Bank of England stress test 'raises questions' about dividend returns

The Bank of England said none of the seven high street banks needs to strengthen its capital position as a result of its stress tests, though it will require them to hold extra capital as Brexit nears.

Banks should be able to cope with a “disorderly” Brexit without having to curb lending or be bailed out by taxpayers, the tests found, but raised some questions over some banks.

Although none of the banks failed the stress tests, Barclays and Royal Bank of Scotland fell below their systemic reference points, which are the capital ratios required to withstand any shocks to the financial system without needing a bailout. Last year, both banks built up their finances under orders from Threadneedle Street.

The BoE's Financial Policy Committee confirmed that the UK countercyclical capital buffer will be increased to 1% from 0.5% from 28 November 2018, meaning banks will be required to hold an extra £11.4bn in regulatory capital by next November. This will not require them to strengthen their capital positions but rather to move some of their excess capital into their regulatory capital buffers.

The FPC will also review whether an additional capital cushion is needed. Losses that exceed the capital conservation buffer of 250 basis points and countercyclical buffer of 100bps for UK exposures could warrant an extra buffer determined by the Prudential Regulation Authority.

Governor Mark Carney said: "The FPC is taking action to ensure the financial system is resilient to a very broad range of risks so that the people of the United Kingdom can move forward with confidence that they can access the financial services they will need to seize the opportunities ahead."

In the test, banks incurred hypothetical losses of around £50bn in the first two years of the stress, which, the BoE said, would have wiped out the common equity capital base of the UK banking system ten years ago. The hypothetical economic scenario in the test is designed to be more severe than the global financial crisis.

"The 2017 stress test shows the UK banking system is resilient to deep simultaneous recessions in the UK and global economies, large falls in asset prices and a separate stress of misconduct costs."

As well as RBS and Barclays, the five other banks tested under two scenarios in the 2017 test were HSBC, Lloyds Banking Group, Nationwide Building Society, Santander UK and Standard Chartered.

RBS had the worst ratio of maximum stress test losses to each bank's ET1 ratio, at 640 basis points; it was followed by Standard Chartered at 600bps; Lloyds' ratio was 570bps or around 490bps if excluding MBNA; the ratio for Barclays was 500bps and HSBC 470bps.

REACTION AND ANALYSIS

Shares in Lloyds, Barclays and RBS were all in the red after almost two hours of trading on Tuesday. Overseas focused HSBC was up almost 1% while StanChart was just in positive territory.

RBC chief executive Ewen Stevenson, said the bank is making progress, but that there were still some issues hanging over its head: "We continue to make progress towards the stress resilient bank we aspire to be. 2017 represented another year of material improvement with our peak-to-trough stress resilience improving by 300bps from last year’s stress test. 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.”

Barclays noted that an element of the 5.0% drawdown in the BoE's 2017 stress test reflects litigation and conduct issues which it "is aiming to resolve", adding that it "continues to target an end state CET1 ratio of around 13%, although it may temporarily run above that level until these legacy issues are resolved".

But analysts at Exane BNP Paribas said the outcomes of this stress scenario "are somewhat negative for the UK domestic banks" and "raises questions over the speed to dividend normalisation".

Exane noted that the losses were much larger than seen in the 2016 stress test and "are likely to raise concerns over the extent to which PRA buffers are required".

By the time fully loaded requirements become binding at the start of 2019 these numbers might have changed markedly, with misconduct costs expected to fall markedly over the next year or two, removing 170bps of losses in these tests, "but the size of these losses will still raise question marks over these banks".

Exane said its initial view is that "Barclays looks most vulnerable of the UK domestic banks to a PRA buffer" at the start of 2019, with Lloyds "borderline" and RBS looks to have come out the worst but litigation and misconduct is likely to represent a significant portion of losses.

While the HSBC loss was quite large, Exane noted that it has done very well in each of the previous three stress tests so analysts "aren’t overly concerned". While StanChart continues to perform poorly in the test "this should improve as misconduct and legacy portfolios are dealt with". However, the BOE test was particularly stringent on Asian exposures and a reasonably part of the test loss related to risk-weighted asset inflation, so Exane continue to assume a PRA buffer for StanChart.

"Overall therefore, we think this is a slight negative for the sector and once again raises questions over the speed to dividend normalisation," the analysts said.

UBS said it does not expect an automatic increase in capital requirements across the sector.

It pointed the BoE's words that 'The setting of the countercyclical and PRA buffers, as informed by the stress test, will not require banks to strengthen their capital positions.'

"Though the banks won't know their PRA buffers until next year (a practice which we think needs to change) the question is
whether bank management buffers change as a result of this test as the regulator appears largely content. We don't see today's results as dictating disappointment on dividends."