Ever wondered what would happen to banks if the economy went pear-shaped? The Bank of England (BoE) has, and has put eight banks through their paces in a stress test which mimics economic meltdown to see if they would stick or fold.
The Co-Operative Bank, which nearly collapsed in 2013 and lost 38,000 customers following a drugs scandal involving its former chairman, has failed the BoE's stress test. Lloyds and Royal Bank of Scotland, both state-owned since the 2008 banking crisis, scraped through by the skin of their teeth. Which isn't very reassuring when you consider they've had £66bn pumped in to keep them afloat.
What are the economic conditions in the Bank of England's stress test? The BoE doesn't expect all of the scenarios in the test to happen at the same time, but it does expect the UK's banks to be ready if some of them do:
- A 3.5% fall in the economy
- Interest rates rise from 0.5% to 4%
- Shares fall by 30%
- Unemployment doubling to 12%
- House prices falling by 35%
- Inflation reaching 6.5% (it's 1% today)
- The pound's value falls by 30%
The pass mark for the test is 4.5%. Lloyds got 5.0%, while RBS got just 4.6%. Other high street banks participating were Santander (7.6%), HSBC (8.7%), Barclays (7%), Nationwide (6.1%) and Standard Chartered (7.1%). So what does this actually mean?
The Bank of England's Financial Policy Committee demands that banks have enough money to cope if something catastrophic happens in the financial markets and economy. This is called capital adequacy, and is meant to help stop the bank either going under completely or having to be bailed out by the government.
Co-Op has been told to submit a new plan to improve its finances, while RBS put theirs in voluntarily in case they failed the test. The two state-owned banks' performance does raise some questions on how well they're recovering from their bail-out, and the BoE may decide not to approve Lloyds’ plan to restart dividend payments this year. Governor of the Bank of England Mark Carney said the test was a demanding one:
“The results show that the core of the banking system is significantly more resilient, that it has the strength to continue to serve the real economy even in a severe stress, and that the growing confidence in the system is merited.”
Photo by Sam Carpenter in the Londonist Flickr pool.