John Thanassoulis, professor of Financial Economics, Warwick Business School
"The reputational damage of doing things of which the Bank of England does not approve will make banks risk averse. Whether this is bad is a question of degree."
The Bank of England today announced the results of the first concurrent stress testing exercise of the UK banking system. Alongside the stress test publication, the Bank of England also published its Financial Stability Report, which sets out the Financial Policy Committee's (FPC) assessment of the outlook for the stability and resilience of the financial sector, and the Systemic Risk Survey, which quantifies and tracks market participants' perceptions of systemic risks.
Following on from the EU-wide stress test, the 2014 UK stress test of the eight major UK banks and building societies was designed specifically to assess their resilience to a very severe housing market shock and to a sharp rise or snap back in interest rates. This was not a forecast or expectation by the Bank of England regarding the likelihood of a set of events materialising, but a coherent, severe 'tail risk' scenario.
The eight banks and building societies tested as part of this exercise were Barclays Bank, Co-operative Bank, HSBC Bank, Lloyds Banking Group, Nationwide Building Society, Royal Bank of Scotland, Santander UK and Standard Chartered.
There was substantial variation across the banks and building societies in terms of the impact of the stress scenario. From an individual-institution perspective, the Prudential Regulation Authority (PRA) Board judged that this stress test did not reveal capital inadequacies for five out of the eight participating banks, given their balance sheets at end-2013 (Barclays, HSBC, Nationwide, Santander UK and Standard Chartered). The PRA Board did not require these banks to submit revised capital plans.
Following the stress testing exercise, the PRA Board judged that, as at end-2013, three of the eight participating banks (Co-operative Bank, Lloyds Banking Group and Royal Bank of Scotland) needed to strengthen their capital position further. But, given continuing improvements to banks' resilience over the course of 2014 and concrete plans to build capital further going forward, only one of these banks (Co-operative Bank) was required to submit a revised capital plan.
The FPC considered the information provided by the stress-test results from the perspective of the resilience of the UK banking system as a whole. The FPC noted that only one bank fell below the 4.5% threshold at the trough of the stress scenario, that the capitalisation of the system had improved further over the course of 2014 and that the PRA Board had agreed plans with banks to build capital further. Overall, the FPC judged that the resilience of the system had improved significantly since the capital shortfall exercise in 2013. Moreover, the stress-test results and banks' capital plans, taken together, indicated that the banking system would have the capacity to maintain its core functions in a stress scenario. Therefore, the FPC judged that no system-wide, macroprudential actions were needed in response to the stress test.
Mark Carney, Governor of the Bank of England, said: "The stress test completes our capital framework by informing judgments about the appropriate size of capital buffers for individual firms and for the system as a whole. It is a major component of both our macro- and micro-prudential regimes. As a joint exercise between the PRA and FPC, it demonstrates the major synergies possible across the Bank of England. This was a demanding test. The results show that the core of the banking system is significantly more resilient, that it has the strength to continue to serve the real economy even in a severe stress, and that the growing confidence in the system is merited."
Commenting on the results, John Thanassoulis, professor of Financial Economics at Warwick Business School, said: "The Bank of England are being diligent and fair to all the banks, but the downsides of this approach to financial regulation are that we publicly name certain banks as being distressed sellers of assets. For example the Co-operative bank has now been required to sell a large part of its mortgage book. A forced seller is one who will not receive a good price.
"The second downside is that the reputational damage of doing things of which the Bank of England does not approve will make banks risk averse. Whether this is bad is a question of degree. But if lending costs rise for individuals and businesses in the medium term then the poorest consumers and the small entrepreneurs will be the ones who suffer first.
"Having said that this regulatory system has many positives as banks will have to be constantly wary of what the Bank of England will permit. To prevent a box ticking culture the Bank of England is also working to make individuals personally liable through the Senior Manager Certification Regime. And the news of a weak bank might encourage movement of consumers and so help bring more active competition to the sector."
a) The minimum CET1 ratios shown in the table do not necessarily occur in the same year of the stress scenario for all banks. (b) Actuals are in Q2 2014 for the Co-operative Bank plc, Santander UK plc and Standard Chartered Bank Group; Q3 2014 for Barclays Group,
HSBC Holdings PLC, Lloyds Banking Group, Royal Bank of Scotland Group; and September 2014 for Nationwide Building Society. (c) As a result of Nationwide's different reporting date, the Bank used an estimated 4 April 2014 balance sheet as the start point of the stress-testing analysis. This results in the difference between the CET1 ratio quoted in this table and that reported in Nationwide's annual accounts.