There has been a lot of recent trade press coverage in respect of Basel 3.1, and in particular the potential negative impact on the availability of niche mortgage products following various changes to the risk-weighted asset calculations. So, what’s going on and might it impact on product availability and choice?
Firstly, there is no doubt that the newest version of global banking regulations introduced by the Basel Committee on Banking Supervision [‘BCBS’], Basel 3.1, is designed to make significant changes to the way banks operate, particularly in relation to niche lending products. These products, which often serve specialised markets or less mainstream segments of the economy, will face increased scrutiny and, therefore, reduced profitability. This is largely driven by changes in risk-weighted asset [‘RWA’] calculations and resulting capital requirements that will make it more expensive for banks to offer such products. However, there may be some relief for ‘smaller’ lenders in the UK as the Prudential Regulation Authority [‘PRA’] has recently issued its near-final policy statement and rules covering the implementation of Basel 3.1 in response to consultation paper CP16/22.
The greater the risk-weight assigned to these products, the more capital banks must hold
The Basel 3.1 impact
The core objective of Basel 3.1 is to ensure that banks maintain sufficient capital buffers to cover their risks, particularly under stress scenarios. The increased capital requirements that banks will face under Basel 3.1 for niche lending products will likely make such lending less profitable. The greater the risk-weight assigned to these products, the more capital banks must hold, tying up funds that could otherwise be deployed in more traditional, lower-risk products.
Relief for some UK lenders?
While Basel 3.1 is a globally applied framework, individual jurisdictions have some flexibility in how they implement these rules. In the UK, the PRA has been exploring initiatives to address some of the challenges posed by the new capital requirements. The PRA’s Small Domestic Deposit Taker regime [‘SDDT’] could offer a pathway for banks to better manage the impacts of Basel 3.1, especially in relation to niche lending. The SDDT regime could potentially help banks with assets less than £20bn. In building society terms, that includes all bar the largest 5 firms!
The SDDT regime focuses on streamlining regulatory requirements for smaller banks and those with simpler business models, potentially making compliance with Basel 3.1 less onerous for these institutions. Recently, the PRA issued its near-final policy statement and rules covering the implementation of Basel 3.1. Many of the recommendations will be helpful, especially some issues that niche lenders were concerned about. In particular,
- the implementation date has been delayed by 6 months to 1 January 2026
- the use of AVMs for a product switch is permitted
- use of the original valuation has been maintained, but there is to be a re-valuation after 3 or 5 years for products like lifetime or equity release mortgages
- self-build mortgage risk weightings have been aligned to owner occupied at 20% up to 55% LTV and 75% thereafter
- holiday let risk weightings have been aligned to buy-to-let at 30% – 105% depending on the LTV.
Final thoughts
Basel 3.1’s recalibration of risk-weighted assets and capital requirements will undoubtedly limit the profitability and availability of niche lending products, particularly by making them more expensive for banks to offer. These changes may result in reduced lending to higher-risk sectors and borrowers, potentially stifling innovation and access to credit. However, regulatory initiatives like the PRA’s SDDT regime offer some hope for mitigating these impacts by providing more tailored, proportionate regulatory treatment for smaller and specialised banks.
These issues are, of course, critical to consumers who depend on product availability in underserved markets and lenders who rely on lending in riskier sectors to maintain profitability, but they should also be high on minds of compliance and risk officers. They will, of course, remember the PRA fine, which exceeded £5m, when a lender applied an incorrect risk weighting, 35%, to a category of lending that should have been weighted at 100%.
Readers will be hearing a lot more about Basel 3.1, the PRA near final rules and the SDDT regime before implementation in 2026. There are certainly opportunities, but also challenges!
