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Royal Bank of Scotland Group plc & Standard Chartered PLC Bottom In Stress Test

The results of the latest Bank of England (BoE) stress tests are in, and Royal Bank of Scotland (LSE: RBS) and Standard Chartered (LSE: STAN) came out bottom of the pile — the only two found not to have sufficient capital strength.

The test, applied to the seven banks operating in the UK with £50bn or more in deposits, imagines a tough scenario of low oil, bad debts, and potential misconduct charges, and saw Lloyds Banking Group and Barclays come out well ahead of the BoE’s minimum requirements.

But despite their weak performance, neither RBS nor Standard Chartered will have to come up with a new plan as both had already raised new capital since the end-of-2014 snapshot used in the tests.

The question for us is, does this result really mean RBS and Standard are the two weakest banking investments in the FTSE 100 right now? I think the answer is yes.

Shares up

RBS, whose shares are up 3% to 312p as I write (presumably due to relief that no changes have been ordered), has lagged bailed-out rival Lloyds in the recovery stakes, but we still see its shares on a significantly higher forward P/E — for 2016, RBS is on a multiple of 13.5 compared to Lloyds’ 9.5.

That might be expected if we had significantly better EPS growth forecasts for RBS in 2016, but we don’t. In fact, after the first significant profit in years expected this year, RBS earnings are forecast to fall 10% in 2016, while Lloyd has a 7% fall on the cards. On top of that, RBS isn’t back to paying dividends yet — it’s hoping for a modest yield of around 0.5% next year, but Lloyds is predicted to hand over 5%.

And Standard Chartered (up 1.5% to 566p), well, that bank’s international difficulties are well known, and its capital strength in the UK seems like the least of its problems.

Heavily exposed to China and the Far East, and with its Korean operations a disaster in recent years, the bank finally caved in to shareholders’ demands and recently had a board shake-up. But there’s still a significant fall in earnings expected this year and only a relatively mild recovery next — and with the Chinese economy (and stock market) looking shaky, it’s certainly not one I’d buy.

Tougher regulations

Capital regulations are set to be toughened up even more, and the BoE’s next step up in capital requirements will require an extra £10bn to be set aside in what is called a “countercyclical capital buffer”. That’s going to have to come out of profits or from new equity or debt issues — and that will mean less cash going into shareholders’ pockets.

Still, with the BoE having declared that the UK’s financial system is now out of its “post-crisis period”, and with the banking sector coming through the test looking pretty resilient, the future for banking shares is surely looking brighter today — but they’re not all equal by any means.

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Alan Oscroft owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.