Our response to the PRA consultation paper, “Prudential Regulation Authority regulated fees and levies: rates proposals 2013/14”, CP 3/13

Background

The Building Societies Association represents mutual lenders and deposit takers in the UK including all 46 UK building societies.  Mutual lenders and deposit takers have total assets of over £375 billion and, together with their subsidiaries, hold residential mortgages of £245 billion, 20% of the total outstanding in the UK.  They hold more than £250 billion of retail deposits, accounting for 22% of all such deposits in the UK.  Mutual deposit takers account for 31% of cash ISA balances.  They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.

Executive summary

We recognise the need for an adequately-resourced prudential regulator staffed by competent, experienced and effective people. But this also entails robust budgetary control, resistance to “mission creep” and prioritisation of tasks - resources simply cannot cover everything. The ability to levy fees on PRA-regulated firms does not constitute a blank chequebook.  There is no clear correlation between high spending regulators and successful ones.

We are therefore greatly concerned at the 24% increase in costs for both the PRA and the FCA for 2013/14, particularly as these costs will far exceed the original £500 million ceiling proposed by the government.   And the extra fee weighting for deposit acceptors has a disproportionate effect on mutuals – as the basis for allocation is size of deposit base, without any reflection of relative risk.  Size, while a reasonable indicator of impact, is a poor proxy for risk; we urge the PRA to carry out a fundamental review of its funding model and consider approaches that incorporate an element of “polluter pays” as well as provide incentives for better and more prudent behaviour.  . 

General

In earlier consultations[1], the government stated that the FCA’s and PRA’s combined ongoing running costs “should not be materially different (in real terms) in aggregate from the current FSA budget of about £500 million”.  The FSA said[2] the same.  But this has not been honoured, as the budgeted ongoing costs for the two new regulators have turned out to be 24% higher combined for 2013/ 14 than the last ones for the FSA, which themselves had risen steeply year-on-year[3]. Even after adjusting for HM Treasury’s retention of financial penalties, the increase in costs is 15%.  And there are transitional – ie non-ORA – costs on top of that.

We think it very important for the government and the two successor regulators together to take responsibility for honouring the earlier statement concerning projected “twin peaks” costs.  We need to know how the joint costs of the PRA and FCA are far exceeding the £500 million ceiling[4], why this excess was not foreseen and  halted, and also what is now being done to bring the costs back to the agreed figure.  The PRA says[5] it will adhere to the principles of good regulation including the efficient and effective use of resources.  This must involve a degree of prioritising. But PRA says simply that the costs of specific new policy initiatives will mean that it may overshoot against its plan for no further real-terms cost increases.

This issue is just as important as the fees and levy rates themselves.  Without cost control, these regulatory fees become a significant burden on firms that are already operating on the margins, and paying via the FSCS for the costs of the banking crisis: in 2012, FSCS levies were equivalent to approximately a fifth of our members’ pre-tax profits. 

We have expressed elsewhere our concern that in order to demonstrate  “market discipline”, rather than intervening to avert failure, the PRA might be too ready to allow bank failures, without  considering how the costs fall on other authorised firms via the FSCS. 

Question 1: Do you have any comments on the proposed PRA 2013/14 minimum fees and periodic fee rates for authorised firms?

The £214.2 million costs of the PRA are spread over six fee blocks and the minimum fee block in 2013/14.  Table 3.B in the consultation paper shows that the A.1 fee block – deposit acceptors – will be required to pay 68% of that sum.  Cost recovery in the A.1 fee block is weighted towards “higher impact firms”[6].  Impact is judged by the size of the firm only.  This affects our larger members, which, as mutuals, operate different, lower-risk business models to plc-owned banks.  But fee-wise larger mutuals are treated the same as large, international and complex plc-owned banks.  That cannot be fair.

Building societies’ stautory principal purpose remains the making of residential mortgage loans funded by the savings of members (customers), so their business models are necessarily simple and lower-risk, involving straightforward savings and mortgage accounts. Few operate current accounts, and building society law forbids them to take risk positions in commodities, currencies or derivatives.

The flaw in the PRA model is that there is no mechanism or incentive to “reward” lower risk firms.  Low risk deposit acceptors, such as mutuals, particular the smaller ones, are penalised if they grow by higher fees and levies.  In light of the new regulatory framework, we believe that this imbalance should be addressed.

Costs

It is not possible to know the split pre-“legal cutover” between prudential and conduct areas of the FSA’s work.  We are therefore only able to compare the combined figures for 2012/13 and 2013/14.

In 2012/13, the FSA budgeted for £535.5 million yet the equivalent figure one year later for the PRA and FCA is £663.3 million[7].  Some of the 24% increase can be accounted for by the government’s decision to retain financial penalties net of enforcement costs.  Without the loss of the financial penalty discount the increase would have been 15% - still a very large increase.  It could be argued that the PRA and FCA should take steps to reduce overheads or curtail non-essential work in light of this loss; this is what industry has to do.

There are a number of areas where spend appears to be inadequately controlled.  The first is staff. 

Staff – Numbers and associated costs continue to rise steeply.  In 2013/14, the two regulators are seeking a £34.4 million, or 15%, increase in front-line staff, which includes supervisory and policy staff.  The PRA numbers in prudential supervision are 5%[8] higher than the FSA equivalent.  The FCA’s staffing increase is a similar 6%.   Both increases are necessary to “deliver the new supervision approach”.  But how “new” is this approach, given that the FSA had been configured as a prudential and conduct business units, developing and pursuing separate approaches, for over a year?

One of the reasons given for a higher annual funding requirement in 2012/13 was a core work programme which included more intensive supervisory costs (and a 3.5% salary increase for FSA staff). This led to an increase in the AFR of £29.1 million, or 5.9%.  Compare this with the previous year, 2011/12 when it was announced that there was no plan to increase the overall FSA headcount.  Interesting, the FSA said in that consultation[9]: “Our intensive approach to supervision will complete its implementation with increased resources, including prudential risk specialists now assigned to our largest firms.”  So why was that earlier increase not sufficient ?

The upward trajectory of staff numbers is regrettably a key feature of recent regulatory fee consultations.  In 2007/08, the FSA announced it would spend up to £50 million over three years on a programme of change across the organisation, including upgrading the skills and expertise of its people, staff reorganisation and improving its knowledge management capability. [Two years later the FSA is still confident[10] that: “This investment will lead to benefits that will be realised over a longer period and will contribute to our move to a more outcomes-based regulatory approach.”]

The following year, 2008/09, the FSA increased its budget to include an additional £13.6 million for a supervisory enhancement programme that entailed the recruitment of 280 extra staff. In 2009/10, reference is made to the continuation of further expenditure through the year “driven by the enhancement of our supervisory processes”. But in 2010/11, the FSA concluded it needed even more staff - another 460[11]. Total headcount appears to have increased from 2,740 (March 2008) to 3,992 (March 2012) - a 46% increase over four years.  Neither the PRA’s approach documents for banking or insurance supervision reveal the headcount, just the numbers allocated to supervision (600 in total).  By contrast, the FCA’s business plan 2013/14 shows it will have 2,848 FTE staff at 31 March 2014, just under a quarter of whom will be allocated to supervision.  Since the FCA and PRA are committed to making more use of section 166 reports, we would have assumed the number of staff would diminish, not increase.

Pay rises for PRA (and FCA) staff are “limited” to 2.5% in 2013/14.  The previous year they enjoyed a 3.5% increase.  Many of their private sector equivalents had no such rise; several took cuts in salaries/ hours. 

The continuation of such increases in staff expenditure, year on year does lead us to question why the earlier increases – substantial as they were – have not proved sufficient, or whether such spending was in fact misdirected.  The PRA says it will embrace value for money and not increase costs in real terms but even then caveats that “with the exception of new policy initiatives”. We find this puzzling, given that the completion of major EU banking legislation reduces the range of matters on which PRA has policy discretion. If a new policy initiative is important enough, should there not be a switch of resources from another activity?

Our members are concentrating on core business and making economies; we believe the PRA should do the same – by prioritising the most important areas and discontinuing or winding down less important activities. That would then release resources - whether cash or staff - to devote to the priority areas. There is a feeling that the regulators lose sight of whose money it is spending – firms’, and ultimately consumers’ – as the blank cheque mentality takes hold.

The second area of concern is IT costs:

IT

Year-on-year, the FSA’s IT spend increased but, despite this considerable financial input, the Bank of England made it clear that it did not regard the FSA’s IT infrastructure as appropriate for use by the PRA.  This means that a new IT system will have to be developed for the PRA, while continued changes will have to be made to the FSA/ FCA system – meaning a double spend that will have to be financed by regulated firms during particularly difficult economic times.  So far, we have not seen enough financial control, transparency or accountability regarding this situation and we believe that it is crucial that this is rectified going forward. The FSA’s track record on controlling, and getting value for money from, IT spending does not inspire confidence for the future.

For 2013/14, the increase in both regulators’ IT costs and associated depreciation is a staggering 36% or £43.9 million.  The PRA’s business transformation programme is aimed “to complete the transition to the new supervision approach and deliver the associated data strategy and IT changes that support the new approach”.  How very different is this approach to prudential supervision to the one(s) adopted by the FSA right up to legal cutover?   We also need detail on the projected IT spend of £28.7 million including a plan for progress reports which cover convincing explanations of how any proposed over spends will be mitigated.  Informal feedback from officials suggests that the level of increase would continue for 3-4 more years.  We find this unacceptable, and it is even further in breach of the government’s promised ceiling.

Finally, to underline our point about continued expenditure (it can hardly be classified as investment given its surprisingly short life), we would like to draw attention to the history of FSA expenditure on IT before legal cutover:

• Increased expenditure was flagged for “development of new regulatory reporting forms including development of new, and/or enhanced, IT systems” in 2009/10[12].

• “Further investment is also needed to address the increase in Information Services (IS) development work and the growing role of IS solutions in facilitating new initiatives. Funding will also be required for the ongoing development of our IS architecture and Knowledge Information programme, and general demand for IS support on existing projects.” This relates to 2010-11[13].

• “In particular, as a result of significant changes to our role and structure - e.g.   European-led regulatory change and the UK regulatory change programme - our work has become increasingly data and IT dependent. During 2011/12, we plan to deliver a large number of 'non-negotiable' policies and business initiatives, requiring further investment in the operational platform”. This relates to 2011-12[14].

Yet, despite such expenditure by the FSA, the 2011 HM Treasury publication, “A new approach to financial regulations – building a stronger system”[15], stated:

• “In the short run, however, the transition will involve significant expense to the Bank on premises and IT. . . . The Bank is also clear that in order to contain costs in the long run it would not wish to share in the existing IT systems at the FSA, which have relatively high running costs. So in order to reach a position in which it can both ensure integration and exercise a proper control over future costs, the Bank will need to invest in the transition”.

The impact assessment goes on to state:

• “The FSA has indicated that much of its regulatory IT estate would be in need of amendment or replacement even in the absence of the changes envisaged by the Government’s proposals. New or amended systems for the PRA will therefore be developed as part of ‘business as usual’, though under the guidance of the PRA Transition Programme Board, a joint Bank/FSA body chaired by Hector Sants” (paragraph 11).

• “The FSA legal entity will become the FCA and retain the staff and systems not transferring to the PRA. As with the PRA, there will be significant system development, although this would have been necessary in any event and is not seen as part of the cost of the transition” (paragraph 13).

Our third area of major concern is central and support services.  These are not specified – we know they do not relate to accommodation or office services as these comprise a separate category.  For such a large spend, this is a serious omission. 

Under the FSA in 2012/13, these costs were £115.2 million but in 2013/14 they have risen for the PRA and FCA to £142.6 million.  The PRA’s share is £28.7 million.  More detail on these costs, particularly as they are also prone to constant above-inflation increases, is important.

Allocation

We note that in 2013/14 all costs of banking sector prudential regulation will be allocated to deposit acceptors.  Previously the cost of prudential regulation of other business activities, for example, mortgage lending, advising and arranging was distributed across the relevant FSA fee blocks.  We welcome this clarification.

Tables 4.A and 4.B of the PRA document provide a comparison to 2012/13 FSA costs.  Table 4.C shows the allocation of costs with the A.1 (deposit acceptors) fee block having an above-average increase of 20% (the "average" increase of 15% relates to the annual funding requirement, not ongoing regulatory activity). Deposit acceptors are not alone; insurers and firms dealing as principal also face high rises.  But the biggest effect will be felt by deposit acceptors as they fund 68.21% of the PRA’s operating costs in 2013/14.  

As mentioned previously, our  members’ activities are limited prudentially and by statute, yet the costs of the entire PRA, which include supervising far more exotic activities than mutuals engage in, are allocated on firms’ size alone.  Lower risk profiles are ignored.  Now is the time for the PRA to carry out a fundamental review of its funding model and consider approaches that incorporate an element of “polluter pays” as well as provide incentives for better and more prudent behaviour.  This will go some way to correct the imbalance.

Question 4: Do you have any comments on the proposed PRA financial penalty scheme?

We agree that the total retained penalties (now enforcement costs only) should be allocated across the A.1, A.3, A.4, A.5, A.6 and A.10 fee blocks.