U.K. Banks Face 65% Hang Seng Slump in Trading Book Test

The Bank of England will assess the resilience of Britain’s seven biggest banks against a 65 percent plunge in the Hang Seng Index, as well as a 34 percent collapse in Brent crude oil prices, in this year’s stress test.

Banks such as HSBC Holdings Plc and Barclays Plc will also be examined on their ability to weather trading book shocks including a 23 percent decline in the euro versus the U.S. dollar over one year, the BOE said in a statement on May 26. To pass the test, lenders must maintain 4.5 percent common equity tier 1 and a 3 percent leverage ratio, both measures of financial strength.

The “innovations in the 2015 traded risk stress test are inspired by what has happened in real stress events (and especially in the crisis that followed the Lehman default) and by a desire to create a link to the forward-looking macro scenario, and are intended to impart a greater sense of realism to the stress test and its outcome,” the BOE said.

The stress test is the central bank’s second since taking over as the U.K. banking regulator in 2013, and reveals how its focus has shifted from domestic risks to concerns over liquidity in international markets.

The scenarios apply to a snapshot of lenders’ trading books as of Feb. 20. Banks will be locked into losses on trades over periods of one day, one week, one month and one year. Lenders may have to raise additional capital after the tests even if they pass, the regulator said.

With potential market stresses related to events in Greece and elsewhere, BOE officials have been sounding the alarm about low liquidity in recent months. Executive Director Chris Salmon said that structural changes in financial markets leave them less able to absorb shocks, leading to the type of volatility seen in U.S. Treasury bonds in October and the Swiss franc in January.

Last year, the regulator modeled a rise in the BOE benchmark interest rate to 4 percent and house prices falling by more than a third, a financial catastrophe so severe that it has only happened once in the last 150 years.

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