- Bank of England published the results of its annual stress test of the UK financial system later on Tuesday.
- The test is designed to ensure that banks are in possession of right tools – such as sufficient liquidity and relatively strong capital positions – to weather an economic storm.
- It included a 4% fall in the UK’s GDP growth, as well as a more than 30% fall in the value of the pound.
- All seven major banks passed the test in 2017.
LONDON – The Bank of England published the results of its annual stress test of the UK’s banking system on Tuesday morning, with all lenders passing for the first time since the introduction of stress testing in the UK in 2014.
“For the first time since the Bank of England launched its stress tests in 2014, no bank needs to strengthen its capital position as a result of the stress test,” the Bank of England said.
“The 2017 stress test shows the UK banking system is resilient to deep simultaneous recessions in the UK and global economies, large falls in asset prices and a separate stress of misconduct costs.”
The test was the fourth run by the Bank of England, and was used as a measure of how well Britain’s banks would be able to cope should the world suffer a major economic shock in the coming year.
The test is designed to ensure that banks are in possession of right tools – such as sufficient liquidity and relatively strong capital positions – to weather an economic storm.
It is pretty apocalyptic, setting out major collapses in a whole heap of asset classes and a massive worsening of economic conditions. As the BoE put it when announcing the test scenario in March, the scenario “incorporates a severe and synchronised UK and global macroeconomic and financial market stress.”
Here is what Britain’s banks had to resist in the case of a global macro shock:
- In the UK economy, the BoE modelled the effects of a sharp recession of more than -4% GDP. This is accompanied by the pound collapsing to just $US0.85, a fall of about a third from current values.
- Global growth is also hit, with banks tested on how they would cope with a worldwide contraction of 2.4%. This scenario also includes a collapse in Chinese commercial real estate of more than 40%.
- As a result, unemployment in the UK climbs higher than during the financial crisis.
- Commercial lending collapses, leading to disaster in the property market. House prices fall by 33% and commercial real estate loses 40% of its value.
It is important to note that the scenario presented in the stress test is not supposed to be indicative of what the BoE actually thinks will happen to the British and world economies but rather a total worst case scenario.
Domestically, the Bank of England said in March that the stress test scenario is broadly the same to the one undertaken in 2016, but globally “the stressed outcome is worse than in 2016, largely reflecting continued rapid growth of credit in China.”
This year, the bank also outlined another test, known as the exploratory scenario, which tested how banks would cope with increased competition and a bank rate cut to zero.
The Bank of England used its exploratory scenario to “consider how the UK banking system might evolve if recent headwinds to bank profitability persist or intensify.”
“It incorporates weak global growth, persistently low interest rates, stagnant world trade and cross-border banking activity, increased competitive pressure on large banks from smaller banks and non-banks, and a continuation of costs related to misconduct. The test will have a seven-year horizon to capture these long-term trends,” the bank said.
Stress tests have gained a lot of popularity with central banks since the financial crisis when numerous banks across the globe collapsed or had to be bailed out by governments. Nowhere was that more true than in Britain, where the government, then led by prime minister Gordon Brown, had to pump billions of pounds into both RBS and Lloyds to keep them afloat.
Last year Royal Bank of Scotland, Barclays, and Standard Chartered were all found to have inadequacies in the test, with RBS forced to submit plans to the regulator detailing how it would raise capital and boost resilience to financial shocks.
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