UK Banks Can Withstand Deep Recession: Bank of England

UK Banks Can Withstand Deep Recession: Bank of England
The Bank of England and the City of London financial district in London, on Nov. 5, 2020. (John Sibley/Reuters)
Evgenia Filimianova

The UK banking system would be able to withstand a severe economic turbulence, deeper than the 2008 financial crisis, a report by the Bank of England (BoE) has claimed.

The stress test performed by the BoE will likely appease British businesses and households who are concerned with the rising interest rates and high inflation.

The results show that the UK’s biggest lenders have built up resilience in recent years to withstand economic shocks, including deep and simultaneous recessions and sharp falls in asset prices.

The current inflation rate is 8.7 percent, which is significantly higher than the government’s target of 2 percent. The bank rate has been recently increased to 5 percent.

The scenario tested by the BoE combines interest rates with “considerably higher inflation than recent peaks,” said the announcement, published on Wednesday.

The stress scenario assumed an unemployment rate of 8.5 percent, inflation rising to 17 percent, and house prices falling by 31 percent.

Eight banks were analysed as part of the stress test, including Barclays, HSBC, Lloyds, NatWest, Nationwide, Santander UK, Standard Chartered, and Virgin Money.

“Major UK banks’ capital and liquidity positions remain robust and profitability has increased, which enables them both to improve their capital positions and to support their customers,” the BoE said in a statement.

UK banks have accumulated large capital buffers and will be able to absorb losses, according to the BoE.

The interest rates were raised to 5 percent in June, which means households and businesses will have to foot higher bills on their mortgage payments moving forward. There is a risk that some won’t be able to make their payments on time or not at all. This in turn increases the risk of losses for banks.

However, the stress test showed that the UK’s biggest lenders are resilient enough to keep up the support for families and businesses in the country.

“This should mean lower defaults than in previous periods in which borrowers have been under pressure,” said the bank.

The banks’ robust capital and profitability allow them to limit higher payments faced by borrowers and to vary the terms of their loans.

Additionally, homeowners whose mortgage is provided by signatories to the government’s Mortgage Charter will be able to stay in their homes for a year after the first missed payment.
The government acknowledges the impact of high inflation and increased interest rates on British households. In June, Chancellor Jeremy Hunt said that families will receive some of the largest support packages in Europe, worth £94 billion, or £3,300 per household on average.

Capital Buffer

The BoE decided to maintain its counter-cyclical capital buffer (CCyB) for banks unchanged. CCyB is designed to counter fluctuations of financial variables during an economic cycle.

“This will help to ensure that banks have sufficient capacity to absorb future shocks without unduly restricting lending,” the bank said.

Individual bank results showed that no bank is required to strengthen its capital position.

The bank measured the banks’ capital against the risk of loans and other assets, defined as the common equity tier one ratio (CET1).

The passing CET1 grade in BoE’s stress test was set at 6.9 percent. Barclays and Standard Chartered fell to the lowest levels during the test, reaching 8.5 percent and 8.8 percent, respectively.

The highest level was recorded for Nationwide, at 20.4 percent.

The stress scenario also assessed the resilience of UK banks to risks posed by the global financial system, including that of the United States, the eurozone, China, and Hong Kong.

This includes the impact of spillover effects on Britain from increasing global interest rates, deep simultaneous recessions, higher unemployment, and sharp falls in asset prices.

The findings showed that even in a severe global macroeconomic stress, major UK banks would continue serving the real economy.

The stability of global banking has been questioned earlier this year following the collapse of Silicon Valley Bank and the takeover of Credit Suisse by rival UBS.

In April, Barclays Chief Executive CS Venkatakrishnan said this “cast a bit of a shadow over the rest of the sector,” with Barclays remaining cautious in the months ahead.

Evgenia Filimianova is a UK-based journalist covering a wide range of national stories, with a particular interest in UK politics, parliamentary proceedings and socioeconomic issues.
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