Comment: Bring on demanding stress tests for banks

THE severe wounds to regulatory self-esteem engendered by the 2008 financial crash have left scars. It is apparent in the vastly greater demands by global regulators for extra capital to bolster banks’ balance sheets to try to ensure we never venture into taxpayer bailout territory again.

The latest Bank of England stress tests indicate vividly how watertight the BoE want the safety valves to be. Picture: Getty Images

In fact, some believe the pendulum has swung too far; that banks are being given too onerous targets for capital cushions which is rendering them less competitive and constricting lending.

The latest Bank of England stress tests indicate vividly how watertight the BoE and its global counterparts want the safety valves to be.

This year’s tests – what one analyst said yesterday were effectively game simulations on bank balance sheets – include UK lenders being faced with a three-year downturn in Europe, Chinese growth spiralling down from 6 per cent to 1 per cent, and the oil price crashing afresh to $38 a barrel.

There’s more. The hypothetical set of economic circumstances envisaged includes a crash in commodity prices; buy-to-let property owners coming under pressure from an unexpected rise in interest rates; potential cyber attacks on the UK financial services system; and an extra £40 billion wiped off UK banking profits for further mis-selling fines and compensation.

Clearly, the Bank does not buy into the argument that the latter are just “legacy issues”, but could flare up anew.

In other words,the stress tests do not exactly posit a potential Armageddon facing UK banks when assessing how much capital reserves they might need, but they do set the bar very high indeed.

I am not in the camp that thinks there has been a balance sheet health over-reaction to the banking crash by the British authorities. We flirted with the abyss back in 2008.

Lehman Bros, US Wachovia, Northern Rock and Bradford & Bingley failed. Royal Bank of Scotland, UBS and Citigroup would have gone without taxpayer lifelines.

HBOS was whitewater rafting without pants, and Lloyds was brought into the taxpayer bailout scene by being strong-armed into taking its rival over. Memories are short.

Better to have really stressful stress tests and sleep more soundly about the health of the financial system that keeps the world’s wheels turning, rather than soft-pedalling. Officialdom occasionally gets it right.