Bank stress tests – how the UK banks fared

James Box, Equity Analyst at Brewin Dolphin discussed the Bank of England Stress tests

The PRA (Bank of England Prudential Regulatory Authority) stress test results were released this morning. These tests assessed the UK banks’ capital adequacy, under a theoretical adverse macroeconomic shock, subject to a 4.5 % Common Equity Tier 1 (CET1) capital threshold. Unlike the European stress tests last month, the PRA tests were dynamic, allowing the results to be offset by management actions, such as cost cuts. The results were as follows:

• 2016 CET1 pre management action: Barclays, 7.0%; HSBC, 8.7%; Lloyds, 5.0%; RBS, 4.6%; Standard Chartered, 7.1%. 
• 2016 CET1 post mitigating management actions: Barclays, 7.5%; HSBC, 8.7%; Lloyds, 5.3%; RBS, 5.2%; Standard Chartered, 8.1%. 

The theoretical stress scenario was quite severe. The key assumptions included base rates rising to 4%, a sharp deterioration in sterling, the UK house price index falling 35% and unemployment peaking at 11.8%. The stress test, by its design, resulted in a material impact on those banks which are significantly exposed to the UK housing market, with less focus on investment banking and overseas operations. 

All the listed UK banks under our coverage passed which removes another tail risk for the sector. Despite negative press headlines around Lloyds and RBS being at the lower end, the numbers do not include any allowance for the capital build during 2014, which has been meaningful. We would not place too much importance on the specific numerical results of these tests.

1. This was a highly specific and theoretical exercise. It penalised UK centric banks with mortgage exposure while ignoring investment banking and overseas operations (which both involve vulnerabilities).
2. In other words, the stress tests have helped quantify the impact of tail risks for Lloyds and, to a certain extent, RBS, but less so for the other UK banks.
3. History tells us that the biggest risks tends to involve something that nobody is thinking about. It is unlikely that the next crisis will resemble the adverse scenario that underpinned these stress tests. For instance, while these tests were carried out, potential vulnerabilities have emerged in the oil and commodity sectors and bank exposures thereon. 

We believe that a bank’s ability to weather a storm is based on its underlying earnings power, which determines the ability to re-build capital following a negative shock. On this basis Lloyds and HSBC compare favourably, in our view. 

ENDS

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