CP12/25 – Updates to Pillar 2A Capital Framework
Overview
On 22 May 2025, the Prudential Regulation Authority (PRA) published Consultation Paper (CP) 12/25 as the first phase of a two-stage review of its Pillar 2A methodologies and guidance.
Pillar 2A capital requirements are designed to ensure firms hold sufficient capital for risks not fully or sufficiently captured by Pillar 1 requirements. This consultation addresses the consequential impacts of the PRA's near-final rules implementing the Basel 3.1 standards and proposes changes aimed at improving information, guidance, transparency, and proportionality for firms.
While this CP applies to all PRA-regulated firms, the PRA clarifies that many key proposals within this CP, particularly concerning credit risk and operational risk methodologies, do not apply to Small Domestic Deposit Takers (SDDTs). The proposals relating to SDDTs are being consulted separately in CP7/24.
Timelines
This consultation closes on Friday, 5 September 2025. The PRA proposes that the changes to pension obligation risk, market risk, and counterparty credit risk would come into effect on 2 March 2026.
The implementation date for the remaining proposals in this CP, covering credit risk and operational risk, would be aligned with the PRA’s implementation of the Basel 3.1 standards, currently scheduled for 1 January 2027.
Key Changes
The key changes proposed in this CP across all risk areas are outlined below:
Credit Risk:
The CP proposes significant updates to the Pillar 2A methodology for credit risk. Key proposals include:
Removing the Internal Ratings-Based (IRB) approach risk weight benchmarking methodology. The PRA considers that this methodology will no longer be appropriate following the implementation of Basel 3.1, given enhancements to the Standardised Approach (SA) that will make it more risk-sensitive.
To mitigate potential under-estimation of credit risk for certain exposure types under the Pillar 1 SA, two systematic methodologies are proposed:
- Application of minimum effective risk weights for specific exposures currently eligible for preferential risk weights under:
· CRR Article 114(7): exposures to central governments and central banks, and
· CRR Article 115(4): exposures to regional governments and local authorities.
The proposed Pillar 2A minimum effective risk weights are as follows:
· Non-UK Central Governments and Central Banks
o CQS1 / MEIP[1] 0–1: No minimum
o CQS2–3 / MEIP 2–3: 5%
o CQS4–6 / MEIP 4–7 and Unrated: 20%
· Non-UK Regional Governments and Local Authorities
o CQS1: 5%
o CQS2–3: 20%
o CQS4–6 and Unrated: 100%
- Introduction of a prescribed Conversion Factor (CF) reference point of 20%[2] for revolving retail exposures classified as unconditionally cancellable commitments (retail UCCs).
Introducing expectations on the use of credit scenarios in firms' ICAAPs. This is intended to achieve greater consistency and comparability in firms' assessments of idiosyncratic risks not captured by Pillar 1 or the systematic methodologies. Firms should design scenarios exploring high-severity tail events over a 12-month horizon.
The proposals also involve reducing reporting requirements by streamlining the FSA076 template and decommissioning the FSA077 and FSA082 templates.
[1] MEIP refers to ‘Minimum Export Insurance Premiums’ and is applicable to exposures rated by an Export Credit Agency.
[2] Firms will be able to use a lower, substantiated CF if they can demonstrate lower realised CFs.
Operational Risk:
For operational risk, the PRA is not proposing significant changes to its Pillar 2A methodology in response to Basel 3.1. Instead, the focus is on enhancing transparency and clarity in policy materials. Proposals include:
Introducing clearer expectations on scenario analysis in SS31/15 for all firms to improve the quality and consistency of ICAAP scenario analysis.
Providing more transparency in the Pillar 2 Statement of Policy (SoP) by clarifying the factors the PRA considers when setting Pillar 2A operational risk capital, for all firms and specifically for significant firms.
Introducing a set of good practices for significant firms on maintaining a robust operational risk measurement framework in SS31/15.
Making minor clarification changes to the instructions of FSA072–075 templates.
These changes aim to help firms better understand PRA expectations and assess their operational risk add-ons more consistently, reducing firms’ burden. The PRA expects most firms' total operational risk capital requirements to remain unchanged as a result of these specific proposals.
Market Risk and Counterparty Credit Risk:
For market risk and counterparty credit risk, the PRA proposes to enhance transparency by clarifying and expanding the information available on its existing methodologies, without making changes to them.
The updated information for market risk includes details on the assessment of illiquid risks (such as illiquid, one-way, and concentrated positions), as well as other market risks, including gap risk, intraday risks, non-interest rate risks on fair-valued positions, and syndicated loan underwriting.
For counterparty credit risk, the updates cover areas such as settlement risk, residual risks arising from credit risk mitigation, wrong-way risk, exposures to central counterparties (CCPs), and other tail risks — including weaknesses in stress testing or models and the adequacy of Pillar 1 capital for Credit Valuation Adjustment (CVA) volatility risk.
These proposals aim to promote more consistent and transparent submissions from firms. The PRA does not expect these changes to result in any increase in firms’ total capital requirements for these risks.
Pension Obligation Risk:
The PRA notes that pension risk for most firms has significantly decreased recently due to de-risking strategies and falling scheme deficits. In light of this, the CP outlines two main proposals aimed at reducing regulatory burden.
The first proposal is the removal of the two PRA-prescribed stress scenarios. The PRA has observed that firms increasingly use their own modelling capabilities and rely less on the prescribed scenarios. Removing them aims to reduce firms' disclosure burden without significantly affecting the PRA's ability to assess Pillar 2A pension risk capital.
The second proposal is to exempt firms with fully bought-in or sufficiently well-funded schemes from the full Pillar 2A pension risk assessment and reduce the associated reporting requirements. The PRA considers that schemes with full buy-ins or a funding ratio of at least 130% on an accounting basis are unlikely to pose a material risk or result in a material Pillar 2A add-on. This exemption would be applied on an individual scheme-by-scheme basis if a firm has multiple schemes.
These proposals reduce the regulatory burden for qualifying firms.
Impact on Small and Medium-Sized Banks
While most of the proposals in this consultation paper aim to simplify the framework, enhance transparency, and reduce the reporting burden, certain elements may introduce additional complexity to the Pillar 2A assessment. For example, the proposed use of credit scenarios exploring high-severity tail events over a 12-month horizon could increase assessment requirements for firms.
Following the implementation of the Basel 3.1 standards, the PRA intends to undertake a more detailed review of individual Pillar 2A methodologies. This future review will focus on further clarifying expectations and enhancing proportionality, potentially creating additional opportunities to ease regulatory requirements for smaller firms.
How We Can Help
At Katalysys, we recognise the practical challenges these changes present, especially for smaller and medium-sized firms with limited internal capacity. Our specialist team offers tailored, pragmatic support to help you manage this transition effectively. We can assist you with:
Pillar 2A Assessment Frameworks: Supporting the development or enhancement of internal Pillar 2A assessment processes — including credit scenario design, high-severity tail event analysis, and documentation aligned to PRA expectations.
System, Data, and Scenario Readiness: Advising on data capture and scenario development to support the proposed reporting requirements and new stress testing components.
Staff Training and Practical Guidance: Delivering focused training sessions and technical briefings to build awareness and strengthen your teams’ ability to meet evolving regulatory expectations.
Capital Impact Assessment and Planning: Quantifying the potential impact on your capital requirements and integrating these outcomes into your ICAAP, capital planning, and risk appetite frameworks.
Our experience in supporting firms through regulatory change will allow us to help you navigate the evolving landscape with confidence.
For more information, please contact:
Josh Nowak
Managing Director
Risk & Regulatory Consulting
T: +44 (0)7587 720988
E: josh.nowak@katalysys.com