The Bank of England’s stress tests for large financial institutions are “highly unreliable” and “fatally flawed”, a report from an influential think-tank argues.
The Bank uses stress tests to analyse the resilience of the UK banking system in the event of a deterioration in global economic conditions.
However, a report from the Adam Smith Institute argues the “pass” rate for the BoE’s solvency test – a 4.5 per cent minimum ratio of capital to risk-weighted assets – is “very low” and significantly weaker than incoming European Basel III requirements.
It says if the Bank had used the standards set out in Basel III, at best just two of the eight banks and building societies tested would have passed.
In the stress test results published in December, the Bank said only three institutions – Co-operative Bank, Lloyds Banking Group and Royal Bank of Scotland – needed to strengthen their capital position further. In addition, the Co-op was required to submit a revised capital plan.
Professor Kevin Dowd, who authored the report, says: “The Bank’s party line is that the UK banking system is safe. However, it is simply impossible to assess the health of the banking system using a stress test based on a single scenario, which is all that the Bank considers. How do we know that the banking system will be safe under all the other scenarios that the Bank of England didn’t consider? Well, we don’t.
“On the other hand, had the Bank carried out a meaningful stress test, then all sorts of awkward questions would have arisen – such as why the banking system is still in a mess despite the vast amounts of public money that have been thrown at it since the onset of the financial crisis. But no-one – especially not the Bank – wants to face up to the point that Bank’s policy towards the banking system has been a very costly failure and continues to leave the banking system vulnerable.”