UK banks face tough tests to prove their resilience

 
Tim Wallace
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BRITAIN’S biggest banks must be able to cope with a housing crash of the type seen in the 1980s, under a trial set up by the Bank of England to make sure the system is strong and safe.

The fictional crisis scenario would see the economy shrink by 3.5 per cent, unemployment soar to nearly 12 per cent and house prices dive by 35 per cent.

The idea is to make sure banks do not let down their guards just because the economy is doing well – although the collapse shown in the trial scenario is one which is very unlikely to occur.

Analysts expect the major banks to cope well with the mock attack, but the Co-op Bank may be in trouble as it already has to raise more capital, while Nationwide could be hit hard as it is particularly focused on mortgages.

Banks will be forced to take more action, such as raising capital or suspending dividends, if their capital buffers fall below 4.5 per cent of assets in the scenario.

Even if they stay above that level, regulators could make them take action if their plans are not strong enough.

Industry insiders fear the scale of the stress test could mean banks slow down lending again, in order to bolster their positions.

“There is a cost to banks of having to raise ratios, it constrains their ability to lend,” said one source. “My one concern is that banks might become completely bulletproof, but will not be able to lend to the real economy at the same time.”

The tests are tougher than those faced by UK banks’ competitors in the EU, where the scenario will not see an interest rate hike, and house prices will only fall by 20 per cent.

But the British Bankers’ Association welcomed the move as restoring faith in the sector.

The results will be published at the very end of this year, a couple of months after the EU’s tests.