Bank of England Stress Tests – What & Why?

by Dec 1, 2016

What are bank stress tests and why do they matter?

Under its remit to maintain stability in the UK economy, the Bank of England (BoE) under its governor Mark Carney, routinely carries out what is known as ‘stress testing’ on the UK’s main banks this week. The idea behind the tests is to evaluate just how strong these institutions are, and whether they have enough fail-safes and resources to deal with another potential financial crisis (or other worst case scenario).

The BoE looks at lots of different factors, including things like ‘leverage ratio’ (meaning the amount of money the bank has borrowed, as opposed to the assets it holds on its balance sheet), as well as looking at general risks to the UK’s economy as a whole (Brexit for example), to create a picture of the risks for the country’s financial system & the economic health of the individual lenders.

Why istress testing banks important for you

Well, it just so happens that the banks under scrutiny are the very same banks you probably have deposits with or loans from, the top high-street names you are so used to seeing on a daily basis, namely: Barclays, HSBC, Lloyds Banking Group, Nationwide, The Royal Bank of Scotland (RBS), Santander UK & Standard Chartered. Not only do they play a key role in terms of your own borrowings and outgoings, but they play a huge part in the overall UK economy as well – they provide about 80% of the lending to the UK ‘real’ economy (the part of the economy that’s about actually producing goods and services).

Back in 2008 at the peak of the financial crisis, the banks that we all thought were safe as houses, turned out not to be so. Years of deregulation of the financial sector, meant that many banks were taking huge risks with people’s cash, and what started as a crisis in American financial institutions soon hit our shores.

At that time, the responsibility for helping to prevent financial catastrophe fell on the shoulders of central banks like the Bank of England, while the government also stepped in where necessary to rescue our lenders, some of which were on the brink of collapse, meaning that people’s money within them would have potentially gone up in smoke.

So, with these events of almost a decade ago still fresh in the minds of central bankers, stress testing (not only in the UK but also across the world) is now a fundamental part of the strategy they use to ascertain whether our banks could withstand the same global downturn & shocks again, putting your money at risk.

Historically, we have tended to trust our high street banks, similarly to brands we’ve known all our lives, but a closer look has revealed that the legacy of the financial crisis is still hanging over some of our oldest lenders. Banking is an industry built almost entirely on trust, so if the trust that we take for granted becomes eroded, the value of shares may fall as people look at banks differently.

Want to learn more about the markets and how to become a better investor?

Download the Invstr App now.

Share This