Investors in the high-street banks are breathing a sigh of relief this morning after the Bank of England’s stress test showed that they are more resilient to a deep global recession than they were during the financial crisis.

Shares in RBS (RBS), which is still 62%-owned by the Treasury, are leading the sector higher, bid up 1.4% to 223p, followed by Lloyds (LLOY), marked 1.3% higher to 57p and Barclays (BARC),which improves 0.8% to 168p.

According to the stress-test results, the UK banking system could weather ‘deep simultaneous recessions in the UK and global economies that are more severe than the global financial crisis? combined with large falls in asset prices and a separate stress of misconduct costs’.

Despite potential losses of £140bn due to write-downs on loans and assets under the most extreme scenario, the banks’ overall core equity tier 1 (CET1) ratio would still be twice the level before the financial crisis and above the new, higher ‘hurdle rates’.

NO NEED FOR MORE CAPITAL DESPITE TOUGHER TEST

The stress test reduces the banks’ aggregate CET1 capital ratio from a starting level of 14.5% to a low of 9.2% in the second year without the need for any of them to reclassify other assets.

This means that even in a worst-case scenario none of the banks would need to raise more capital to continue lending and there is no need to change their current dividend pay-out plans.

The main change to the Bank of England’s latest test was the timing of taking losses on bad loans before the full introduction of a new financial reporting requirement (IFRS9) which forces the banks to provision for bad loans earlier.

In last year’s test, 64% of impairments had to be recognised in the first two years while in this year’s test the level rose to 80%. Despite this none, of the banks saw their capital ratios hurt to the same extent as they did in the crisis.

Another change was the addition of £25bn of extra charges for misconduct in the event of another PPI-style mis-selling scandal. This knocked a further one percent off the banks’ CET1 capital ratios but again they passed the test.

LLOYDS REMAINS COY ON SHAREHOLDER RETURNS

Investors in Lloyds will be relieved that the bank has passed the stress test as there are hopes that it will announce a new share buyback and a higher dividend.

Under the test, Lloyds’ CET1 ratio drops from its current level of 14.6% to 9.3% which is above the new higher hurdle rate of 8.5%.

The bank has issued a statement to say that its business is still ‘strongly capital generative’ and it expects to end the year with an even stronger CET1 ratio, but it stops short of mentioning returns to shareholders.

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Issue Date: 29 Nov 2018