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BoE Stress Test Results: 6 Banks Pass, RBS Fails

Zacks

The verdict of the stress test conducted by the Bank of England (“BoE”) is out. The U.K. banking system has been found well capitalized to “support the real economy in a severe, broad and synchronized stress scenario.”

Six of the seven participating banks – Barclays plc BCS, HSBC Holdings plc HSBC , Lloyds Banking Group plc LYG, Nationwide Building Society, Santander UK and Standard Chartered plc SCBFF – have cleared the BoE’s 2016 stress test.

Only the 73% government-owned The Royal Bank of Scotland Group plc RBS failed to clear the stress test that was conducted to scrutinize “the resilience of the system to a more severe stress than in 2014 and 2015.” The company was, hence, asked to resubmit its capital plan and must add approximately £2 billion ($2.5 billion) in capital. Following this announcement, Royal Bank of Scotland’s shares plunged and closed the day nearly 1.2% down on NYSE.

Standard Chartered, Barclays Reveal Capital Inadequacies; Clears Stress Test

Of the six banks that cleared stress test, Standard Chartered and Barclays disclosed capital inadequacies, but were not required to declare new capital plans. These banks cleared the overall thresholds set by the BoE, while failing to meet the judgment-based assessment of their capital strength.

Nonetheless, since the stress test was based on Dec 31, 2015 data, the measures undertaken by these banks in 2016 to improve capital levels were not part of this test.

Other lenders – HSBC, Lloyds Banking Group, Nationwide Building Society and Santander UK – easily passed the stress test scenarios, given their strong capital base and de-risking strategies. Moreover, except HSBC, others face less impact from global exposures.

Backdrop for Stress Test; Tougher Scenarios this Time

This is the third year of BoE stress test. Last year, all the banks had cleared it.

The primary goal of the test is to gauge how much the banks would lose in case of a future economic downturn. The test rounds aid in determining how banks would respond to another economic crisis and a slump in the markets. Hence, BoE has come up with hypothetical scenarios that were considered while conducting the stress test.

This year, the stress test was conducted under tougher hypothetical scenarios. However, the scenarios did not include the impact of Brexit.

The hypothetical setups in BOE’s stress test included Chinese economy declining 0.5% and U.K. GDP falling by 4.3% with 4.5% rise in the unemployment rate. Further, the scenario assumed U.K. residential property prices plunging 31% and a commercial property prices tumbling 42%.

Moreover, a fall in oil price to $20 per barrel and global GDP contracting 2% were among the other situations. Other than these, a reduction in interest rates to zero and a drastic increase in costs for fines and legal bills of £40 billion were part of this year’s tougher hypothetical scenarios.

Road Ahead

This is just the beginning for the major U.K. banks. They will be required to undergo stress tests on an annual basis. The U.S. Federal Reserve and the European Central Bank have also been conducting their stress tests on a yearly basis.

We believe that such measures would serve to improve U.K.’s financial stability and aid the overall global economic recovery as well. Further, this will boost the lending capacity of banks, thereby bolstering their financial positions.

Among the banks mentioned above, Barclays, HSBC, Standard Chartered and Royal Bank of Scotland carry a Zacks Rank #3 (Hold).

You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

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