The latest round of stress-testing, carried out on the UK's major lenders by the Bank of England, has confirmed that the banking sector now looks far better placed to weather a crisis. Almost flat share price responses to the news from the listed players suggested that the market wasn't entirely surprised by the outcome, either. That said, some banks coped better that others: Lloyds (LLOY) and RBS (RBS) only just scraped through, for instance, while the Co-operative Bank failed outright.
The tests were designed to model capital adequacy under an especially adverse set of conditions - including a 35 per cent fall in house prices, a 3.5 per cent slide in GDP, a base interest rate of 4.2 per cent, a weak pound and an unemployment rate of almost 12 per cent. That left the eight participating lenders with a projected £13bn of cumulative losses in the first two years of the scenario and an additional £70bn of impairment charges.
On that basis - and excluding any likely management actions, such as cost-cutting, to meet the challenges of such a scenario - the core equity tier one capital ratio (comparing its highest-quality capital with risk-weighted assets) at Lloyds and RBS reached just 5 per cent and 4.6 per cent, respectively. The pass level was set at 4.5 per cent. While, reflecting the ongoing hit from the acquisition of Britannia at the height of the financial crisis, the Co-operative Bank failed completely with a negative ratio. In contrast, the other listed banks - Standard Chartered (STAN), HSBC (HSBA) and Barclays (BARC) - sailed though with ratios of 7 per cent or more.
Still, the near-fail at RBS and Lloyds isn't as worrying as it seems. Significantly, that's because the tests were applied to banks' figures as at end-December 2013. Accordingly, the results "do not include any allowance for capital build during 2014, which has been meaningful," explains equity analyst James Box of Brewin Dolphin Wealth Management. Indeed, such progress during the course of this year has been sufficiently robust for the Bank of England's Prudential Regulatory Authority not to require the pair to submit revised capital plans - only the Co-op has needed to do that.
Moreover, a scenario with a focus on extreme housing market weakness is also thought to have set the bar especially high for Lloyds and RBS. "The stress test, by its design, resulted in a material impact on those banks which are significantly exposed to the UK housing market, with less focus on investment banking and overseas operations," explains Mr Box. Add that to capital building measures this year and fears for Lloyds' return to the dividend list are likely to prove overdone. "We expect LBG [Lloyds] to restart dividends with a small payment for FY14 [full-year 2014]," say analysts at Deutsche bank. A long list of legacy issues at RBS, however, mean the near-80 per cent state-owned lender remains unlikely to follow any dividend moves at Lloyds for some years to come.
Despite the largely comforting outcome, however, a qualitative review of banks' stress-testing and capital-planning frameworks did reveal concerns. Specifically, the Bank of England pointed to "a wide variation in banks' ability to provide accurate data and in the strengths of banks' modelling approaches". The quality of data submissions often varied substantially by risk type, too, and regulators found banks' modelling for net interest income "particularly challenging".
| Stress-testing: how the banks coped | ||||
| Actual end-2013 capital ratio | Minimum stressed ratio (before management actions) | Minimum stressed ratio (after management actions) | Latest actual ratio | |
| Barclays | 9.1% | 7.0% | 7.5% | 10.0% |
| The Co-operative Bank | 7.2% | -2.6% | -2.6% | 11.5% |
| HSBC | 10.8% | 8.7% | 8.7% | 11.2% |
| Lloyds Banking Group | 10.1% | 5.0% | 5.3% | 12.0% |
| Nationwide | 14.3%† | 6.1% | 6.7% | 17.6% |
| RBS | 8.6% | 4.6% | 5.2% | 10.8% |
| Santander UK | 11.6% | 7.6% | 7.9% | 11.8% |
| Standard Chartered | 10.5% | 7.1% | 8.1% | 10.5% |
Note: all ratios refer to core equity tier one capital ratios | ||||
| †Based on end-April 2014 estimated balance sheet | ||||
Source: Bank of England (abridged) | ||||
