The Bank of England today announced the results of the first exercise under its new framework for stress testing the UK banking system. The results are themselves important, but once they have been pored over, attention will turn to how the exercise will evolve. There is a growing trend for supervisory stress testing exercises to increase in intensity over time. The BoE makes clear in its comments today that the UK exercise will be no exception.
There is plenty for banks and building societies (hereafter banks) to think about. For each of the participating banks, the BoE will set out qualitative aspects of the exercise to focus on ahead of next year's stress test. The exercise has also highlighted the importance of banks having credible, pre-planned management actions that could be deployed in a stressed environment; and the interplay between stress testing and strategic business model decisions - banks need to make decisions not only based on "business as usual" activities, but also considering how their balance sheet performs under stress.
Medium-sized UK banks and overseas banks operating in the UK have been given breathing space; participation in the exercise will not be extended in 2015. Those banks though should not be complacent. It is important to understand what preparation will be required and make the necessary investment now. By 2016 the BoE will be well-practised and any bank joining the stress testing exercise for the first time from a standing start is likely to find the experience particularly difficult.
For all banks, the exercise underscores the role stress testing will play in future as an integral part of the capital framework and highlights the importance of considering stress tests when making decisions on capital structure. The BoE also flagged that banks are likely to be required to meet a stressed leverage ratio requirement in addition next year. Banks need to ensure they have robust capital planning capabilities and design a capital structure that is sensitive to all the requirements.
The BoE view: good effort, but room for improvement
The results of the stress testing exercise were used by the PRA Board and the Financial Policy Committee (FPC) to inform judgements about the capital adequacy of individual institutions and the system as a whole. Importantly - and a crucial difference compared to the recent European Banking Authority (EBA) exercise - the results reflect projections of capital ratios in...