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UK Bank Stress Test 2016

30 November 2016 by Gary Kirk

This morning Mark Carney announced the results of the annual bank stress test for the main UK lenders, in which the BoE’s Financial Policy Committee found that the UK banking system was robust enough to avoid any macroprudential action and that the UK countercyclical buffer was to be maintained at zero until at least June 2017 (unless there is a material change in the outlook).

Mark Carney mentioned that this year’s tests were severe, with the adverse scenario including a 1.9% reduction in the global economy (including a sharp economic decline in China and Hong Kong), a 31% decline in UK house prices over the 5-year test period and a 42% decline in UK commercial real estate. With some justification Mark Carney reiterated the resilience of the UK banks, following years of building up capital defences in the balance sheet.

The tests revealed three banks that had some capital inadequacies under the stressed scenario, however neither Barclays or Standard Chartered were required to submit a revised capital plan to the Prudential Regulation Authority (PRA). Only RBS was required to improve its capital plan as it failed multiple hurdles of the test; although these weaknesses were highlighted by RBS’ own internal assessment and an updated plan had already been submitted to and accepted by the PRA before today’s announcement. RBS stated that its revised plan would include cost cutting, a reduction in risk-weighted assets and the sale of personal and commercial loan portfolios. In addition to the economic scenario the BoE tests also required the lenders to consider projections for litigation fines and settlements, which for RBS includes the forthcoming US Department of Justice (DoJ) claim relating to the mismanagement of its US mortgage business; the settlement of which could fall within a very wide range and remains a major uncertainty.

In summary :

CET1 TEST

LEVERAGE TEST

We see the results as being reasonably benign for the sector and would not expect to see too much in the way of price action based on these outcomes (with the obvious exception of the upcoming DOJ settlement for RBS, the size of which is unknown at the moment). In addition, these tests once again illustrate the improvement in the balance sheet strength of the UK banking sector. The subordinated bank sector is always likely to be associated with a degree of volatility but in our opinion the high returns from these bonds and robust nature of balance sheets continue to offer attractive compensation over the medium term.

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