The Bank of England gave Britain’s state-backed lenders a narrow pass in its debut annual stress tests yesterday, but warned that next year banks would face tougher checks of their capital strength and inter-national exposure.
Lloyds and rival Royal Bank of Scotland scraped through a doomsday scenario of plummeting house prices and soaring unemployment after both took pre-emptive measures to boost their defences against potential losses.
The Co-operative Bank, which nearly collapsed last year before being bailed out by bondholders, was the only bank to fail the test, which was tougher on lenders with high exposures to British mortgages, such as Lloyds and Nationwide.
Co-op Bank, whose core capital fell to minus 0.2 per cent under the stresses, said it would not have to tap shareholders for additional capital but would probably not make a profit in the next three years as it works out a recovery plan with the Bank of England.
Although Lloyds’ narrow pass raised questions about whether it can convince the regulator to allow it to pay a dividend for 2014, investors said both Lloyds and RBS had performed credibly in a test which simulated the impact of a property crash and rising interest rates.
“While the passes weren’t great, they were passes ... The test was deliberately harsh and what’s key is they passed and we can move forward,” said David Moss, head of European equities at F&C Investments.
Britain decided to introduce annual stress tests of its banks in the wake of the 2007-09 financial crisis which required taxpayers to pump £66 billion into RBS and Lloyds to keep them afloat.
“The results show that the core of the banking system is significantly more resilient (and) that it has the strength to continue to serve the real economy even in a severe stress,” the governor of the BOE, Mark Carney, said.
This year’s stress tests required banks to have a core capital ratio of 4.5 per cent but from next year, the Bank of England said that it would also assess banks’ leverage ratios, which reflects their level of indebtedness.
Regulators are increasingly focussing on leverage ratios amid widespread distrust of banks’ own assessment of the riskiness of their assets. The leverage ratio removes assets’ risk weighting.
Both Lloyds and Royal Bank of Scotland had leverage ratios below the current 3 per cent requirement under the Bank of England’s stressed scenario. Barclay’s leverage ratio was 3 per cent under the stress test.
From 2019 onwards, large UK banks will have to have a leverage ratio of 4.5 per cent and that could be increased in boom times by an extra buffer of another 0.9 per cent to cool lending.
The BOE confirmed yesterday that for now there is still no need for banks to hold boost buffers during booms.
The BOE stress test added a number of additional layers on top of those applied by European regulators in an EU-wide test of 123 banks in October, including a rise in interest rates to 4 per cent from 0.5 per cent currently.
Under the stress scenario, Royal Bank of Scotland’s core capital ratio fell to just 4.6 per cent, a whisker shy of the 4.5 per cent minimum required, before actions it had taken this year to shrink its balance sheet were taken into account.
Lloyds’ core capital ratio was 5 per cent before its actions were taken into account. Royal Bank of Scotland, which is 80 per cent owned by the state, said it would sell £2 billion of notes to bolster capital.
“We recognise that there is still much work to be done to improve the resilience of our balance sheet,” chief executive Ross McEwan said in a statement.
Britain’s other large banks, HSBC, Standard Chartered, Santander UK and Barclays, scored comfortably in the test with pass rates of between 7 and 8.7 per cent.
But the BOE warned that a stress test focussed on emerging market shocks – which would affect HSBC and Standard Chartered more – could come in future and investors said none of the banks could afford to sit back.
“There will be no let-up even for those who passed with flying colours,” said Neil William-son, co-head of EMEA credit research at Aberdeen Asset Management.