How does Proportionality apply for New and Simple Firms?
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What does proportionality mean in practice?
Proportionality is about right-sizing regulatory requirements to match a bank’s risk profile, complexity, and systemic importance. It rejects the “one size fits all” approach that dominated pre-2008 thinking.
Think of proportionality as a tailored suit versus off-the-rack. The largest, most complex banks with global operations need comprehensive requirements that address their multifaceted risks. Meanwhile, a small building society focusing on local mortgages requires something different; not necessarily less stringent, but certainly less complex.
We need to distinguish between proportionality in regulation versus supervision. Regulatory proportionality focuses on reducing compliance costs through simplified rules for certain institutions. Supervisory proportionality is essentially risk-based oversight, directing more attention towards institutions that pose greater systemic risks. While different concepts, they often work in tandem to create a more efficient system. Supervisory intensity varies according to risk profile, affecting everything from examination frequency to governance expectations and stress testing requirements.
The principle isn’t about being “easier” on smaller banks. Rather it’s about making requirements appropriate to the actual risks they pose.
So, what does this mean in practice?
There are several areas of regulation which have been simplified to reduce the compliance costs and burden on small firms.
Prudential requirements represent perhaps the most significant application area, with tailored standards for capital and liquidity. Simpler banks may benefit from streamlined versions of standards or exemptions from complex risk categories like market risk or counterparty credit risk.
Remuneration policies have also seen enhanced proportionality from the Prudential Regulation Authority (PRA) with tailored requirements for smaller firms, particularly around claw-back provisions and deferral periods.
Another area where proportionality applies is in terms of resolution planning requirements. Review frequency, data reporting needs and complexity of the recovery plans are increasingly tailored according to an institution’s systemic significance.
Reporting and disclosure often feature proportionality through simpler templates, reduced submission frequencies, or specific exemptions, particularly for liquidity risk reporting where the burden can be substantial.
While these simplified regulations present clear benefits to small firms and new entrants, operationalising proportionality can sometimes be challenging. While proportionality in regulation follows prescribed criteria (such as quantitative metrics) that firms can use to assess whether they are in scope of simplified requirements, it is difficult to apply proportionality in certain areas. These include designing appropriate governance and risk frameworks, drafting fit-for-purpose policies and procedures and assessing the appropriate amount of capital and liquidity which firms should hold under Pillar 2A. In these areas, it is particularly difficult for firms to predict supervisory judgment and determine what constitutes a truly proportionate approach.
How should management apply proportionality day-to-day?
For banking executives, proportionality isn’t simply accepting differentiated rules but actively applying proportionality principles throughout their operations.
Management should first develop a comprehensive understanding of their firm’s specific characteristics: size, complexity, business model, interconnectedness, and risk profile. This self-assessment forms the foundation for determining how proportionate rules apply to specific circumstances.
Even within the same regulatory tier, firms may need different approaches based on their individual circumstances. For instance, identifying and risk-adjusting performance measures requires processes of varying sophistication depending on the firm’s complexity.
Executives should consider materiality: whether certain regulations are being applied to activities or risks that aren’t material to their specific business. Focusing resources on what truly matters allows more efficient allocation.
For smaller institutions, governance structures should also be appropriately scaled. Smaller banks need to balance functional separation requirements ( e.g. risk management) with maintaining an integrated management approach that provides oversight across the organisation.
Applying proportionality to the authorisation process
For new entrants to the UK banking sector, proportionality principles offer a pathway through the authorisation process.
During authorisation, firms should clearly articulate their intended business model, projected growth trajectory, complexity level, and risk profile. This assessment will determine which proportionality thresholds apply to the institution.
New entrants should familiarise themselves with simplified regulatory frameworks specifically designed for smaller entities, such as the PRA’s Strong and Simple Framework. Understanding eligibility criteria for these regimes can streamline compliance planning significantly.
Rather than implementing comprehensive requirements designed for systemic institutions, firms should develop compliance plans proportionate to their specific nature, scale, and complexity. Resources should focus on material risks relevant to the business model.
Smaller entities should be mindful that fixed compliance costs will represent a proportionally larger burden. Understanding available proportionate approaches for reporting, governance and risk management can help manage these costs effectively.
When articulating a proportionate response to regulatory requirements, early and frequent engagement with supervisory teams is advisable. Firms should clearly explain their proportionate approach and its rationale, demonstrating how the solution meets regulatory objectives despite being tailored. Adjustments based on regulatory feedback may be necessary.
The goal remains clear: avoid excessive compliance burdens that could undermine competitive position without delivering clear prudential benefits, thereby supporting competition and growth within the sector.
In brief
For new entrants wrestling with the question of “what is the regulatory expectation?”, proportionality provides a framework for developing appropriate responses to regulatory requirements. It allows firms to:
- Design governance and compliance frameworks suited to their size and complexity
- Draft policies and procedures that are relevant and implementable
- Allocate resources efficiently to manage material risks
- Demonstrate regulatory compliance without unnecessary burden
Proportionality is not merely a regulatory concession but a sophisticated approach to financial regulation that recognises institutional diversity while maintaining system integrity. When properly implemented, it helps new entrants navigate the complex regulatory landscape, address the specific challenges of governance and compliance design, and develop documentation that meets regulatory expectations without imposing disproportionate burdens. New firms can develop regulatory approaches that are both compliant and commercially viable by creating a more efficient, competitive, and resilient financial ecosystem that benefits both the regulator and the regulated.
This article is provided for general informational purposes only and doesn’t constitute legal, investment, or regulatory advice.
Date: 17 March 2025
Written by: Zaynah Mosafeer