RBS must raise £2bn after failing stress tests

Three banks show signs of “capital inadequacies” in the latest round of tests, with RBS forced to review its capital plan; Carney says global and domestic risk remains “elevated”, prompting the FPC to leave the buffer unchanged

The Royal Bank of Scotland has published a revised capital plan today (November 30) after it emerged as the worst performer in the latest round of stress tests conducted by the Bank of England.

Two other banks – Barclays and Standard Chartered – also showed signs of weakness, in what some observers say are the toughest stress tests ever set by the central bank, but were judged to have sufficient capital plans in place. The four remaining lenders – HSBC, Lloyds Banking Group, the UK arm of Santander and Nationwide – passed the tests with no sign of capital inadequacy.

Tests this year consisted of a "synchronised global downturn" over a five-year period, resulting in the global economy contracting by 1.9%. Also incorporated was a 31% fall in house prices, 42% reduction in commercial property prices prompting a contraction of 4.3% in the domestic economy and a 4.5% rise in unemployment.

RBS's updated plan, which forces the lender to raise at least £2 billion ($2.5 billion) in extra capital, has already been approved by the central bank's Prudential Regulation Authority (PRA), ahead of today's announcement. RBS had failed to meet both its Common Equity Tier 1 (CET1) capital and Tier 1 leverage hurdle before a forced conversion of Additional Tier 1 (AT1).

Once the debt had been converted under the stress scenario, the additional capital pushed RBS to meet the 4.5% CET1, but the lender still failed to meet the newly introduced systemic reference point, which holds global systemically important banks to a higher standard.

This is the second time in 2016 that RBS has performed poorly in stress tests, with the lender showing signs of weakness in the European Banking Authority's tests earlier in the year. Both results reveal that, despite improving its capital position from 8.6% in 2014 to 15% in 2016, the lender is still struggling in the aftermath of the global financial crisis.

Barclays and Standard Chartered also failed to meet "some" of their capital requirements under this year's new 'countercyclical' stress test, with Barclays failing to meet the systemic reference point before AT1 conversion occurred. Standard Chartered, on the other hand, met all the hurdle rates set by the BoE, but did not meet its Tier 1 minimum capital requirement. Tier 1, which currently stands at 6%, includes both CET1 and additional capital, such as 'bail-inable' debt.

Despite some banks showing clear signs of weakness under this year's scenario, the BoE said the lenders showed "increased resilience", and therefore no system-wide macro-prudential actions on bank capital were required.

The BoE notes "significant" movements in asset prices during the review period, including a 12% fall in sterling, declines in real government bond yields and a rise in market measures of inflation expectations

This is the third annual test by the BoE. In the first, run in 2014, the bank had focused on risk to UK households, while the test in 2015 looked at global risks, such as a contraction in China and parts of the eurozone. Next year, the BoE will once again tweak its stress test framework, introducing a second, longer-term exploratory scenario.

The new biennial test will span a seven-year period and test lenders' ability to withstand strong headwinds to profitability, exposing them to persistent low interest rates and weak GDP growth, among a number of other factors. Unlike the current test, the new scenario will assess the lender's ability to maintain viability in such an environment, rather than strain their capital positions.

Changes will also be made to the current test, which will now be made risk-contingent, with the size of stress varying systemically.

State of play

Released alongside the central bank's stress test results was the financial policy committee's (FPC) latest assessment on the resilience of the UK's financial system.

Last year, governor Mark Carney said the UK's biggest lenders were strong enough to withstand pressures in global economy. This year, the UK's financial system has maintained its stability, despite the "challenging" environment that had materialised, the financial stability report says.

The BoE notes "significant" movements in asset prices during the review period, including a 12% fall in sterling, declines in real government bond yields and a rise in market measures of inflation expectations.

The BoE also recognises that changes to the trading relationship between the UK and the European Union may require financial firms to "alter their operations and services they provide". This could, Carney said today, "disrupt" the European real economy, causing a "spillback" to the UK financial system.

"The fall in sterling implies markets expect new trading arrangements [between the UK and the EU] to be less open for a period," Carney said. "It is important firms know as much as possible about a desired end point and what the new relationship will be. Firms are making contingency plans for a variety of outcomes. We have a direct line of sight of what these firms will do, and having a degree of clarity – when appropriate – will help with a smooth transition."

The international picture was not much better, with the BoE noting vulnerabilities stemming from the global environment and financial markets "had increased further" over the past six months. Carney noted that: risky asset prices in emerging markets have fallen in recent weeks; China's growth has become increasingly reliant on rapid credit expansion; and the resilience of the European banking system still hangs in the balance.

As a result, the FPC agreed to maintain the UK countercyclical capital buffer rate at 0%, reaffirming it expects to maintain this rate until "at least" June 2017, subject to no change in the outlook.

This story was originally published on Risk.net's sister website, CentralBanking.com.