UK regulator’s concerns about the resilience of neobanks

Some banks are so large that regulators worry about the impact their failure could have on the financial system. Most banks are not that big. But some, typically newer digital banks, are growing fast and so attract increasing scrutiny of how they manage risk. A recent review by the UK prudential regulator highlights the risk controls that it thinks all banks should have in place.

What has happened?

The Prudential Regulatory Authority has reviewed 20 neobanks to test their financial resilience and has set out its findings in a letter to CEOs.

The review looked at these banks’ ICAAP stress testing, asset quality reviews, and funding and lending analysis.

What did the PRA find?

The PRA was reassured about the resilience of this fast-growing part of the banking sector. But its review did find several issues for neobanks to work through. The PRA stresses that firms’ governance and risk management functions should be tailored to their business model and risk appetite.

Stress testing

  • According to the PRA, some firms have been too optimistic about the impact of a stressed scenario on their business. They were not able to demonstrate a proper understanding of the underlying issues or the practical actions that they would take in the event of a stressed scenario.
  • The PRA expects senior management and boards to engage with, and challenge, stress testing exercises.
  • The review found that neobanks tend to have concentrated exposures to higher-risk market segments. This should be considered when provisioning and stress testing.
  • Firms should closely consider management actions proposed in their ICAAP stress tests. The PRA will be sceptical, for example, of firms which expect to raise new capital during a market-wide stress scenario.

Asset quality reviews

  • The review found that some neobanks take commercial lending decisions too quickly.
  • The PRA encourages firms to have sufficient data and management information available in relation to their loan portfolios.
  • The letter reminds firms that risk management functions should be adequately resourced and provide appropriate challenge to, and oversight of, the business.

Funding and lending analysis

  • The review found that many firms are too reliant on funding from short-term, fixed rate deposits.
  • The PRA calls on firms to consider, for both baseline and stressed scenarios, how they will price their borrowing and their lending, having regard to the spread between these and how that compares to the broader market.
What happens next?

The PRA plans to provide further feedback in July. Neobanks can also expect engagement from their supervisory contacts on the findings of the review.