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Stress tests: bailed-out banks scrape a pass but global risks loom large Stress tests: bailed-out banks scrape a pass but global risks loom large
(35 minutes later)
It’s a triumph. The big UK lenders – apart from the Co-op Bank, obviously – can withstand a 35% fall in house prices in the UK, a deep recession and a surge in unemployment. And they can do so without cutting lending, according to the Bank of England’s stress tests. Reassured?It’s a triumph. The big UK lenders – apart from the Co-op Bank, obviously – can withstand a 35% fall in house prices in the UK, a deep recession and a surge in unemployment. And they can do so without cutting lending, according to the Bank of England’s stress tests. Reassured?
Up to a point, we should be. Lloyds and Royal Bank of Scotland only just squeaked a pass, but both can make fair arguments that their capital positions have improved since the Bank flexed the numbers based on balance sheets at the end of 2013. Indeed, RBS today off-loaded a £1bn bundle of Irish property loans as part of its capital-enhancing efforts.Up to a point, we should be. Lloyds and Royal Bank of Scotland only just squeaked a pass, but both can make fair arguments that their capital positions have improved since the Bank flexed the numbers based on balance sheets at the end of 2013. Indeed, RBS today off-loaded a £1bn bundle of Irish property loans as part of its capital-enhancing efforts.
Lloyds’ dreams of paying a token dividend for 2014 are just about intact. Chief executive António Horta-Osório has made something of a fetish of this ambition given that the last Lloyds dividend came in 2008. A payment of 0.5p per share would cost about £300m. If the Bank’s Prudential Regulation Authority is feeling generous next February, it might just allow such tokenism. The level of real dividends for 2015 and thereafter remain a mystery however. Lloyds’ dreams of paying a token dividend for 2014 are just about intact. Chief executive António Horta-Osório has made something of a fetish of this ambition given that the last Lloyds dividend came in 2008. A payment of 0.5p per share would cost about £300m. If the Bank’s Prudential Regulation Authority is feeling generous next February, it might just allow such tokenism. The level of real dividends for 2015 and thereafter remains a mystery however.
As for the Co-op Bank, the best that can be said is that it is less of a basket-case than it was. In a perfect world, the Co-op would have been told to raise even more capital a year ago, and so avoid a situation where all its capital would be exhausted under stress. Since a fatter fund-raising was impossible, the bank must shed more mortgage assets and has been told to hurry up about it – management had to submit a revised plan to the PRA.As for the Co-op Bank, the best that can be said is that it is less of a basket-case than it was. In a perfect world, the Co-op would have been told to raise even more capital a year ago, and so avoid a situation where all its capital would be exhausted under stress. Since a fatter fund-raising was impossible, the bank must shed more mortgage assets and has been told to hurry up about it – management had to submit a revised plan to the PRA.
This seems a reasonable pragmatic fudge by the regulators. No rival wants to buy the Co-op Bank and, at this point, the institution is probably not big enough to shake the UK financial system. So the plan is to force the Co-op into safer waters – or, as governor Mark Carney put it, oblige it to get a balance sheet that provides “a resilience commensurate with a bank of its future size and business model.” This seems a reasonable pragmatic fudge by the regulators. No rival wants to buy the Co-op Bank and, at this point, the institution is probably not big enough to shake the UK financial system. So the plan is to force the Co-op into safer waters – or, as governor Mark Carney put it, oblige it to get a balance sheet that provides “a resilience commensurate with a bank of its future size and business model”.
Yet the underlying worry about these stress tests is that they are one-dimensional. It is perfectly fair, of course, to look first at UK house prices, UK commercial property loans and the UK economy as a source of potential stress. That is where the big direct exposures lie for most UK banks.Yet the underlying worry about these stress tests is that they are one-dimensional. It is perfectly fair, of course, to look first at UK house prices, UK commercial property loans and the UK economy as a source of potential stress. That is where the big direct exposures lie for most UK banks.
But the next dangers – at least as the world looks today – probably lie overseas. “Risks stemming from non-EU jurisdictions were explored less comprehensively,” admits the Bank, adding that “risks from global credit exposures are expected to be an area of greater focus in the 2015 stress test.” In other words, banks with big Asian exposures – think Standard Chartered and HSBC – were treated relatively lightly this time. But the next dangers – at least as the world looks today – probably lie overseas. “Risks stemming from non-EU jurisdictions were explored less comprehensively,” admits the Bank, adding that “risks from global credit exposures are expected to be an area of greater focus in the 2015 stress test”. In other words, banks with big Asian exposures – think Standard Chartered and HSBC – were treated relatively lightly this time.
But the economic downturn in Asia and the developing crisis in Russia are now the main global risks for banks. Carney seemed mildly relaxed about the Russian threat – UK banks’ direct exposure is small and Russia is less linked to the global financial system than it was at the time of the 1998 debt default. Fair enough, but what that answer does not reveal is how the risks would play out if the Russian economic crisis becomes a political crisis. Unpredictable is the only honest response to that question. But the economic downturn in Asia and the developing crisis in Russia are now the main global risks for banks. Carney seemed mildly relaxed about the Russian threat – UK banks’ direct exposure is small and Russia is less linked to the global financial system than it was at the time of the 1998 debt default. Fair enough, but what that answer does not reveal is how the risks would play out if the Russian economic crisis becomes a political crisis. Unpredictably is the only honest response to that question.