Banks should expect tougher stress tests ahead

By Nicole Miskelly | 17 December 2014

After the results of the first stress testing exercise of the UK banking system were revealed yesterday, the Bank of England has warned British banks they should expect tougher testing next year.

During news that the Co-operative Bank failed the stress test and Lloyds and Royal Bank of Scotland (RBS) narrowly passed, the regulator said they will be thoroughly testing the banks’ defences in the event of a crisis abroad next year.

Following on from the EU-wide stress test of 123 banks in October, the UK stress test accessed the resiliency of eight major banks and building societies if they were to be faced with a severe housing market shock and a sharp rise or snap back in interest rates. This year’s participants proved that they could withstand the regulator’s hypothetical scenario of falling UK house prices and increasing unemployment, with Lloyds and RBS both taking measures to reduce their balance sheets and raise capital.

According to Mark Carney, the governor of the Bank of England, the 2015 stress test is going to focus more on overseas risk which could prove to be a harder test for banks such as Standard Chartered and HSBC who do a lot of their business in Asia. "We can expect that we will look to some of those global risks much more closely, they will feature much more prominently," said Carney.

This year’s stress test required banks to meet a core capital ratio of 4.5 per cent and during the stress test RBS’ core capital fell to 4.6 per cent and Lloyds’ fell to 5.0 per cent before actions they took this year were taken into account. From next year the Bank of England said they would also be scrutinising leverage ratios and examining banks’ ability to cope with an unexpected liquidity crunch.

According to some industry experts the failure of one bank and near misses of two others has come as no suprise. Dale Stevens, Head of Risk, SAS said: “The possible failure of three banks to withstand the domino effect of economic hardship put forward by the Bank of England, will be of little surprise to the market. Especially considering the recent failure of 24 banks in the European stress tests.  The key here is that a stress test is the reaction to that particular set of hypothetically harsh economic conditions. And, whilst these latest tests are a useful indicator of the UK risk exposure, a single stress test cannot ever give a complete picture.”

Under the harsh economic conditions outlined by the regulator, many believe that British banks would survive if they faced economic downturn. BBA Executive Simon Hills said: “These tests confirm that the UK’s banking industry is in a much stronger position and that the recent reforms are working. The majority of our major banks would be able to weather even the severest of storms and appropriate action is being taken to make all banks more resilient.”

 

By Nicole Miskelly, bobsguide Lead Journalist

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