The UK Banking system is healthy enough to withstand another financial crisis.
This is the outcome of the stress test conducted by the Bank of England (“BoE”). All seven participating banks – Barclays plc BCS, HSBC Holdings plc HSBC, Lloyds Banking Group plc LYG, The Royal Bank of Scotland Group plc RBS, Nationwide Building Society, Santander UK and Standard Chartered plc SCBFF – have cleared the BoE’s 2015 stress test.
Results depict “the resilience of UK banks and building societies to deterioration in global economic conditions.” Therefore, none of the banks were ordered to submit a revised capital plan. Banks were required to maintain a minimum core capital ratio of equity to risk-weighted assets of 4.5% and a leverage ratio of 3%.
Mark Carney, governor of the BoE, said, “The stress test results, taken together with banks’ capital plans, indicate that the UK banking system would have the capacity to continue to lend to the real economy even under such a severe scenario.”
Results in Detail
Five of the seven banks – Barclays, HSBC, Lloyds, Nationwide Building Society and Santander UK – did not reveal any capital inadequacies, given their balance sheets at 2014-end. Among these, Nationwide Building Society emerged the strongest, followed by Lloyds, Santander UK, HSBC and Barclays.
The other two – Royal Bank of Scotland and Standard Chartered – were not required to resubmit their capital plans as they continued to show “improvements to their resilience over the course of 2015 and plans to increase capital.”
Though Royal Bank of Scotland did not meet an individualized capital requirement, the company’s actions – such as the sale of its Citizens unit in the U.S. and plans to issue bonds – were deemed as sufficient to address the shortcoming.
Similarly, Standard Chartered was found to have fallen short of the tier 1 minimum core capital requirement of 6%, but was spared from submitting revised plan owing to announcement of restructuring measures and a $5.1 billion rights issue.
Backdrop & Scenarios for Stress Test
This is the second year of BoE stress test. Last year, The Co-operative Bank plc and Royal Bank of Scotland had failed to clear the stress test and were required to submit revised capital plans. This time, the BoE conducted stress tests for banks with deposits of £50 billion or more, leading to the removal of Co-operative Bank from the list.
Further, the time span of the 2015 stress test has been expanded from three to five years. The stress test covers the period from end-2014 to 2019.
The stress test is mainly aimed at gauging how much the banks would lose in case of a future economic downturn. The test rounds aid in determining how banks would respond to another economic slowdown and a slump in the markets. Hence, BoE has come up with hypothetical scenarios that were considered while conducting the stress test.
The BoE based the stress test on several hypothetical setups including a drastic slowdown in Chinese economy with growth deteriorating to 1% from 7%, leading housing crisis in China and Hong Kong. Further, a fall in oil price to $38 (£25) per barrel and a slump in commodity prices were among the hypothetical situations.
Additionally, the test included a circumstance in which the European economy would face three years of slump that would lead to long-term market uncertainty. The setting also took into consideration potential legal costs pertaining to banks’ business malpractices.
Road Ahead
This is just the beginning for major UK banks. They will be required to undergo stress tests on an annual basis. The U.S. Federal Reserve and the European Central Bank have also been conducting their stress tests on a yearly basis.
While coming out with their 2015 stress test results, the BoE also outlined its plans for conducting stress test over the next three years:
- “Develop an approach to stress testing that is explicitly countercyclical, with the severity of the test, and associated regulatory capital buffers, varying systematically with the state of the financial cycle.
- "Improve the consistency between the concurrent stress test and the overall capital framework, including by ensuring that systemically important banks are held to higher standards.
- "Enhance its own modelling capability, while ensuring that participating banks continue to play an important role in producing their own projections of the impact of the stress.”
We believe that such measures would serve to improve UK’s financial stability and aid the overall global economic recovery as well. Further, this will boost the lending capacity of banks, thereby bolstering their financial positions.
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