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Bank of England Cancels Stress Test for UK Banks, Too Afraid to Fail?

Anatol Antonovici | Mar 20, 2020 | 09:00

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On Friday, the Bank of England (BoE) and the Prudential Regulation Authority (PRA) cancelled the 2020 stress test of eight major British banks and building societies, citing the emergency situation amid the coronavirus outbreak. This is another example of how governments are supporting the banking systems while the crypto market is on its own. 

Test “Would Be Stupid,” Bank Executives Say

Every year, the central bank checks whether the major banks are strong enough to resist a financial crisis. Specifically, the BoE calculates if the tested banks hold sufficient capital to withstand a hypothetical crisis and are able to absorb losses.

However, given that the coronavirus pandemic has already triggered a real crisis, the central bank found it unnecessary to hold the annual test scheduled for the end of this month. But are the banks really prepared for the worse?

The list of banks that should have been under review includes Barclays, HSBC, Royal Bank of Scotland (RBS), and Lloyds Bank, among others.

The BoE’s decision to skip this year’s test comes a week after the European Union’s regulators delayed their 2020 stress test and eased capital rules. The EU test would have checked both Barclays and HSBC.

In light of the EU’s decision, British banks required the BoE to ignore its test, with executives saying that “it would be stupid to run a stress test during a stress. Let’s concentrate on this situation rather than a hypothetical one.”

The executives also asked the BoE to lift a newly introduced accounting rule called IFRS 9, which requires banks to book bad loans before the losses are actually incurred.

Given the current virus outbreak, the UK is facing a sharp economic decline, which increases the number of bad loans. The central bank said that it “continues to consider the potential interaction of COVID-19 with IFRS 9…. and expects to provide further guidance to firms regarding our approach next week.”

BoE’s 2019 Stress Test Showed British Banks Were Resilient

While the Bank of England hasn’t decided on the IFRS rule yet, the central bank cancelled the test. It said that the previous one showed that the banking system was resilient “to deep simultaneous recessions in the UK and global economies that are more severe overall than the global financial crisis, combined with large falls in asset prices and a separate stress of misconduct costs.”

However, the last year’s test showed that the situation was already deteriorating at the banks. The BoE’s report for 2019 reads:

Losses on corporate exposures are higher than in previous tests, reflecting some deterioration in asset quality and a more severe global scenario. Despite this, and weakness in banks’ underlying profitability (which reduces their ability to offset losses with earnings), all seven participating banks and building societies remain above their hurdle rates.

Those who invested in the stocks of major banks should know that their resilience during a crisis comes at the expense of significant cuts in dividend payments, employee remuneration, and coupon payments. This comes on top of the major decline in the stock prices caused by the panic.

Government Would Support Failing System Anyway

Given the double standards of the financial world, even if the UK banking system wouldn’t be resilient enough, the government would save it. That’s how it worked during the previous global crisis. Elsewhere, the crypto market is on its own.

During the last few days, the BoE and the British government led by Prime Minister Boris Johnson have taken unprecedented measures to stimulate the shaking economy amid the COVID-19 pandemic and the Brexit transition period. Yesterday, the central bank cut the interest rate to a record low of 0.1%. At the beginning of the month, the rate was at 0.75%.

Meanwhile, the government announced a major package of financial stimulus, which in total is the equivalent to 15% of the country’s gross domestic product (GDP).

Do you think the BoE should test major banks despite the current economic crisis? Share your thoughts in the comments section!

Images via Shutterstock, YouTube: Bank of England