The Prudential Regulation Authority (PRA) has today opened a consultation on its approach to market risk for banks, specifically focusing on the internal model approach (IMA). This represents the final element of the Basel 3.1 international banking standards to be implemented in the United Kingdom, concluding a major regulatory reform programme initiated after the global financial crisis.
Under the Basel 3.1 market risk rules, also known as the Fundamental Review of the Trading Book, banks are required to calculate the amount of capital they must hold to cover potential losses from their trading operations. This can be achieved either through a more straightforward, standardised approach, which typically demands higher capital, or via internal models. The latter is generally favoured by larger financial institutions with extensive international trading activities.
The PRA had deliberately delayed the implementation of its IMA rules to allow time for consideration of how other major trading jurisdictions were adopting these standards. This strategic pause aimed to ensure the UK's approach would foster international alignment and proportionality, particularly given the global nature of banks' trading operations and the PRA's objective to support competitiveness and growth within the UK financial sector.
Key proposals within the consultation include extending the monitoring period for the profit and loss attribution test from one year to three. This extension is designed to provide the PRA with sufficient time to gather data and confirm the appropriate calibration of the test before it directly impacts capital calculations. Additionally, the PRA proposes a more targeted approach to identifying unmodellable risks in activities with limited trading data, which could allow for more extensive modelling where suitable, leading to a more risk-sensitive capital framework.
Further adjustments aim to simplify the transition process for firms adopting a mix of internal models and standardised approaches, preventing potential increases in capital requirements as banks gradually move towards full IMA approval. Operational simplifications are also being introduced to ensure the IMA operates more proportionately. Sam Woods, Deputy Governor for Prudential Regulation and Chief Executive Officer of the PRA, highlighted that these rules are the final piece of the post-financial crisis reform programme, aiming to ensure UK trading activities are appropriately capitalised while considering international implementation.
The PRA intends to implement these adjustments to the IMA on its previously announced date of 1 January 2028. All other Basel 3.1 rules are set to come into force in January 2027 as planned. This forms part of broader efforts by the PRA to support economic growth and maintain financial stability, including the Financial Policy Committee's recent reduction of the benchmark capital requirement for the financial sector from 14% to 13%, and initiatives to simplify capital requirements for smaller, domestically focused lenders.