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Lloyds, RBS, Barclays and other UK banks pass tough 2018 stress test ahead of Brexit

In the 2018 scenario, UK GDP falls by 4.7%, the UK unemployment rate rises to 9.5%, UK residential property prices fall by 33% and UK commercial real estate prices fall by 40%
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Filippo Alloatti, senior credit analyst, Hermes Investment Management said: “The stress test results have highlighted banks’ ability to absorb a ‘cliff-edge’ Brexit given the draconian inputs to the modelled scenario"

The Bank of England’s 2018 stress tests show that UK banks are strong enough to withstand a disorderly Brexit and the country's financial system is able to weather the wide range of risks it could face.

The latest stress test, released at the London market close on Wednesday, showed that the UK banking system is resilient to deep simultaneous recessions in the UK and global economies that are more severe overall than the global financial crisis and that are combined with large falls in asset prices and a separate stress of misconduct costs.

READ: Brexit: Bank of England says UK risks suffering an even bigger hit to its economy than during the global financial crisis

In the 2018 scenario, UK GDP falls by 4.7%, the UK unemployment rate rises to 9.5%, UK residential property prices fall by 33% and UK commercial real estate prices fall by 40%.

The stress test scenario also includes a sudden loss of overseas investor appetite for UK assets, a 27% fall in the sterling exchange rate index and Bank Rate rising to 4%.

Additionally, it included worst-case assumptions like the sudden imposition of trade barriers with the EU, loss of existing trade agreements with other countries, severe customs disruption, a sharp increase in the risk premium on UK assets and negative spill-overs to wider UK financial markets.

Resilience measured

Stress tests were introduced in the wake of the 2008 financial crisis and are designed to measure the resilience of participating banks in adverse economic conditions. The tests are intended to model for unlikely severe economic and financial shocks.

The BoE said that the seven participating banks, which include the Royal Bank of Scotland Group PLC (LON:RBS), Barclays PLC (LON:BARC), HSBC Holdings PLC (LON:HSBA), Lloyds Banking Group PLC (LON:LLOY), Standard Chartered PLC (LON:STAN), Nationwide Building Society and Santander UK did not reveal capital inadequacies and were consequently not required to submit a revised capital plan.

The BoE said: "All participating banks remain above their risk-weighted capital and leverage hurdle rates and would be able to continue to meet credit demand from the real economy, even in this very severe stress.”

Commenting on the stress tests, Filippo Alloatti, senior credit analyst, Hermes Investment Management said: “The stress test results have highlighted banks’ ability to absorb a ‘cliff-edge’ Brexit given the draconian inputs to the modelled scenario which are likely to be worse than even the most nightmarish of Brexit outcomes.

“Certainly, they look well placed to weather the types of economic storms in the Treasury and BOE models published today.”

Lloyds the bank most at risk

He added: “The bank most at risk in this test is Lloyds given the size of its £300bn+ mortgage book as well as the introduction of the Systemic Risk Buffer. This higher hurdle rate will also have a greater impact on Barclays because it had the lowest CET1 ratio at cut-off date YE17. On the flip side, RBS’ higher CET 1 ratio of 15.9% will see it come out of the tests in a stronger position having previously been one of the worst capitalised banks with a CET 1 ratio of 7%.”

Alloatti concluded: “Ultimately, banks are in a far stronger position than they were 10 years ago, are more attractive from a credit standpoint and no longer pose the risk to financial stability that they once did.”

In a separate statement, published simultaneously on the effects of various Brexit scenarios, the Bank of England said that sterling would crash, inflation soar, interest rates would have to rise and growth would plummet in the event of a no deal disorderly Brexit.

It added that, in the event of a disorderly no deal Brexit, GDP could fall by 8%, sterling plummet 25%, unemployment rate rise by 7.5%, inflation surge 6.5% and interest rates could rise as high as 5.5%.

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