The Challenges and
Opportunities Ahead for the
Mutual Sector - speech by
David Bailey
Given at The Building Societies Association Conference
04 May 2023
Speech
Introduction
Good morning everyone and I'd like to thank Robin, Mark, Rob and their colleagues at the
Building Societies Association for inviting me to speak today.
I'm delighted to be able to join the BSA conference in person for the first time and meet
members face to face. It's an added bonus that we are meeting in Liverpool where there is
a building sense of excitement and anticipation, not just about this conference but also
about the Eurovision song contest next week.
In recognition of Eurovision, I did think about peppering my speech with references to
famous songs from over the years, but my team told me to as they said 'David,
"Refrain1"
you'll have trouble so I reluctantly agreed to take a
"Making your mind up2"' "Better the
Devil you know3" approach and stuck with a more traditional format instead.
This year's Eurovision theme is "united by music". Whilst the audience today is possibly
it does bring together a wide range of building
dressed 'slightly' differently to next week's,
societies and credit unions who are united by their mutual ownership model and the
provision of financial services to a diverse set of members and customers right across the
UK.
At the PRA we recognise the vital role mutuals play in the UK financial sector. Collectively,
BSA members manage over £500bn of assets, nearly 15% of assets managed by the UK
deposit takers we supervise at the PRA. Also, all 50 BSA members have headquarters
outside London enabling a connection with local communities, some members of whom
might not have other ways of accessing mainstream financial services. This is further
fostered through a network of almost 1350 branches serving more than 26 million
members. In line with this, we see our role in supervising BSA members as central to our
mission at the Bank of England to 'promote the good of the people of the United Kingdom
by maintaining monetary and financial stability'.
My remarks today will focus on two areas. Firstly, a key challenge for the mutual sector to
tackle over the coming year, managing a fast-evolving outlook for credit risk whilst
supporting your members in the current economic climate. I will be setting out the PRA's
expectations and a flavour of what we are doing in this space. Secondly, the opportunity
we are taking to evolve our regulatory regime to ensure it continues to deliver resilience in
the sector, remains proportionate and supports growth, including in light of the Financial
Services and Markets Bill which is currently making its way through Parliament.
Economic outlook and credit conditions
Let me turn to the first of those areas, the current outlook for households and businesses,
and what that means for your lending portfolios.
Here the backdrop is clear. Over the past few years, the UK economy has faced a series
of events which our Governor, Andrew Bailey, summarised in recent remarks4, including
the Covid pandemic and the interruptions to economic activity that caused; and the rise in
by Russia's invasion of Ukraine. Andrew also outlined the
energy prices caused
challenging economic conditions we now face including through inflation, which at 10.1%5
remains well above the 2% target and continues to outstrip wage growth, and a growth
rate which the latest Monetary Policy Committee report6 estimates is around 1% per
annum compared to a typical rate of nearly 2.75% in the decade leading up to the 2008
financial crisis.
In response to inflation, the MPC has raised interest rates 11 times to 4.25%. Whilst
inflation is expected to fall sharply by the end of this year and growth to pick up, the impact
on the finances of the households and businesses that you serve has been significant.
We have seen this through indicators showing consumer confidence at its lowest levels
since the 1970s7, households increasingly focusing on value and cost savings in their
spending habits, decreased demand for mortgage borrowing in the first quarter of this
year8, and subdued demand for credit from corporates who remain under pressure from
the impact of higher interest rates9. Furthermore, the stress on household finances is
likely to increase as around 4 million mortgage borrowers10 see their monthly mortgage
payments increase, including as borrowers roll off the current fixed term of their mortgages
over 2023.
What does this mean for mutuals' credit portfolios?
What I have outlined so far are potential early indicators of pressures to come. The credit
data that PRA regulated firms report to us have not yet shown a significant increase in
levels of arrears or defaults. These have typically remained at or below pre-Covid levels
and only in Q1 2023 have started to show an uptick in areas like 'new to arrears'. This
uptick is not yet at a level that indicates a material amount of credit risk is crystallising, but
rather I take it as a clear warning that firms need to take action now to be prepared both to
support their customers and preserve their resilience should the stress that we are
observing result in a marked deterioration in their credit portfolios.
That is exactly why we put credit risk at the top of our list of Supervisory Priorities11 for UK
deposit takers in our annual letter to CEOs in January.
What do we expect mutuals to do?
As I noted at the start, your services are instrumental in supporting UK households and
businesses. It's in all our interests that
this is maintained, both to the members who rely on
your services and also to support the resilience of the broader economy. But it is also
vitally important that the risks of doing so are managed prudently.
Whilst the mutual sector generally has a good track record of doing this, it is important that
firms continue to enhance the way they manage risk. Aligned with this, we've seen the
most proactive firms taking steps that include:
•
Using early warning indicator frameworks that highlight emerging risks in
portfolios at an earlier stage than more traditional, backward-looking credit metrics.
•
Reviewing credit risk management frameworks to ensure they remain
appropriate, with robust governance and controls around credit and affordability
assessments.
•
Reviewing lending criteria to ensure they remain prudent and sustainable.
•
Assessing concentration risks in their portfolio. This is especially important for
firm-specific concentrations, for example in the type or location of their customer
base.
•
Regularly analysing whether the levels of credit loss provisions are sufficient
and ensuring these are recognised in a timely manner.
•
Early outreach to customers whose finances are most vulnerable in the current
circumstances whilst bearing in mind relevant FCA guidance12.
• Ensuring that
customer support and collections arrangements are
appropriately scaled so they can expand rapidly if need be.
This is, of course, not an exhaustive or comprehensive list but simply highlights some of
the good practices we are seeing amongst the firms we supervise. However, the message
is clear: the outlook is highly uncertain; and we expect firms to be proactive in
-
enhancing the way you manage the risks in your credit portfolios rather than simply
relying on historic approaches. Doing so will enable you to continue to support your
members in a sustainable way.
As your supervisor, we have been increasing our own focus on credit risks. You will
probably have seen this in your firm's engagement with our supervisory teams; through the
questions we are asking, the data we are collecting and the reviews we are conducting
both with individual firms and thematically. And, of course, our Annual Cyclical Scenario
stress test will enable us to assess the resilience of the largest UK deposit takers. The
results of this will be published in July. We expect all other firms to use the PRA published
scenario as a benchmark in their own stress testing processes.
In short, we expect firms to have a very clear focus on managing the evolving credit risks
within their portfolios and we will supplement that with our own ongoing attention in this
area.
Finally on this topic, whilst my comments have focused on the short- to medium-term
implications of the current outlook, it is important firms focus on the horizon as well. I
therefore encourage you to consider how current conditions may impact demand for your
services over the longer term and what this may mean for your business model and
strategy. This is an area that we will increasingly be asking you about as your supervisor.
The PRA's Supervisory & Regulatory Agenda
-
Let me move on to the second area I promised to touch on the opportunity we are taking
to evolve our supervisory and regulatory regimes to ensure they remain fit for purpose and
proportionate. Doing so will help maintain a resilient mutual sector in the UK, which can
support its members with sustainable growth and innovation. It will also allow us to
manage our resources efficiently whilst focusing on the biggest risks.
A starting point is to note that the core of our supervisory approach will remain unchanged;
it will continue to be underpinned by three key principles:
• -
Firstly, it is judgement based with supervisors making judgements about the
risks that a firm poses to our objectives based on evidence, analysis and direct
interaction with firms. The actions we expect firms to take will be based on those
judgements;
• -
Secondly, it is forward looking assessing firms not just against the current risk
environment but, as I have just outlined, on how existing risks may evolve and new
risks emerge; and
• - and that is where we'll primarily dedicate
Thirdly, it is focused on the key risks
our focus and attention.
Across those three principles we will continue to apply proportionality. This means the
supervisory focus on your firm will reflect your size and complexity.
Although the key elements of our supervisory approach remain, we have made some
enhancements, which we communicated to you in our January Priorities letter13. These
include revising the way we categorise the 'potential impact' of firms and refining our
schedule of ongoing core assurance work. We are communicating what this means to
individual firms over the next year, through the supervisory communications we send.
We also have some significant change taking place on the regulatory front.
The Financial Services and Markets Bill, which is currently making its way through
- -
Parliament will if passed into law introduce a new secondary competitiveness and
growth objective for the PRA. This would sit below our primary objective, to promote the
safety and soundness of firms, and alongside our existing secondary objective to facilitate
effective competition in the market for services provided by PRA-authorised firms. The
new objective would require the PRA to act in a way which, in advancing our primary
objective, and subject to aligning with relevant international standards, facilitates the
international competitiveness of the UK economy and its growth in the medium to long
term.
In a recent speech14 my colleague, Vicky Saporta, set out how we plan to take forward that
new objective, through an approach based on 'responsible openness'. In short
this means
we will provide a predictable and stable regulatory environment that is grounded in
international standards (for example those set out by the Basel Committee), and we will
collaborate closely with overseas regulators to maintain their trust in what we do, as well
as that of investors and firms.
But importantly and against that backdrop of responsible openness, there is still space to
tailor rules to UK circumstances when it is appropriate and when we can do so in ways
that maintain trust across markets and with fellow regulators.
And that last point about supporting the specific needs of the UK economy is of particular
relevance to our discussions here. I see it as precisely where the mutual sector comes in,
through providing high quality financial products and services to households and
businesses right across the UK, including some who might not have access through any
other routes.
Two priority areas:
That evolving regulatory approach is underpinning our approach to two pieces of policy I
-
know are of keen interest to BSA building society members Basel 3.1 and our Strong
and Simple regime for smaller firms.
Basel 3.1
In keeping with what I have set out, the PRA's proposed approach to the
Basel 3.1
standards15 maintains high levels of resilience and is aligned with international standards
that we helped shape. The standards constitute a comprehensive package of measures
that make significant changes to the way firms calculate risk-weighted assets for the
ratios. The proposed changes will make firms'
purposes of calculating risk-based capital
capital ratios more consistent and comparable.
But we also need to make sure that the new rules work effectively, and in line with our
objectives, both for banks and building societies. That is why we stressed in our recent
Basel 3.1 CP that it was very much an open consultation and that we welcomed
evidencebased analysis and feedback to help shape our final rules.
Input from both the BSA and its members is core to that, and we are grateful for the
feedback you have collectively and individually given. We are particularly focused on your
feedback in areas where our proposals will impact those products and services that are
central to the mutual business model, like both owner occupied and buy to let mortgages.
The consultation closed in late March. We are considering all the feedback received which
will inform our final policies and approach to implementation, which we will look to
communicate in due course.
Strong and Simple
Alongside that process and aligned with my earlier comments about tailoring rules to UK
circumstances where appropriate, we are investing in our Strong and Simple project.
Through this we will create a simplified prudential framework for domestically focused
nonsystemic banks and building societies that is, when compared to the standards that apply
today, more proportionate, easier to understand and less costly to implement.
But importantly that simplified framework also has to be strong, by which I mean
maintaining overall resilience which is equivalent to what we have today. Events in the
global banking sector in recent months have clearly demonstrated why the 'simple' needs
to be accompanied by the 'strong'.
As the target population of firms for the first layer of the framework is smaller domestic
firms providing savings and lending products in the UK, many building societies are likely
to be eligible to take advantage of the simplifications.
Our Basel 3.1 consultation paper set out some proposed revisions to the scope of the first
layer, including to address feedback on the definition of domestic exposures. On 27
we published our 'Phase 1' Consultation Paper, setting out a number of
February16
simplified liquidity, disclosure and reporting measures that address good suggestions
respondents raised in relation to our previous discussion paper17. In addition, we intend to
consider possible further changes to regulatory reporting requirements as part of
implementing the Bank's plan for transforming data collection.
The Phase 1 consultation closes on 30 May and, in the spirit of my previous comments,
we welcome responses on all aspects of it. I would encourage societies to respond
individually as well as via the BSA. I'd also recommend the Strong & Simple briefing
session we are running later in the conference, which will provide further explanation of the
proposals.
we are planning a 'Phase 2' consultation on the simpler regime capital
Following this,
framework in H1 2024. Our planning assumption is that the Basel 3.1 Pillar 1 approach to
credit risk would be a good starting point for designing the simpler regime risk-based
capital framework. Hence, I strongly encourage your engagement with all of the policy
developments I have outlined in my remarks today. And I also recognise that you will want
-
to see all our proposals before you can assess the overall impact on your business
which is why we are working hard to get them published in a timely manner. We are also
considering what a layer of the framework for firms might look like, and are
'mid-tier'
currently undertaking some engagement with relevant firms to understand where they see
scope for simplification of the prudential regime.
Other Priorities
Before I close, I did want to note our ongoing focus on Diversity & Inclusion in the sector.
This is an important area which helps enhance governance, decision-making and risk
management in firms, as well as the services you provide your members. We plan a
consultation paper later this year, building upon the joint 2021 PRA/FCA discussion
paper18, setting out proposals to introduce a new regulatory framework on diversity, equity
and inclusion in the financial sector. I strongly encourage you to engage with those
proposals once they are published.
In Conclusion
Let me briefly sum up.
I've stressed today the important role that mutuals play in providing your services to a
of households and business right across the UK. It's vital those services are
diverse range
underpinned by resilient firms. The outlook for credit risk remains uncertain and we
therefore expect firms to be forward-looking in how you manage the risks this presents.
We are doing the same. I also set out the ways in which we are evolving our supervisory
and regulatory regimes to ensure that they can support growth and innovation within a
sustainable and resilient mutual sector. I encourage you to engage actively with those
changes to help us make them work well.
Finally, I was asked before I came up to Liverpool whether I was looking forward to the
Q&A section which will follow my remarks. The answer of course is a resounding 'yes' as I
enjoy the open and frank engagement I have with BSA members. But I also know that
some of your questions can be really quite challenging. So, my response, in recognition of
events here next week was to quote Gina G by saying, 'Ooh, Aah...just a little bit'19
(sorry I
just couldn't resist that one).
I would like to thank Phil Evans, Alison Scott, Vicky Saporta, Monica Shant, Rogier
Wieffer, Nick Lock, Vrunda Chunilal, Isabel Jennings and Anjli Shah, for their assistance in
preparing these remarks.
Thank you.