Finance

Edward Evans is a managing editor with Bloomberg Gadfly. He is former managing editor for European finance at Bloomberg News.

When everyone's a winner, everyone should worry. The Bank of England's stress tests weren't stressful enough.

None of the seven banks assessed will need to raise additional capital. RBS and Standard Chartered would have failed parts of the tests -- except they have plans to bolster capital, so they passed.

Burdensome Backdrop

Then look at the criteria, and it's clear they aren't particularly strenuous. In the doomsday scenario, oil is assumed to tumble to $38 a barrel. It's at $41 today. Volatility, as measured by the VIX index, is assumed to be less than it was during the collapse of Lehman Brothers.

Much was made of the BOE decision to model the impact of a slowdown in the Chinese economy on Britain's banks for the first time. So how stressful was it? The BOE found total five-year impairments on corporate loans are 6 percent of lenders' gross exposure to China and Hong Kong. Yet, as Jonathan Tyce of Bloomberg Intelligence points out, Chinese banks had a non-performing loan ratio of 19 percent as recently as 2004. The stress test may be underestimating the risk of losses overseas. 

As the tests get nearer home, the BOE's worst-case scenario becomes more benign and the regulator more blind to the biggest risk facing the industry: Britain's ballooning credit bubble.

BOE Governor Mark Carney has repeatedly voiced concern about the crazy state of the U.K. property market, in particular buy-to-let mortgages. But instead of making its scrutiny tougher, the bank did the reverse.

Rather than assuming a 35 percent percent drop in home prices as it did in last year's test, the BOE assumed a drop of just 20 percent, reducing the losses in the stress test. To put that in context, house prices fell 50 percent from their peak when Ireland's property bubble burst. 

And shouldn't the BOE be more worried by the staggering growth in unsecured consumer lending, in particular through credit cards? The stress tests show such lending accounted for three-quarters of total UK impairments in retail banking.

Lastly, the BOE tried to assess the impact of additional misconduct fines on individual lenders. These have been the biggest drag on bank profitability since the crisis. The test assumes they will reduce banks' pretax profit by about 40 billion pounds ($60 billion). The BOE won't disclose its calculations for individual banks and that figure only relates to misconduct we know about: mis-selling of payment protection insurance and the rigging of wholesale markets. There was no real attempt to model the impact of another big scandal on the industry.

Bank shares climbed on Tuesday after the results, as you'd expect. In fairness, Carney isn't blind to the risks in the sector. But, as constructed, the tests seem as much an exercise in being seen to do something as protecting the interests of investors and taxpayers.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Edward Evans in London at eevans3@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net