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By Steve Slater and Huw Jones
LONDON, Nov 30 (IFR) - Royal Bank of Scotland must bolsterits capital after failing this year's stress test of Britishlenders as the state-backed lender faces a big US fine formisconduct and continues to struggle with its turnaround.
RBS, 73%-owned by the UK taxpayer, said it would take arange of actions, including selling off bad loans and cuttingcosts to make up the capital shortfall of about £2bn identifiedby the test.
Barclays and Standard Chartered also came up short in thePrudential Regulation Authority's annual health check of sevenlenders, although their turnaround and capital raising plansalready in place will be enough to address their problems, theregulator said.
RBS shares fell 4% after the results, as analysts said itshowed the big hit from potential litigation it faces and itsongoing struggles to improve its business.
"The bank continues to be a work-in-progress restructuringstory," said Chirantan Barua, analyst at Bernstein.
RBS said it had agreed a plan of action that the regulatorhad accepted. This involved "an array of capital managementactions", including cutting costs, reducing risk-weightedassets, running down or selling non-core loans, and "theproactive management of undrawn facilities", such as reducingoverdraft facilities.
The bank said this should address the shortfall, but said"additional management actions may be required until RBS'sbalance sheet is sufficiently resilient to stressed scenarios".
£30BN MISCONDUCT
This year's test was the third annual healthcheck by theBank of England's PRA and was more severe than in 2014 and 2015.It was the first based on the central bank's new approach tostress testing, which includes potential misconduct costs.
The PRA estimated the banks could incur £30bn of misconductcosts by the end of 2017, although it did not give a breakdownby bank. It said, by design, the estimate was much larger thanprovisioned by the banks.
RBS faces a fine from US authorities for mis-sellingmortgage-backed securities, which analysts estimate could be asmuch as £12bn.
This year's healthcheck also included material traded risklosses, which the PRA said reduced capital by £20bn by 2017across all the banks.
The banks had to withstand valuation adjustments,counterparty credit risk, a fall in investment banking revenuesand volatile markets, with the VIX volatility index averaging 37for a year.
They were tested against a sharp rise in credit spreads oncorporate bonds. Investment-grade US corporate bond spreadswiden to about 500bp from around 170bp in the scenario, forexample, while high-yield US corporate bond spreads widen to1,690bp from 640bp in the scenario.
Other scenarios in the test include global GDP contractingby 1.9% in the first year, oil prices dropping to US$20 perbarrel, a 50% crash in Hong Kong property prices and a 42% dropin UK commercial real estate prices.
The PRA did not set a standard pass/fail for its test, butset a "hurdle level" for each bank's common equity Tier 1 (CET1)ratio based on their existing capital requirements. It also seta "systemic reference point", which adds a capital buffer basedon their global, systemic importance.
For the five main listed banks, CET1 hurdle levels rangedfrom 6.1% for Standard Chartered to 6.8% for Barclays. Thesystemic reference points ranged from 6.6% for StanChart to 7.8%for Barclays, and was 7.1% for RBS.
Banks also had to keep their leverage ratio above 3%.
Banks were able to use additional Tier 1 capital - bondsthat convert into equity if their CET1 ratio falls below 7% - inthe stress test for the first time. The seven firms had issued£23bn of AT1s by the end of 2015.
RBS's CET1 ratio fell to 5.5% under a stressed scenario andwas 6.7% even after mitigating action and the conversion ofAT1s, still 40bp short of its systemic reference point.
Barclays' CET1 fell to 5.9% under a stressed scenario, butimproved to 8.3% after mitigating action and the conversion ofAT1 bonds, above the required level. Standard Chartered'scapital fell to 5.5% under stress, but was 9.9% after mitigatingaction and AT1 conversion.
HSBC, Lloyds Banking Group, Nationwide and Santander UK didnot suffer any capital inadequacies in the test, the BoE said.
In aggregate, the banks fared worse than analysts andinvestors had expected.
"Today's performance is worse than predicted, this is thehighest average fall in CET1 and leverage ratios we've seen inthe history of a UK concurrent stress test," said Steven Hall,banking partner at KPMG.
The BoE said the overall level of capital in the UK bankingsystem was satisfactory, equivalent to 13.5% of risk-weightedassets, and in aggregate could support the economy in a severe,broad and synchronised stress scenario.
The BoE will next year introduce a second stress test to runalongside its annual check. It will be more of a test of banks'business models and strategies.
The UK's annual stress test process is shifting closertowards the US system, whereby banks are not only told to raisecapital if necessary but can also be to told to cut or stopdividends or be prevented from buying back shares. (Reporting by Steve Slater and Huw Jones; Editing by IanEdmondson)
