Three banks – the Co-operative Bank, Lloyds Banking Group and Royal Bank of Scotland – were found to be lacking financial strength by the Bank of England after being subjected to tests designed to measure their ability to withstand economic shocks.
In order to test the resilience of the financial sector, the central bank created a hypothetical scenario involving a deep recession, an unprecedented collapse in house prices, soaring unemployment and a sharp rise in interest rates.
Threadneedle Street stressed it was not handing out a pass or fail on the eight lenders exposed to the extensive exercise, nor did it intend to order any system-wide changes to the banking industry.
Only the Co-op Bank – whose capital would be “exhausted” under the most severe stress test – was ordered to submit a revised plan to the Bank. It was the only one to fall below the 4.5% minimum core tier one capital ratio – a key measure of financial strength – set by the central bank.
Owned by the Co-operative Group until last year, the Co-op bank had already warned it might fail the test.
The results published on Tuesday showed its capital would fall into negative terrority, knocked by losses on commercial property loans under the hypothetical scenario.
Bailed-out RBS, 81% owned by the taxpayer, would have been required to submit new plans had it not already begun to raise its capital buffers at the end of 2013, which was the starting point for the tests. .
Lloyds, which is 24% owned by the taxpayer, was not required to submit new plans although it may now face questions about its ability to resume paying dividends to shareholders for the first time since the 2008 banking crisis.
The Bank of England governor, Mark Carney, said policy makers had been reassured about the banking sector after the first ever industry-wide stress tests, which are to become an annual event.
“This was a demanding test. The results show that the core of the banking system is significantly more resilient, that it has the strength to continue to serve the real economy even in a severe stress, and that the growing confidence in the system is merited,” Carney said.
Publishing its half-yearly outlook on risks to the financial system, the Bank of England also said the global economic outlook had weakened from six months ago. It added: “The recent sharp fall in the oil price should support global and UK growth but it also entails some risk to financial stability.”
The bank also said its financial policy committee had been worried in June about the risk of the housing market and debt levels in UK households, which remain high relative to income.
HSBC, Barclays, Santander UK, Standard Chartered and the Nationwide building society were the five other institutions tested and were not found to have any capital inadequacies. They were not required to submit new plans to the Bank of England’s regulation arm, the Prudential Regulation Authority.
Over the three-year test period, which ran from the end of 2013 to the end of 2016, the banks made £13bn of losses before making profits in the third year. Without the series of economic stresses, the lenders were projected to make £100bn of profits over the three years.
Impairment charges would rise by £70bn under the stress tests. Capital ratios are also severely affected, with systemwide ratios falling from 10% to 7.3%.
The Bank of England also took into account actions that banks could have taken during the three-year period, which included cutting staff costs and dividends, and changes in lending patterns. But banks were not allowed to reduce their lending to the economy.
The Bank has stepped back from including more banks in the tests next year and warned that the leverage ratio – another way of measuring financial strength – would become part of the test in the future.
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