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Bank of England to stress test banks for global slump scenario

03/30/2015 | 08:59am US/Eastern
A pedestrians walks under an arch opposite the Bank of England in London

Britain's seven biggest lenders will have to show they can cope with a global economic slump triggered by a sharp slowdown in China and a crash in the euro zone in this year's round of stress tests conducted by the Bank of England.

Britain decided to introduce annual stress tests for its banks after the 2007-09 financial crisis which required taxpayers to pump 66 billion pounds into Royal Bank of Scotland (>> Royal Bank of Scotland Group plc) and Lloyds Banking Group (>> Lloyds Banking Group PLC).

"By assessing the resilience of the UK banking system against a major external shock we will improve further our ability to identify vulnerabilities and we will ensure that banks have plans in place to address a wider range of possible stresses," BoE Governor Mark Carney said on Monday.

The Bank also said the Co-operative Bank, which failed last year's tests and is deep in a restructuring programme, would not be assessed as it is now too small.

That leaves six banks and one mutual lender to face this year's tests -- Barclays (>> Barclays PLC), HSBC (>> HSBC Holdings plc), Standard Chartered (>> Standard Chartered PLC), RBS, Nationwide Building Society (>> Nationwide Building Society), Santander UK (>> Banco Santander, S.A.) and Lloyds.

The global downturn scenario which the lenders will have to prove they could survive includes various financial shocks such as a contraction of more than 2 percent in the euro zone economy but not a Greek exit.

It also sets out the prospect of a slowdown in economic growth in China to 1.7 percent of GDP by the end of this year, tipping Hong Kong into a deep recession. That would cause a 40 percent slump in Hong Kong property prices, hitting some British lenders such as HSBC.

Commodities would also take a hit with the oil price troughing at $38 a barrel.

Last year's tests, in which the Co-op was the only one to fail, largely focused on a 35 percent crash in UK housing prices amid concerns at the time that the British property market was in danger of overheating to the point of creating a bubble.

In the 2015 tests, the British house price fall has been set at 20 percent over the five-year scenario period, the BoE said.

The UK-specific focus last year caused some critics to say HSBC and Standard Chartered got off lightly. Both banks already face pressure from some investors to relocate many UK operations to Asia after a jump in UK bank taxes.

HSBC, 40 percent of whose assets are in Asia on a risk-weighted basis, had no comment on Monday. StanChart, with 59 percent of its risk-weighted loans in Asia, said it would examine the details.

The results are due to be published in December. Shares in all those being tested were flat to higher after the news, in line with the London market's FTSE 100 index <.FTSE>.

CLEAR PASS NEEDED

Under the tests banks will have to show they can maintain a Tier 1 core capital adequacy ratio of 4.5 percent of risk-weighted assets after being exposed to the theoretical shocks, the same pass mark as 2014.

Concerns among global policymakers about shrinking liquidity in markets have also shaped aspects of this year's tests, which were developed with the International Monetary Fund.

The BoE has pointed to a surge in U.S. Treasury bond prices last October after economic data sparked a mass sell-off, raising questions about the ability of investors to sell even very liquid assets when they want to. Banks will also have to show they can withstand several customers defaulting in Asia and elsewhere.

In this year's test banks will also have to show they can maintain a Tier 1 capital leverage ratio of 3 percent, a measure of core capital as a percentage of total assets, not risk-weighted, a new addition to the examinations.

The British Bankers' Association had no comment.

The seven lenders, which account for 70 percent of UK corporate loans and 75 percent of UK mortgages, will also have to show they can expand lending to the UK economy by 10 percent during the test.

Where banks scrape a pass, they may still have to boost their capital levels or take other, unspecific action.

RBS and Lloyds were required to bolster their capital defences despite passing last year's tests.

The BoE is likely to consider including the UK arms of foreign banks in future stress tests.

(Additional reporting by Steve Slater; Editing by Greg Mahlich)

By Huw Jones and William Schomberg

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