Today, the Prudential Regulation Authority, the Bank of Englands regulator,announced the results of its health check of UKbanks, the findings of which have been eagerly awaited by City analysts and traders alike.
Much like the European Central Banks stress tests conducted earlier this year, the PRAs test was designed to test whether or not the banks tested could survive a simulated period under stress. Specifically, the test assessed whether or not the banks in question would still be able to function after a 35% fall in house prices, a spike in interest rates and a surge in unemployment to 12%.
The tests revealed that during this period of simulated stress,the aggregate common equity Tier 1 ratio across the UKs eight main banks would fall to an average of 7.3% to 2015, from an average of 10% during 2013. In total, the PRAs tests revealed that this stress scenario would cause 13bn of cumulative losses at these eight major banks, with a further 70bn of impairment chargesto account for.
Of the eight banks tested, five did not display any sign of capital inadequacy. Co-op Bank failed, whileLloyds(LSE: LLOY) andRoyal Bank of Scotland(LSE: RBS) just passed thank to last-minute plans to strengthen their balance sheets.
Just passed
Unfortunately, with the PRA testing for a 35% fall in house prices, domestic banks were penalised for their lack of overseas exposure. Lloyds suffered more than most.
Indeed, Lloyds has been trying to scale back its international operations for several years now. The bank currently operates in less than ten countries around the world.
Nevertheless, Lloyds managed to scrape through the test. The groupsCommon Equity Tier 1 capital threshold capital cushion fell to a low of 5% after the simulated period of stress, just above the 4.5% minimum threshold. Even though the bank passed the test (although only just) the PRA still found the group to be lacking adequate capital resources.
However, before todays announcement Lloyds submittedrevised capital plan to the PRA, outlining plans boost its balance sheet. These plans were found to be adequate.
Moreover, Lloyds management noted, alongside the release of these results thatthe group has generated a 1.9% increase in its CET1 ratio during 2014 not reflected in the stress test and further contingent capital is available to the bank, which if trigged would boost its CET1 by 2%.
Work to do
On the other hand, RBShas some work to do.
While the bank did pass the test, with a minimum stressed capital ratio of 4.6%, the PRA found the bank to be short of capital based on 2013s figures. But just like Lloyds,RBSpre-emptively submitted a revised capital plan to boost its balance sheet, which was considered sufficient by the PRA.
As part of this revised capital plan, RBS announced this morning that the bank was sellinga portfolio of Irish home loans to hedge fund Cerberus, for which it will receive up to 1.1bn in cash.
Management will be glad to shift these loans off RBSs balance sheet. Last year the assets generated a loss for the bank of 800m, mostly due to impairments.
Difficult to understand
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
