Britain’s major lenders will be able to withstand an economic shock more severe than the global financial crisis, according to the stress tests carried out by the Bank of England (BoE).
The results, released after the close on Monday, showed that the UK banking system is “resilient to deep simultaneous recessions in the UK and global economies” and would be able to meet credit demand from UK business and consumers despite an economic crash, the central bank said.
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While the BoE highlighted higher losses on corporate exposures compared to previous tests and weakness in the underlying profitability of the banks, it maintained that all seven of the participants, Barclays PLC (LON:BARC), HSBC Holdings PLC (LON:HSBA), Royal Bank of Scotland Group PLC (LON:RBS), Standard Chartered PLC (LON:STAN), Lloyds Banking Group PLC (LON:LLOY), Nationwide and Santander UK, would be able to withstand another crisis.
Nationwide was the strongest performer in the latest round of tests, while Barclays came in last place as a result of risks connected to its UK and international credit card business.
However, one area that may concern investors is that the bank’s ability to cut dividends was cited by the BoE as one of the core pillars of their resilience, meaning that in the event of another financial meltdown the payout will likely be the first things to face the axe.
“Investors should be aware that banks would make such cuts as necessary if a stress were to materialise”, the BoE said.
Following the results, the BoE added that next year it will be increasing the size of the countercyclical capital buffer, the amount of cash needed for banks to withstand financial shocks, to 2% of risk weighted assets from 1%.
“The aim of the increased buffer is therefore to provide the regulatory with greater flexibility in setting systemic capital requirements as the risk environment changes”, said analysts at Shore Capital, adding that they expected to capital requirements of RBS and Lloyds to be most affected by the increase given their “high level of exposure to the UK economy”.
Another potential complication is IFRS9, an accounting standard the forces banks to provide for expected losses on loans as opposed to logging the provision after a default.
While these rules are not expected to come into force until 2023, the BoE said if the standard was in force today both Barclays and Lloyds would fall below the capital levels required to avoid converting debt into equity, a process that often causes share dilution.
The stress tests were introduced following the 2008 financial crash, which left many of the UK’s banks including RBS, Lloyds and Barclays on the brink of collapse.
While the results will have been reassuring for the banks' customers and shareholders, said KPMG partner Rob Smith, “however investors won’t miss the warning that in order to survive these stresses dividends dropped to near zero...And bankers won’t miss the fall in bonuses under the stress".
He added that the PRA’s consultation on reducing capital requirements whilst increasing high quality “will be welcomed" but “next we’ll need to see if banks can pass the equally crucial Thunberg test”.