The Prudential Regulation Authority (PRA) has reviewed the recovery planning capabilities of approximately 70 non-systemic UK banks and building societies over the past 18 months. On 15 May 2024, the regulator issued a Dear CEO letter, giving industry feedback, identifying areas for improvement, planned next steps and effective practice examples.
While many firms understand the basics of recovery planning – read our guidance here – the PRA’s review found there are significant areas requiring improvement. Most notably, these related to the development of recovery scenarios and the calculation of recovery capacity.
The PRA recognises considerable overlap with recovery planning and solvent exit planning. Non-systemic firms will be aware that from October 2025, they must meet the rules and expectations introduced in policy statement 5/24 Solvent exit planning for non-systemic banks and building societies, as well as the related supervisory statement (SS2/24). The findings of this thematic review are therefore relevant when considering solvent exit planning. Firms should leverage their work on recovery planning when implementing their solvent exit approach.
The PRA highlights that a number of firms didn't use scenarios of sufficient severity in their scenario testing, meaning testing will only be of limited effectiveness and value. This is something we often see in our work across the financial services sector helping firms with their recovery, solvent exit or wind-down planning.
Choosing appropriate scenarios under a wide range of stress levels and types should test how different elements of the plan (ie, indicators, calibration, governance and deployment of plan) would interact and work.
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PRA requirements for recovery scenarios |
Tips from effective practice examples |
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Firms should ensure scenarios are sufficiently severe and bring the firm close to its point of non-viability (PONV). Firms should provide analysis outlining how they define and calculate their PONV. Recovery capacity calculations for each scenario should reflect the parameters of the stress: eg, macro or market conditions, or interdependencies between recovery options. |
Firms can demonstrate the severity of their modelled scenarios by linking it back to their reverse stress testing and their ICAAP/ILAAP scenarios. Many firms may need to increase the severity of these stresses considerably in order to bring the firm closer to its PONV. It's a good idea to provide analysis outlining what the PONV is, and how the scenario design has taken this into consideration. |
In designing their recovery scenario testing, banks should consider the following:
The PRA’s review found that firms are not calculating their recovery capacity effectively, and are also not adequately showcasing it in an understandable and usable way. This reduces the accuracy and reliability of the recovery capacity calculations.
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PRA requirements for calculating recovery capacity |
Tips from effective practice examples |
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Firms need to ensure they understand and utilise the methodology for calculating recovery capacity correctly – as outlined in SS9/17. Firms’ capacity needs to be calculated individually for each stress scenario. The calculated benefits and timelines must be adjusted to take into consideration the parameters of the modelled stress. Recovery capacity should also be quantified in terms of Common Equity Tier 1 (CET1) capital, leverage ratio, and liquidity coverage ration (LCR) percentage points and relevant nominal amounts for each scenario. The impact on balance sheet and profitability for each scenario should also be considered. |
The PRA emphasises the importance of showcasing findings in an easily interpretable and useful way. The ‘Dear CEO’ letter includes suggestions of how a table might be created outlining all a firm’s available options, alongside benefit calculations for those options for each modelled scenario. A stacked cumulative benefit chart is highlighted as an effective way to illustrate the firm’s capital or liquidity position over time (pre-deployment of option), the impact of recovery options stacked on top and in the firm’s preferred sequencing, and the firm’s regulatory minimums and risk appetite or indicator levels.
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When considering recovery indicators, the PRA notes that not being limited to fixed point-in-time indicators is good practice. For example, firms should use forward-looking indicators based on their financial projections and deviations from business plan. This can aid firms to develop and implement their recovery or solvent exit plan while there's still a chance of success.
Another useful indicator is the movement-type indicator. This flags fast movements in metrics that may not necessarily breach indicator or risk management levels, but nonetheless could still highlight impending stress.
The PRA will be engaging collectively with firms and trade associations in the second half of 2024. It expects firms to have considered the actions outlined in the Dear CEO letter and to meet all expectations outlined in SS9/17. Banks should therefore reflect and consider what improvements may need to be made to their recovery plans based on this thematic review, and how any changes will feed into their solvent exit planning preparations.
A common mistake we see is where banks view recovery and solvent exit planning as a regulatory exercise that can be done by the chief risk officer's (CRO) team, without engagement from the whole team. Our experience shows that this won't suffice. It will require input from, and impact upon, risk management frameworks, liquidity planning, governance structure and management responsibilities and accountabilities. Management often finds it becomes much more aware of the strengths and vulnerabilities in the business, improving both financial and operational resilience as a result.
We recognise that implementing this regulatory feedback can be onerous and time-consuming. It can also be difficult for management teams to know what ‘good’ looks like from a regulatory perspective. Our experienced team understands what the regulator is looking for, as well as the practical operational aspects of both recovery planning and solvent exit planning.
For more insight and guidance, contact Russell Simpson, Kantilal Pithia or Sonam Nawani.
