Listen to this article
Give us your feedback Thank you for your feedback.
What do you think?
On Tuesday, the results of the Bank of England’s latest stress tests of the UK’s biggest lenders will be revealed.
Introduced in the wake of the financial crisis, the annual stress tests are meant to probe whether banks’ balance sheets can withstand a doomsday scenario without a bailout.
This year’s tests were billed as the toughest the BoE has ever undertaken. Here are five things to look out for:
1. Royal Bank of Scotland
Last year RBS failed some parts of the stress tests, forcing it to sell assets to raise an extra £2bn of capital. But its situation has improved and analysts are more confident it will pass this year.
The government will be hoping the analysts are right after chancellor Philip Hammond used the Budget last week to announce plans to start selling the state’s 71 per cent stake in RBS by March 2019.
A clean bill of health from the BoE is vital for RBS to resume paying dividends — a vital step if the bank’s shares are to rise and thereby reduce the loss the government is set to suffer on selling its stake.
2. An additional assessment
This year will be the first time that the BoE included an extra assessment of banks’ business models.
The so-called exploratory scenario will be conducted on a biennial basis, with regulators scrutinising banks’ resilience to a wide range of risks — such as persistently low interest rates and stagnant world trade — over a seven-year timeframe.
Banks say privately they found this part of the exercise the most useful. However, for analysts and investors it may be less insightful as the BoE has no plans to publish bank-by-bank data.
3. New accounting rules
In January accounting rules called IFRS 9, which were drawn up in response to the financial crisis, take effect.
They force banks to make provisions for expected losses in the future. The hope is to avoid problems that occurred during the crisis, when banks could not book losses until they happened, even though they could see them coming.
“This year the BoE has run a series of tests to begin to understand how the new accounting standard will impact the results of future stress tests,” says Rob Smith, a partner at KPMG, the accounting firm. “In 2018 we may see a very different set of stresses and results because of the impact IFRS9 will have on how banks forecast, calculate and provision for risks.”
4. Rising interest rates
Unlike last year, when the stress tests assumed BoE interest rates being cut to zero, this year’s exercise assumed a tightening of monetary policy. The latest tests were based on rates peaking at 4 per cent in response to inflation triggered by a depreciation of sterling.
This scenario is likely to favour most of the banks. Lenders typically benefit from higher rates because they can raise the charges on the loans they issue faster than they lift the interest they offer to savers. Secondly, the banks that generate large revenues overseas — such as Barclays, HSBC, and Standard Chartered — will benefit when these are converted back into weaker sterling.
But there is a hitch, as higher rates will push more borrowers into default, boosting volumes of bad loans.
5. Misconduct issues
A string of scandals — ranging from mis-selling of payment protection insurance to Libor rate rigging — have weighed on banks.
The stress tests will accept a particular figure if banks have provisioned for an upcoming fine or settlement with the authorities. However, if the amount is still uncertain, banks will have to use the upper range of estimates in their figures submitted to the BoE.
Last year RBS did particularly badly on this part of the tests. With a fine from the US Department of Justice still outstanding over alleged mis-selling of mortgage-backed securities, and upper-end estimates by analysts predicting a $12bn penalty, this part of the exercise could be demanding for RBS once again.