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Mark Carney on Tuesday declared the Bank of England was “putting our money where our mouth is” by presenting the UK’s banking system as ready to withstand even the worst possible disruption posed by Brexit.

The central bank governor said it was the first time since the BoE’s annual stress tests of the country’s biggest lenders began in 2014 that they had all come through the exercise without needing to take remedial action.

However, Barclays and Royal Bank of Scotland emerged as the weakest performers in the most severe economic downturn scenario that the BoE has ever modelled. Both lenders only came through unscathed because of actions taken since the start of this year.

The BoE said its tests had found the banking system could absorb £50bn of UK losses and a $40bn hit on overseas assets in the next few years. Lenders also withstood an extra £40bn of misconduct costs — on top of the £60bn they have money set aside for.

Mr Carney said the exercise, which modelled a severe global recession, a surge in defaults by UK consumers and a sudden rise in interest rates, was not modelled on a worst-case Brexit scenario but was at least equivalent to the economic impact it would have.

“What we have to do is to look at the tail risk — what could go wrong — and to ensure that the core of this system has enough capital and liquidity to withstand a shock to the financial system,” he added. “UK banks could continue to support the real economy even in the event of a severely disruptive exit from the EU.”

In the stressed scenario, which the BoE said included a 2.4 per cent contraction of the world economy, a rise in UK unemployment to 9.5 per cent and a one-third drop in British house prices, the capital levels of the country’s seven biggest banks fell by more than a third to 8.3 per cent of risk-weighted assets. The drop in overall capital was a quarter greater than in the 2016 stress tests.

But the BoE said so far this year, the banks have upped their average capital levels from 13.4 to 14.4 per cent. It added that capital levels have more than trebled since the 2008 financial crisis.

In the BoE exercise, RBS’s capital ratio fell to a low point of 7 per cent — below its 7.4 per cent minimum “systemic reference point” even after assuming management actions, such as cutting dividends and bonuses. Barclays’ capital ratio fell to a low point of 7.4 per cent — below its 7.9 per cent minimum requirement.

Since the start of this year, RBS has bolstered its balance sheet by offloading assets and Barclays has raised capital by selling a large chunk of its African operation. This means both banks have already taken sufficient action to clear the stress tests hurdle.

The five other banks — HSBC, Standard Chartered, Lloyds Banking Group, Nationwide and Santander UK — all maintained their capital levels above their minimum requirements during the exercise.

Even though RBS fell below minimum requirements in the tests, most analysts were relieved by this year’s strong capital generation at the bank, which is hoping to return to profit and restore dividend payments next year.

The tests had extra importance for the government, which said in last week’s Budget that it aims to start selling its 71 per cent stake in RBS in the next 16 months.

Peter Richardson, analyst at Berenberg, said that once it completes an expected multibillion dollar settlement with US authorities for mis-selling mortgage securities, RBS would be well placed to restart dividends for the first time since the 2008 crisis.

In contrast, Lloyds disappointed with the limited amount of headroom it had in the stress tests due to the impact of its recent acquisition of the MBNA credit card business, which increased its consumer loan losses in the stressed scenario.

Lloyds shares fell more than 1.3 per cent on the news, before recovering slightly. Barclays shares also fell 1.4 per cent as analysts worried that its stress tests result could hamper its ability to restore the cut to its dividend of two years ago.

“Overall, the results show that there are pockets of problems in the sector but that the banks are broadly ticking all of the right stress test boxes,” said Laurent Frings, head of credit research at Aberdeen Standard Investments.

However, he added: “The reality is that Brexit is the key risk today for the UK banking system. Leaving the EU is going to cause the UK banking sector all sorts of stresses that these tests just do not account for.”

For the first time, the BoE included an extra assessment of banks’ business models, designed to examine how they would cope with increased competition from financial technology companies in a seven-year period of low growth and zero interest rates.

The exercise revealed three risks to the banks’ assumptions, said the BoE: what if fintech groups disrupt banks’ business models more than expected; will lenders be able to cut costs as much as they hope if they have high investment needs; and could an anticipated fall in their cost of equity fail to materialise.

Officials added that the banks seemed to want to “have their cake and eat it” by presuming that new technologies would let them cut costs without losing much market share.

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