BOE May Seek Management Change at Banks Failing Stress Tests

The Bank of England said regulators may take steps to remove bank executives if stress tests reveal weaknesses in their governance and capital-planning processes.

In a discussion paper on planned tests, the BOE said financial institutions should have at least enough capital to absorb losses in a stressed scenario, and that this could be higher than international minimums. Banks that fail may be forced to limit bonuses and dividend payments, issue equity or other capital instruments, or reduce certain risk exposures.

“From a bank-specific perspective, the exercise might reveal weaknesses” in governance, the BOE said in the paper. In such cases, options include “changing banks’ management and requiring specific actions to improve stress testing, risk management or capital planning processes.”

The BOE’s Financial Policy Committee, set up as part of an overhaul of banking regulation, recommended earlier this year that banks be tested for resilience to shocks. The first tests will take place next year and cover Britain’s eight biggest lenders. The central bank said today that institutions are making progress toward meeting regulators’ capital requirements and that it will continue to monitor the situation.

“The new stress tests will bring together expertise from the bank, including macro economists, financial-stability experts and supervisors,” Governor Mark Carney said in a statement. “This will materially strengthen the banks’ analytical capability to assess risks to resilience. Our intention is that stress testing evolves into an essential component of our prudential framework.”

Management Issues

In the discussion paper, the BOE said during previous stress tests, the Prudential Regulation Authority noted “insufficient engagement” by banks’ boards and senior management as well as evidence that the scenarios set by lenders were too weak.

“Such practices, where they occur, are at odds with the importance that the PRA will expect banks to attach to this stress-testing framework,” the BOE said.

The BOE in June ordered the five largest U.K. lenders, including Barclays Plc, Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc, to plug a 13.4 billion-pound capital shortfall by the end of the year.

It revealed today that in a discussion about banks’ vulnerabilities, it withheld a paragraph from a November 2012 statement because it would have been “contrary to the public interest” to reveal regulators’ judgment of the capital position of banks.

Confidence Concern

“There was a risk that if these factors were highlighted by the committee in public, without there being clear accompanying action, confidence in U.K. banks -- and hence financial stability -- could be adversely affected,” the FPC said in the paragraph.

In the discussion paper, the BOE said it expects the stress tests to take place on an annual basis. A more frequent program would “entail material resource costs” and could compromise the quality of the process. It also said there are both “benefits and costs” to publishing the detailed results of stress tests. It is seeking responses to its paper by January 2014.

Stress testing “can help to calibrate macro and micro prudential policy,” BOE Deputy Governor Paul Tucker said in a speech in London today. “And a good stress-testing regime will make it easier to explain and defend the standard of resilience that the bank requires. And for that, the bank can be held to account.”

FPC Record

The BOE also published the record of the FPC’s Sept. 18 meeting, which showed the panel split on the reasons for the recent increase in market interest rates.

“There was a range of views about the precise extent to which the recent asset-price movements had reflected changes in underlying economic conditions,” it said.

In the record, the FPC noted that while preliminary work suggested that a “moderate rise” in long-term interest rates did not pose an immediate threat to financial stability, “it should not draw too much comfort from this.” The FPC said there was a possibility that rates “might overshoot” the improvement in economic conditions, “with potentially greater consequences.”

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