Bank of England Stress Tests – What & Why?

by | Dec 1, 2016

The results of the Bank of England stress tests for UK banks are in, but what is a stress test 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, has carried 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 is stress 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.

As an Invstr, it pays to keep abreast of developments like these. Yesterday it was revealed that while most of the banks tested fared OK, the Royal Bank of Scotland failed, with the BoE citing ‘legacy issues’ (hangover problems from misconduct during the financial crisis) and more, but Governor Mark Carney says they have made progress overall. If you hold cash with RBS in reality, the result isn’t a reason to panic, or withdraw your money, but it’s something to keep in mind. 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, so keep in mind the test results and adjust your positions in the invstr games accordingly.

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Risk Disclosure:
Invstr is a technology platform, not a registered broker-dealer or investment adviser. Invstr does not offer its own recommendations of any security or provide its own research to any user regarding any security transaction or order. Brokerage services, including fractional trading of US securities, are provided to Invstr users by DriveWealth LLC, a regulated member of FINRA/SIPC. DriveWealth may not establish investment accounts to residents of certain jurisdictions. For more information, including disclaimers, risk and transaction fees click here. Please note, investing involves risk and investments may lose value. Past performance does not guarantee future results.

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ALL RIGHTS RESERVED © INVSTR LTD. 2017

Risk Disclosure:

Invstr is a technology platform, not a registered broker-dealer or investment adviser. Invstr does not offer its own recommendations of any security or provide its own research to any user regarding any security transaction or order. Brokerage services, including fractional trading of US securities, are provided to Invstr users by DriveWealth LLC, a regulated member of FINRA/SIPC. DriveWealth may not establish investment accounts to residents of certain jurisdictions. For more information, including disclaimers, risk and transaction fees click here. Please note, investing involves risk and investments may lose value. Past performance does not guarantee future results.

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