Setting boundaries: finding thresholds in bank regulation

Zahid Amadxarif, Paula Gallego Marquez and Nic Garbarino

“We’ve done a lot to lower prudential barriers to entry into the banking sector […] but have we done enough to lower the equivalent barriers to growth?” asked PRA CEO Sam Woods in a recent speech. To make regulation proportionate, policymakers adapt regulatory requirements to the risks posed by each firm. But regulators face a trade-off between addressing systemic risks in a proportionate way and limiting regulatory complexity. New thresholds can create complexity and cliff-edge effects that can discourage healthy firms from growing. We identify regulatory thresholds for UK banks and building societies using textual analysis on a new dataset that contains the universe of prudential rules.

But first… what is a barrier to growth? There are different regulatory requirements for different sizes of firm. For example, a firm becomes subject to ring-fencing requirements when it passes the threshold of £25bn in core deposits. A threshold might be a barrier to growth if firms choose to slow their growth to avoid breaching the threshold and triggering the new requirement.

A threshold could become a barrier to growth if it leads to higher operational costs (e.g. additional data or modelling costs) or balance sheet costs (e.g. higher capital or cost of funding). Fixed operational costs can be diluted if growth leads to economies of scale but balance sheet costs have more limited economies of scale.

Identifying potential barriers to growth is challenging because regulation is lengthy, among other reasons. A recent Bank of England staff working paper found that PRA prudential rules included over 720,000 words in 2017, and that they have become more complex since the financial crisis.

We use a novel textual analysis approach to identify the universe of regulatory requirements for deposit-takers. Our dataset includes the entirety of the PRA rulebook, the EU Capital Requirements Regulation, supervisory statements and European Banking Authority technical standards, complemented by statement of policy documents. We search our dataset for currency references, quantitative references and expressions or references that could define a threshold (e.g. less/more than, greater/smaller than, up to) and collect a list of all thresholds. We then review this list with supervisors and other subject matter experts, to ensure it is comprehensive.

We find that… The UK regulatory framework has 53 thresholds for deposit-takers. These are concentrated in capital (17), reporting (11) and remuneration (8) policy. 33 are UK specific and the rest are international. And while 13 different metrics are used to set the thresholds, the most common by far is assets (26). The asset thresholds vary widely and range from €10mn for consolidation of subsidiaries to £755bn for the highest Systemic Risk Buffer threshold.

We plot the results in a “regulatory gradient” (Figure 1). This shows the cumulative number of thresholds by asset size, including thresholds based on deposits and transactional accounts that we translate into asset-space (a total of 35 thresholds are based on or can be translated into asset). Most thresholds are concentrated below £50bn assets, but a large number of requirements kick in at the £50bn mark: the leverage ratio, ACS and reporting requirements apply at £50bn (retail) deposits, while requirements on remuneration and auditors start at £50bn assets. The costs and potential cliff-edge effect associated with all these thresholds could pose a barrier to growing beyond £50bn assets.

Figure 1: Cumulative number of regulatory thresholds by asset size (2017)

Sources: CRR, BCBS, EBA Technical Standards, PRA Rulebook, Supervisory Statements, and Statements of Policy. Notes: Only includes thresholds that are either set using assets/deposits values, or can be translated into assets/deposits values. Assumes average size of transactional accounts of £500. The y-axis corresponds to the number of thresholds below the £ value for assets/deposits on the x-axis.

We also compare the cumulative distribution of thresholds with the cumulative distribution in the number of banks (Figure 2). The y-axis is normalised such that at a value of 1 we cover all thresholds and banks. So a flattening in the distribution of banks would suggest that there are no additional banks within this asset size region.

A long flattening would likely happen because regulators purposefully set high thresholds to be proportionate and reduce the burden on smaller firms. But it might also suggest that a threshold could be acting as a barrier to growth and that banks are slowing down growth on purpose. More analysis would be required to understand the drivers.

Figure 2: Cumulative number of regulatory thresholds and banks by asset size (2017)

Sources: SNL Capital IQ, CRR, BCBS, PRA Rulebook, EBA Technical Standards, Supervisory Statements, and Statements of Policy. Notes: Only includes thresholds that are either set using assets/deposits values, or can be translated into assets/deposits values. The y-axis corresponds to the proportion of thresholds/banks below the £ value for assets/deposits on the x-axis.

So we find that there is a large number of thresholds in the PRA’s regulatory framework. This suggests that, in the trade-off between addressing risks in a proportionate manner and reducing regulatory complexity, regulators might have favoured proportionality. Here we have focused on individual thresholds. But it is also important to think about the contribution of thresholds to overall complexity, to understand whether rules have overall become too complex. Another Bank Underground post explores this. The credit unions regime is a good example of where the PRA has already proposed actions to reduce cliff-edge effects that could lead to barriers to growth. In the banking sector, our findings suggests further work is worth pursuing.

Zahid Amadxarif, Paula Gallego Marquez and Nic Garbarino work in the Bank’s Prudential Policy Division.

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