Publication alert: BoE - Key Elements of the 2022 Stress Test
We communicate that the Bank of England (BoE) has published the following documents regarding the stress test of the UK banking system:
Guidance on the 2022 annual cyclical scenario for participants
Key elements of the 2022 annual cyclical scenario.
1. Context
Following the COVID-19 outbreak, the BoE cancelled the 2020 concurrent stress test and instead undertook desktop analysis of the resilience of the UK banking sector to the unfolding stress. In 2015 the stress-testing framework was developed further, and in 2016 the Bank implemented its first annual cyclical scenario (ACS). Having conducted this stress test in 2021, the BoE is reverting to the ACS stress-testing framework for 2022.
In this context, the BoE has published the Guidance on the 2022 annual cyclical scenario for participants , the templates used for collecting data, and the Key elements of the 2022 annual cyclical scenario which provides further details on the 2022 baseline scenario and ACS.
2. Main points
Scope. The 2022 stress test will cover the following banking groups and building societies (hereafter ‘banks’):
- Barclays, HSBC, Lloyds Banking Group, Nationwide, NatWest Group, Santander UK, Standard Chartered and Virgin Money UK.
- For the first time, the 2022 ACS will assess the ring-fenced subgroups of the existing participating banks on a standalone 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.
All participating banks should provide results at their highest level of UK consolidation and sub-consolidation (if applicable). Insurance activities are excluded, although banks are expected to assess the impact of the scenarios on their insurance activities and model the impact on any dividend streams, significant investments or minority interest capital deductions and risk weightings.
Hurdle rate. Since 2018 the Bank has adjusted hurdle rates in the stress test to take into account the impact of the IFRS 9. This will continue to be the case in the 2022 ACS.
Time horizon and reference date. The 2022 stress test will cover a five-year horizon. Unless otherwise agreed, the reference date will be 30 June 2022. Exceptions include some traded risk elements. Banks are expected to submit projections as at 30 June for subsequent years unless agreed otherwise with the Bank.
Macroeconomic scenario. Banks should follow the guidance to assess the impact of the baseline and annual cyclical scenarios. In order to do this, it is likely that banks will need to expand the set of macroeconomic and financial variables provided alongside the Key elements document.
Libor transition. The 2022 ACS incorporates an orderly transition from Libor to alternative reference rates in line with planned timelines. For the purposes of the 2022 ACS, banks should make the simplifying assumption that all contracts not renegotiated before the proposed cessation dates can be transitioned through fallback arrangements. Banks should develop projections for the transition of Libor-linked contracts based on the principles set out in the Guidance (e.g market developments).
Management actions and mandatory distribution restrictions. Banks are asked to consider what realistic strategic and business-as-usual management actions could be taken in response to the stress scenario. A description of all material business-as-usual actions should be submitted alongside banks’ projections. On the other hand, banks should ensure that the strategic management actions they propose fulfill some characteristics lusted in the guidance.
Qualitative review. In 2022 the Bank will carry out a Delivery Assessment, an assessment of submission quality (focused on errors and resubmissions and explanations provided for the stress results) across the different risk areas. Further details can be found in the guidance for stress-test participants.
Policy responses. The FPC and Prudential Regulation Committee (PRC) will consider how banks perform in the test to determine if any actions are required. Banks that fall below their hurdle rate will generally be required to take action to strengthen their capital position, if they have not already done so. Some banks may see their capital depleted by more than the aggregate effect of the UK economic component of the test.
Types of stress. In common with previous exercises, the 2022 ACS contains three types of stress, which are assumed to be synchronised: a UK and global macroeconomic stress, spanning a five-year period from 2022 Q3 to 2027 Q2; a traded risk stress, linked to a financial market scenario consistent with the content and calibration of the macroeconomic stress and a misconduct costs stress:
- As a novelty to previous ACS scenarios, it takes into account the latest risk assessment and its severity has been calibrated to ensure greater consistency across different variables.
- Additionally, this ACS will for the first time 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.
- The stress scenario is more severe than the global financial crisis for both the UK and the world. In the stress scenario, weaker household real income growth, lower confidence and tighter financial conditions result in severe domestic and global recessions
3. Next steps
The projections data requested (structured and unstructured) should be submitted to the BoE by 11 January 2023.
The qualitative review will be carried out in 2023 H1.
The results of the test will be published in summer 2023 and, along with other relevant information, will be used to help inform banks’ capital buffers (both the UK countercyclical capital buffer (CCyB) rate and Prudential Regulation Authority (PRA) buffers). The BoE is committed to disclosing the information necessary to explain the results of the ACS, including sufficient information on ring-fenced subgroups.