R.B.S., Lloyds and Co-op Bank Fall Short in Bank of England Stress Test

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A branch of Lloyds Bank in London.Credit Toby Melville/Reuters

Updated, 9:24 a.m. | LONDON — The results from the Bank of England’s latest health check on Britain’s top banks are in, with one bank failing, one coming razor close to failing and a third looking bad enough at the end of 2013 to warrant significant fund-raising.

The central bank said on Tuesday that the Royal Bank of Scotland, the Lloyds Banking Group and the Co-operative Bank would not have had sufficient capital in 2013 to comfortably weather its hypothetical financial storm, although it added that Lloyds had raised enough capital this year to be considered out of danger.

The Royal Bank of Scotland, which just barely passed the test, submitted a revised capital plan during the process announcing its intention to raise £2 billion, or about $3.13 billion, in debt capital that can convert to equity to bolster its position.

Only the Co-operative Bank completely failed the test, as was widely expected. The bank was required to submit to the Bank of England a new capital plan, which was approved. Under that plan, it will reduce its risky assets by £5.5 billion by the end of 2018.

“This was a demanding test,” the governor of the Bank of England, Mark J. Carney, said in a news release. “The results show the core of the banking system is significantly more resilient, that it has the strength to continue to serve the real economy even in a severe stress.”

The stress tests were published at the same time as the bank’s semiannual Financial Stability Report, which provides an overview of the strength of the financial system. In the report, the bank said the global economic outlook has worsened since its first-half review, and concerns about geopolitical risk and weak growth have risen.

Mr. Carney said the most important risks to global stability were international, noting that while the sharp decline in oil prices should help the British economy, it could pose risks to financial stability.

The banks, however, are in better shape to cope with any headwinds, Mr. Carney said.

The stress test found that core Tier 1 capital ratio, a measure of banks’ ability to weather financial shocks, across the eight institutions would be reduced to a low of 7.3 percent in 2015 from 10 percent in 2013.

The tests are intended to assure investors that the banks can survive the sort of financial storm that brought them to their knees in 2008 and that required billions of dollars in taxpayer support.

The examination was performed on seven banks and one building society: Co-Operative Bank, the Royal Bank of Scotland, Lloyds, Barclays, HSBC, Santander UK, Standard Chartered, and the Nationwide building society. The last five of those institutions were found to have no problems.

The Bank of England assessment came less than two months after the European Central Bank and the European Banking Authority tested the health of Europe’s banks against a future financial shock.

The E.C.B. test, known as an asset quality review, focused on 130 banks in the 18-member euro currency bloc, while the authority’s test also included banks in Britain, Sweden and other European Union countries that do not use the euro. In the European Banking Authority’s stress test, 14 banks fell short of the capital requirements and were ordered to add capital. None of those banks were in Britain, and several had already raised capital in anticipation of the review.

The Bank of England’s tests were intended to measure reactions to more country-specific risks, namely the levels of indebtedness in Britain and the dominant role housing plays in its economy.

The situation the Bank of England used in its hypothetical crisis was dire: The British pound plummets 30 percent amid growing fears about the country’s debt. The fall-off causes inflation to rise to 6.5 percent in early 2015. The central bank responds by raising rates, and 10-year government bonds yields peak just below 6 percent. Real gross domestic product falls to 3.5 percent below its third-quarter 2013 level, unemployment hits 12 percent and home prices fall 35 percent. Commercial real estate collapses 30 percent and over the three years, bank profits would be reduced by £90 billion.

Under those conditions, the central bank examined what would happen to the banks’ core Tier 1 capital ratios in the event of a housing crisis and a financial downturn. It then considered plausible actions the banks would take, and how capital levels would react.

The Royal Bank of Scotland reported core Tier 1 capital of 10.8 percent. In the shock scenario, that would fall to 4.6 percent, just above the 4.5 percent threshold deemed by the Bank of England as prudent. R.B.S. said it could take action to raise that figure to 5.2 percent.

“We recognize that there is still much work to be done to improve the resilience of our balance sheet,” said Ewen Stevenson, the chief financial officer at the Royal Bank of Scotland. Taking into account further potential conduct and litigation settlements and redress, he said the bank remained on track to reach its core Tier 1 capital ratio targets of 11 percent by the end of 2015 and at least 12 percent by the end of 2016.

Lloyds’s most recently reported core Tier 1 capital figure was 12 percent. It was estimated that it would fall to 5 percent in the crisis scenario and would increase to 5.3 percent with management action.

The Co-Operative Bank’s most recent Tier 1 capital figure was 11.5 percent. In the stress scenario, its capital would be depleted, the bank said. In a bid at transparency, the bank calculated the ratio, which came in at negative 2.6 percent, regardless of what management would do.

Neil Williamson, co-head of EMEA Credit Research at Aberdeen Asset Management, noted that Lloyds and RBS did better than they had on the European stress test because their 2014 capital-raising efforts were taken into account. “The clean-up of their balance sheets has resulted in a more comfortable result under the U.K. test,” he said.

The central bank also performed a qualitative assessment of the eight lenders’ stress-testing and capital-planning frameworks, which produced mixed results. “There was a wide variation in banks’ ability to provide accurate data and in the strength of bank’s modeling approaches,” the report said.

The bank’s presentation revealed a significant weakness to the tests: It was geared toward concerns from the first half of the year – the rocketing price of houses – and not current headwinds, like plummeting commodity prices or a more severe emerging market correction.