Once upon at time a recession like this would have wiped out every single bank.
The fictional apocalyptic scenario sketched out by the Bank of England would have destroyed all of Britain’s big banks’ capital buffers and then some, if they were still as weak as they were going into 2008.
Yet the lenders all survived this hypothetical shock when regulators worked out the damage that a new crisis, every bit as big as the credit crunch, could wreak.
That is cause for celebration, showing the bad days of reckless lending and wafer thin capital buffers are long gone. Banks have raised capital and should be safe in a storm.
There is little jubilation around, however.
One reason is that not every bank passed the tests, with Barclays and Standard Chartered only scraping through and RBS promising to work harder to improve its financial strength.
And the second is that these tests only show the banks will probably survive and be able to keep lending in a recession – not that they are going to be good, profitable investments for the long-term.
In a way it is not a surprise – the bank is loss-making, mired in the ongoing Williams & Glyn debacle, and haunted by the prospect of a multi-billion dollar fine in the US related to toxic mortgage bonds.
Despite that, the stress test revealed a worse than expected situation, so RBS’s long-suffering shareholders took another blow with the stock down by as much as 4pc. In part that is because a stress test failure means dividends and re-privatisation are still not in sight.
Bosses hope that the much overdue upswing, whenever it happens, should all come at once. When the US fine is out of the way and W&G is sold, the thinking goes, then profits in the ‘good’ bits of the bank will shine through, the capital position will recover, RBS will be able to pay dividends and sell shares like nobody’s business, and the sun will shine on all and sundry.
Until that happy day, however, it is hard to see beyond the mud in which the bank is buried, and RBS warned it could have to take yet more steps in future to bolster its capital position.
The other banks which struggled were Barclays and Standard Chartered, both of which had already satisfied the regulator that they have plans in place to address the shortfall.
A significant element of these two banks’ test results is that they had to take emergency steps in a crisis enabling them to pass the test. One example is promising to slash dividend payouts when in a tight spot.
The new element is a dry run of the bail-in mechanism, which sees investors in contingent convertible, or coco, bonds lose out, boosting the capital buffers.
The idea is fine in theory but the market for cocos crashed earlier this year, in part because some investors appeared to have misunderstood what they had bought.
This dry run of the system, therefore, is an important illustration of the process so bondholders will not be surprised if the day comes when they do get bailed in.
HSBC, Santander UK, Lloyds and Nationwide all passed the test without having to take any such management actions.
The Bank of England said British retail banking appears to be in relatively good shape, as the banks which struggled all have investment banking arms which are performing relatively poorly compared to their high street operations.
It is true that banks are finding it difficult to make investment banking pay, but it is an oversimplification to pick only on those units.
Although it passed the test with flying colours, it is worth noting the Nationwide’s capital buffer was the second-most depleted of any institution when faced with the fictional recession, diving from 22.6pc of its assets to 15pc.
It is well above the building society’s 8.1pc pass mark, but still a precipitous drop.
But it also reflects a genuine fear that house prices could dive, as well as underlining the dangers of a highly concentrated business model.
Building societies performed very well through the financial crisis, but that does not mean regulators should be complacent.
This stress test result is a sign the Bank of England is trying not to take any chances. Regulators are terrified of a return to the lax monitoring of the pre-crash days, which shamed their part of the industry and trashed the names of those involved in keeping an eye on lenders.
It is not only shocks which are under the microscope.
Significantly, the Bank of England is also looking into the other big cause of gloom in banking, which is the sector’s chronic profitability underperformance in recent years, a long-term problem rather than one which could knock the sector off its feet overnight.
The inclusion of this worry in next year’s test shows the Bank of England is aware that the sector’s stability depends on more than just building capital buffers, and also that regulators are aware those buffers have dented returns for investors.
What is harder to find, however, is a solution – after ratcheting up capital buffers, regulators are unlikely to reduce some of that safety barrier just so banks can make more money.
Source: The Telegraph