Bank of England stress tests: what are the banks being tested on?

Bank Of England Building

To test the resilience of the financial sector, the Bank of England created a hypothetical scenario in which economic growth plunges, the housing market crashes, and inflation and unemployment soar.

On top of the slump that came in the wake of the banking crisis, the UK economy is seen as contracting by 3.5% in late 2015. Such a severe downturn has “happened only in a single episode over the past 150 years – and that was in the immediate aftermath of the first world war,” the Bank said.

The central bank instructed seven banks and one building society – Nationwide – to assess what would happen to their balance sheets if such a catastrophic series of events were to occur during the three years from December 2013.

To test the mortgage books of the major UK lenders, the hypothetical scenario included interest rates spiralling from their record low of 0.5% to over 4% and an unprecedented 35% crash in house prices back to 2002 levels. Unemployment, meanwhile, would hit 12% – double its current level; sterling would fall 30% in the first year and inflation would peak at 6.5% in early 2015.

These UK specific scenarios have been bolted on top of the one designed by the European Banking Authority (EBA) and imposed on 123 banks - 24 of which failed when the result was published at the end of October. The EBA tests also included scenarios for world events and required banks to a meet a minimum core tier-one capital ratio – the best measure of their financial strength – of 5.5%.

Four UK banks were tested by the EBA – HSBC, Barclays and bailed-out Royal Bank of Scotland and Lloyds Banking Group. They and four other lenders – Santander UK, Nationwide Building Society, the Co-operative Bank and Standard Chartered – were tested by the Bank of England.

The Bank set a lower minimum as a threshold – 4.5% – but is also using some subjective measures of a bank’s financial health, such as the type of capital that is being accumulated and the extent to which the lender has been able to anticipate risks.

The starting point for the lenders is the end of 2013, since when around £17bn of additional capital has already been raised.

Powered by article was written by Jill Treanor, for The Guardian on Tuesday 16th December 2014 06.00 Europe/London © Guardian News and Media Limited 2010


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