The Bank of England has abandoned a proposed capital hike for some key trade finance instruments after receiving “convincing data” showing the plans were too conservative.
The central bank’s prudential regulation division said today it will maintain credit conversion factors for off-balance sheet items such as guarantees, warranties, standby letters of credit and short-term letters of credit at the current 20%, and not lift them to 50% as previously planned.
The move is part of the UK’s implementation of the final tranche of the global Basel banking regulations, dubbed Basel 3.1.
Maintaining the current capital treatment puts the UK at odds with the Basel Committee’s framework, but is aligned with a similar decision by the EU last year. Banks in the UK feared being put at a competitive disadvantage to their European rivals if the Bank of England had persisted with the capital hike.
“We received convincing data regarding the calibration of certain trade finance related conversion factors, which demonstrated that our proposal of 50% was too conservative and not commensurate with the risk. So, we have followed the evidence,” the Bank of England’s director of prudential policy Phil Evans said in a speech to lobby group UK Finance.
In its policy statement, the Bank of England’s Prudential Regulation Authority (PRA) says empirical evidence supplied by the International Chamber of Commerce and Global Credit Data, a bank-led consortium, “sufficiently addresses” its prior worries that the existing conversion factor “may not fully reflect the probability of a ‘trigger event’ occurring” during an economic downturn.
“A [conversion factor] of 20% therefore advances the PRA’s primary objective in a more proportionate manner,” it says.
Lenders had argued that the planned bump in capital requirements for trade finance would harm trade-exposed businesses because they may have to pay more for the products, which generally generate low margins for banks.
“The reduction of the proposed [credit conversion factor] from 50% to 20% for transaction-related contingent items is very welcome, vindicating industry lobbying efforts and the power of data,” Sean Edwards, chair of the International Trade and Forfaiting Association, tells GTR.
Global Credit Data chief executive Krishnan Ramadurai says the announcement demonstrates the impact “if you can show empirical data”.
“The clear case this is showing you is that regulators are willing to listen, and that is a positive,” he tells GTR. “We need to continue this work because the empirical data is dynamic, so we need to continue providing this data to show this is a low-default asset class and product.”
But in a blow to banks and credit insurers, the PRA has stuck to its initial plans to increase capital requirements on exposures to insurance providers held by larger banks.
The decision means credit insurance is likely to become a less attractive option for banks that use the product for credit enhancement and to help with regulatory capital relief, industry experts have argued.
The PRA says it “was not persuaded by respondents’ arguments” for lighter capital treatment during its consultation on the Basel 3.1 proposals, citing a “lack of evidence that losses on exposures protected by credit insurance” justify such a move.
More broadly, the Bank of England shed much of the capital regulation overhaul it mooted last year. It said the slimmed-down reforms mean “tier 1 capital requirements for major UK firms will be virtually unchanged” and will ultimately rise by less than 1%.
The new standards will be implemented from January 1, 2026.
“These rules will improve the way in which we regulate the banks in order to maintain safety and soundness and wider financial stability,” Bank of England deputy governor and PRA chief Sam Woods says in a statement.
“We have made a number of important changes following consultation, and the resulting package will support growth and competitiveness while also ensuring that the UK aligns with international standards.”
The watering down of the initial plans is expected to be mirrored in the US, where a previously announced hike in capital requirements for the country’s biggest banks will be cut in half, a top Federal Reserve official said earlier this week.
