The Bank of England (BoE) said on Tuesday that for the first time since it started stress testing banks in 2014, none of Britain’s major lenders need to raise extra capital and could handle a Brexit-driven recession without a government bailout.
Lloyds Banking Group PLC (LON:LLOY), Royal Bank of Scotland Group (LON:RBS), Barclays PLC (LON:BARC), HSBC Holdings (LON:HSBA), Standard Chartered PLC (LON:STAN), Nationwide Building Society and Santander UK PLC (LON:SANB) all passed the central bank’s test for being able to withstand another financial crisis.
The BoE's Financial Policy Committee (FPC) found that the lenders were strong enough to handle a "disorderly" no-deal Brexit.
The test examined the strength of a bank’s balance sheet against the central bank's capital requirements, including the common equity tier 1 ratio (CET1) and the Tier 1 leverage thresholds.
The aggregate CET1 ratio of the country's seven biggest banks was 13.4%, three times stronger than a year ago.
Under a stressed scenario, which includes a 4.7% decline in UK gross domestic product, a rise in UK unemployment to 9.5% and a 33% fall in British house prices, the CET1 ratio fell from 13.4% to a low point of 8.3%.
"The 2017 stress test shows the UK banking system is resilient to deep simultaneous recessions in the UK and global economies, large falls in asset prices and a separate stress of misconduct costs," the FPC said.
RBS and Barclays come out the weakest
RBS and Barclays failed the test on the amount of capital banks must hold at the start of 2017.
However, the banks do not need to raise extra capital after strengthening their balance sheet throughout the year. RBS has improved its balance sheet by shedding assets and Barclays has raised capital by selling a large chunk of its African operation.
In the stress test, RBS's CET1 ratio fell to a low point of 7% - below its 7.4% minimum systemic reference point - while Barclays' capital ratio dropped to 7.4%, below its 7.9% minimum requirement.
RBS has increased its actual CET1 ratio from 13.4% at the end of 2016 to 15.5% in the third quarter quarter of this year, and Barclays bolstered its CET1 capital ratio from 12.4% to 13.1%, and its Tier 1 leverage ratio from 5% to 5.1%, over the same period.
RBS, which failed last year's stress tests, has been working to return to an annual profit and restore dividend payments next year. The government last week announced that it plans to start selling its 71% stake in RBS in the next 16 months.
Lloyds and HSBC exceed minimum capital requirements
Lloyds increased its CET1 ratio from 13.6% at the end of 2016 to 14.1% in the third quarter while the leverage ratio rose from 5.2% to 5.4% over the same period.
In the BoE's exercise, it calculated Lloyds' CET1 ratio post-management actions as 7.9%. The lender did not provide a minimum systemic reference point.
"Despite the severity of the stress, the group exceeds the capital and leverage thresholds set out for the purpose of the stress test before the application of any management actions; therefore, the group is not required to take any capital action as a result of this stress test," Lloyds said in a statement.
HSBC's CET1 ratio edged up 14.6% in the third quarter from 13.6% at year end. In the Bank's stressed scenario, the CET1 ratio fell to a low point of 8.9%, compared to its 8.0% systemic reference point.
BoE raises CCB rate as it warns on Brexit risks
The FPC said while the UK banking system could handle the financial shocks, "the combination of a disorderly Brexit and a severe global recession and stressed misconduct costs could result in more severe conditions than in the stress test".
"In such circumstances, capital buffers would need to be drawn down substantially more than in the stress test and, as a result, banks would be more likely to restrict lending to the real economy."
Amid worries about the impact of the UK's withdrawal from the European Union in March 2019, the BoE is pressing on with plans to raise the countercyclical capital buffer (CCB) rate to 1% from 0.5% with effect from November 2018.
The Bank will consider raising the CCB rate again in the first half of next year.
UK economic growth has lost its momentum this year as the weaker pound following the Brexit vote pushed inflation higher and put pressure on households' disposable incomes.
The Office for Budget Responsibility last week cut its UK GDP forecasts for the next few years. It now expects the economy to grow by 1.5% this year, compared to a previous forecast of 2%.
Stress test results as expected
"As we had anticipated, none of the banks that were tested will be required to take additional action to shore up their balance sheets, thus highlighting the improving health and strength of the UK banking sector," said Shore Capital analyst Gary Greenwood.
"That said, Royal Bank of Scotland did come close to missing the cut," he said, adding that Barclays also fell short of its systemic reference point in part due to litigation matters.
Test assumes dividend cuts in 2018, AJ Bell warns
Russ Mould, AJ Bell Investment Director, said major lenders are much better placed to withstand the next financial downturn but investors should be aware that the stress tests assume that banks would slash their dividends in 2018 to preserve cash.
He said it seems unlikely cutting dividends would be welcomed by "income-hungry portfolio builders, especially as the 6%-plus dividend yield on offer from Lloyds and the 5.4% available at HSBC form a key plank of the investment case for both stocks".
“Nevertheless the Bank of England’s conclusion that no big bank needs to raise additional money does reflect how so-called equity and leverage ratios have consistently improved as the big banks have in effect shrunk themselves back to health, cutting costs, selling non-core assets and restraining their loan books," he said.