Banks To Be Tested On 35% House Price Slump

By Mark Kleinman, City Editor

Britain's biggest banks and building societies could be forced to raise billions of pounds of fresh capital unless they can demonstrate their ability to withstand a house price slump of roughly 35%.

Sky News has learnt that stress tests to be carried out by an arm of the Bank of England later this year will also assess their readiness to cope with a sudden spike in interest rates to more than 5%.

A series of commercial real estate losses will also be applied to the banks' balance sheets as part of the tests, insiders said.

Details of the stress tests, which have been drawn up by the Financial Policy Committee and the board of the PRA, will be disclosed to markets on Tuesday.

It is unclear whether the interest rate hike will be quantified as part of the tests, while the 35% figure is "in the ballpark" of the housing market scenario to be tested by the PRA, a source said.

The Prudential Regulation Authority (PRA) will unveil the UK tests of banks' resilience alongside a similar exercise being carried out by the European Banking Authority, which will include lenders from across the Continent.

The PRA is to announce the stress test of UK banks

The tests will come amid growing concerns about overheating in the housing market, particularly in London, where price rises have accelerated amid the improving economy.

Government ministers including Vince Cable, the Business Secretary, have warned that the Help to Buy scheme has contributed to the inflation of a housing bubble.

Banking sources have expressed concern about the PRA's methodology for conducting the tests, with some uncertainty about the timing and extent of the publication of the results.

In a statement last month, the FPC said the stress test "was not intended to be the FPC's expectation of what would happen, but a coherent tail risk event against which banks' resilience could be tested".

"A key part of the scenario would examine the resilience of the banks to a housing market shock and to a snap back in interest rates," it added.

The Government wants to avoid a 'too big to fail' scenario

Lenders including Nationwide and Santander UK, which have a substantial proportion of their business skewed towards the UK mortgage market, are said to be concerned about the possible outcome of the tests.

Banks such as HSBC, meanwhile, are also being tested for the impact of a severe slowdown in the Chinese economy.

The stress tests are designed to ensure that British banks have sufficient capital to withstand another economic slump, obviating the need for taxpayers to bail them out, as happened during the crash which began in 2007.

"The philosophy is that banks' bondholders and shareholders, rather than UK citizens, should pick up the tab," said a source familiar with the PRA's plans.

Banks would be given a substantial period of time to raise any capital that the PRA deems necessary as a consequence of the stress tests, insiders said.

The PRA declined to comment on Monday on the details of the stress tests ahead of Tuesday's announcement.

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