The Prudential Regulation Authority is a UK financial services regulator, which oversees banks, building societies, insurance firms and some large investment companies.
Rather than being a totally distinct regulatory body, the Prudential Regulation Authority operates as an arm of the Bank of England, and is managed by their Prudential Regulation Committee.
The purpose of the Prudential Regulation Authority
The word prudence means “care and good sense shown when reaching a decision or taking action.”
The PRA has a remit to ensure that the financial system remains sound, and through prudential supervision, it hopes to avoid a repeat of the 2007 financial crisis, which was seen to have been caused by excessive risk-taking by firms.
It does this through ‘tailored supervision’, which means it takes a hands-on approach and responds to the risks that are present in each institution it regulates.
This could include:
- Ensuring that banks are adhering to capital requirements. Capital requirements force banks to capitalise themselves with a safe buffer of their own money. This would become a natural source of finance should any economic or business event result in catastrophic losses. This should reduce the likelihood of a firm needing to seek a public bailout.
- Requiring firms to create a contingency plan in the event of their own demise. The PRA recognises that even with sound regulation, some firms may cease trading and therefore a process should be in place to ensure this happens on an orderly basis.
- Challenging the risk management strategies of financial institutions. It can be more profitable for a firm to take bigger risks regarding liquidity and solvency, and therefore the PRA will monitor such risks and push back where they conclude that a firm has overstepped a line.
- Performing resilience testing to analyse whether its firms could actually withstand an economic shock, and feeding these results back to firms (and the wider public).
The formation of the Prudential Regulation Authority
The PRA was formed in 2013 after the Financial Services Act 2012 came into effect. The new legislation updated the existing rules in Financial Services and Markets Act 2000 and overhauled the regulatory system.
The previous regulator the FSA (Financial Services Authority) was effectively broken up into different bodies, with some of its responsibilities being handed to the Bank of England via the creation of the PRA as a new independent body.
The best books on financial history that detail the turmoil at the time will remind you of the existential threat that the financial crisis posed to the financial system. The value of companies in the FTSE 100 index fell by half within a year.
What type of firms does the PRA regulate?
The Prudential Regulation Authority oversees roughly 1,500 firms, including just under 100 British banks.
Relative to the total number of investment firms, stockbrokers, banks and exchanges in the financial services sector, this is a very small portion. This demonstrates that the remit of the PRA is to oversee only the largest of firms that pose a systemic risk to the financial sector should they collapse. It isn’t to regulate all stockbrokers and firms.
How does the PRA compare to the Financial Conduct Authority?
At first glance, the PRA and the Financial Conduct Authority appear to have much in common.
They are both regulatory bodies that oversee financial services firms, with a view to restraining poor behaviour and reducing the risk of scandal and crises to the wider public.
So how do they differ? And why are they separate bodies in the first place?
As stated above, the PRA was formed in 2013 when the previous regulator the FSA was split into two.
The FSA regulated every facet of the financial sector. Enquiries and reports in the wake of the 2007 financial crisis were critical of the sprawling regulator. They accused the regulator of not being fit for purpose, and for taking the eye off the ball with regards to systemic risks and the stability of the overall banking system.
The division of responsibilities broadly asks the FCA to ensure that firms treat customers fairly, employ the right people into positions of responsibility, and abide by industry rules. Its remit is client-focused and tries to produce the best outcome and protection for clients.
The PRA takes a much wider view, and focuses on the firms which would deal an economic blow to the UK should they fail. It adopts a top-down, flexible approach that is designed to allow it to sniff out and mitigate the ‘next crisis’ proactively.
The result of this split is that many large financial firms are ‘dual-regulated’, which means they fall under the supervision of both the FCA and the PRA. Firms deal with each regulatory separately.
How large is the PRA?
The PRA discloses on its website that it employed a total of 1,250 full-time equivalent staff at 31 March 2020. The FCA, in contrast, employed 4,200 people.
This makes sense considering that the FCA oversees 51,000 firms versus the 1,500 firms kept under the watchful eye of the PRA.