Brexit Stress Lingers Even as U.K. Banks Pass Their Tests

The Bank of England may increase a key financial safety measure for a third time because it’s worried that a combination of a disorderly Brexit and a global recession could be enough to put the brakes on lending.

The central bank is going ahead with a planned increase in the countercyclical capital buffer to 1 percent from 0.5 percent, and said Tuesday it will review the level again early next year, citing the “overall risk environment.” It also revealed that all U.K. lenders passed stress tests for the first time since it started the annual exercise.

However, Barclays Plc and Royal Bank of Scotland Group Plc were the weakest of the seven major U.K. banks in the exercise, although they were not ordered to raise any additional capital or change their strategies in light of actions they’ve made since the end of last year. Both fell below their systemic reference point, a higher threshold that reflects their global significance.

“Until we have resolved our remaining major legacy conduct issues and non-core portfolio interests, we will continue to show stress test results weaker than our long term targets,” said RBS Chief Financial Officer Ewen Stevenson in a statement following the results. Barclays said the results reflect “litigation and conduct issues” which the bank is aiming to resolve.

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HSBC Holdings Plc, Lloyds Banking Group Plc, Nationwide Building Society, Santander U.K. Plc and Standard Chartered Plc all passed the health check, which was based on end-2016 data.

Barclays fell 0.2 percent to 187.05 pence and RBS rose 0.6 percent to 269.3 pence at 8:16 a.m. in London trading, while Lloyds dipped 0.4 percent to 65.25 pence.

Combined, the seven lenders would incur losses of about 50 billion pounds ($66 billion) in the stress scenario, a level that “would have wiped out” their common equity capital a decade ago. All banks stop paying dividends, bonuses and additional Tier 1 debt coupons under the scenario.

Bank Costs

The latest buffer increase — to take effect in November 2018 — will cost banks about 6 billion pounds, though they have the resources and won’t have to raise money from shareholders.

The 2017 stress tests included U.K. and global economic slumps, a record house-price drop and a plunge in sterling. The BOE’s Financial Policy Committee said even in that scenario, banks are resilient enough to keep lending to consumers and businesses, based on current capital and leverage levels.

“However, the combination of a disorderly Brexit and a severe global recession and stress misconduct costs could result in more severe conditions than in the stress test, ” it said. “In such circumstances, capital buffers would be drawn down substantially more.”

The FPC, led by Governor Mark Carney, said it’s continuing to assess threats to financial services related to the withdrawal from the European Union. It warned it will be difficult for institutions to fully mitigate risks on their own and “timely agreement on an implementation period” would help.

Potential Problems

The BOE also highlighted potential problems resulting from voided insurance contracts between the U.K. and the EU, and the increased costs of fragmenting the clearing of derivatives and other instruments, which are currently centralized in London.

Those are warnings for Prime Minister Theresa May, who is heading toward a crucial deadline at a December EU summit to make progress on Brexit negotiations. The slow movement in talks means companies are still awaiting clarity on the U.K.’s new trading arrangements and a transition period.

Brexit dominates when it comes to domestic threats, though the committee also highlighted the pace of consumer-credit growth — currently close to 10 percent — and the current-account deficit. On household borrowing, it describes it as a “pocket of risk.”

The FPC warned that the large current account deficit means the country is “vulnerable” to global investors losing appetite for U.K. assets. That would mean a hit to sterling, higher import costs, tighter credit conditions and weaker domestic demand. There would also be indirect risks to financial stability.

Globally, it says risks from global debt levels, stretched asset valuations and misconduct costs “remain material.” There was also a warning about threats to banks’ operating models from FinTech innovations, while it cast doubt on the industry’s cost- reduction plans.

“As Brexit uncertainty persists and U.K. growth projections are adjusted downwards, there is some comfort to be had in the knowledge the banking system is strong enough to withstand a severe economic deterioration,” said Michael Snapes, financial services director at PricewaterhouseCoopers LLP. “Banks may finally be emerging fully from their post-crisis downturn.”
Source: Bloomberg