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LONDON (Alliance News) - The Bank of England Tuesday said it will test whether some of the UK's biggest banks and building societies are able to withstand scenarios including a house price collapse or a sharp rise in interest rates, as it detailed its future so-called stress tests.
Institutions that don't meet the stress test requirements could be forced to strengthen their balance sheets once more, even though most institutions have been doing that to meet regulatory requirements introduced in the wake of the financial crisis.
The eight banks and building societies - Barclays PLC, Co-operative Bank, HSBC Holdings PLC, Lloyds Banking Group PLC, Nationwide, Royal Bank of Scotland Group PLC, Santander UK and Standard Chartered PLC - will be tested on a scenario that will include house prices falling by around 35% and commercial real estate prices falling by around 30%, as well as the headline unemployment rate rising to around 12%.
The central bank has set a capital requirement of a 4.5% Common Equity Tier 1 ratio threshold, and warned that, depending on specific outcomes, firms may be required to strengthen their capital positions even if the threshold is met.
Factors that will play a part in the decision, on top of the 4.5% CET1 ratio, include firms' leverage ratios, Tier 1 and total capital ratios on a risk-adjusted basis, the adequacy of their recovery and resolution plans and the extent to which potentially significant risks are not quantified adequately or fully as part of the stress.
The scenario will also test how the banks and building societies respond to "substantial falls" in other UK financial assets, including equities and corporate bonds. Firms also face tests to their resilience in the face of a sharp depreciation in the value of the sterling, a build-up of inflationary pressures in the UK and real gross domestic product falling by about 3.5% from its 2013 fourth-quarter levels.
"Although the events depicted in this stress-test scenario are extreme, and thus highly unlikely to transpire, by bringing together the microprudential standards for banks with a macroprudential assessment of the tail risks to which they must be resilient, the bank is working to ensure that the UK financial system remains one that absorbs rather than amplifies shocks," Governor Mark Carney said in a statement.
The Bank of England said it will publish the results of its stress test after they have been through regulators towards the end of this year.
Analysts at Deutsche Bank, who described the test as "very tough", said they think that the five listed banks will have enough of a capital cushion to avoid restructuring or further rights issues, but said they aren't expecting any "meaningful" interim dividend increases.
Barclays, HSBC, Lloyds and RBS will also face stress tests by the European Banking Authority.
Under the EBA's tests, firms must show they can withstand a 2.2% drop in baseline EU GDP in 2014, 5.6% in 2015, and 7.0% in 2016, amongst other stresses.
The EU-wide stress test will be conducted on a sample of 124 EU banks which cover at least half of each national banking sector.
By Samuel Agini; samagini@alliancenews.com; @samuelagini
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