TwentyFour Asset Management

Carney to Leave UK Banks on Solid Ground

TwentyFour Blog

The Bank of England (BoE) on Monday published its latest financial stability report and the results of its 2019 bank stress tests, and declared that the UK financial system is well prepared for even a worst-case Brexit and consequent trade war. Once again the test used a severe set of scenarios with global GDP growth declining to -2.6%, UK GDP growth falling to -4.7%, base rates rising to 4% and UK unemployment rising to 9.2%.

All the UK banks tested passed, though Barclays and Lloyds would be flirting with emergency debt-equity triggers on the basis of future accounting changes (IFRS9) due to be introduced in 2023 (this doesn’t take account of three years of potential capital increases). In aggregate the UK banks have over twice the capital, after this severe stress test, than they had before the global credit crisis. Currently, they have well over three times the capital they did in the pre-crisis period.

We also noted that the BoE’s Prudential Regulation Committee (PRC) took the opportunity to announce an increase in the Counter Cyclical Buffer (CCyB) from the current 1% to 2% over the course of 2020. The CCyB is a macro prudential tool used to strengthen the resilience of banks in the face of challenging economic conditions. The concept is to increase the capital buffer during benign periods and then allow it to be loosened when conditions change, such as in future recessionary periods. The BoE’s Financial Policy Committee estimates that releasing the 2% CCyB in the future would enable UK banks to absorb £23bn of losses, which would help keep the transmission mechanism working; given the level of leverage that banks operate with, this would equate to around £500bn of bank lending capacity, equivalent to around five years of total net lending.

In addition, and recognising the greater resilience of the banks, the Prudential Regulation Authority (PRA) will consult next year on proposals to reduce minimum capital requirements, thereby leaving banks’ overall loss-absorbing capacity broadly unchanged (this includes capital and bail-in debt), so we must wait to see how much new issuance the banks will actually undertake.

Overall we think this is a prudent measure by the PRC and should give debt investors another reason to view UK banks with a degree of comfort, despite the possibility of a potential hard Brexit at the end of 2020. The increase in the UK’s CCyB compares favourably to its peers in Europe, with French CCyB currently at 0.25% (rising to 0.5% in July 2020), German CCyB at 0.00% (rising to 0.25% in July 2020), and only Norway and Sweden currently at the maximum level of 2.5%.

These actions could be viewed as a swansong from BoE governor Mark Carney, who is due to step down on January 31, and one that leaves the UK banking system in a good place to face an uncertain future.