The implementation of Basel 3.1, often referred to as the "Basel endgame," represents the most significant shift in banking regulation since the 2008 financial crisis. As of January 2026, the Prudential Regulation Authority (PRA) has formally introduced these standards into the UK market, fundamentally altering how financial institutions calculate the capital they must hold against their lending. At the heart of this regulatory overhaul is the "Output Floor," a mechanism designed to restore credibility to the calculation of risk-weighted assets (RWAs). For years, a significant gap existed between the way major banks and smaller building societies assessed risk. While large banks used sophisticated internal models to minimize their capital requirements, smaller institutions were often tethered to standardized, one-size-fits-all formulas. The Output Floor is intended to narrow this gap, but its ripple effects on mortgage interest rates are creating a new competitive dynamic in the high-street lending market.

The End of Internal Model Dominance for Major Banks

Before the arrival of Basel 3.1, major banks utilized the Internal Ratings Based (IRB) approach to calculate their capital requirements. This allowed them to use their own vast historical data to argue that certain loans—particularly low-LTV residential mortgages—were significantly less risky than the regulator's default assumptions. Consequently, large banks could hold far less capital against a mortgage than a small building society using the Standardised Approach. This "capital efficiency" allowed major banks to undercut the market, offering interest rates that smaller competitors simply could not match without eroding their own stability. The Output Floor changes this by setting a "floor" on how much a bank can benefit from its internal models; they can no longer report RWAs that are lower than 72.5% of the standardized equivalent.

As a result, major banks are facing a "capital hit" on their most popular mortgage products. When a bank is forced to hold more capital against a loan, its "cost of capital" increases. To maintain their return on equity (ROE) for shareholders, these banks must either accept lower profits or, more likely, increase the interest rates they charge to consumers. This is particularly noticeable in the 60% to 75% LTV brackets, where internal models previously suggested very low risk weights. For students currently enrolled in a cemap mortgage advisor course, this explains why the price gap between big banks and building societies has narrowed so significantly in the 2026 market. The "unfair advantage" of internal modelling has been capped, forcing the giants to price their products more in line with the rest of the industry.

Building Societies and the "Simpler-Regime" Advantage

While the major banks are grappling with the restrictions of the Output Floor, smaller building societies are finding themselves in a surprisingly resilient position. Under the PRA’s "Strong and Simple" framework, many smaller mutuals and building societies have been given the option to stay on a simplified capital regime rather than adopting the full complexity of Basel 3.1. Because these institutions were already using the Standardised Approach, the Output Floor doesn't "penalize" them in the same way it does the IRB-permitted banks. In fact, the revised Standardised Approach under Basel 3.1 has actually become more "risk-sensitive," lowering the risk weights for many standard residential mortgages that building societies specialize in.

This means that while major banks are seeing their capital requirements rise, many smaller building societies are seeing theirs stay flat or even decrease slightly. This shift has allowed building societies to become more aggressive with their interest rates. In the current 2026 climate, it is not uncommon to see a local building society offering a more competitive 2-year or 5-year fixed rate than a global banking conglomerate. For a modern mortgage broker, this shift requires a broader knowledge of the market.

Impact on High-LTV Lending and First-Time Buyers

The Output Floor also has a secondary effect on the types of lending that banks and building societies prioritize. Because the floor is based on the Standardised Approach, it encourages banks to look at higher-LTV lending (such as 90% or 95% mortgages) where the gap between internal models and standardized weights was already smaller. If a bank is going to be "floored" on its low-risk lending anyway, it may decide to shift its focus toward higher-margin, higher-risk products to maximize its returns. This could, ironically, lead to more competition in the first-time buyer market, as major banks seek higher yields to offset the capital costs imposed by the new regulations.

However, smaller building societies have traditionally been the champions of high-LTV and "niche" lending, such as self-build or shared ownership mortgages. The new regulations ensure that they are no longer at a massive disadvantage when competing for these customers. The "Standardised" risk weights for these products have been refined to better reflect actual historical loss data, making them more attractive for societies to hold on their balance sheets. change the rate; it changes the "appetite" of the lender, potentially opening up more options for underserved borrowers as banks and societies recalibrate their portfolios.

Long-Term Market Stability vs. Consumer Costs

The ultimate goal of the Basel 3.1 Output Floor is to ensure that the global banking system is never again brought to its knees by hidden risks buried in complex mathematical models. By imposing a minimum level of capital that is transparent and comparable across all institutions, the PRA is building a more resilient UK financial sector. However, resilience comes at a price. While the playing field is more level, the aggregate amount of capital being held by the UK’s largest lenders has increased. In a competitive market, this usually translates to a slight upward pressure on base interest rates as banks pass on the cost of their "safety buffer" to the borrower.

[Image showing the 5-year transition path of the Output Floor from 50% to 72.5%]

For the consumer, this means that the era of "vanishingly thin" margins on mortgages may be over. However, the benefit is a more diverse and stable market where smaller building societies can actually compete on price and service. As a mortgage advisor, your role is to help clients see the value beyond just the headline rate.

Conclusion: Navigating the New Regulatory Era

The implementation of Basel 3.1 and the Output Floor has fundamentally rewritten the rules of engagement for UK mortgage lenders. Major banks are no longer able to use "black box" internal models to gain an insurmountable capital advantage over their smaller rivals. Instead, we are seeing a convergence in mortgage pricing, where building societies are leveraging their "Strong and Simple" status to offer rates that challenge the dominance of the traditional giants. This regulatory shift is a win for market competition and systemic stability, even if it adds a layer of complexity to how mortgage products are priced and marketed.