LONDON: Britain’s biggest banks can withstand a series of economic shocks — including a no-deal Brexit — that would have more severe impacts than what they experienced during the global financial crisis, the Bank of England said Tuesday.
While concluding that lenders can deal with Britain crashing out of the European Union without a deal and restrictions imposed on British business, the Bank of England warned that additional problems may emerge if a “disorderly” Brexit takes place at the same time as a sharp global recession.
In its annual stress test of the sector, the central bank said the country’s biggest lenders, such as Barclays and Lloyds Bank, were “resilient” to a raft of adverse scenarios, including deep simultaneous recessions at home and abroad and hefty falls in the price of assets.
“Despite the severity of the tests, for the first time since the bank began stress testing in 2014, no bank needs to strengthen its capital position as a result,” Bank of England Governor Mark Carney said.
Stress tests have become a key policy instrument of central banks around the world since the global financial crisis. In Britain’s case, many of the country’s banks, including Royal Bank of Scotland, had to be bailed out by taxpayers at the height of the global crash in 2008-9 because they weren’t strong enough to cope with the shock.
In what is effectively a war-gaming exercise, the Bank of England tested banks’ ability to withstand a recession that was even worse than the one that took place after the global financial crisis nearly a decade ago. Included in the test was the simulation of a 2.4 percent fall in global GDP, a 4.7 percent contraction in Britain, a domestic housing market crash, a further fall in the value of the pound to below a dollar and a spike in interest rates.
In the test, banks would incur losses of around 50 billion pounds ($65 billion) in the first two years of the stress, the scale of which, the Bank said, would have wiped out the underlying capital base of the sector ten years ago. Since the crisis, banks have been forced by regulators to boost their buffers, which they can draw upon in the event of a financial shock.
The bank’s Financial Policy Committee, which monitors the stability and resilience of the banking system, also concluded that banks can continue to support the British economy in the event that the country experiences a “disorderly” exit from the European Union, which would see Britain crashing out of the bloc with no deal on future relations with the EU.
Britain is due to leave in March 2019 but negotiations with Brussels over the post-Brexit relationship have failed to make much progress, raising fears that tariffs and other restrictions would be slapped on British exports to the EU.
“We’re putting our money where our mouth is,” Carney said. “This is not a good scenario; it’s a scenario that we are all trying to avoid because it has some material economic costs even if financial system continues to function through it ... There will be some pain.”
However, Carney warned that losses to the banking system would “likely be more severe” than in this year’s annual test if a “disorderly” Brexit takes place at the same time as a sharp global recession and banks are simultaneously hit with a series of fines such as those they’ve faced in past scandals involving the mis-sale of financial products.
“In this case, where a series of highly unfortunate events happen simultaneously, capital buffers would need to be drawn down substantially more than in the test and as a result banks would likely need to restrict lending to the real economy, worsening macroeconomic outcomes,” Carney said.
Carney said the FPC will reconsider the requirement that banks stash away 1 percent of their capital in the first half of next year to protect against risks. But he said that the central bank’s central assumption is that a “disorderly” Brexit is not the most likely scenario and that the relationship between Britain and the EU will remain “highly cooperative.”
Carney said a transition period after Brexit of between 18-24 months is the “minimum necessary” and that it’s a view “increasingly appreciated on both sides of the Channel.” During this period, Prime Minister Theresa May has indicated, Britain would trade with the EU under the same terms as now and would remain subject to the EU’s legal codes.