Earlier this week, The Bank of England published their scenarios as part of the 2017 Concurrent Stress Testing (CST). The 2017 stress tests, which are aimed at the seven largest lenders, are deemed to be the toughest ever test of resilience after the Bank of England unveiled extra assessment of their ability to weather certain economic scenarios.
Alongside the usual annual cyclical scenario, the Bank of England is running an additional exploratory scenario this year, which is intended to represent an important step towards achieving the Bank of England’s vision for stress testing, as set out in 2015. These scenarios are devised by a panel of experts at the Bank of England and comprise of forecasts across a selection of key UK macro-economic variables over a seven-year horizon.
The annual cyclical Scenario
This scenario is based on an economic shock, and evaluates how well banks can absorb a large shock and continue lending. For the global economy, the stressed outcome is worse than in 2016, which is largely down to the continued rapid growth of credit in China, and the impact of withdrawal from the EU. That’s why the annual cyclical scenario incorporates a severe and synchronised UK and Global macroeconomic and financial market stress – as well as an independent stress of misconduct costs.
In addition, the Bank of England is also changing its regular annual stress test by including an “anchor” on its severity, which means the test will only get more severe in areas where the Bank of England thinks risks have grown.
The Bank of England has revealed that the annual scenario will include a rise in Bank Rate peaking at 4%, differentiating it from the 2016 exercise – where the Bank Rate was cut to zero. The scenarios will allow banks to assess the impact of both rising and persistently low Bank Rate.
The biennial exploratory scenario
In contrast to the annual scenario, the biennial exploratory scenario is based on long-term challenges, and will evaluate how a bank’s reactions could impact on the economy. Banks are expecting a return to profitability this year, but this biennial exploratory scenario challenges banks to consider what would happen if headwinds persist or intensify.
The biennial exercise will incorporate stress to both the British and global economy, with weak growth, low bank rates, increased competition and cross-border banking activity. It will also test whether lenders can face increased competition from challenger banks and further misconduct costs.
In addition, the hurdle rates above which banks will be expected to maintain their capital positions in the 2017 scenario, have been set on the same basis as it was in the 2016 exercise, and all banks will be expected to meet their minimum CET1 capital requirements.
The results of the annual test will be published in the forth quarter of 2017.