Plans by Lloyds Banking Group to resume dividend payments could be rejected unless it performs strongly in a test of its financial health, the results of which are due to be published on Tuesday.
Along with fellow state-backed lender Royal Bank of Scotland, Lloyds narrowly passed a “stress test” by European regulators in October and now faces a more stringent examination by the Bank of England.
The central bank is testing how resilient Britain’s biggest eight lenders would be in the face of a slump in house prices and higher interest rates, and some analysts believe Lloyds is vulnerable in the test, which adds extra elements on top of those applied by Europe.
Industry sources said the emphasis on home loans in the Bank of England test means Lloyds and mutually-owned Nationwide – Britain’s two biggest mortgage providers – will come under pressure. “Lloyds will pass but it won’t be the strongest pass,” one source said. Lloyds has said it is confident it will pass.
The Bank is expected to order those who fail or narrowly pass the test to take actions to strengthen their capital, which could include dropping or scaling back their dividends.
Banks will have to show that they would still have a core capital ratio of at least 4.5 per cent of risk-weighted assets in stress scenarios that include a 35 per cent drop in house prices and a rise in interest rates to 6 per cent.
Analysts at Citi expect Lloyds to pass the test, holding core capital of 5.7 per cent under the stresses, although this would be the weakest result among Britain’s biggest four banks.
Lloyds has been in talks with regulators to start paying dividends for the first time since it was rescued by the UK government during the financial crisis of 2008-9 and wants to hand shareholders a modest payment.
Analyst Ed Firth at investment bank Macquarie said there was a risk Lloyds might fail the Bank of England stress test and that he did not expect the bank to be able to pay a dividend until 2015, although he did not see it needing to raise funds.
“Whilst we do not see failure as having capital-raising implications, we no longer expect Lloyds to pay a 2014 dividend,” Firth said.
If the regulator blocks Lloyds’ dividend plans, it could make it harder for the government to sell off more of its remaining 25 per cent shareholding in the bank.
RBS, which is 80 per cent owned by the state, will also be under scrutiny after saying last month it had only just passed the European test in October, after initially submitting incorrect data that made it appear to have passed comfortably.
The European test had a pass mark of 5.5 per cent for core capital – RBS held just 5.7 per cent, while Lloyds had 6.2 per cent.
SUBSCRIBE TO THE SCOTSMAN’S BUSINESS BRIEFING