Banks Stress Tested On 35% Drop In House Prices
And 5% Rise In Interest Rates
UK and Continental banks are to be stress tested using a worst case scenario in an effort to assess if they could cope with a house price slump of 35% or a sudden spike in interest rates to more than 5%, the exercise will be monitored by the Bank of England.
Sky News broke the story on Monday ahead of an official announcement on Tuesday by the Prudential Regulation Authority (PRA), after learning that banks would be subjected to an armageddon style scenario to see if they have sufficient capital to withstand another economic slump.
A series of commercial real estate losses is expected to be applied to the banks’ balance sheets as part of the tests, but it’s not certain whether or not the interest rate hike will be quantified as part of the tests, but the 35% slump in property prices could reveal if banks and building societies would need to raise billions of pounds of fresh capital to survive, unless they can demonstrate their ability to withstand such a huge slump.The stress tests have been drawn up by the Financial Policy Committee (FPC) and the board of the PRA, to run in conjunction with a similar exercise being run by the European Banking Authority (EBA), which will test the resilience of lenders on the Continent
The stress tests will happen while concern grows about the UK housing market overheating, particularly in London, where property prices have accelerated due to the improving economy.
Government Business Secretary, Vince Cable has already sounded warnings over another property bubble as he feels that the Help-To-Buy scheme is contributing to unsustainable property price inflation.
Bank insiders are also said to be concerned about the timing of such actions and remain uncertain over the publication of the PRA’s results as well as the methodology behind conducting the tests.
Banks such as Nationwide and Santander UK, have a substantial proportion of their business in the UK mortgage market, and are most concerned about the possible outcome of the stress test. Other banks including HSBC, are also being tested against the impact of a severe slowdown in the Chinese economy.
The FPC said in a statement last month that the stress test was not intended to be the FPC’s expectation of what would happen, but a coherent risk event against which banks’ resilience could be tested. A key part of the scenario would examine the resilience of the banks to a housing market shock and to a snap back in interest rates.
The idea behind the stress testing is to enable banks to have enough time to raise any capital that the PRA deems necessary as a direct result of the findings of the tests. The thinking is that bank shareholders should pick up any shortfall rather than UK taxpayers as happened back in 2007.
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