Bank of England releases stress test scenario

The exercise subjects the major UK banks to hypothetical deep simultaneous recessions in the UK and global economies, large falls in asset prices and higher global interest rates, and a separate stress of misconduct costs.

The results are used by the Financial Policy Committee (FPC) and Prudential Regulation Committee (PRC) to assess bank balance sheets and the resilience of the UK banking system, ensuring they can absorb rather than amplify shocks, and serve UK households and businesses.

The stress is not a forecast of macroeconomic and financial conditions in the UK or abroad resulting from the current geopolitical situation and government responses to it. It’s a severe but plausible tail risk scenario intended to test the resilience of the UK banks to a range of materially adverse economic shocks. The scenario considers the FPC’s risk assessment. It is more severe than the global financial crisis for both the UK and the world. 

Previous stress tests have included the impact of higher interest rates in the UK. The 2022 test will also include higher global interest rates in the face of a series of global cost shocks and high and persistent global inflation.

Selected key elements in the scenario include the UK GDP falling by 5% over the first year of the scenario, while World GDP falls by 2.5%.

Additionally, it involves UK unemployment more than doubling to a peak rate of 8.5%. In terms of property prices, the scenario will see residential property prices falling by 31% over its first year; while UK commercial property prices fall in the scenario by 45% from start to trough.

Regarding inflation, the scenario will see it peak at 17% in 2023 and remain persistently high - averaging around 11% for the first three years of the scenario.

Additionally, Bank Rate is assumed to rise rapidly to a peak of 6% in early 2023 before reducing gradually to under 3.5%; and Interest rates rise to 4.7% in the Euro-area and 6.5% in the United States by beginning of 2023.

The eight participating banks and building societies are Barclays, HSBC, Lloyds Banking Group, Nationwide, NatWest Group, Santander UK, Standard Chartered and Virgin Money UK. Together they account for around 75% of lending to the UK real economy. For the first time ring-fenced subgroups of Barclays, HSBC, Lloyds Banking Group and NatWest Group will also be assessed on a standalone basis.

The last ACS stress test was conducted in 2019. This was followed by two years of Covid-19 pandemic crisis-related stress tests, while the intended March 2022 stress test launch was postponed because of economic and financial issues arising from Russia’s invasion of Ukraine. 

The scenario will cover a five-year horizon using the end of June 2022 as the starting point. Each bank is assessed against ‘hurdle rates’ for their capital position.

Results will be published in the summer of 2023 and will be used to help inform banks’ capital buffers.