UK banks face 65% Hang Seng slump in trading book stress test

[LONDON] The Bank of England will assess the resilience of Britain's seven biggest banks against a 65 per cent plunge in the Hang Seng Index, as well as a 34 per cent collapse in Brent crude oil prices, in this year's stress test.

Banks such as HSBC Holdings Plc and Barclays Plc will also be examined on their ability to weather trading book shocks including a 23 per cent decline in the euro versus the US dollar over one year, the BOE said in a statement on May 26. To pass the test, lenders must maintain 4.5 per cent common equity tier 1 and a 3 per cent leverage ratio, both measures of financial strength.

The "innovations in the 2015 traded risk stress test are inspired by what has happened in real stress events (and especially in the crisis that followed the Lehman default) and by a desire to create a link to the forward-looking macro scenario, and are intended to impart a greater sense of realism to the stress test and its outcome," the BOE said.

The stress test is the central bank's second since taking over as the UK banking regulator in 2013, and reveals how its focus has shifted from domestic risks to concerns over liquidity in international markets.

The scenarios apply to a snapshot of lenders' trading books as of Feb 20. Banks will be locked into losses on trades over periods of one day, one week, one month and one year. Lenders may have to raise additional capital after the tests even if they pass, the regulator said.

With potential market stresses related to events in Greece and elsewhere, BOE officials have been sounding the alarm about low liquidity in recent months. Executive Director Chris Salmon said that structural changes in financial markets leave them less able to absorb shocks, leading to the type of volatility seen in US Treasury bonds in October and the Swiss franc in January.

Last year, the regulator modeled a rise in the BOE benchmark interest rate to 4 per cent and house prices falling by more than a third, a financial catastrophe so severe that it has only happened once in the last 150 years.

BLOOMBERG