The Bank of England has announced that it is returning to the annual cyclical scenario (ACS) stress-test framework in 2022. This follows two years of Covid-19 pandemic crisis-related stress testing and the BoE's decision in March 2022 to postpone the 2022 stress test following Russia's invasion of Ukraine. The results will be published in the summer of 2023 to help inform banks’ capital buffers.

The stress tests are used to check banks’ overall resilience and ensure that they hold sufficient capital to enable them to absorb (rather than amplify) shocks, and serve UK households and businesses even in a stress scenario.

The 2022 stress test will test the resilience of the UK banking system to:

  • Deep simultaneous recessions in the UK and global economies.
  • Large falls in asset prices and higher global interest rates. While previous stress tests have incorporated the impact of higher interest rates in the UK, this stress test will be the first to test UK banks' resilience to higher global interest rates, in the face of a series of global cost shocks and high and persistent global inflation.
  • A separate stress of misconduct costs.

The scenario will cover a five-year horizon from the end of June 2022 and includes the BoE’s Bank Rate rising to 6% early next year and a 5% fall in British economic output, as well as a 31% fall in house prices.  While previous stress tests have incorporated the impact of higher interest rates in the UK, this ACS will for the first time test UK banks’ resilience to higher global interest rates.

The BoE emphasise that “the stress applied under the ACS is not a set of events that is expected, or likely, to materialise”, but rather, it is intended to be a worst case “tail risk” scenario.  The market turmoil of recent days does nevertheless raise questions around whether the scenario is as theoretical as intended.  

Participants

Eight firms will be tested in the ACS – Barclays, HSBC, Lloyds, Nationwide Building Society, NatWest, Santander UK, Standard Chartered and Virgin Money.

For the first time the ring-fenced bank subgroups of the existing stress-test participants will be assessed on a stand-alone basis, where these differ materially from the group as a whole (this will include: Barclays Bank UK, HSBC UK Bank, Lloyds Bank and NatWest Holdings ).This is in addition to the banking groups of these participants, which incorporate both ring-fenced and non ring-fenced entities.

Unless agreed otherwise with the BoE, these participants are expected to complete all aspects of the 2022 stress test.

Timing and Process

In addition to participants’ own analysis, BoE staff will perform analysis to independently assess the impact of the stress scenario on participants’ profitability and capital and leverage ratios.  Submission instructions have already been disseminated to participants (in January 2022) and  participants are required to submit the projections data requested (structured and unstructured) by 11 January 2023. 

Additional BoE Guidance  

The BoE has published guidance to assist participating banks with conducting their own analysis for the 2022 stress test, together with the traded risk scenario for the 2022 stress test and variable paths for the 2022 stress test scenarios.

You can find the statement, published by the BoE on 26th September, here.