PS7/25 - Basel 3.1 - Pillar 2A SME and Infrastructure Lending Adjustments
Overview
Today, the Prudential Regulation Authority (PRA) has published further details on its approach for calculating the Basel 3.1 Pillar 2A Small and Medium-sized Enterprises (SME) and infrastructure lending adjustments (“lending adjustments”) as part of Policy Statement (PS7/25).
The core principle relating to these adjustment factors remains consistent with the information set out in the second phase of the near-final rules (PS9/24). However, this policy statement provides additional clarification on the calculation mechanics.
The implementation date for this policy will align with the wider Basel 3.1 framework, currently scheduled for 1 January 2027.
Frequency
These lending adjustments will initially be determined through the off-cycle review process, which will establish the capital requirements applicable from ‘Day 1’ of Basel 3.1 implementation. Subsequently, the recalibration of these adjustments will be incorporated into the ongoing Capital Supervisory Review Process (C-SREP).
Calculation Approach
This article focuses on the SME lending adjustment, as infrastructure lending adjustments are expected to be less relevant for most small and medium-sized banks.
The process begins by identifying eligible exposures based on the revised definition of an SME under Basel 3.1 (i.e., overall SME group annual turnover does not exceed GBP 44 million).
Once eligible exposures are identified, the SME lending adjustment is calculated using the following formula:
Pillar 2A Lending Adjustment = ( Σ Change in RWA (Δ RWA) ) × Capital Adjustment Factor (CAF)
Where:
Change in RWA (Δ RWA) * is, for example, in the case of unrated corporate SMEs:
RWA calculated under Basel 3.1 rules using a risk weight of 85%
minusRWA calculated under Basel 3.1 rules but with a risk weight of 100%, with the SME support factor applied (76.19% to 85%).
*The calculation of the change in RWA may vary depending on the type of exposure.
CAF is a firm-specific multiplier used to convert the ΔRWA into a corresponding Pillar 2A lending adjustment amount. The Pillar 2A requirement is calculated as a nominal amount and then expressed as a percentage of the banks total RWAs. The CAF multiplier will take this into consideration and be adjusted to factor in the Total Capital Ratio, Capital Conservation Buffer (CCoB) and Countercyclical Capital Buffer (CCyB).
Note: In a few cases, the general methodology outlined above in calculating Δ RWA will not be applicable, where the Pillar 1 Risk weights under Basel 3.1 is lower than that in the existing CRR Regime (e.g., Regulatory Retail exposures to SME’s that qualify as transactors, where under Basel 3.1 rules the Risk Weight is 45%, whereas under CRR rules the risk weight it could be 57% to 64%).
Reporting Requirements
As outlined, firms will be required to submit relevant data at inception as part of the off-cycle review, with similar reporting obligations for regular C-SREP assessments through the ICAAP submission process. This will be in addition to the submission of applicable Pillar 2 returns, such as FSA071–82 and PRA111.
Impact on Small and Medium-Sized Banks
For small and medium-sized banks, these new requirements will bring about significant benefits, and at the same time likely to create a few challenges:
Decrease in capital requirements: The reduction in the overall capital requirements for SMEs enables banks to continue developing and offering specialised lending products for SMEs, contributing to overall economic growth and the government’s growth strategy.
Operational Complexity: The need to identify, document, and manage exposure eligibility for lending adjustments will place additional demands on resources and internal systems.
Increased Reporting Burden: Firms will have to establish new processes and frameworks to meet reporting obligations, adding to the operational cost and complexity of regulatory compliance.
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:
Eligibility Assessment: Reviewing your existing portfolios and risk frameworks to assess exposure eligibility under the revised SME definitions.
Reporting Framework Development: Designing reporting templates, control frameworks, and governance processes to meet off-cycle review and ongoing C-SREP submission requirements.
System and Data Readiness: Advising on data capture, system configuration, and reporting processes to ensure accurate, timely submissions.
Staff Training and Guidance: Delivering focused training sessions to build awareness and practical understanding within your teams.
Capital Impact Assessment and Planning: Quantifying the impact on your capital position and integrating these outcomes into your capital planning and ICAAP.
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
