PRA considers fundamental changes to mortgages IRB approach for medium-sized firms

What does this mean?

The DP presents a range of options for consideration, paving the way for possible significant changes to the mortgages IRB framework aligned to the PRA’s secondary competition objective.

This is not the first time the PRA has recognised the importance of IRB as a catalyst for growth and competition. In 2017, it introduced a series of targeted reforms aimed at making IRB more accessible for Standardised firms. However, these changes have not materialised in additional IRB approvals for aspirant firms, while incumbent firms of all sizes have grappled with obtaining re-approval under the hybrid approach. This DP represents a fundamental shift in approach that, if successful, could go a long way in fostering competition in the mortgage market.

More broadly, the DP introduces the possibility of material divergence from the Basel framework, signalling a potential shift in regulatory priorities, given Basel alignment had been a hallmark of the PRA’s post-Brexit policy approach. 

Foundation IRB

The PRA has put forth the option of introducing a FIRB approach for residential mortgages, under which firms could model PD and use regulator-prescribed values for LGD. This represents a positive step for medium-sized firms who have found it challenging to meet LGD modelling requirements.

The PRA has not shared any expectations regarding the calibration of supervisory LGD values, but indicated LTV and segmentation between owner occupied and buy-to-let (BTL) as the likely risk drivers. It has, however, indicated that any FIRB approach would likely result in industry risk weights that are lower than Standardised but more conservative than Advanced IRB (AIRB). As demonstrated by the challenges firms have faced in considering the current PPGD “reference points,” ensuring any FIRB calibration appropriately balances simplicity and financial stability would be critical to the regime’s success. 

In terms of scope, the PRA has questioned whether FIRB should be available to both incumbents and aspirants. Depending on calibration, there is potential for uptake amongst the former given challenges with model maintenance and potential data issues. The DP also considers whether FIRB should be a permanent option or used as a transitional step towards AIRB.

Finally, broader factors also warrant further consideration –  including the impact on defaulted exposures, where there is no capital requirement under FIRB, and consequential impacts on risk management processes and monitoring.

PD estimation

The PRA has suggested six potential changes in relation to PD estimation requirements. These proposals and their impacts are summarised below:

• Removing or increasing the cyclicality cap: This would not address the fundamental issue firms face today: significant volatility in cyclicality and implications for observed model cyclicality. Removing the cap entirely may also result in significant risk-weight divergences across the industry and through the economic cycle.

• Use of GFC data for long-run average default rates: This could yield reliable long-run default estimates closer to firms’ internal experience, though this would increase subjectivity and outstanding questions remain: impact on model cyclicality, calibration of the PRA uplifts and the need for adopting a different approach for BTL.

• Simplified approach to long-run average default: This increases the accessibility of IRB for firms with limited data. However, the calibration of these uplifts vis-à-vis Standardised risk-weights is critical to ensuring that pursuing IRB remains worthwhile. Use of external data for the long-run average estimation could provide a suitable compromise option.

• Permitting use of less cyclical drivers: Several firms have already gone down this path to manage model cyclicality and achieve a level closer to the theoretical 30%; however, there is a risk that scorecards become unreliable in these circumstances, creating perverse outcomes. 

• Periodic recalibration of hybrid PD models to achieve target cyclicality: Whilst this approach has its merits, it does have a fundamental assumption that firms’ through-the-cycle (TtC) models are performing well. Furthermore, this would have broader implications on the model change process and PRA’s own capacity for reviewing model monitoring.

• Permitting non-hybrid rating philosophies: Use of a TTC approach brings data history challenges and there is a fundamental issue with the reliability and conservativeness of TTC approaches, especially during stress periods. 

Whilst not all of these options could be implemented together, a targeted series of structural amendments to PD requirements would have the potential to lower the barrier to compliance.

What do firms need to do?

Next steps

The consultation closes on 31 October 2025.

Whilst the objective is ultimately for more firms to receive IRB approval for residential mortgages portfolios, specific timelines are unclear. There is a long road to implementation and go-live of any eventual changes; specific rule amendment proposals will require consultation, cost-benefit analysis, final policy formulation (updates to SS and PRA rulebook) and lead time ahead of implementation.