The UK's major banks are resilient enough to maintain lending to the real economy even in a macroeconomic stress situation, including a surge in credit losses. That's according to the European Banking Authority (EBA), which recently tested the EU's banks' capital adequacy under a range of stress scenarios during a three-year period. While the Bank of England has welcomed the results - which are consistent with its March stress tests - a major international economic think-tank has asserted serious flaws in the BoE's ability to carry out such tests.
The tests are designed to provide supervisors, banks and other market participants with a "common analytical framework" to consistently assess the resilience of large EU banks to adverse economic developments. The EBA assessed the impact of risks including profitability in a low growth environment, rising public and private debt on bank balance sheets and an abrupt rise in low global bond yields.
Royal Bank of Scotland (RBS) suffered the fifth largest fall in capital of the 51 banks under the adverse conditions, with its common equity tier one (CET) ratio falling to 8.1 per cent from a starting ratio of 15.5 per cent recorded end-2015. However, this was still higher than that of Barclays (BARC), at 7.3 per cent. Lloyds (LLOY) performed best out of the UK banks, with an end ratio of 10.1 per cent, while HSBC (HSBA) came in at 8.8 per cent. Unlike the 2014 EBA stress tests - which set a 5.5 per cent threshold - no pass/fail barrier was set.
That Europe's banks are better capitalised is evident, with a started weighted average CET one ratio of 13.2 per cent, compared with 8.9 per cent for the first stress test carried out by the EBA in 2011. However, there are a number of differences between the EBA and BoE stress tests. The EBA test assumes banks' balance sheets remain static throughout the stress period, whereas the BoE allows banks to dispose of assets so long as they continue to meet the projected demand for credit in the real economy. The EBA also places greater constraint on banks' ability to cut costs and boost income in the stress scenario.
However, in a report published by the Adam Smith Institute, Durham University's Professor Kevin Dowd argues that the BoE's stress tests lack credibility because of conflicted objectives and "political pressures on the Bank and the Bank's own institutional self-interest [which] create incentives to engineer a pass result". Professor Dowd also claimed the test was reliant on a single, insufficiently stressful adverse scenario, with "extremely low pass standards and inadequate metrics". The BoE is due to release the results of this year's stress tests during the final quarter of the year.
