Prudential regulation
Also called prudential supervision, prudential rules
Prudential regulation is the set of rules that keeps banks, insurers and investment firms financially sound. It sets minimum capital and liquidity, limits on leverage and large exposures, and standards for risk management and governance. Its aim is to reduce the chance of firm failures and to limit the damage to customers and the financial system when one occurs.
How it works
Prudential supervisors such as the PRA, the ECB and the Federal Reserve set rules and review each firm's risks. Banks calculate capital and liquidity ratios, run stress tests and submit regular returns. Insurers hold capital against their risk profile under Solvency regimes. Supervisors can raise a firm's requirements, restrict dividends or require recovery plans when weaknesses appear.
Prudential rules differ from conduct rules, which govern how firms treat customers and markets. Most prudential standards for banks come from the Basel Committee and are written into national law, such as CRR in the EU. The UK splits prudential and conduct supervision between the PRA and the FCA. Changes to these rules drive large data, reporting and capital planning programmes at regulated firms.
The rules
Completes the Basel III framework with revised credit and operational risk approaches, a leverage buffer and an output floor.
Internationally active banks, via national implementationCreated the PRA within the Bank of England to supervise the safety and soundness of deposit takers and insurers.
UK banks, building societies, insurers and major investment firmsSets risk-based capital, governance and reporting requirements for insurers across three pillars.
EU insurers and reinsurersCommon questions
What is the difference between prudential and conduct regulation?
Prudential regulation focuses on the financial soundness of firms, through capital, liquidity and risk management. Conduct regulation focuses on how firms treat customers and behave in markets. In the UK the PRA leads on prudential matters and the FCA on conduct.
Who sets prudential standards for banks?
The Basel Committee on Banking Supervision sets global standards for internationally active banks. Each jurisdiction then writes them into law, through CRR and CRD in the EU, the PRA Rulebook in the UK and rules from the Fed, OCC and FDIC in the US.
Which firms are prudentially regulated?
Banks, building societies, credit unions, insurers and investment firms are prudentially regulated. In the UK, the PRA supervises deposit takers, insurers and major investment firms, while the FCA is the prudential supervisor for the rest of the around 42,000 firms it oversees.
