Testing times are back for execs at the UK’s biggest banks: annual results of the Bank of England’s stress tests will be released on Tuesday. The Bank orders lenders to conduct ‘what if’ exercises of varying severity each year.
Whilst an explanation of the test scenarios runs to 26 pages in this explainer on the BoE’s website, their aim is simple: to root out overlooked areas of financial weakness that could make them a risk to themselves, their depositors and society as a whole in the event of an economic, financial or corporate shock.
The tests are of course an important safeguard for the financial system as a whole, and they are certainly taken seriously by bank investors. RBS failed last year’s stress test. Its stock fell about 5% on the news. The bank then had to raise capital by cutting costs and selling £2bn in assets.
Test anxiety may be a little higher this year. 2017 is the first year that the BoE ran an “additional exploratory scenario”, designed to test how the banking system would cope if recent headwinds to bank profitability were to persist or intensify. Even more unsettling for banks, this set of tests does not focus on capital adequacy. Rather “Its purpose is to explore the impact of banks’ actions on both the real economy and the future resilience of the system to shocks.”
Either way, the chances that a major bank will fail this year’s tests look remote given that their closely watched key capital buffers—Common Equity Tier 1 Capital (CET1)—have strengthened since last year’s tests, or at least, in the case of Barclays, have been steady. The average CET1 of Barclays, HSBC, Lloyds and RBS in the current financial year is 13.30% right now, 112 basis points better than in November 2016, according to Thomson Reuters data.
Still, even assuming it passes the tests Barclays may find itself marked out for particular commentary from the BoE since its capital buffer is now the lowest among the Big 4 lenders, according to the chart below. (Note the data includes estimates for the most recent values). Such negative attention and the likely hit to Barclays’ shares would be fitting end to a rough year for the bank. It is already the worst-performing big UK bank share due to deteriorating earnings quality and investor disquiet over strategic direction.
The test results will be published at 0700 GMT on Tuesday, followed by a press conference with BoE Governor Mark Carney.
Figure 1: Tier 1 capital ratio time series for LLoyds Banking Group, Barclays, HSBC and RBS (two years)
Source: Thomson Reuters and City Index
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