Bank Of England Releases Details Of ‘Stress Tests’ Amid Preparations For Potential Brexit

UPDATE: 6:20 a.m. EDT — In its last scheduled policy statement before a looming referendum on the U.K.’s future in the European Union, the Bank of England’s Financial Policy Committee (FPC) said Tuesday that the outlook for financial stability in the country had deteriorated since its last meeting in November, and put in place a measure that requires banks to hold more capital as an extra layer of protection against bad loans.

“Risks stemming from the global environment have increased. Domestic risks have been supplemented by risks around the EU referendum. Weighed against these developments, the resilience of the core banking system has improved further since November 2015, though investor expectations of future profitability have weakened, with possible implications for banks’ ability to build resilience in the future,” the BoE said, in the statement.

By the end of March 2017, banks will have to hold 0.5 percent of their risk-weighted assets as a counter-cyclical buffer against bad loans, which tend to increase during economic crises. The rule applies to British banks as well as to branches of EU banks that lend into the country. Prior to this the rate was zero.

In another widely expected move, the central bank tightened mortgage lending rules, announcing that it would recommend higher minimum standards for issuing loans to small landlords who want to buy property specifically for the purpose of letting it out.

“The proposals seek to ensure that firms conduct their buy-to-let business in a prudent manner. They aim to prevent a marked loosening in buy-to-let underwriting standards and to curtail inappropriate lending and the potential for excessive credit losses,” the bank said, adding that while most lenders already met the standards, it wanted to ensure the banks properly scrutinized landlords' incomes.

The central bank also published key elements of its 2016 stress test, which the U.K.'s largest banks will face later this year. The test is intended to check how lenders would fare in a scenario where global growth falls 1.9 percent, British gross domestic product growth contracts to 4.3 percent, and domestic unemployment increases by 4.5 percent.

"The stress scenarios incorporated in the Bank’s concurrent stress tests are not forecasts. Rather, they are coherent ‘tail-risk’ scenarios designed to be severe and broad enough to assess the resilience of U.K. banks to adverse shocks, which can occur even when risks are not elevated," the BoE said in a statement. The results of the stress test will be published in the fourth quarter of 2016.

Original story:

The Bank of England (BoE) will release on Tuesday a quarterly assessment of risks to the U.K.'s financial stability, including any actions retail banks need to take to guard against looser lending standards. Additionally, the central bank is also expected to reveal its findings on lending standards for buy-to-let mortgages, wherein loans are issued to buyers who purchase a property with the sole intention of renting it out.

Tuesday’s comments would mark the BoE Financial Policy Committee’s last scheduled policy statement before the U.K. votes on June 23 on whether to leave the European Union (EU). Earlier this month, BoE chief Mark Carney described “Brexit” as the single biggest domestic risk to the nation’s economy, even as he insisted the central bank would remain neutral in the debate.

“The issue is the biggest domestic risk to financial stability because, in part, of the issues around uncertainty,” Carney said, during a testy exchange with members of a House of Commons committee.

The four main British banks — Barclays, HSBC, Royal Bank of Scotland and Lloyds Banking Group — are among the lenders subject to the BoE’s stress tests, which aim to assess if the banks are sufficiently equipped to cope with a house price crash or an emerging market slump. In the current scenario, when the prospect of the U.K. exiting the EU is casting a long shadow over the country’s banking sector, findings of the stress test assume special importance.

Members of the central bank's Financial Policy Committee, who met earlier this month, are reportedly split over whether it is time to raise the new counter-cyclical capital buffer banks must hold to 1 percent — its neutral level — from its current level of zero.

The counter-cyclical capital buffer provides an extra layer of protection in the form of higher capital requirements against future loan losses, and could be raised if the BoE thinks domestic banks need to be more insulated from a potential Brexit shock.

However, even if the capital requirement for the buffer is raised, the immediate impact on banks is likely to be small, as most lenders already hold more than the minimum amount of core capital.

Insofar as the buy-to-let market is concerned, the BoE could introduce new rules that include increasing the amount of capital borrowers must place against the loans, and a limit on the number of buy-to-let loans lenders can grant as a percentage of their overall lending.

The central bank has, in the past, expressed concern about the amount of money pumped into the market and its vulnerability to even small changes in borrowing costs.

“The Bank of England and the financial policy committee have identified potential systemic risks in the large increase in the buy-to-let market,” the British Chancellor of the Exchequer George Osborne said last week, adding it was “highly likely” that the central bank would be given greater powers to intervene in the market “later this year.”