[2025] UKUT 00185 (TCC)

In relation to its compliance with prudential regulation and supervision, the Bank is, and was at the time, regulated by the Prudential Regulation Authority (“the PRA”), part of the Bank of England. The PRA’s role is to promote the safety and soundness of the firms it regulates, focusing primarily on the harm that firms can cause to the stability of the UK financial system.

At the relevant time, the UK had adopted the EU’s prudential rules, in accordance with the Capital Requirements Regulation No. 575/2013 (“the CRR”) and the Capital Requirements Directive 2013/36/EU (“the CRD”). Banks were required to satisfy the requirements of the three Pillars in the CRD as follows.

A bank had to meet a minimum “capital ratio”, being the amount of its regulatory capital divided by its RWAs. Regulatory capital is the sum of its ordinary shares, retained earnings, perpetual subordinated debt instruments and unsecured subordinated debt. RWAs are a bank’s assets and credit exposures, weighted (i.e. multiplied by a percentage factor) according to the potential to suffer loss. Safer assets were attributed a lower allocation of capital, while riskier assets were given a higher risk weight. In other words, the riskier its assets, the more capital a bank had to set aside in relation to the risk of loss.

One of the types of risk which a bank had to consider was “credit risk”, namely the risk that a borrower fails to repay a loan. There were two approaches to calculating RWAs for credit risk:

The IRB/AIRB approach could result in lower capital requirements, but Article 143(1) of the CRR provided that it could only be used if the PRA had given permission. At the relevant time, the Bank used the standardised approach for the calculation of its RWAs, but was hoping to move to an IRB or AIRB approach.

For financial institutions using the standardised approach to credit risk, such as the Bank, Article 112 of the CRR set out the different asset or exposure classes and the risk weights to be assigned to each. The risk weighting requirements in that Article were directly applicable in the UK, so the PRA did not have the discretion to amend them.

Article 501 of the CRR related to small and medium sized businesses (“SMEs”) and was headed “Capital requirements deduction for credit risk on exposures to SMEs”; it was commonly referred to as “the SME supporting factor”, and included the following provisions:

“1.

Capital requirements for credit risk on exposures to SMEs shall be multiplied by the factor 0,7619.

2.

For the purpose of this Article:

(a)

the exposure shall be included either in the retail or in the corporates or secured by mortgages on immovable property classes. Exposures in default shall be excluded;

(b)

an SME is defined in accordance with Commission Recommendation 2003/361/EC of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises. Among the criteria listed in Article 2 of the Annex to that Recommendation only the annual turnover shall be taken into account;

(c)

the total amount owed to the institution and parent undertakings and its subsidiaries, including any exposure in default, by the obligor client or group of connected clients, but excluding claims or contingent claims secured on residential property collateral, shall not, to the knowledge of the institution, exceed EUR 1,5 million. The institution shall take reasonable steps to acquire this knowledge.”