An FPC Response - 2024 O-SII buffer framework review

Overview

1. This paper contains responses from the Financial Policy Committee (FPC) on feedback to the FPC consultation paper, 2024 O-SII buffer framework review.

2. This paper also contains the FPC’s final policy in the form of a box (Annex) to be inserted into the FPC’s framework for the other systemically important institutions (O-SII) buffer.^{footnote [1]}

3. This paper is relevant to Prudential Regulation Authority (PRA) regulated firms that are subject to the O-SII buffer.

Background

4. The O-SII buffer is the UK’s capital buffer for certain domestic systemically important firms that could, in distress, disrupt the supply of credit to the real economy. The Financial Policy Committee (‘the FPC’ or ‘the Committee’) must have a framework for the O-SII buffer and review this framework as per the legally mandated cycle, while the PRA is responsible for setting firms’ O-SII buffer rates at least annually, based on the FPC’s framework.^{footnote [2]}

5. Given the risk that a distressed ring-fenced bank or large building society could disrupt the supply of credit to the real economy, the O-SII buffer framework recognises that domestic systemically important firms may warrant higher capital requirements than non-systemic firms to enable them to absorb stress, and so sets O-SII capital buffers for some firms. Following the FPC’s 2023 review of the framework, the Committee announced that it intended to assess in 2024 whether the current thresholds used to set firms’ O-SII buffers continued to remain appropriate in the context of the intended aims of the framework.^{footnote [3]}

6. Accordingly, in 2024, the FPC reviewed the O-SII buffer framework and decided^{footnote [4]} to consult on proposals outlined in the consultation paper, 2024 O-SII buffer framework review, summarised below.

FPC consultation

7. The FPC’s consultation set out its proposed revisions to the O-SII framework as follows:

1. To index the O-SII buffer thresholds based on the 20% cumulative growth in nominal GDP between 2019 and 2023.
2. To assess the thresholds as part of the FPC’s regular review of the framework in the future and update them in line with nominal GDP growth, as appropriate.

8. The proposals aimed to ensure that the framework still operates as intended by the FPC, consistent with its primary objective to maintain financial stability, but without undue tightening. The Committee recognised that the UK has seen substantial growth in nominal GDP since the thresholds were last set in 2019, potentially impacting financial sector activity. If the nominal thresholds used to set O-SII capital buffer rates were to remain unchanged, more firms would be captured under the framework over time, and those already captured would move into higher buffer rate buckets, with those changes not necessarily reflecting an increase in firms’ potential to disrupt the credit supply. Thus, updating the thresholds supports the efficient allocation of capital and supports lending to the real economy, in line with the FPC’s secondary objective to support the Government’s economic policy.

9. To ensure the framework reflects the original risk appetite of the Committee, the FPC proposed to increase O-SII buffer thresholds based on the 20% cumulative growth in nominal GDP between 2019 and 2023.

10. To ensure the framework continues to operate as intended in the future, and to avoid significant one-off increases in the threshold, the FPC proposed to assess the thresholds as part of its regular reviews of the framework – which take place at least every three years^{footnote [5]} – and to update them in line with nominal GDP growth, as appropriate.

Summary of responses

11. The FPC received four written responses to its consultation paper.

12. Overall, the respondents welcomed the proposed amendments to the FPC’s O-SII buffer framework. Respondents particularly noted that this proposal would effectively address the issue PRA CEO Sam Woods referred to as ‘prudential drag’, whereby thresholds set in nominal terms ‘tighten’ over time as the economy grows. A respondent noted that this would mitigate the risk of firms altering their behaviour to restrict lending to the real economy in order to stay below the next threshold.

13. Feedback on the proposals included suggested changes to the indexation period used to calculate the appropriate increase in thresholds, and questions about the frequency of reviews and what factors might lead to ‘off-cycle’ reviews. Respondents also raised other issues that were out of scope of the consultation. Such issues included suggestions relating to perceived cliff-edge effects within the O-SII buffer rates, the inclusion of UK government bond holdings in the measure used to assess O-SIIs’ capital buffer rates, and whether the O-SII buffer rates are set at the appropriate levels in comparison to the equivalent buffers applied to global systemically important banks.

Changes to draft policy

14. In light of the responses received, the FPC has made one change to the indexation period and finalised the other aspects of the policy as proposed. The FPC has agreed that a longer indexation period – from 2019 to 2024 – will be used to determine O-SII buffer rates in the future, starting with the O-SII buffer rates set in 2025. This means that the O-SII buffer thresholds will now increase by 27%, instead of the 20% proposed in the consultation. The new thresholds are set out in Table 1 in the Annex. The FPC has decided not to extend the indexation period back to 2016, in line with some feedback, because the O-SII buffer threshold was reset in 2019.

15. The FPC has decided that for the 2024 O-SII buffer rate setting which applies from 1 January 2026,^{footnote [6]} the PRA should reissue firms’ rates based on thresholds indexed by 20%, using data up to end-2023, as consulted on. This maintains consistency within the framework, as 2024 O-SII buffer rates are based on firms’ balance sheet data during 2023, making indexation based on end-2023 data the more appropriate comparison for 2024 buffer rate setting. These indexed thresholds are set out in Table 2 in the Annex.

FPC objectives (including remit and recommendations letter from the Chancellor)

16. The consultation paper set out the Committee’s cost benefit analysis of the proposals. That set out the FPC’s expectation that there would be some benefits for firms in scope of the O-SII buffer as a result of its proposals. The proposed indexation of thresholds would result in greater headroom being available for firms, while maintaining the same level of resilience in the system set in the original framework, in accordance with the FPC’s primary financial stability objective.^{footnote [7]} The increased headroom to each threshold would provide greater space for firms to grow before facing an increase in capital requirements, thereby facilitating greater competition, and which could translate into additional lending, supporting the FPC’s secondary objective. The FPC also noted that by maintaining the same risk appetite, the proposals would continue to be in accordance with the FPC’s financial stability primary objective. The Committee also did not expect the proposed new thresholds to introduce any new costs on firms.

17. The FPC’s proposed change to index the O-SII buffer thresholds based on cumulative growth in nominal GDP between 2019 and 2024 in response to feedback to the consultation is not considered to materially change that cost benefit assessment.

Implementation and next steps

18. The FPC has decided that the changes to the O-SII buffer framework should come into effect immediately to pass on the benefits of the updated framework to firms without any delay. Accordingly, in line with its announcement on 29 November 2024, the PRA has today reissued the 2024 O-SII buffer rates which apply from 1 January 2026 under the revised framework, based on firms’ balance sheet data from 2023^{footnote [8]} and using thresholds indexed using nominal GDP data up to end-2023. The PRA’s December 2025 review of O-SII buffer rates (to take effect on 1 January 2027) will use thresholds indexed using nominal GDP data up to end-2024.

FPC response to the consultation feedback

Feedback to responses

19. The FPC has considered the feedback received to its consultation. This section sets out the feedback which is in scope of this consultation, the FPC’s responses to the feedback, and its final decisions.

20. The FPC’s responses to the consultation feedback, and its final decisions, are grouped into the following categories:

1. Indexing the O-SII buffer thresholds based on the 20% cumulative growth in nominal GDP between 2019 and 2023.
2. Assessing the thresholds as part of the FPC’s regular review of the framework in the future and updating them in line with nominal GDP growth, as appropriate.
3. Requested guidance on the conditions that could trigger off-cycle threshold reviews.
4. Requested clarification on threshold indexation in an economic downturn.

21. This section contains the FPC’s judgement and decisions in relation to the O-SII buffer framework, and a summary of the Committee’s underlying deliberations in relation to those.

1. Indexing the O-SII buffer thresholds based on the 20% cumulative growth in nominal GDP between 2019 and 2023

22. Three respondents suggested indexing O-SII buffer thresholds using nominal GDP growth from 2016, rather than from 2019 as proposed in the consultation. One of those respondents argued that using 2016 as the base year for indexation would better reflect the original threshold setting and capture the full economic developments since the framework’s inception. The respondent also suggested that the FPC should use 2016 as the base year to align with the approach used by the PRA in its consultation to index the threshold for the application of the leverage ratio requirements.

23. Three respondents suggested changing the end year of the indexation period from 2023 to either 2024 or 2025 arguing that indexation would be outdated by the time the policy takes effect. One firm recommended using 2024 to ensure thresholds reflect the most current economic conditions. Another respondent suggested extending the indexation period through to 2025 to ensure the thresholds are appropriately calibrated to prevailing GDP levels at the time of implementation.

24. The FPC considers that starting the indexation period from 2019 is the most appropriate approach to maintain the FPC’s original risk appetite while unwinding unintended tightening in the framework. Indexing from 2019 ensures that the framework reflects broadly the same level of risk appetite as when the FPC last set the thresholds, in its 2021 framework review, at which point it changed the metric for determining the O-SII buffer rates from total assets to the UK leverage exposure measure (LEM) using December 2019 data. In that review, the FPC highlighted that it had calibrated the new thresholds based on the average difference between relevant firms’ 2019 total assets and their 2019 LEM to prevent an overall tightening or loosening of the framework relative to its pre-Covid level. In the FPC response to feedback to the 2021 framework review, the FPC set out that it had decided not to index thresholds at that time. But the recalibration of the thresholds at that point is judged to have been consistent with its risk appetite; it restated that it judged that the size of a bank’s O-SII buffer should reflect the greater costs to the economy if that bank fell into distress relative to a smaller, non-systemic bank. As a result, the FPC judges that indexing back to 2016 would effectively be a loosening in standards.

25. As set out in paragraph 14, the FPC has determined that an extended indexation period to 2024 – rather than 2023 – will be used to determine O-SII buffer rates in the future, starting with the rate setting taking place in 2025. The FPC agrees with the feedback received on this point, and views that indexing up to end 2024 allows for the reflection of recent economic developments to the greatest degree possible, based on the annual data that has been released. However, for the reasons set out in paragraph 15, for the resetting of 2024 O-SII buffer rates, FPC judges that the thresholds should be indexed by 20%, using data up to
end-2023, as consulted on.

26. The FPC judges that extending the indexation period to 2025 is not desirable because it would require the use of nominal GDP forecasts and so would introduce uncertainty and complexity to the process.

2. Assessing the thresholds as part of FPC’s regular review of the framework

27. Overall, respondents supported the inclusion of an assessment of the thresholds in the FPC’s regular O-SII framework reviews taking place at least every three years. Some respondents suggested considering shorter review cycles for the thresholds. They suggested that it would enhance the framework’s responsiveness and effectiveness against evolving economic conditions, reduce prudential drag and improve the accuracy of firms’ forecasting and planning. One respondent supported the three-year review cycle proposal of the thresholds, noting that it provides predictability and supports strategic planning by avoiding significant increases in thresholds.

28. As it set out in its consultation, FPC intends to assess the thresholds as part of its regular reviews of the framework – which will take place at least every three years. The FPC considers that shorter review cycles could lead to more volatility in buffer setting as it would allow for less smoothing of economic cycles. Nonetheless, the FPC also set out in its consultation that it may choose to conduct an off-cycle review to ensure the framework keeps working as intended. These off-cycle reviews could cover a review of thresholds if deemed appropriate, including to avoid significant increases in thresholds. The FPC considers this approach gives the best balance of predictability for firms with flexibility to react, if needed.

3. Off-cycle threshold reviews

29. One respondent requested guidance on the conditions that could trigger an off-cycle review, specifically in relation to any additional indicators that would be considered relevant beyond nominal GDP. The FPC judges that an off-cycle review would be primarily triggered by the need to ensure that the framework continues to operate as intended while avoiding significant one-off increases in the thresholds, as set out in its consultation. In deciding whether to trigger an off-cycle review, the FPC would consider the outcome of its regular assessment of financial stability conditions, drawing on a broad set of indicators, including growth in nominal GDP. It could also consider in this assessment where firms are in relation to buffer rate thresholds, to inform its judgement of whether the framework is correctly recognising firms’ systemic importance and the greater costs to the economy if a firm fell into distress relative to a smaller, non-systemic firm.

4. Indexation in an economic downturn

30. One respondent sought to confirm that once thresholds have been increased, they would not be reduced during economic downturns.

31. The FPC approach to reviews, generally taking place every three years, would allow its decisions around the indexation of thresholds to smooth out the impact of economic downturns and avoid unnecessary volatility in the thresholds.

Annex

The FPC will implement the changes set out in this paper by adding a new box to the framework.