HSBC (LSE: HSBA), Lloyds (LSE: LLOY) (NYSE: LGY.US), Royal Bank of Scotland (LSE: RBS) and Barclays (LSE: BARC) are facing yet another round of stress tests, as regulators continue to seek assurances that banks have learnt from past mistakes.
However, this latest round of tests is set to be more vigorous than ever before, with both the Bank of England and the European Central Bank conducting their own separate tests. The results of the assessments by both the ECB and BoE will be released around October, giving banks plenty of time to sweat it out.
Several tests
As mentioned above, both the ECB and BoE will be assessing banks using their own versions of similar stress tests. In the ECB’s test, which is being carried out by the central bank’s regulator, the European Banking Authority, banks must prove that they can withstand a simulated three-year period under stress.
During this three-year period, economic output will fall 2.1%, pushing unemployment to 13% and sending house prices down 20% on average. Meanwhile, the BoE and its regulator, the Prudential Regulation Authority, will test banks to see if they have enough capital in place to withstand the shock of a record 35% crash in house prices.
RBS, Lloyds, Barclays and HSBC will be subject to both the ECB and BoE tests. Standard Chartered, Co-operative Bank, Santander and Nationwide Building Society will only be subject to the BoE tests.
Dredging
The ECB is taking these tests a step further. In addition to the above tests, the bank is dredging through historic loans on the balance sheets of the banks under examination. This process is intended to uncover any risky assets that have previously gone unnoticed.
Hopefully, this thorough analysis of both past, present and future liabilities will settle once and for all, the debate about bank capital adequacy issues.
Capital shortfall
Nevertheless, while these forensic analysis should reduce risk in the banking system, if the banks fail these tests, there could be severe penalties.
Indeed, the ECB has warned that it will publish the results of its tests in one go, which means the City’s bank analysts are set for a deluge of information later this year. Further, the central bank has stated that it will publish recommendations for banks as to how they should increase capital levels, with test results.
Unfortunately, the ECB has warned at as a result of these tests it could require some banks to cut their dividend payouts, undertake rights issues, or in the worst case the ECB could demand nationalization.
HSBC, Barclays, Lloyds and RBS have all been working had to increase their capital levels during the past few years but these rigorous tests could throw up some surprises.
