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Farrer & Co | Bank of England publishes results of its 2016 stress test

Today the Bank of England published the results of its stress test of the country’s seven systemically important banks and building societies. This was the first stress test carried out under the Bank’s new annual cyclical scenario framework, details of which were published in March 2016.

The key feature of this framework is that it is “explicitly countercyclical, with the severity of the test, and associated regulatory capital buffers, varying systematically with the state of the financial cycle”. This year the Bank’s test assumed that the stress level banks should be prepared to meet was “broad and severe” based on the assessment made by the Financial Policy Committee (FPC) and the Prudential Regulation Authority (PRA) Board in March 2016.  As with the 2015 test, there were three main parts to the 2016 test: 

  • a macroeconomic stress scenario, spanning a five-year period to the end of 2020; 
  • a traded risk stress scenario, which is consistent with the macroeconomic stress scenario; 
  • a misconduct costs stress, which is in addition to the macroeconomic and traded risk stress scenarios.

For 2016, the test incorporates a more severe global stress than either the 2014 or 2015 stress scenarios, and the 2016 test matched the high domestic UK stress scenario in the 2014 in relation to GDP and unemployment rates, although it is slightly less severe regarding house prices falls than the 2014 test. It also tested the banks against the Bank of England’s new hurdle rate framework, which holds systemic banks to a higher standard reflecting the phasing-in of capital buffers for global systemically important banks. Taken as a whole, it is fair to say that the 2016 stress test is a more stringent one that either the 2014 or 2015 test, reflecting the direction of travel that policymakers are taking as regards the level and depth of stress systemic banks should be able to withstand.

Of the seven banks and building societies who were subjected to these tests, four (HSBC, Lloyds Banking Group, Nationwide and Santander UK) have passed, and while some capital inadequacies were discovered for three banks (The Royal Bank of Scotland Group (RBS), Barclays and Standard Chartered), the report states that the banks in question have plans in place to rectify these deficiencies. RBS has already submitted a revised capital plan to the PRA to deal with issues regarding its tier 1 capital requirements and the PRA will monitor its progress against the revised plan. Barclays and Standard Chartered have not been required to submit revised plans. Overall the FPC noted and welcomed the steps the banks have taken so far to increase their resilience to stress scenarios and did not believe it was necessary to implement any system-wide actions regarding bank capital.

Finally, it is worth noting that the FPC is retaining the UK countercyclical capital buffer rate at 0% and has stated that it expects it to remain at this level, subject to any significant change in outlook, until at least June 2017. This reflects the FPC’s concern regarding its view that uncertainty around the UK’s economic outlook could lead banks to “hoard capital and restrict lending” which could cause further issues with the economy.

If you require further information on anything covered in this briefing please contact Fiona Lowrie (fiona.lowrie@farrer.co.uk; +44(0)203 375 7232) or your usual contact at the firm on 020 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, November 2016

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