The purpose of the test is to ensure that the UK banking system can withstand a severe shock and continue to provide financial services to the real economy. Stress testing makes up one of the three pillars of the Bank of England’s framework to assess capital adequacy, alongside risk-weighted capital requirements and a leverage requirement.
The 2015 stress test will assess the resilience of the UK banking system to a synchronised global downturn affecting Asia and the euro area in particular, and amplifying global disinflationary pressures.
The test will consider a severe financial market stress with a reduction in global risk appetite, particularly in indebted economies, reductions in market liquidity, and some defaults of counterparties. It will also consider the impact of a slowdown in the UK driven by the downturn in its trading partners, fall in confidence, and correction in market risk appetite.
As in the 2014 stress test, if a firm’s capital ratio is projected to fall below the 4.5% CET1 threshold, or the new 3% Tier 1 leverage ratio threshold in the stress, there is a strong presumption that the PRA will require the firm to take action to strengthen its capital position. However, depending on the outcomes for specific firms, the PRA may still require action to strengthen capital positions even if the thresholds are met. To determine whether action is needed, the PRA will examine capital adequacy, the adequacy of recovery and resolution plans and the extent to which potentially significant risks are not quantified adequately or fully as part of the stress.
Last year, Co-operative Bank failed a series of stress tests, while RBS and Lloyds 'scraped through'. Five banks - Barclays, HSBC, Nationwide, Santander UK and Standard Chartered - showed no capital inadequacies.
Mark Carney, Governor of the Bank of England, said:
“Last year’s stress tests demonstrated how much stronger the core of the UK financial system has become since the financial crisis. The results showed that the post crisis reforms have put the UK banking system on a stronger footing and made it better able to support the real economy even in the face of a major domestic shock. This year’s test will have a different focus and is equally important. By assessing the resilience of the UK banking system against a major external shock, we will improve further our ability to identify vulnerabilities and we will ensure that banks have plans in place to address a wider range of possible stresses.
“As a forward looking regulator our job is never complete. Our focus is clear. To promote the good of the people of the United Kingdom, we are committed to ensuring that our major banks are resilient, that they can weather shocks without calling on taxpayer support, and that they can continue to lend even in adverse conditions. This year’s stress tests will build on last year’s work and advance our medium-term stress testing framework.”
