banks have proven themselves to be more resilient than firms operating in most other sectors – which is a testament to the PRA’s efforts so far. Loosening the burden of regulation on banks to the extent that the stability of the UK’s financial system is put at risk again is well beyond the PRA’s risk appetite. So the question becomes, how will the PRA make banks’ lives easy without compromising their aforementioned objective? 

Supervisory authorities and the Government have tested the water with various ideas. Most recently, there has been some noise around the possibility of dissolving remuneration rules; but this idea does not seem to have gathered much momentum yet. Interestingly, Sam Woods – the Deputy Governor for Prudential Regulation at the Bank of England – mentioned a very interesting plan in his Mansion House speech last week; this plan revolves around more closely managing banks’ “deaths”.

If we think about what could really bring the system to its knees, it’s perhaps not about how well the banks live their “lives”, but rather how much harm might they cause when they “die”. When a bank fails, depositors may suddenly lose their deposits and thus be unable to settle their obligations (such as rent, mortgages or taxes) or pay for goods and services (such as gas and electricity, entertainment, new clothing or travel), thereby challenging the financial viability of companies that trade in these sectors, including the Government. This may lead to redundancies, which will further compound the adverse systemic impacts until the Government resorts to borrowing and then injecting cash into the system, hoping for a revival. As such – a planned and “managed failure” – to the extent that it does not trigger such a disruptive chain reaction, will go a long way in mitigating any additional risks to the PRA’s objectives that might be brought about by applying a more streamlined approach to regulating small and medium-sized banks during their lifetime.

Small and -sized banks should thus expect the PRA to be much more involved in reviewing and appraisal of their plans for exiting the market without disturbing it. It is also likely, that the PRA – now in its capacity as the “rule-maker” rather than the “rule-taker” – will introduce new rules in their rulebook around such plans. Questions that firms should be prepared to answer include:

  1. What is their estimated cost of winding down, how frequently is this calibrated, how are these funds protected, and how liquid are these reserves?
  2. What are the wind-down-centric Early Warning and Key Risk Indicators, and how do they blend in with their existing Risk management Frameworks and governance arrangements? 
  3. What are the specific actions that will be taken when the aforementioned indicators are breached, who might be responsible for taking them, how frequently is the viability of such actions tested, is there any key-person risk, and how might the board monitor the progress of such actions?; amongst many more.

Both recently and in the past, Mazars have helped clients with their wind-down planning. We have helped our clients estimate their exit costs, design wind-down risk assessment and governance frameworks, develop wind-down action plans and assist with regulatory reviews. Our in-house methodologies on this subject are based on regulatory guidance, publications and feedback, and our extensive experience working with small and medium-sized banks for many years. Want to know more about how we can help? Get in touch with us to know more.