Bank of England stress tests to examine management execution

In its 2017 stress test, the Bank of England UK banks will scrutinise the UK's biggest banks for their ability to cope with an interest rate hike and a seven-year continuation of the industry's current headwinds to profitability.

As part of the two-prong 2017 stress test from the BoE, seven high street banks - Barclays, HSBC, Lloyds Banking Group, Nationwide Building Society, Royal Bank of Scotland, Santander UK and Standard Chartered - will be tested in the usual annual cyclical scenario that measures the adequacy of bank capital in the face of a severe shock to the economy plus a new biennial exploratory scenario.

The bank's new “anchor” on its severity means the test will only get more severe in areas where the BoE thinks risks have grown.

Differentiating its from last year's annual test, which measured for a potential cut in the bank rate to zero, the 2017 scenario incorporates a rise in the bank rate peaking at 4% plus a 27% fall in the pond to $0.85 and a sudden increase in the return investors demand for holding sterling assets, while the test will examine how lenders deal with a spike in UK unemployment to 9.5% and a 33% slump in house prices.

All this reflects "a challenging trade-off between growth and inflation" in the scenario.

The new exploratory scenario, on the other hand, will assess banks’ resilience and management's strategic reactions to a wider range of risks beyond those emanating from the financial cycle – such as persistent low interest rates and high costs over a future decade of lost profitability.

The Bank said the aim of this year's exploratory scenario "is to consider how the UK banking system might evolve if recent headwinds to bank profitability persist or intensify".

In the theoretical environment, banks’ profitability would be permanently lower unless they were to make changes to their business models, the Bank said.

The exploratory scenario incorporates weak global growth, persistently low interest rates, stagnant world trade and cross-border banking activity, increased competitive pressure on large banks from smaller banks and non-banks, and a continuation of costs related to misconduct.