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RBS fails BoE's toughest stress test yet

The state-backed bank failed to clear its hurdle rate for the minimum amount of capital it should hold under a stress test scenario
November 30, 2016

Royal Bank of Scotland (RBS) has failed the Bank of England's annual stress test, forcing the largely state-owned lender to present a revised capital plan - which the regulator has accepted. Under a stressed scenario, RBS did not meet its hurdle rate for common equity tier one (CET1) capital, even after including debt that can be converted into equity.

The BoE applied a hypothetical UK and global recession - with associated shocks to financial market prices - to banks' balance sheets as at the end of December 2015. It then compared their CET1 ratio and tier one leverage positions before and after the impact of management actions, such as the conversion of additional tier-one securities (AT1).

Barclays (BARC) and Standard Chartered (STAN) also failed to meet some of the minimum hurdles in the stress test scenarios, but the additional capital held was judged to be sufficient to withstand severe shocks. Therefore these banks were not required to submit revised capital plans.

There is some debate about necessary levels of capital in the system. Sir John Vickers, who chaired the government's banking commission, has drawn a contrast between what banks and regulators believe are appropriate capital requirements and what many economists and independent academics think.

A spokesperson for RBS said the bank has taken a number of steps since the end of December 2015 to improve its resilience, including the ongoing rundown of its non-core riskier assets, the continued reduction in higher-risk credit portfolios, the settlement of various litigation cases and regulatory investigations and the issuance of £2bn in additional AT1 securities.

The group has announced further steps to shore up its capital position, including further cutting its cost base and risk-weighted assets, and has said additional management actions may be required "until RBS's balance sheet is sufficiently resilient to stressed scenarios". Its shares fell 3 per cent in early trading.

However, some analysts do not think the results of the stress tests materially change the investment case for the banks, including RBS. Cenkos analyst Sandy Chen says: "Although RBS also stated that additional management actions may be required to boost balance sheet resilience, there was no mention of additional equity capital issuance being required. [It's] a fail, but not a big worry, in our view."

 

Core capital ratio at Dec 2015 (%)Minimum stressed ratio (%)After strategic management actions (%)*Hurdle rate (%)
Barclays11.45.98.36.8
HSBC11.97.69.16.1
Lloyds12.89.710.37.0
RBS15.55.56.76.6
Standard Chartered12.65.57.26.1
*Includes conversation of AT1 capital