On 15 May 2024, the Prudential Regulation Authority (PRA) published a letter to CEOs outlining the findings from its thematic review of non-systemic firms’ recovery planning. The PRA says it found that, although many firms understand the basics of recovery planning, there are significant areas for improvement, most notably related to the development of recovery scenarios and the calculation of recovery capacity.
The letter sets out areas for improvement, planned next steps, and effective practice examples.
Areas for improvement
Recovery scenarios
The PRA flags that scenario testing should test how different elements of the recovery plan (choice of indicators and their calibration, governance and deployment of plan, optimal options strategy) would interact and work. The review found that a number of firms did not use scenarios of sufficient severity, which the PRA warns will limit the effectiveness and value of the testing.
The letter outlines that firms should ensure scenarios are sufficiently severe and bring the firm close to its point of non-viability (PONV). Firms should provide analysis outlining how they define and calculate their PONV. Furthermore recovery capacity calculations for each scenario should reflect the parameters of the stress: for example, macro/ market conditions, firm’s operational capabilities, and consideration given to dependencies/ interdependencies between recovery options.
Recovery capacity
The PRA explains that a well calculated recovery capacity analysis gives firms and their boards an insight into the strengths and weaknesses of their capital and liquidity generating capabilities under various scenarios. The review found that firms are not calculating their recovery capacity effectively, nor are they adequately showcasing it in an understandable and usable way, which reduces the accuracy and reliability of the capacity calculations.
The letter emphasises that firms should look to understand and utilise the methodology for calculating recovery capacity correctly, using supervisory statement SS9/17 as a guide to how this can be achieved. Recovery capacity is calculated individually for each stress scenario with the calculated benefits and timelines being adjusted to take into consideration the parameters of the modelled stress. Total recovery capacity, timelines, optimal options available and deliverable benefits likely vary considerably depending on the scenario. The letter also states that recovery capacity should be quantified in terms of Common Equity Tier 1 (CET1) capital, Leverage Ratio, and Liquidity Coverage Ratio percentage points and relevant nominal amounts for each scenario. The impact on balance sheet and profitability should also be considered.
Next steps
The PRA states that it will engage collectively with firms and trade associations in H2 2024 to discuss the findings of the letter, and it will include it as a topic for discussion at the June CEOs conference. Firms are expected to consider the actions outlined in the letter and to update their recovery plans to meet the expectations outlined in SS9/17.
From October 2025, non-systemic firms must meet the rules and expectations introduced in the PRA’s new policy statement, PS5/24, as well as the expectations set out in supervisory statement SS2/24. The PRA suggests that firms may wish to consider leveraging their work on recovery planning when implementing their solvent exit approach.