The UK’s largest banks face a review of consumer credit and their toughest ever test of resilience after the Bank of England unveiled an extra assessment of their ability to weather certain economic scenarios.
The BoE will put the seven largest lenders through an additional examination alongside its regular annual stress test, which measures how banks would fare if the economy experienced a severe shock, at the end of this year.
The new “exploratory” test, which will occur every other year, will assess banks’ resilience to a wider range of risks beyond those emanating from the financial cycle – such as persistent low interest rates and high costs.
The longer-term test involves banks submitting projections for seven years and will help the Bank of England identify how the financial system will be reshaped if, for example, there are persistent headwinds to bank profitability. The BoE will not publish details of the results on a bank-by-bank basis.
One advisor said no other central bank has launched such a test before and that it is “uncharted waters for both the BoE and banks”.
Ahead of two-year Brexit talks which kick off this week, the BoE said:
Risks to financial stability will be influenced by the orderliness of the adjustment to the new relationship between the United Kingdom and the European Union.
The FPC will oversee contingency plans to mitigate risks to financial stability as this process unfolds.
In another move, the BoE revealed that the Prudential Regulation Authority will launch a review into banks’ lending standards in relation to consumer credit following the soaring growth of the sector.
The new review will focus on underwriting standards and the risk models employed by banks.
Consumer credit is the largest single risk on a bank’s balance sheet. Last year banks had £19bn of impairments on credit cards, compared to £12bn on mortgages.
The BoE’s Financial Policy Committee will also oversee banks’ contingency plans to mitigate risks as the process for withdrawing from the EU unfolds.
The BoE warned a year ago, ahead of the EU referendum, that the vote represented the most significant near-term domestic risk to financial stability. However, governor of the BoE Mark Carney earlier this year said that the risk has abated.
The seven lenders undertaking the annual stress test – Barclays, HSBC, Royal Bank of Scotland, Lloyds Banking Group, Santander UK, Standard Chartered and Nationwide – also face the exploratory assessment.
The BoE is also changing its regular annual stress test by including an “anchor” on its severity. This means the test will only get more severe in areas where the BoE thinks risks have grown.
This year the test will examine how lenders deal with a spike in UK unemployment to 9.5 per cent – the same as last year – and a 33 per cent slump in house prices.
But the global economic scenario will be made more severe, with global GDP contracting by 2.4 per cent and Chinese GDP by 1.2 per cent.
David Strachan, a head of regulatory strategy at Deloitte, said: “I think the way that it tests business models and capital levels…in terms of organisation and administration and logistics then it is more challenging this time around.”