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Big Seven lenders pass Bank of England stress test

Published 01/12/2015

The Bank of England carried out an annual health check on the UK's biggest lenders
The Bank of England carried out an annual health check on the UK's biggest lenders

All seven of the UK's largest lenders have passed the Bank of England's stress test.

The results of the banking sector's annual health check showed it has enough capital "to support the real economy in a severe global stress scenario", such as a major slump in the Chinese economy or a financial market crisis.

The Prudential Regulation Authority (PRA) said Barclays, HSBC, Lloyds Banking Group, Nationwide Building Society and Santander UK did not show capital inadequacies.

The Royal Bank of Scotland Group did not meet its individual capital guidance and Standard Chartered did not meet one of the minimum capital requirements; however, the PRA ruled they did not have to submit new plans.

Taxpayer-owned RBS missed fulfilling one of the capital guidance criteria after "management actions" in the test.

However the PRA board was reassured by steps the bank had taken to strengthen its capital position for extra security in Tier 1, its central reserves, in future.

Standard Chartered did not meet the minimum capital of 6% in Tier 1 after management actions in the scenario.

The PRA viewed the bank's recent strategy review and steps it had taken to shore up its capital position were sufficient to pass the test.

The minimum overall capital level under stress conditions set by testers is 4.5%.

Standard Chartered was reportedly facing tougher scrutiny because of its exposure to emerging markets.

The Bank of England modelled a fall in Chinese economic growth from 7% to 1%, leading to a crisis in housing markets in China and Hong Kong.

The five-year simulation also saw the price of oil crash to 38 US dollars (£25) a barrel and a sharp fall in commodity prices.

Meanwhile, Europe would be faced with a three-year slump as domestic demand fell and world trade and commodity prices suffered, leading to long-term market uncertainty and investors retreating into "safe-havens".

The modelling also took into account potential costs to the banking sector resulting from misconduct scandals, such as the mis-selling of payment protection insurance (PPI)

In total, the banks' pre-tax profits were projected to take a £40 billion hit as a result of fines and costs created over the five-year stress scenario.

The figure was based on the approximately £43 billion in fines and costs paid and provided for by the banking sector since 2009.

The big seven banks, that account for 80% of UK lenders regulated by the PRA, were examined to gauge their ability to withstand the resulting cuts in the flow of credit.

Economists chose the scenario after the Financial Policy Committee (FPC) raised concerns about an increase in global and financial risks during 2014.

BoE analysts used the lenders' own models, as well as in-house models and statistical analysis.

In the event of the scenario becoming a reality most of the banks would lose a total of £37 billion, equivalent to two thirds of their central reserves, the Tier 1 capital, while profits across the board would fall £100 billion by the end of 2016.

Shareholders could see a £21 billion reduction in their dividends to mitigate the impact on the banks' capital. The cuts would come as a result of either banks' individual policies or a new set of EU rules.

The Bank said: "In a real stress, which had a significant impact on banks' profits, investors should expect banks to cut dividends materially, in line with published dividend policies and the operation of the capital conservation buffer."

The impact of the stress varied "substantially" across the lenders, the report said.

This was due to differences in the banks' business models and where in the world they were exposed to risk, especially as the simulation envisaged a crisis in Asia and emerging markets.

This particularly impacted the profitability of Standard Chartered and HSBC, the lenders least focussed on UK markets, the BoE said.

The two banks, along with Barclays and RBS saw the "vast majority" of losses in their risk trading arms.

The international pressures in this year's test meant that impairments on UK mortgage lenders were not projected to become "particularly elevated", compared with the previous test which modelled larger "shocks" to UK property prices and a rise in unemployment.

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