The challenge for challenger banks

12 July 2019

Bovill - The challenge for challenger banks

Challenger banks were reminded last month of the combined pressures of being dual regulated. The PRA and the FCA both published papers which should be read in parallel. And although they apply specifically to challenger banks, any dual regulated firm looking to square the circle between prudential and conduct responsibilities should take heed.

PRA Dear CEO letter to challenger banks

Firstly, the Dear CEO letter sent by the PRA to ‘fast growing firms’ (challenger banks) regarding their approach to risk quantification and control. Questions were raised in a number of areas:

  • Firms being overly optimistic about the potential impact of stress scenarios on their businesses. In particular, assumptions that they would be able to raise capital, dispose of assets or widen margins in times of market-wide stress.
  • The concentration of lending in segments (for example, SMEs and buy-to-let), which may be more vulnerable to stress. And an underestimate of the potential losses that could occur from these segments.
  • The engagement of Senior Management, and their ability to make an informed challenge regarding the plausibility of their firm’s approach to stress testing.

The challenger bank business model inherently trends towards higher risk business. The incumbent lenders have already taken the low-hanging fruit. So it’s important that risks are priced in, and that risk controls are too. Firms need to align their exposure to risk to their expenditure on a control framework to make sure it’s mitigated. And this involves taking a 360-degree view across all elements of the firm:

  • Governance – developing an effective Senior Management team who can make informed judgements, take appropriate action, and are mindful of their SMCR responsibilities (more on that in the next section on the FCA)
  • Risk management – ensuring sufficient resources and expertise within the business to identify, quantify and mitigate the risks. Ensuring the full range of risks are captured.
  • MI – developing accurate and timely information, delivered to the right people (particularly Senior Management).
  • Operational effectiveness – making sure the underwriting and collections sides of the business are in order. Both in terms of resourcing, and their adherence to policy (and regulatory) requirements.


While the PRA have a (justified) focus on prudential requirements, and the overall stability of the market, the FCA expect firms to pay due regard to the potential conduct risks of their actions. To this end, they put out a paper last month on their further steps in relation to RBS GRG. This was an issue that harked back to the last financial crisis, where there were allegations (denied by the firm) that inappropriate collections practices were applied to commercial borrowers. The FCA didn’t pursue an action against the firm then (because the loans were unregulated), but they have made it clear now, that they could take action against individuals, under the SMCR regime.

So, firms should be mindful that, in the kind of market stress scenarios the PRA are envisioning, there will still be an expectation from the FCA that business is conducted with due regard for fair customer outcomes (in both their regulated and unregulated activities).

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