Will the Bank of England stress tests persuade investors to give the banks another chance?

Russ Mould
27 November 2018

“The Bank of England is to release the results of its fifth annual stress tests of the UK’s banks a week early on Wednesday 28th November and it will be interesting to see if investors draw any more comfort that they did from the 2017 test results,” says Russ Mould, AJ Bell Investment Director. “Even though all seven banks passed the test, investors did not seem to share the Bank of England’s satisfaction with the result, as shares in the quoted lenders, Barclays, HSBC, Lloyds, RBS and Standard Chartered have all performed poorly in 2018.

“The Bank of England will apply the same scenario as it did last year to test the banks’ financial mettle.

•    World GDP falls by 2.4%
•    UK GDP falls by 4.7%
•    UK residential property prices fall by 33%
•    UK commercial real estate values fall by 40%
•    UK unemployment surges to 9.5%
•    The Bank of England takes interest rates up to 4%, from their current level of 0.75%

“Under this scenario in 2017 the Bank of England’s calculations suggested the banks would suffer £50 billion in losses but would nevertheless be able to weather such the storm without having to raise any fresh capital. 

“The Bank’s study suggested that those £50 billion in losses over a two-year initial period of the five-year stress test would take the UK bank’s common equity tier 1 (CET1) to risk-weighted asset (RWA) ratio down from 13.4% at the end of 2016 to a low-point of 8.3% - still well above the target of 4.5% by the end of 2019 laid down by European regulations.
“All seven of the banks tested passed the test. Nationwide did best, followed by Santander UK and then HSBC, Standard Chartered, Lloyds and Barclays, with RBS faring least well but still emerging with a sufficient capital buffer.

 

Common Equity Tier 1 (CET1) ratio

 

 

Actual end-2016

13.4%

Baseline assumption end-2018

14.3%

 

 

Impact of stress tests

 

Impairments

(4.2%)

Traded risk losses

(1.8%)

Net interest income

+1.2%

Misconduct costs

(1.7%)

Risk weighted assets / leverage exposure

(2.7%)

Reductions in discretionary distributions in stress

+2.2%

Expenses and taxes

+0.6%

Other

+0.3%

 

 

Stress end-2018

8.3%

Source: Bank of England

“Loan impairments of £50 billion, misconduct costs of £40 billion and £33 billion in trading losses and revenue reductions at investment banking operations represented the biggest hits, while higher interest income, lower pay and bonus payments and an assumed £26 billion cut in dividend payments helped to shore up the banks’ balance sheets.

“The Big Five quoted FTSE 100 banks have since further buffered their balance sheets as their CET1 ratios have continued to improve. 

“Each of Barclays, HSBC, Lloyds, RBS and Standard Chartered have a CET1 to risk-weighted-assets (RWA) ratio well above 10%, well above that end-2019 target of 4.5% stipulated by European regulations.

 
Source: Company accounts

“What is striking, however, is that financial markets do not appear to have been reassured by the results of the 2017 stress tests, even if the Bank of England declared itself perfectly satisfied.

“The UK Banks sector has been a terrible performer this year. It has fallen by nearly 19% in 2018 to date, compared to a near 10% drop in the All-Share, to leave Banks ranked 33rd out of the 39 industrial groupings which make up the FTSE All-Share benchmark. 

“After last year’s clean sweep it would be a surprise if any of the seven UK lenders tested were to fail the latest annual test, but whether it does their share prices any good is a different matter, given what seem to be gathering doubts about global growth, the huge increase in global indebtedness since the end of the financial crisis in 2009 and whether financial markets can continue their multi-year bull run.”

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