- Test is designed as a worst-case scenario
- Assumptions include 17% inflation and 31% fall in house prices
- Lloyds sees smallest ‘hit’ to capital base
Shares in the big UK lenders were higher across the board after the Bank of England released the results of its 2022/23 banking sector ‘stress test’, even though the outcome was always likely to be positive.
Lloyds (LLOY), the biggest UK retail bank by loans and deposits, was the biggest gainer on the FTSE 100 with 2.2% rise to 44.3p followed by Barclays (BARC) with a gain of 1.5% to 152p.
WHAT IS THE STRESS TEST?
Every couple of years the Bank of England likes to make all the major UK financial institutions undergo a ‘severe’ stress analysis to make sure they can withstand a five-year scenario which includes ‘persistently higher advanced economy inflation, increasing global interest rates, deep simultaneous recessions with materially higher unemployment in the UK and global economies, and sharp falls in asset prices’.
Specifically, the scenario considered:
- a 5% start-to-trough fall in UK GDP
- a start-to-trough drop of 31% in UK house prices
- a 45% drop in UK commercial property values
- an 8.5% peak in unemployment
- a peak of 17% in annual CPI inflation
- a peak base rate of 6%
The good news is that, as governor Andrew Bailey put it, the UK banking system was ‘resilient’ to this severe stress scenario, although he admitted it still remained vulnerable to shifts in interest rates as the full extent of rate rises feeds through to the economy.
While the stress test didn’t include an additional test for liquidity, the Bank of England noted that ‘a combination of regulation, supervision and banks’ risk management means that the major UK banks have large liquid assets buffers which would be available to be drawn upon if a liquidity stress did occur alongside the scenario’.
WHO DID BEST IN THE TEST?
While all of the big listed banks – and the major unlisted lenders – passed the test, some inevitably did better than others.
Lloyds suffered the smallest ‘hit’ to its tier one capital, which dropped 250 basis points from 14.1% to 11.6% under the stress test, after allowing for management actions, compared with the minimum hurdle rate of 6.6%.
Next best was HSBC (HSBA) with a drop of 290 basis points from 13.6% to 10.7%, followed by NatWest (NWG) with a drop of 320 basis points from 14.3% to 11.1%, while bottom of the pile was Barclays which would see its core capital ratio take a hit of over 500 basis points or 5% to 8.5%.
Of the big players which revealed their results, the best performer was unquoted building society Nationwide, which although it saw a big hit to its core capital ratio still emerged with a score of 20.4%, well ahead of its quoted rivals.
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