The UK’s biggest banks will be tested on their ability to withstand a rise in defaults linked to sky-high energy prices, as part of the Bank of England’s delayed health check of the financial sector.
The Guardian understands that Threadneedle Street has crafted a new crisis scenario which will feature a deep economic downturn, punctuated by rising energy bills which could make it harder for some borrowers – especially businesses – to repay their loans.
It comes as UK businesses await details of Liz Truss’ £150billion energy bill bailout, which the new PM pledged last week to temporarily cap sky-high bills for businesses that could otherwise be forced to close.
This year’s stress test scenario will also feature falling asset prices, a further rise in interest rates and soaring costs to cover misconduct. Any lender deemed too weak to cover these eventualities could be forced to raise billions of pounds in capital to bolster its finances.
The Prudential Regulation Authority, part of the Bank of England and responsible for ensuring the financial stability of banks and insurers, is set to publish details of its stress test scenario in the coming weeks, after having postponed the annual exercise due to the war in Ukraine.
Results from the UK’s biggest banks – including NatWest, Barclays, HSBC, Lloyds, Standard Chartered, the UK branch of Santander, Nationwide Building Society and Virgin Money UK – will be released in the summer of 2023.
While the annual stress test exercise usually features a severe economic downturn, this will be the first time banks will be forced to prove they can withstand the effects of an energy crisis. The central bank has already tested lenders against worst-case scenarios related to major events such as Brexit and the Covid-19 pandemic.
This follows similar efforts by the European Central Bank, which reportedly asked lenders to analyze how gas shortages could affect their business customers and default rates. Bloomberg said the ECB expected responses from lenders by mid-September, with follow-up conversations scheduled for the end of the month.
In their second quarter results in July, the UK’s biggest lenders largely ignored concerns about potential defaults linked to weaker economic forecasts and soaring costs, noting that few vulnerable customers are actually borrowing from big street banks.
However, energy bill forecasts have since exploded, putting many of their business customers at risk, who are more exposed to price fluctuations since they do not benefit from the UK energy cap for households.
While Truss has promised to freeze household energy bills at £2,500 over the next two years, details of a similar scheme for businesses have yet to be released. The government has only confirmed that businesses will be offered “equivalent support” under a shorter six-month scheme, although additional help is being considered for “vulnerable industries”. A review will take place in three months.
Economists believe the massive bailout package for households and businesses will lessen the severity of the recession set to hit this winter, reducing the number of business bankruptcies and giving consumers more purchasing power.
The Bank of England has been carrying out annual stress tests on the UK banking sector since 2013, as part of its response to the 2007 financial crisis. The tests aim to identify potential weaknesses in the banking system that could jeopardize stability financial situation and to determine whether individual banks can continue to lend to households and businesses despite the additional pressures.
This year’s test results will be released six months later than normal, with the central bank having postponed the exercise to March to give lenders a break as they grappled with financial disruption caused by the war in Ukraine.
The regulator has yet to raise concerns about the health of Britain’s banking sector despite the rising cost of living crisis. In July, its financial policy committee said lenders had “considerable capacity” to continue lending despite the deteriorating economic outlook.
However, the committee warned that the war in Ukraine could have a ripple effect on energy-hungry companies, including in the transportation and manufacturing sectors. He promised to monitor the sector for “further downside risks”.
The Bank of England declined to comment on pending details of the stress test scenario.