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Testing time at the banks

Stress testing the banks gives consumers the confidence that institutions will survive severe economic downturns and a disorderly exit from the EU, says Bank of England Deputy Agent for Financial Stability Jay Jobanputra.

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Jay Jobanputra

January 2018

A key job of the Bank of England is to ensure that the financial system works well for everyone. By that, we mean that businesses and households can rely on banks, building societies and other financial firms through thick and thin.

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We know from our regular conversations we have had with businesses here in Greater London since the financial crisis the costs when that isn’t the case. It makes it harder for businesses to raise money to invest, and for families to access mortgages.

In short, if the financial system isn’t functioning properly, we all pay the price.

For this reason, every year the Bank of England subjects the UK’s major banks to a rigorous stress test to see how well they would cope with a severe economic downturn. In this year’s test, the scenario was particularly challenging. It included a sharp drop in economic growth at home and overseas, a big rise in unemployment to nearly 10%, higher interest rates and a severe fall in property prices.

Despite the severity of that test, for the first time since the Bank began stress testing in 2014, the banks came through it without the need to take any action. These results reflect the work that has been done to increase the resilience of our banks since the financial crisis, a process that is continuing.

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They give us confidence that the banking system can continue to provide a service to businesses and households even in much tougher economic conditions. This would even be the case if the UK experienced a disorderly exit from the EU.

Of course, Brexit could affect the financial system more broadly. For this reason, the Bank has also set out some key steps, contained in the latest Financial Stability Report, that need to be taken to minimise the impact on the financial sector in the event of a no-deal outcome.

Other issues were also addressed in the report. These included the level of household debt which, at £1.6 trillion, is high by historic standards and relative to income, although it remains below its 2008 peak.

High household indebtedness can pose a risk to financial stability either directly through higher rate of defaults or through cut-backs in consumer spending. To address these risks, the Bank’s Financial Policy Committee (FPC) has already taken action in the mortgage market to guard against the risk of looser underwriting standards and prevent an increase in the number of highly-indebted households. Fast growth in consumer credit is another area the committee has addressed, by requiring banks to make more realistic assumptions about the potential losses on that type of lending.

By vigorously stress-testing the banking system, assessing the potential impact of a disorderly Brexit and guarding against other pockets of risk such as in consumer credit, the FPC is taking action to reinforce the financial stability of the UK. That should give households and businesses the confidence that the financial system will continue to provide for them, whatever the future holds.

Jay Jobanputra is Deputy Agent for Financial Stability based in London. Twitter: @BoELondon

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