Bank stress tests: longer-term resilience of lenders to be revealed

Stress Test

The Bank of England is to reveal the damage inflicted on the UK’s biggest lenders from £30bn of hypothetical consumer loan losses, an economic downturn and a collapse in the pound.

Threadneedle Street’s latest health check on the sector – the first was conducted in 2014 – could have an impact on a bank’s ability to pay dividends and on its business models. The lenders could be forced to sell off assets or ask existing shareholders and bondholders for more cash if they fail the tests based on hypothetical scenarios intended to put the sector under severe stress.

The results will be published on Tuesday alongside the Bank of England’s latest assessment of risks to the financial sector against the uncertainty created by Brexit.

Stress tests are used to assess the financial strength of a bank. They are based on hypothetical scenarios but designed with historic events in mind, such as the Black Monday stock market crash in 1987 or the banking crisis of 2008. In the 1990s, banks devised their own tests and used them to measure the impact on their trading positions. But the fallout from the banking crisis has given them more prominence, and illustrates why we need them. Banks collapsed in 2008 because they did not have the financial strength to withstand their losses. In 2014, the Bank of England began annual stress tests on the biggest lenders, publishing the scenarios that would be used and publishing the results. Each bank has its own pass rate – and if they fail can be required to find more capital.

Royal Bank of Scotland, which is still 70% taxpayer-owned, will be closely watched after it failed the stress test a year ago, and because it is being readied for privatisation by the chancellor, Philip Hammond.

In last week’s budget, the Treasury said it wanted to sell off £15bn of its stake in RBS, which is worth about two-thirds of the bank’s current value, even though this would leave taxpayers with a £26bn loss.

As well as RBS, results will be published for Barclays, HSBC, Lloyds Banking Group, Standard Chartered, Nationwide Building Society and the UK arm of the Spanish bank Santander. All are holding more capital than before the credit crisis and their financial strength has been measured against a series of hypothetical scenarios, including a 4.7% fall in UK GDP, a 33% fall in house prices, interest rates rising to 4% and 27% fall in the pound.

Threadneedle Street has already warned that under the scenario lenders could incur £30bn of losses over three years through lending on credit cards, personal loans and car finance. On Tuesday, it is expected to become clearer how the £30bn is distributed among lenders and which lenders the Bank of England has demanded hold extra capital against these loans.

Each lender has its own pass rate and the Bank will announce how each has coped with the tests.

For the first time the lenders have been tested not only on their ability to withstand economic shocks. They have also been tested on an exploratory scenario that will examine banks’ resilience over seven years of weak global growth, low interest rates and high legal costs and fines for misconduct. It will also look at the viability of their business models.

RBS is facing the added uncertainty of a multimillion pound settlement with the US Department of Justice over the way the bank packaged up and sold mortgage bonds in the run-up to the financial crisis. RBS has said it wanted to reach a settlement for this residential mortgage bond securities (RMBS) scandal. On 23 December last year, the DoJ extracted $12.5bn in settlements from Deutsche Bank and Credit Suisse in relation to this toxic bond mis-selling scandal.

Gary Greenwood, an analyst at Shore Capital, said this so-called conduct risk could lead to a “technical fail” for RBS, which last year had to cut back on risks when it did not meet the hurdle rate.

Analysts at Royal Bank of Canada do not expect RBS to fail and point out Barclays has a higher hurdle rate and in last year’s tests had higher losses on consumer finance than average.

Powered by Guardian.co.ukThis article was written by Jill Treanor, for theguardian.com on Sunday 26th November 2017 12.39 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010

 

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