PS18/25 – Retiring the refined methodology to Pillar 2A

The latest Policy Statement from the regulator near-finalises the retirement of the refined methodology for Pillar 2A capital, and embeds some non-substantive changes on pension obligation risk and interest rate risk in the banking book

Introduction

On 28 October, the Prudential Regulation Authority (PRA) published Policy Statement PS 18/25 ‘Retiring the Refined Methodology to Pillar 2A,’ alongside two other policy statements: PS 20/25 ‘Strong and Simple Regime for Small Domestic Deposit Takers (SDDTs)’, PS 19/25 ‘Restatement of CRR Provisions.’

PS 18/25 is interlinked with the SDDT publication, as there is overlap between the impacts of the two statements.

Two Core Parts of PS 18/25

PS 18/25 responds to two remaining chapters (2 and 4) of the PRA’s earlier Consultation Paper CP 9/24 ‘Streamlining the Pillar 2A Capital Framework and the Capital Communications Process.’ (PS 2/25 ‘Streamlining firm-specific capital communications,’ was published by the PRA earlier in the year in response to Chapter 3 of this CP, which finalised the streamlining of firm-specific capital communications – hence all parts are now covered.)

Part 1: Retirement of the Refined Methodology

The first element, which reflects only “near-final” changes, concerns the proposal to retire the “refined methodology” to Pillar 2A capital. Under this methodology, the PRA used supervisory judgement to adjust Pillar 2A add-ons for lower-risk, well-managed firms by comparing their Credit Risk Standardised Approach (CR SA) risk weights to Internal Ratings Based (IRB) model benchmarks, ensuring total capital adequacy relative to underlying risks.

These changes are published as near-final because their implementation is directly linked to Basel 3.1 rules taking effect in the UK. The policy material will be finalised by the PRA as the UK Government progresses legislation to revoke prevailing Capital Requirements Regulations (CRR) legislation and the PRA will replace much of it with PRA Rulebook Parts/provisions.

The PRA is planning to retire the refined methodology because the fundamental changes in the CR SA as part of the Basel 3.1 package render a comparison to IRB benchmarks less meaningful given the gaps are expected to be substantially reduced in most cases. It is also consistent with the near-final rules for the SDDT capital regime, under which Pillar 2A credit risk capital will focus on short, sharp credit shocks instead of benchmarking to IRB models. The PRA views retirement as enhancing transparency and proportionality.

The final rules will come into effect on 1 January 2027, alongside the Basel 3.1 reforms.

Part 2: Amendments to Pension Obligation Risk & IRRBB

The second part covers definitive rules and final changes to policy for setting Pillar 2A capital in respect of pension obligation risk and updates to supervisory expectations on interest rate risk in the banking book (IRRBB).

The PRA proposed to embed minor changes and clarifications in relevant policy material such as SoP 5/15 ‘The PRA’s Methodologies for Setting Pillar 2 Capital,’ and SS 31/15 ‘The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP)’ – these were not substantive, nor were they intended to change the PRA’s approach, rather the intention was to clarify pre-existing policy.

Pension obligation risk (SoP 5/15)

• Update a reference regarding the inclusion of deficits in, and the deduction of pension scheme surpluses from, the common equity tier 1 capital (CET1) of a firm.

IRRBB (SS 31/15):

• Add a reference to the Basel Committee on Banking Supervision (BCBS) for the Standardised Framework reflected in the PRA Rulebook.

• Update obsolete references and incorporate minor wording changes.

The amendments on pension obligation risk become effective 1 July 2026; for IRRBB, only the proposed clarifications noted above in SS 31/15 will come into force on this date, with the proposed minor updates to SoP 5/15 – which are not described in detail here – being shelved as part of a broader review of the PRA’s approach to Pillar 2A capital for IRRBB, which will be subject to a separate consultation.