Foreign Investment Banks May Face BOE Stress Tests Before 2018

  • Broader test planned that may include hedge, investment funds
  • BOE announces approach to bank stress tests for next 3 years

The Bank of England may expand the scope of its annual stress tests beyond the biggest domestic lenders to include the London units of foreign investment banks in the next few years.

“U.K. subsidiaries of foreign-owned investment banks will not be brought into scope at this time, but this will be kept under review,” the BOE said on Wednesday. A decision to include them could be made before 2018 when the next update of the BOE’s approach to stress tests is due, according to the central bank.

In addition to annual assessments of banks, the BOE will also develop a broader test to cover non-bank financial institutions such as asset managers, hedge funds and central counterparties, which account for half of the British financial sector. The BOE has no set timetable for rolling out this check of the financial system as a whole.

“The discussion was more of a ‘this is what we would like to do if we knew how’ than a firm plan,” said Steven Hall, a risk consultant and partner at KPMG in London. “Right now it’s too complex to run a stress test across the entire financial system,” though “it’s a reasonable aspiration to understand all the interactions.”

The BOE on Wednesday announced changes to its annual stress tests through 2018 to encourage banks to lean against the business cycle in a bid to smooth peaks and troughs in lending. The assessments will apply to banks with total retail deposits of more than 50 billion pounds ($77.3 billion), catching the seven largest U.K. lenders, and will include domestic, global and market elements.

Broader Test

This year’s test covers seven U.K. lenders: Barclays Plc, HSBC Holdings Plc, Lloyds Banking Group Plc, Nationwide Building Society, Royal Bank of Scotland Group Plc, Santander U.K. Plc and Standard Chartered Plc. It sets out a “major external shock” to the banking system, including Chinese growth slowing “materially” and plunging commodity prices.

In addition to stress-testing banks, general and life insurers, the BOE plans to develop an assessment of the financial system as a whole.

The purpose of this broader assessment would be to “examine how the financial system behaves, and what this implies for systemic risk and the possibility of disruptions in the provision of financial services to the real economy,” the central bank said. This wider test could take in asset managers, investment funds, hedge funds, foreign investment banks, insurance companies, pension funds and central counterparties in addition to banks.

Financial Cycle

Under its new approach to bank stress tests announced on Wednesday, the BOE will “link the severity of the test to the financial cycle systematically.” The rigor of the checks will increase during upswings, such as when “growth in credit is rapid or assets prices unsustainably high,” the BOE said.

There will also be a new “exploratory scenario” in the 2017 test covering structural risks unrelated to the financial cycle that are judged to be “emerging or latent threats” to U.K. financial stability or specific lenders. Such scenarios may include buy-to-let mortgages, vulnerable countries and deflation.

This means banks will face two stress tests every year, with the exploratory tests taking place every two years and only when the European Banking Authority doesn’t conduct its own assessment of the financial health of European Union lenders. This will help ensure that the burden on the lenders taking part will be “reasonable and proportionate.” It will also select participants based on the nature of the scenario, excluding banks for which the scenario is less relevant.

‘Severe Scenario’

In an effort to increase transparency, each bank will be set a pass rate based on its minimum capital requirements and extra requirements for lenders of global systemic significance. The current test sets a single pass mark for all banks.

“The United Kingdom needs banks that can weather shocks without cutting lending to the real economy,” BOE Governor Mark Carney said in a statement. “Our first concurrent stress tests run in 2014 -- centered on the housing market -- gave us assurance that the banking sector as a whole was well placed to withstand such a severe scenario. We have also recognized, however, the need for our approach to evolve.”

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