UK to launch new bank stress test
Britain’s seven biggest lenders will have to show how they would cope with a global economic downturn causing the worst deflationary spiral since the 1930s under a new Bank of England stress test later this year.
The test factors in the potential implications of an international crisis on banks following the most recent examination last December which was more focused on a domestic doomsday scenario.
It would see inflation turning negative for seven successive quarters resulting in the largest fall in UK prices since the 1930s, with interest rates slashed to zero and the wider economy shrinking by 2.3%.
However the hit to Britain’s growth and decline in house prices envisaged would be smaller than those seen in the last test, which looked at a situation which would see a 3.5% contraction in gross domestic product (GDP).
A greater focus this time on global risks is seen as likely to have a bigger impact on Asia-focused Standard Chartered as well as HSBC.
They are included in the tests alongside Barclays, Lloyds, Nationwide, Royal Bank of Scotland, and Santander UK.
But the Co-operative Bank, which failed last year’s test – but has since put in measures to accelerate the repair of its balance sheet by speeding up the sell-off of its loan book – will not be included.
It has shrunk since last year and its resilience on its own was unlikely to have a “material impact on the resilience of the financial system”, the Bank said.
The new stress scenario, covering a period from the start of 2015 to the end of 2019, will include a dramatic slowdown in China and a eurozone contraction of 2%.
Banks and building societies being assessed represent 70% of lending to UK businesses and 75% of mortgage lending.
Bank of England governor Mark Carney said: “Last year’s tests demonstrated how much stronger the core of the UK financial system has become since the financial crisis.
“The results showed that the post-crisis reforms have put the UK banking system on a stronger footing and made it better able to support the real economy even in the face of a major domestic shock.
“This year’s test will have a different focus and is equally important.
“By assessing the resilience of the UK banking system against a major external shock, we will improve further our ability to identify vulnerabilities and we will ensure that banks have plans in place to address a wider range of possible stresses.”
The tests will assess how much a bank’s ratio of capital to loan assets will be hit in the event of severe economic stress. A lender that falls below a minimum 4.5% threshold would face a requirement to shore up its financial position.
Banks will also have to beat a separate 3% minimum leverage threshold, which also measures the ratio of capital to assets but treats all loans as the same rather than using “risk-weighting” based on the idea that some are less risky than others.
Results of the stress test will be published alongside the second of the Bank’s Financial Stability Report in December.
The Bank emphasised that the scenario that it sets out was not a forecast of expected conditions in the UK or other markets.
But it said that the “shocks to activity” in most cases assumed in it had in most cases been observed in recent decades – with the exception of China.
The new test acknowledges the impact that the imagined global crisis would have on the domestic economy but pencils in a smaller hit to UK growth and a fall in house prices of 20% – as compared to a 35% decline under the 2014 scenario.
However this year’s assessment factors in a series of shocks that are for the corporate sector “more severe in some respects than in 2014” with shares falling 35% – rather than 30% in the previous scenario – and profit growth also turning negative.
Last year’s test saw only the Co-op fail but also raised concerns about state-backed Lloyds and RBS, though improvements an changes to their plans during 2014 meant they were given the all-clear.
