The Prudential Regulation Authority (PRA) is consulting on increasing the retail deposits leverage ratio to £70bn, a jump of £20bn.
The retail deposits leverage ratio is an indicator of a company’s solvency and measures a firm’s capital resources relative to its exposures without risk-weighting. The lower the ratio the less the firm uses regulatory capital to fund its activities.
The aim of the ratio, according to the PRA, is for it to “guard against – as a backstop measure – the risk of errors and uncertainties in assigning risk weights” and to “limit excessive balance sheet growth or act as a constraint to such excess before it occurs”.
The retail deposits leverage ratio is a requirement for major banks, building societies and investment firms as well as companies with “significant non-UK assets”,
The PRA is proposing to increase the threshold for the retail deposits leverage ratio from £50bn retail deposits, which was set in 2016, to £70bn.
Sam Woods, deputy governor for prudential regulation and CEO of the PRA, said: “Guarding against excessive leverage in our banking system is essential for economic stability, but we should achieve that in a proportionate way. Today’s proposals will support growth and innovation by giving smaller banks more space to grow before entering the leverage regime.”
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Leverage ratio changes could boost competition in retail mortgage lending
Within its consultation paper, the PRA said the proposal could have “some beneficial effects for competition”, in particular the retail lending mortgage market.
It explained: “Smaller UK firms would have more scope to grow before becoming subject to the requirement, and lower requirements might translate into additional lending, although these effects are expected to be relatively minor.”
The PRA said no direct costs have been identified for firms, however, operational cost savings for impacted firms could be around £130,000 per year.
“Overall, the PRA does not consider that there are material costs to firm-level resilience or financial stability. There could be some benefits in relation to supporting competition and, at the margin, competitiveness and growth. For firms, there will be benefits to some that have more space to grow before becoming subject to the requirement, with the associated capital and operational costs,” it said.
The PRA added that it did not expect smaller mutuals to be affected differently from peer banks, but warned mutuals that were “sufficiently large enough” could be.
“For example, they may face greater challenges than banks in issuing Additional Tier 1 capital (AT1) – generally a cheaper form of capital – to meet any increase in capital requirements, because of more limited access to capital markets.
“Nonetheless, we think that this is justified prudentially. Mutuals will only become subject to the requirement as a consequence of having grown sufficiently to pose a greater risk to the UK financial system, to the point where a stronger guardrail against shortcomings in risk measurement is warranted,” it said.
The PRA said it believed the proposal would “preserve the safety and soundness of firms by maintaining strong prudential standards”.
“The PRA considers that the retail deposits threshold for the leverage ratio requirement has become increasingly binding over time, as a result of inflation and growth in the economy. This has inadvertently tightened the leverage ratio framework.
“Consequently, the requirement no longer exclusively applies to the ‘major’ UK firms, as directed by the Financial Policy Committee. Absent changes, the threshold would start to capture firms that have not become more systemic in nature, as their contributions to the UK financial system and economy have remained broadly unchanged. Over time, this issue could become more acute, with an increasing number of firms being inappropriately captured by the threshold,” the regulator explained.
