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U.K. Stress Test Results: Banks to Endure Brexit Disorder

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The Bank of England (BoE) 2017 stress test results are out. This is the first time since the launch of the U.K. stress test in 2014 that all the seven major banks have shown resilience toward tough economic scenarios. Also, they are expected to be able to cope with the Brexit disorder.

Of the seven banks, Barclays PLC BCS and The Royal Bank of Scotland Group plc RBS emerged the weakest under the severe economic stress scenario. Nonetheless, these two are not required to raise additional capital as they have made significant progress in improving their respective capital positions this year.

The other five banks — HSBC Holdings plc HSBC, Lloyds Banking Group plc LYG, Nationwide Building Society, Santander UK and Standard Chartered plc SCBFF — maintained their capital levels above the minimum requirements.

Under a tougher backdrop, capital levels of these seven major banks declined to 8.3% from 13.4% of risk-weighted assets.

Tougher Scenarios This Time

The hypothetical setups in the BOE’s stress test include the Chinese economy declining 1.2% (from 0.5% decline scenario in 2016), global GDP contracting 2.4% and the U.K. GDP falling 4.7%. Moreover, domestic unemployment rate of 9.5% and a rise in interest rates to 4% (a significant change from interest rate of zero in last year’s stress test) are among the other situations.

Further, the scenario assumes the U.K. residential property prices plunging 33%, commercial property prices tumbling 40% and a fall in oil price to $24 per barrel.

Additionally, this was the first time that major the U.K. banks were tested under the Biennial Exploratory Scenario (BES). The BoE’s primary reason of conducting this test was to scrutinize banks’ strategic responses to a more challenging operating backdrop.

These were focused on banks’ business models and sustainability to long-term changes in financial and macroeconomic scenarios. The hypothetical scenarios under the BES include continued low interest rates at near 0%, a decline in global trade, weak global growth, increased competition from smaller banks and persistent misconduct expenses.

The test had a seven-year horizon to assess the trends.

Backdrop for This Annual Exercise

This is the fourth year of the BoE stress test. Last year, all the banks except Royal Bank of Scotland had cleared it.

The primary aim of the test is to determine 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. Therefore, the BoE has come up with hypothetical scenarios that were considered while conducting the stress test.

Road Ahead

The U.K. is due to leave European Union in March 2019. Though the country’s banking system will likely be able withstand Brexit disorder, shuttering of talks related to post-Brexit relationship is expected to hurt the economy.

This could result in losses to the banking system that will exceed the losses predicted under the above-mentioned tough scenarios in case Brexit is accompanied by a global recession and further penalties for business misconducts. Nonetheless, until that time, banks are expected to further strengthen their capital levels and improve the U.K.’s financial stability.

With banks taking measures to strengthen their financials and confront challenges, the stress test will further help regulators to check their progress in the same and avert another crisis. Further, this will boost the lending capacity of banks, thereby bolstering their financial positions.

Among the banks mentioned above, Standard Chartered, Royal Bank of Scotland and HSBC 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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